By Nina Mehta

After making threatening noises last summer, the Cantor Exchange, a joint venture by Cantor Fitzgerald and the New York Board of Trade, turned in what could best be described as a timid performance. It wanted to rip away a chunk of the Chicago Board of Trade’s Treasury futures business by launching Treasury futures trading on-line, but wound up only nicking the surface. Lately, however, the fledgling exchange has again been showing its teeth, and major firms are taking note.

In February, the CX unveiled a plan to attract liquidity to its markets: fee discounts, à la Eurex. Firms that signed up as market makers by the end of March get to trade free until the end of 2001; those that sign up by the end of April can trade free until the end of 2000; and those that sign up after April will get a fee holiday for the rest of the year.

The Cantor Exchange is back on the offensive, offering electronic access, a new trade-matching system and other goodies to woo business from Chicago.

The plan worked. By late February, the exchange had 16 market-makers (another one has since come on board), and volume had surged from a couple thousand trades a day to around 8,000 by the end of the month. Volume dropped off in the first half of March, but overall futures volume dipped a bit as well. In addition, the CX spruced up its prospects by promising customers true electronic trading—rather than voice access, for which it has been criticized—and by getting approval from the Commodity Futures Trading Commission for a flexible notional coupon rate for Treasury futures.

So far, all business at the Cantor Exchange has passed through CX terminal operators who execute the trades. Starting this month, however, customers can access the markets electronically—through a CX keyboard, CX-supplied trading software or a third-party desktop interface. While this is a step forward, since customers will be able to execute cash and futures trades from the same platform, the exchange is hedging its bets, cautioning that it doesn’t expect electronic futures trading to overrun voice access anytime soon. Electronic futures trading “is being well-received but will take time to ramp up,” says Debra Walton-Collings, managing director at Cantor Fitzgerald, and will depend on a number of factors, including “lead times for installations as well as customers training and getting comfortable using a keyboard—because for some customers this is the first time they’ve ever used a keyboard.”

To ensure tight markets, the exchange is offering what it calls interactive matching, based on a proprietary algorithm. Instead of orders that come in at the same price being matched proportionally, regardless of when they walk in the door, the CX system gives preference to the first buyer or seller, allowing that person to take everything that is bid or offered and then place more buy or sell orders. “Basically, we’re rewarding people who come first, people who make a market and step up and provide liquidity—we’re giving them the option to execute additional trades,” notes Walton-Collings.

The CX also recently got the nod from the CFTC to lower the notional bond coupon rate from 8 percent to 6 percent on all Treasury futures products. “With the reduction in interest rates, the cash and futures markets don’t work as ideal hedges anymore because they’ve become less correlated,” says Walton-Collings. “So creating a futures contract, or adjusting the calculation of the futures contract to 6 percent, brings it more in line with the underlying cash instrument. That should stimulate the basis market and make futures a more effective hedging tool for cash.”

The CBOT had been contemplating the same change for the last year but got bogged down in red tape and a lack of consensus. Yet after the CX filed for a flexible coupon Treasury futures contract, the CBOT powers-that-be came to a quick consensus that the change was, after all, necessary, and shot off an application to the CFTC to lower the coupon rate to 6 percent. The CBOT plans to switch to the lower rate on its March 2000 contracts. Until then, the rate will remain at 8 percent.

Cantor Fitzgerald is quick to highlight the CBOT’s lack of alacrity. “One of the problems in an open-outcry or physical market,” notes Walton-Collings, “is simply, Where do you put the trading for new contracts?” Traders need separate pits to trade each of the contract expiry months, and extra pits may not be available. Unlike the CBOT, she says, “we’re going to list the 6 percent and the 8 percent alongside each other for all contract months—that’s the advantage of having an electronic marketplace. The CBOT has been contemplating doing this for a long time. We’ve been open for less than six months and we’re doing it immediately, because we don’t have physical constraints to listing new contracts.”

The CBOT, however, isn’t exactly standing still. Deep liquidity and tight markets are and always have been its calling card, and the exchange is taking care to protect its franchise and expand its European Treasury business. Still, trading costs remain an issue for member firms, and competition—whether from the CX or elsewhere—is likely to gear up at some point. The CBOT launched daytime Project A trading on its debt products last September, when the CX set up shop, and has now decided to absorb trans-Atlantic communications costs for European users on Project A. This should result in an average monthly cost savings of 62 percent for member firms trading from Europe, where the CBOT will soon have close to three-dozen screens. In addition, the first Project A screen went live in Japan last month, with more expected to be rolled out soon.

NYBOT Trades Russell 1,000 The New York Board of Trade has launched futures based on the Russell 1,000 index. Trading commenced on March 5 on the New York Futures Exchange, NYBOT’s subsidiary, for a “regular” futures contract, priced at $500 times the index, and a “large” contract, valued at $1,000 times the index. For large-cap pension funds and endowments already benchmarked to the Russell 1,000, the futures should provide easier and cheaper exposure to the broad index than current alternatives. Moreover, commission savings will be in the offing since the new futures are a one-shot deal, thus reducing the number of contracts needed to control exposures. The large Russell 1,000 futures will have a notional value of approximately $600,000, almost double the notional value of the S&P 500 futures contract. “The Russell 1,000 futures contract should be most appealing to institutions looking to replicate Russell 1,000 index exposure on an ongoing basis, with low tolerance for tracking error,” speculates a Goldman Sachs equity derivatives research report. In mid-March, after a week of trading, the new futures were already logging in decent activity, averaging more than 2,000 contracts per day (with a notional value two-and-a-half times the NYSE Composite’s daily average so far this year). The Russell 1,000 also easily stepped across the 5,000 mark in open interest, although most of this, the Goldman Sachs report notes, has been at the expense of the NYSE Composite futures. …While the Amex Launches Nasdaq Shares The American Stock Exchange has been hounding the retail market in recent years—and is seeing a tremendous payoff, especially in its index share products. The latest is Nasdaq-100 Shares, an index-tracking stock that replicates the performance of the tech-heavy index plus dividends. After SPDRs and Diamonds—index share products based, respectively, on the S&P 500 and the Dow Jones Industrial Average—pulled down rave numbers at their launches, Amex expected Nasdaq-100 Shares to take off like a rocket. The exchange wasn’t disappointed. On the product’s first day of trading, 2.6 million Nasdaq-100 Shares changed hands. This didn’t come as a surprise to those involved, since they expected stratospheric volume. What stunned Amex traders, however, was the second day’s volume: 4.5 million shares. In addition, 70 percent of the orders for Nasdaq-100 Shares are executed electronically, notes an exchange official. The push is on for retail participation in structured products as well. Last month, Amex began trading Stock Return Income Debt Securities, or STRIDES, a debt issue whose amount paid at maturity is not fixed, but based on the movement of the Nasdaq 100 index. The exchange also launched S&P 500 Market Index Target-Term Securities, or MITTS—seven-year principal-protected securities that offer upside participation in the S&P 500 index.

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