It’s boom time for derivatives trading

Derivatives exchanges in the United States and Europe have been setting records for volume practically every week this year, thanks largely to institutional investors.

So far this year, the Chicago Board Options Exchange has seen five of the 10 busiest days in its history. The exchange also set a volume record in 2000, the fifth consecutive year in which its volume topped the previous year’s.

Down the street, at the Chicago Mercantile Exchange, April 18 saw the single busiest day in exchange history, with 2.8 million contracts changing hands, eclipsing the previous record of 2.3 million contracts set just over a month earlier.

That high volume likely was driven by trading in interest rate futures following the Federal Reserve’s surprise decision that day to cut interest rates by a half percentage point.

But before the Fed’s announcement, first-quarter 2001 trading volume on the Merc already was the busiest ever, and March was the exchange’s busiest single month in history.

The Chicago Board of Trade also got in on the action in March, setting records in 30-day fed fund futures and Dow Jones Industrial Average futures.

Across the Atlantic, both Eurex and the London International Financial Futures and Options Exchange announced record trading in derivatives products.

A couple of events in 2000 set the stage for a jump in derivatives trading: Stock market volatility increased, and a number of exchanges opened to round-the-clock electronic trading.

“On the equity side, you have a change in the concept of growth and what likely growth rates were to be following the fallout of the dot-coms,” says James McNulty, president and chief executive officer of the Chicago Merc.

“When those prospects changed last February and March, we saw a ripple-down effect that took about nine months. It caused the market to expect correction, and what we see is that volatility picks up during these correction periods. Volatility generally ends up causing increases in volume.”

nervous time

Morgan Burkett, general counsel and chief legal officer for Cygnifi Derivatives Services LLC in New York, a spinoff from J.P. Morgan Chase & Co., says conventional wisdom holds that when markets become more volatile, investors start to get nervous.

“They will attempt to lock in or reduce the volatility by purchasing some form of derivative instrument, the underlying security of which they may or may not have a position in,” Mr. Burkett says.

Among the big-selling derivative instruments are futures and options on interest rates.

Take the eurodollar, for example. The eurodollar is U.S. currency held in foreign banks that is used to settle foreign transactions. Eurodollar securities promise to pay interest in U.S. dollars. Eurodollars are used as a benchmark interest rate in corporate funding.

Eurodollar futures and options are the most heavily traded futures contracts in the world. When the Fed cut interest rates April 18, eurodollar trading at the Chicago Merc reached 1.6 million, easily passing the old record of 1.3 million set in 1994.

Eurodollar options trading April 18 was 511,545 contracts, beating a record of 446,503 contracts set Jan. 4.

In all, eurodollar futures and options trading represented 75% of the volume on the Merc that day.

Plenty of investors also are interested in equity-based products. On April 12, the Chicago Board Options Exchange saw a record 106,346 Dow options contracts change hands – the first time such trading exceeded 100,000.

The record was set on a relatively calm day on the stock market. The Dow gained 31.62 points that day to close at 10158.56, its highest close in a month.

The record also came as big-name companies such as IBM Corp. and Intel Corp. prepared to release their first-quarter earnings reports.