Will the new contracts on the Dow attract retail investors?

By Robert Hunter

In June, the Chicago Board of Trade announced it had outbid the Chicago Mercantile Exchange for the right to issue futures and options-on-futures on the Dow Jones Industrial Average. At the same time, the Chicago Board Options Exchange announced plans to list options on the index. Both products begin trading October 6.

For years, Dow Jones resisted lending its name to derivative products. But everyone has a price, and apparently Dow Jones is no exception. The CBOT reportedly paid Dow Jones as much as $5 million to $7 million to secure the right to use its name.

Now the CBOT is scrambling to get the word out about the charms of the new products. It began a two-tiered marketing blitz in August with $600,000 worth of advertising in major business publications as well as some 20 different direct-mail campaigns. In September, it took its show on the road, hitting major retail investment hubs in the United States, Europe and Asia. And it wrote another big check to construct a brand-new trading pit that's nearly as large as its bustling bond pit. According to CBOT president and CEO Tom Donovan, it plans to spend $4 million to $5 million per year—one-third of its annual marketing budget—for the next five years marketing the Dow contracts.

The CBOE has followed suit. "This is far and away the most ambitious marketing program that any options exchange or options product has ever seen,” says John Roberts, senior vice president of marketing at the CBOE. The exchange is spending what Roberts calls "some significant multiple” of the $2 million the Options Industry Council spends annually on marketing to hype its new product. Clearly, the stakes are high.

Will it play?

There is considerable skepticism about whether a contract on the Dow Jones Industrial Average will be attractive to U.S. institutional investors, the biggest users of listed derivatives contracts. "The standing of the S&P (Standard and Poor's) contract as the most actively traded, most significant contract is unlikely to be challenged,” sniffs one CME official, "because the institutional business is so much more significant for the futures industry than the retail business is or will likely be.”

The CBOT, however, is betting on the retail possibilities of the contract. Exchange officials believe the rapid rise of 401K earnings and the increasing sophistication level among retail investors will allow them to corner a previously untapped retail index futures market. The contracts, set at 10 times the value of the Dow and traded in $10 points, offer retail investors a relatively cheap entre into a market from which they have historically been excluded. The CBOT is also hoping that the contract catches on with institutional investors overseas, who acknowledge the Dow Jones Industrial Average as the world's most recognized stock index, and who may find it easier to track than the bulkier S&P 500.

Some U.S. institutional investors say they hope the new Dow contract will become particularly useful for hedging large-cap equity portfolios. "Some of our clients have specific kinds of cap size targets for their portfolios, and the S&P doesn't focus enough on the cap size they're seeking,” explains Rick Ballsrud, a money manager at the Clifton Group, who hopes to use the contract to construct synthetic large-cap exposures. "When you take a household name, and make it an affordable size, that's exciting,” adds Barry Lind, president of Lind-Waldock and Co. "There is no question how successful this is going to be.”

The CBOT's aggressiveness has not gone unnoticed at the Merc. On September 9, the exchange launched the "Mini S&P,” a contract that trades at one-tenth the size of the standard S&P 500 future. "The proximity of the Mini S&P to the regular S&P is going to enforce a price discipline that just won't be there for the Dow Jones,” predicts one CME official.

The Merc is even allowing its new product to be traded electronically on its GLOBEX trading system—an overt appeal to retail investors. According to Merc chairman Jack Sandner, the new contract is geared toward "computer literate and financially savvy individuals who take charge of and manage their own assets.” The Merc's swiftness in launching the mini S&P has left the CBOT edgy. "It's a concern,” says CBOT chairman Pat Arbor. "It's a bold and aggressive move.” The CBOT, meanwhile, is lobbying Dow Jones to allow overnight trading of the future contracts on its Project A electronic trading system, to appeal to foreign investors.

The CBOT's huge commitment to the new futures contract, along with the Merc's policy of massive retaliation, have many CBOT personnel crossing their fingers. Even the most starry-eyed Dow marketers don't expect it to rival volume in the Merc's S&P pit anytime soon. But a 10th anniversary replay of Black Monday would certainly help things along.