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The Exchanges' Greatest Hits of 1996

Many of last year's most successful new contracts rode the equity bull market to success. Others succeeded on their own charms.

By Karen Spinner

1996 will not be remembered as a banner year for new, innovative exchange-traded contracts. For the major exchanges, in fact, 1996 was what they euphemistically call a "building year."

In Europe, preparations for the European Monetary Union dominated the agenda. Exchanges concerned themselves with how contracts denominated in the Deutsche mark and other likely EMU currencies should settle, and how European interest rate and currency contracts will fare given the probable convergence among euro rates and currencies and the resulting decline in demand. These issues also had an effect on U.S. exchanges such as the Philadelphia Stock Exchange and the New York Cotton Exchange's financial subsidiary FINEX, both of which emphasize currency contracts.

Meanwhile, other U.S.-based exchanges encountered a variety of regulatory hurdles to releasing new, structured products. The Securities and Exchange Commission and the Commodities Futures Trading Commission continued to keep a tight rein over what they see as new "derivative" products and related risks. "I think one reason we didn't see a lot of new offerings last year is that the markets are already well-served by existing contracts," notes one head of product development for a major exchange. "It's getting harder and harder now to come out with the next 'latest and greatest' thing."

Still, there were some strong contenders in the 1996 exchange contract playoffs. Equity indices and sector-specific products-such as options and futures on technology and emerging market indices-rode the current bull market to high trading volume and open interest. Demand for such products has been strong from both retail and institutional investors looking to hedge the gains they've made during the past two years. This demand has also led to a proliferation of options and futures on single, highly popular stocks. Also, a few highly specific niche products have emerged, serving a variety of special interests.

The best way to measure success is with a quantitative measure-consistently high or rapidly growing trade volume and open interest. Qualitatively, success can be defined as contracts that may be particularly significant in the context of recent market events.

We asked the exchanges to select their own picks for the "most successful contracts of '96," and they complied. Some also provided insight into why 1996 was, for them, more of a time for consolidation than for new, sweeping gains.


The big news at the Chicago Mercantile Exchange this year, according to Rick Redding, vice president of marketing and product development for equity indices, was the introduction of futures on the NASDAQ 100 index. "Options have existed on the NASDAQ 100 for the past two years, and they have been popular for institutional investors who want to hedge their exposure," he says. "One effect of the option's popularity was that the market-makers, who track these options, needed someplace to lay off their risk. They've been asking for the product for quite a while now." Trading began on April 10; it quickly became the second-fastest growing future on an index ever released at the CME. (The fastest growing index future was on the S&P 500.) As of September 20, six months after the contract had commenced trading, open interest rose to 11,457 contracts, a significant milestone in a new contracts development. The NASDAQ futures contract was also popular with institutional investors who wanted to hedge hot stocks like Microsoft and Intel.

The contract sailed through its regulatory approvals. It had been in development for more than a year; the biggest issue for CME marketers was timing the launch properly to get the biggest bang for its buck. After interviewing market-makers and customers, Redding and his team concluded that mid-year 1996 would be an auspicious time. "The options were gaining in popularity because, as the bull market continues, there are also concerns about the level of the market. Therefore, we thought it made sense to bring in this new futures contract while demand for options was still accelerating, allowing us to take advantage of pent-up demand on the part of the market-makers."

Another notable contract to come from the CME in 1996 was the euro/yen futures contract, available through SIMEX, which is also covered by the CME's and SIMEX's mutual offset agreement. This means that customers can use the same back office and settlement procedures for the euro/yen contracts that they use for other CME contracts. Customers also have the choice of having margin requirements administered by either SIMEX or the CME. Although the contract hasn't shown dramatic volume numbers, it is, according to most market players, more successful than a comparable euro/yen contract available through LIFFE and the Tokyo exchange. Issued on March 6, 1996, the Merc's euro/yen contract reached an open interest of 10,301 on April 7 of the same year.

According to Peter Barker, a vice president for produce development with the CME, the euro/yen contract has been relatively successful primarily because it is inexpensive and easy to trade. "The euro/yen is a simple, three-month interest rate contract, just like our Eurodollar offerings," he explains. "We think users like the contract because of its simplicity. The mutual offset agreement with SIMEX has been around for years, and users are familiar with how it works."

Barker adds that some customers prefer a contract offered via SIMEX over an identical contract offered through the Tokyo exchange because SIMEX's transaction fees are substantially lower. The CME launched the contract as soon as it received regulatory approval. "It probably would have worked no matter when we brought it out," says Barker. "When you see more volatility in the market, I think we'll really see this contract take off."


At the Marche a Terme International de France (MATIF), concern over the coming EMU went a long way toward putting a damper on new development. According to Louis de Rouge, the New York-based U.S. representative for MATIF, "In terms of new products, there was very little activity last year. We did release a eurowheat contract and options on sugar contracts, but so far those two have gotten off to a slow start. Primarily, our goal for 1996 was to begin addressing EMU, and its implications for both new and outstanding contracts." One new development in 1996 was the modification of contract notional amounts and settlement procedures to account for the possibility of EMU. Another part of MATIF's long-term response to EMU was to sign a five-year accord with the Chicago Mercantile Exchange to allow MATIF's medium- and long-term interest rate contracts to trade on the Merc's GLOBEX system after 6 p.m. Chicago time.


The London International Financial Futures and Options Exchange (LIFFE) spent a great deal of time during 1996 preparing a long-term strategy for coping with EMU and handling the administrative loose ends resulting from its recent merger with the London Commodity Exchange. "We have focused primarily on researching the ramifications of EMU," says Caroline Denton, a spokesperson for the exchange. Already, LIFFE has modified the settlement terms of its three-month euro/mark contracts maturing in 1999 to settle in the euro in case EMU has begun by the time the contracts mature.

Denton explains that LIFFE's eventual goal is to become the premier trading center for "euroderivatives," and the exchange is currently pursuing a four-part strategy to review and enhance its range of contracts for the new environment, reinforce the strengths of its trading platform, build a network of strategic alliances with other exchanges and bolster its position as a well-regulated exchange with high standards. In addition to modifying three-month euro/mark contracts to account for EMU, the exchange also introduced one-month euro/mark futures last year, in order to provide investors with the short end of the Deutsche mark yield curve. According to Denton, "As longer-term interest rates become more correlated in response to EMU, there will be an increase in trading on the shorter end of the yield curve."

LIFFE used its relationship with the Tokyo International Financial Futures Exchange (TIFFE) to begin offering three month euro/yen contracts in 1996. Although the exchange has captured a reasonable volume in a relatively nonvolatile market, it competes directly with the more popular U.S.-based CME contract offered through SIMEX.

LIFFE has also been actively researching how EMU may influence its bond futures contracts. "We have more time on the bonds, because contracts maturing in 1999 will not be listed out until 1998," says Denton. "The big question here is whether investors will perceive a difference in credit risk in bonds issued by two different EMU governments. While there should be no currency risk, there could well be credit and liquidity differences between different issues."

LIFFE, however, is optimistic over the long haul. Says Denton, "Potentially, the euro could one day be as strong as the dollar and the yen. LIFFE regards EMU as both an opportunity and a challenge, because whichever exchange manages to capture the market for euro futures and options will be in an excellent position to be a true market leader."


Despite exchange-related turmoil over the euro, New York-based FINEX, the financial division of the New York Cotton Exchange, is enjoying unprecedented success in the European cross-currency market. One of the most successful contracts listed by FINEX in 1996 was a mark/Swedish krona cross-rate future, issued in February 1996. According to Charles Minnaar, FINEX's executive vice president in charge of marketing, this contract simply represents part of the exchange's ongoing strategy of emphasizing the cross-rate niche. "Unlike other exchanges, we include interbank broker prices in addition to trading floor prices in our contracts," he says. "We believe it is important to encourage cross fertilization between the exchange and the interbank market. They are complementary, not competitive in our view." On December 9, 1996, FINEX experienced a record volume of 13,053 currency contracts traded over a single day.

Minnaar adds that the mark/krona contract is the first futures contract of its kind, and provides a new outlet for money managers and other futures traders both to hedge subsidiary currency risk and to take on additional exposure to the krona, should they so desire. Is the FINEX concerned that the impending EMU could take a bite of the exchange's profitable cross-rate strategy? "According to conventional wisdom, cross rates will become irrelevant as soon as EMU hits," he says. "However, we believe there will be many currencies, such as sterling, lira, peseta, krona and the yen, that will not immediately, if ever, be part of EMU. We are developing a yen/euro contract to replace mark/yen, a euro/lira contract to replace mark/lira and so on. We still think our cross-rate strategy can work, even under EMU."

Likewise, the New York Futures Exchange-another part of the New York Cotton Exchange-released a futures contract on the PSE Technology Stock Index last April that is still doing well. This index has been successful primarily because the bull market in equities-and in tech stocks in particular-has continued unabated for the past couple of years. This particularly suits smaller investors because it is sold in smaller increments than indices on the other exchanges.


The American Stock Exchange has rode the equity bull market to one of its best years ever. According to Joseph Stefanelli, executive vice president of derivative securities, "We have seen tremendous volume in both our WEBS and SPDRS (S&P depository receipts) products." WEBS-otherwise known as world equity benchmark shares-were issued in 1996 in conjunction with Morgan Stanley, which is actually underwriting the WEBS; average daily volume in WEBS is now worth $50,533,500. While SPDRS are offered on the S&P 500 and the mid-cap S&P 400 indices, WEBS give investors exposure to 17 countries represented in the index. "WEBS, like SPDRS, are extremely flexible," says Stefanelli. "Investors can enter and exit the market more easily." He adds that WEBS are particularly attractive to institutional investors and money managers who cannot use futures contracts because of investment guidelines.

Last year the AMEX also enjoyed great success in bringing out flex options on a variety of well-capitalized, liquid individual stocks. "Equity options," says Stefanelli, "were up 17 percent in 1996. The demand for options has become higher as investors seek to protect their returns from the past two years." Flex options are attractive to institutional investors who want to custom-tailor an option to protect concentrated holdings of a particular stock. They are particularly appealing to some because they can be easier to unwind than similar OTC options. The only stumbling block, Stefanelli says, is that the SEC has imposed position limits for options on individual equities. "The SEC is concerned that options can be used to manipulate stock prices," he explains. "However, we are in negotiations to remove these limits for some flex options. This should do a lot to increase institutional trading volume."


The Chicago Board Options Exchange also had a good experience with new contracts, courtesy of the equity bull market. According to Bill Barclay, the exchange's vice president of marketing and strategy, "We have added more than 200 options on individual equities and long-term equity anticipation securities in 1996. It has been a very good year in general for equity options." And for the CBOE, 1996 has been the best year ever for equity options.

One product released in 1996 that has just begun to develop a substantial following is the NASDAQ flex option, which, according to Barclay, is of great interest to institutional investors who want to hedge their exposure to the NASDAQ composite. Other products that did well in 1996 were options on proprietary Goldman Sachs technology indices, a natural match with the market's current and seemingly insatiable appetite for high-tech stocks.

Another successful product released in 1996 is the S&P 500 index-linked structured note, issued by Smith Barney. These structured products give smaller investors the opportunity to gain exposure to the S&P 500 index without buying in large quantities. They also protect investors' principal investment.

In the future-or at least for 1997-Barclay predicts a greater appetite for options on American depository receipts (or foreign stocks listed on U.S. exchanges) both for individual and institutional investors who have increased their exposure to foreign markets.


The Philadelphia Stock Exchange has spent most of 1996 focusing its marketing efforts on contracts released the previous year. "While we are always looking for new product ideas, the markets are very mature now, and we have several new products awaiting SEC approval," says Joseph Rizzello, executive vice president of marketing and development.

One of the most promising of these new ideas now in the pipeline is an equity system that will allow customers to buy and sell individual stocks according to a volume-weighted average price (VWAP). This means that institutional investors can buy and sell large quantities of stocks without having to worry about intraday volatility. "Some brokers guarantee VWAP prices to their customers, and we want to do this on a national level, becoming a country-wide benchmark for VWAP," says Rizzello.

If all goes well on the regulatory side, the VWAP system contract will be introduced in 1997. Other products on the way in 1997 include DIVs, OWLs and RISKs, which will allow investors to purchase one of three components of an individual equity-either the dividend (DIV) portion, the "corpus" of the stock (OWL) or the speculative portion (RISK). "These products are likely to be approved over the next year or so, provided we are able to work out some operational issues."