By Laurie Morse

Is there such a thing as a futures contract that's too big to trade? The Chicago Mercantile Exchange has been trying to convince its best customers that's the case with its benchmark S&P 500 futures contract, the biggest and most successful equity futures contract in the world.

Long a wholesale market for Wall Street's money runners, the S&P 500 futures pit provides a place to buy or sell shares of all 500 companies synthetically in the high-cap index in an instant-something that could take precious minutes or even hours to accomplish in the cash market. Because the contract is an index-the futures value is derived by multiplying 500 times the underlying index value-its value grows or shrinks along with the overall stock market.

As the stock market rallied through 1996 and into the first quarter of this year, the value of a single S&P 500 futures contract pushed past $400,000-four times the value of a Chicago Board of Trade Treasury bond future, and almost seven times the size of the S&P contract when it was launched in 1982. At the same time, volatility in the contract has increased, putting the value of an average daily price swing near $7,000 a contract.

In the last few months, CME officials have been arguing that the need to put so much cash at risk deters small investors from entering the market, and could be damaging the contract's liquidity. The solution, they say, is to cut the S&P 500 futures contract in half by reducing the multiplier to 250, from 500.

Another proposed change would increase the size of the pit's minimum price movement, or tick, by 10 ($50), from the current five ($25).

This kind of talk angers the pit's biggest customers, who are dead set against the changes. They note that the stock index market has never been a place for amateurs, and that the CME's plan to change the contract size is a thinly veiled attempt to raise fees and boost the exchange's flagging volume. "If they cut the contract size, you'd have to trade twice as many contracts to get the same underlying dollar value," says Ralph Reynolds, managing director of equity derivatives for NatWest Securities in New York.

"That means exchange fees are doubled, broker's fees are doubled and customer commissions are doubled" for essentially the same trade.

Wall Street objections held the changes at bay last year, but new leadership at the CME has raised the issue again. In mid-March, armed with a study by two Vanderbilt University professors backing the plan, CME chairman Jack Sandner, senior policy adviser Leo Melamed and a few CME brokers traveled to New York to meet again with the pit's big customers.

"They got their ears blistered," said one CME board member. "They were left with no uncertainty that the Street did not support the changes." Specifically, Wall Street's big trading houses made it clear that cutting the contract in half without corresponding cuts in fees and brokerage costs would drive business to competing products-the S&P 500 options at the Chicago Board Options Exchange, the New York Cotton Exchange's NYSE Composite Index futures, AMEX's SPDR contracts and, most frighteningly for the exchange, the over-the-counter markets. "They think halving the contract would double volume, but if they impose this tax, they won't see volume double, they will see business go out the door," said one of the money managers who attended the meeting.

Floor brokers who work the pit from day to day say the efficiency of the market is breaking down, but drawing in more little one-lot players won't solve the problem. The average spread between the bid and the offer in S&P 500 futures has gone from two ticks ($50) in 1990 to about four ($100) this year. Users "are already paying the price (of the huge contract size) with the wider bid-offer spread," one trader notes.

The real issue, say some floor brokers privately, is money. Wider bid-offer spreads have meant more risk for brokers. "We're seeing risk exposure going up and compensation isn't going up," said one CME trader who specializes in institutional clients. "I can't go on record saying I support the changes because my customers don't want them. I think the solution would be to change commission rates so they are a percentage of the value of the transaction."

That would make the brokers happy, but wouldn't generate more volume, or cash, for the exchange.

The London Clearing House, the trade-clearing and risk management center for all of London's futures exchanges, is talking about getting into the business of clearing swaps. A feasibility study to determine market demand for the project should be completed by late June.

The LCH is entering this new territory carefully. The top-rated institutions that dominate the swaps business have not been enthusiastic about setting up multilateral clearing systems that would allow lower credit risks to compete in the over-the-counter derivatives markets. Swaps, moreover, are bilaterally negotiated instruments that can defy commoditization. Central clearing will only work for the most standard sort of swaps, or "plain vanilla," as they are known in the trade.

"Swaps clearing has been the world's great prize for years, but no one has figured out how to do it," said Jack Wigglesworth, chairman of the London International Financial Futures Exchange. Still, he adds, "LIFFE considers this to be an important initiative for London and is working closely with the LCH in this investigation into swaps clearing."

London is already the foreign exchange trading center of the world, and is quickly becoming the busiest swaps trading center. If a LCH swaps clearinghouse could allow dealers to cross-margin and net offsetting trades made on LIFFE, it could be a winning venture. Competing projects, most recently the Chicago Mercantile Exchange's Depository Trust Company, stop short of actually clearing swaps contracts, and instead offer dealers a centralized, automated center for handling the collateral that is commonly used to back swaps trades.

"The idea of a full clearinghouse for swaps has been around for years," says Sara Williams, director of business development at the LCH. "Our objective is to try to quantify the potential benefits and costs, and determine the interaction with exchange-traded instruments and the acceptability of such a service to the parties involved. To do this, LCH is working closely with several major swaps users."

Mutual funds are the retail investment of choice this year, and the Chicago Board Options Exchange wants in on the action. It filed for regulatory approval in March to trade options on two mutual fund indices designed by Lipper Analytical Services in conjunction with Salomon Bros. The indices will be based on the 30 largest funds in each of two investment categories-growth funds and growth and income funds. The American Stock Exchange is expected to follow quickly with its own version of options on mutual funds indices.

Tech index fever seems to be the newest malady raging on the nation's derivatives exchanges. The latest casualty is the American Stock Exchange, which launched the "de Jager Year 2000 Index" on March 18. The Index tracks 18 stocks that represent companies and industries leading the battle against traumatizing computer glitches set to occur when 2000 rolls around. "According to industry experts, computer glitches resulting from misreadings of the date change to 2000 may wreak havoc on everything from bank deposits to mortgage payments to prison inmate releases to food safety expiration dates," said the AMEX in its promotional materials.

What's next-the Screen Saver Index, listing a dozen top promising Windows screen saver startups?

• Look for the New York Mercantile Exchange and London's International Petroleum Exchange to come up with some proposals this summer to allow cross-margining of their competing Brent and West Texas Intermediate crude oil contracts, as well as cooperation on a common electronic after-hours trading platform. The two arch-rivals in the energy futures arena are getting together to deliver cost-savings to the customers they have in common, betting that will bring more business to both exchanges.

• The lights will go on for the link between the CBOT and LIFFE May 9, in a cooperative project that's been three years in the making. Initially, the CBOT's Treasury bond contract will trade on the London trading floor when Chicago is closed, and LIFFE's Bund contract will be offered in Chicago during the afternoons while London is shut. The open-outcry link will have to fight for business with the two exchanges' growing-and highly successful-domestically based after-hours electronic trading systems. The original link agreement required computer trading to be shut down as floor volume grew, but a special agreement reached in mid-March amended the pact. Leaders at both exchanges are staunch supporters of open-outcry trading, but say the computer systems allow them to hedge their bets.