Contract Specifications (Set by Exchange)
- Quality
- Size (E.g. One Contract (lot) = 1000 Barrels)
- Quotation (How is it priced)
- Tick Size
- Minimum price movement of a contract (E.g. FTSE 100 = 0.5pt)
- Tick Value
- Profit or loss for a one-tick movement (E.g. FTSE 100 = £5)
- Delivery Month
- Notice days
- Last trading days
- Delivery days
- Exchange Delivery Settlement Price (EDSP)
- Price paid for good delivery
Limit Order:
- Level One
- Touch Strip
- Level Two
- Market depth
- No guarentee of execution
- Limited Order - Sell 6000 at 210 Limit
- No worse than price, 211 yes, 209 no
Market Order:
- At best order
- Just fill the full order at the best price possible
- Market if touched
- Market order with an activation price
Stop (or Stop-loss):
- Uses a market order to close the position, to limit trading losses
- Activated when the market moves against a trader, past a certain point
- No guarantee on price once activated
- All positions will be closed
Stop Limit:
- Uses a limit order to close the position, also to limit trading losses
- Closes out a position when the market moves against a trader, past a certain point
- Once activated, the price is limited to a specified price or better
- Some positions may not be closed
Orders can be:
- Day order
- Order to buy or sell a contract that automatically expires at the end of the day if unfilled
- AKA Good for the Day (GFD)
- Good-till-cancelled (GTC)
- The order is firm until the client specifies otherwise
Limit or Market on Close:
- Limit order all day, if not filled buy Market price at closing period
Membership structure and trading rights
- Dealer Members
- Allowed to perform principal trades for their own accounts
- Broker member
- Allowed to perform agency trades for client accounts
- Duel Capacity
- Acts as a broker and a dealer member
- Cross trades
- The member takes both trades and enters into both sides of the trade (buy/sell)
- Then report into the exchange
Clearing Members:
- General Clearing Members (GCMs) can arrange clearing of trades on behalf of:
- Themselves
- Their clients
- Other exchange members
- Individual Clearing Members (ICMs) can arrange clearing of trades on behalf of:
- Themselves
- Their clients
- Non-Clearing Members (NCMs) cannot clear trades, so 'give up' trades to GCMs for clearing (they can have a a maximum of two agreements
- Process
- Pre-registration by the executing firm
- Registered to the clearing firm's accounts
- Final Registeration done by clearing house in clearing brokers name
- Give Up = Executing Broker + Clearing Broker = Different
Order vs Quote Driven Systems:
- Quote-driven - Designed for illiquid contracts (No natural liquidity, so guarteed liquidity through market makers)
- Price makers
- Bid/offer spreads
- Screen and phone based
- Open outcry (Physical, floor based trading)
- Order-driven: Designed for more liquid contracts
- Negotiated prices
- Electronic trading (More of a matching engine, due to high amounts of buyers and sellers)
- More likely to achieve a fairer price
Order Book (Straight Through Processing)
- Client to Broker
- Through the Electronic order book system
- To the clearing house
Open Outcry:
- Client to Broker
- Broker completes order slip to give to booth clerk
- Booth clerk then completes a dealing slip and passed to pit trader
- Trader gives dealing slip back to booth clerk after trades complete
- Booth clerk runs the matching process
- Broker sends to clearing house
- Dealing slip also has to be given to pit officals
- Pit officals are responsible for offical prices and quoting vendors
Open Outcry: Case Study
- London Metals Exchange
- Has open outcry, but also order book (LME Select)
LME Select open from 01:00 - 19:00
Open Outcry Session 1:
- Ring 1
- Ring 2 - Official LME prices set
- KERB 1
Open Outcry Session 2:
- Ring 3
- Ring 4
- KERB 2 - Closing prices set
In each Ring Session, each Metal trades for 5 minutes
In the KERB Sessions, all Metals trade together
- Also has 24 hour inter-office market
- Quote-driven platform
Electronic Order-driven Trading:
- ICE Connect, CME Globex and LME Select
If order is matched between Buyer (Clearing Member) and Seller (Clearing Member)
- The trade is then registered with the Clearing House
- Clearing house then become the Central Counterparty (CCP)
- CCP becomes the buyer to the orginal seller
- And the Seller to the orginal buyer
Wholesale Trading Facilities:
- Block Trading Facility
- Large deals agreed bilaterally off order book but 'on exchange'
- Large - The exchange sets the terms
- Gives certainty of pricing and execution
- Price agreed, doesn't need to be order book price
- Trade details reported to exchange (Five Minutes on ICE Futures Europe)
- Price, volume, time
- Published trade details distinguished from order book execution
- Basis Trading Facility
- Transactions involving the simultaneous exchange of a financial asset for an offsetting number of futures
- E.g. Buy Gilts and Short Gilt Futures
- Agreed off order book but 'on-exchange'
- Trade details reported to the exchange (Fifteen Minutes on ICE Futures Europe)
- Exchange Futures for Physical (EFP)
- An exchange of an OTC position for a future's position (or vice versa)
- Non-financial (generally commodity)
- OTC position and future position must be substantially similar in terms of either value and/or quantity
- Benefits:
- Reduced counterparty credit risk for OTC positions
- Standardised Margin Process through CCP
- Reduced margin requirements - netting off OTC and futures positions
- 24-hour trading
- Risks:
- Operational risk due to daily mark-to-market accounting and margin
Trade Reporting:
- Price transparency
- Making sure we know what the fair price looks like
- Automatic on electronic trading systems
- ICE Futures Europe
- Block Trades (5 minutes)
- Basis Trades (15 Minutes)
- Agreed away from order book but reported into the exchange
- Exchange Price Feeds
- Real-time price and trade information
- Current bids and offers
- Trade Prices
- High/Low Prices
- Closing Prices
- Trade Volumes
- Disseminated by quote vendor, e.g. Reuters and Bloomberg
Monitoring Volume and Open Interest:
- Most exchanges require members to report volume and open interest on a daily basis
- Client positions and firm positions
- Volume = Current Liquity
- Includes people closing out positions
- Open Interest = Future Liquidty
- If volume and open interest is high = both look good
- If volume is high and open interest is low and going down = everyone closing out, future liquidity looking low
- Clients are responsible for monitoring their own positions with their broker
- Poor monitoring can lead to an inability to close out at a fair price (or at all)
- Unwanted delivery situations
- Breaching credit limits
- Unexpected margin calls
