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FUTURES MAGAZINE May 2015 期刊
[attach]6752[/attach]Cover Story
Tales from the Pit
By Daniel P. Collins
The 167-year history of Chicago’s futures trading pits is a rich one. Everyone who has spent time on the floor has their own unique stories. Here are just a few.
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Editor's Note
Transitions: In trading and elsewhere
By Daniel P. Collins
I recently had a conversation with industry stalwart and head of Wedbush Futures Carl Gilmore, and he mentioned that he and other leaders in the FCM space have had discussions wondering who will be the leaders of the industry 20 years from now.
Forex Trader
Beware of parallels in dollar rally
By Ashraf Laidi
The growing parallels between 2015 and 1998 in global market forces—soaring U.S. dollar, plummeting oil prices, rising equities, rising volatility and flattening U.S. yield curve—are startling.
Options Strategy
Long straddles or time valued spreads
By Dan Keegan
How do you trade your opinion that a substantial move in either direction in a particular market is imminent?
Markets
Metals change course
By Yesenia Duran
The value of metals, precious and base, serves as an indicator for the global economy, and right now the global outlook is disjointed and muddled, as is the outlook on metals.
Book Reviews
Sustainable Investing and Environmental Markets: Opportunities in a New Asset Class
By Jay Sorkin
Many commodity traders have found success in being trend followers.
Trading Techniques
Detrended: Modifying price oscillators
By Bramesh Bhandari
The detrended price oscillator is useful to identify troughs in stock prices. It is used to estimate entry and exit points in line with the existing trend.
You can’t have everything
By Art Collins
Developing a strong trading system is a give-and-take process. When you improve the system in one way, you inevitably hurt it in another. Striking the right balance is key.
Darvas box trading: A 21st century blueprint
By Billy Williams
The Darvas box trading method can enhance your profits while greatly controlling risk. Here’s how to apply this technique.
Short-term rate expectations and markets
By Howard L. Simons
While central bank policy-makers steer economies through a difficult obstacle course, the impediments they are swerving to avoid may be the result of their policy choices.
Building a system with simple technical tools
By Jean Folger
New technical indicators are being developed all the time, but sometimes a tried and true method is a better starting point for a strategy.
Trading 101
Short option advantage: Commodities versus stocks
By James Cordier
Short option strategies on futures are a different and potentially more profitable approach than using equity options.
Trading Strategies
The future of fracking
By Ellen R. Wald
Harold Hamm, CEO of Continental Resources, recently had these words of advice for fellow American shale producers: “Save that money. Avoid selling that production in this poor market and wait for service costs to fall [further] before completing those wells.”
Trader Profile
Martin Fund: Combining best of both worlds
By Daniel P. Collins
When the Intercontinental Exchange (ICE) bought the New York Board of Trade in 2006, David Martin understood that his floor trading days were numbered and began to prepare for life as an electronic trader—and eventually as a money manager. Transitions: In trading and elsewhere
[p=30, 2, left]I recently had a conversation with industry stalwart and head of Wedbush Futures Carl Gilmore, and he mentioned that he and other leaders in the FCM space have had discussions wondering who will be the leaders of the industry 20 years from now. [/p][p=30, 2, left]He wasn’t pining for the floor but knew that most leaders had their formative years on the trading floors. Of course, notable exceptions are CME Group CEO Phupinder Gill and Intercontinental Exchange (ICE) Chairman and CEO Jeff Sprecher. [/p][p=30, 2, left]Still, I understood what he meant. [/p][p=30, 2, left]Those of us who had spent a considerable amount of time on the trading floor understand as well. We all have had similar conversations regarding the difficulty in explaining to a spouse or friend how it all works. It is one thing to learn something in a book and quite another to live it. That is why anecdotes from significant—and not so significant—events on the floor, or “floor stories,” are so compelling (see [url=http://www.futuresmag.com/2015/05/15/tales-pit]“Tales from the pit"[/url]). There is comedy and drama there. [/p][p=30, 2, left]To see the markets working live with the flurry of people and movement of prices and the different levels of noise that accompany certain activity, paints a three-dimensional picture that captures its essence, which can’t be duplicated in a book or seminar. [/p][p=30, 2, left]All of your senses are at work. If you talk to the old timers, nearly all, man or woman, say their attraction to the industry was a visceral one based on their interaction with the floor. The excitement of it. It wasn’t simply the idea that great sums of money could be made but the idea of action. [/p][p=30, 2, left]What is replacing those market makers and traders largely is high-speed algorithmic traders. Perhaps it is more efficient. It can be and it also can be an attempt to game the market—something that occurred in the heyday of the floor as well. In that sense it is just about the changing tools used to exploit opportunities. [/p][p=30, 2, left]However, you won’t find the passion and love there. Those programmers will go to where the opportunities are. That is not good or bad, it is simply reality. The question is: How will this new reality affect markets? A computer coding algorithm course — even with the promise of big bucks — is not going to draw the young risk-taker into the futures markets the way the action of the floor did. [/p][p=30, 2, left]Perhaps the young gamers who will be the traders of the future will get that same rush trading as they do with “Total War,” or whatever the popular game of the day is. [/p][p=30, 2, left]Transitions can be tough but they also can be invigorating. Futures will be going through a transition of its own in the coming months. We have been having an internal debate over this transition because we have always been more than a trading magazine. [/p][p=30, 2, left]Futures launched as Commodities magazine in 1972 (This month’s cover pays tribute to Commodities debut cover); in September 1983 we changed our name to Futures because with the influx of financial futures, Commodities no longer encapsulated all that we covered. Even at the time of that change, Futures was a bit limiting and didn’t define all that we covered. [/p][p=30, 2, left]We had been at the forefront of the emergence of the Chicago Board Options Exchange and the listed options markets. We also were at the forefront of the explosion of systematic trading and the growth of the commodity trading advisor universe thanks to the emergence of the personal computer. Many of the groundbreaking works of technical analysis and trading system development were featured in the pages of Futures. [/p][p=30, 2, left]In this issue we include a review of Richard (Doc) Sandor’s new book, “Sustainable Investing and Environmental Markets: Opportunities in a New Asset Class,” which he coathored with three others. Sandor represents both a bridge to the emergence of financial futures, which signified our move from Commodities to Futures magazine, and a bridge to the future with his work in environmental markets. Sandor wrote a piece on the use of computers in trading in the very first issue of Commodities. It is a good metaphor for what we have attempted to accomplish over the year and will continue to work on. [/p][p=30, 2, left]We have covered commodities, interest rates, equities, forex and any market traders were interested in from all sides. Simply put, we have been a guide for the modern trader, offering analysis and strategies: Cutting-edge and time-tested. It is something we are proud of and something we pledge to continue as markets change. [/p][p=30, 2, left]We will strive to offer some new features as well. Hence the debate. In a sense we will be doing what we always have done. The industry has looked to Futures to cover trends: in trading, markets, system development and regulation. We have profiled key players inside the futures world and in the world in general, as everything affects markets. [/p][p=30, 2, left]Our contributors have offered futuristic strategies and reached back in time to apply proven trading methods to new markets. In [url=http://www.futuresmag.com/2015/05/15/darvas-box-trading-21st-century-blueprint]“Darvas box trading: A 21st century blueprint,"[/url] Billy Williams updates a classic and demonstrates how the modern trader can learn from the past. [/p][p=30, 2, left]It is what we have always done and will continue to do.[/p][p=30, 2, left]Stay tuned.[/p][p=30, 2, left][attach]6753[/attach][/p] Tales from the Pit
By Daniel P. Collins
May 15, 2015 • Reprints
The futures trading pits of Chicago and New York were unique places where prices were discovered in countless global commodities, currencies and financial instruments. The floor created efficiencies that truly improved the world. That may sound like hyperbole but it is not. Futures markets have changed all aspects of American life for more than a century and a half and until recently, trading was done in these dynamic trading pits. That technology has perhaps made them nearly obsolete does not lessen their significance in the world of finance.
But they were also more than that. They were complex psychological environments where men, and eventually women, could test their mettle in the fiercest of competitive rings. There are few environments where the Darwinian principle played out in such a raw reality.
With the announcement that CME Group would be closing its futures trading pits, we have sought out anecdotes from long-time traders regarding some of their most memorable experiences on the trading floor.
Some are of historical importance, like the Russian grain embargo, the FBI sting operation or when rogue traders brought down a legendary clearing firm. But there are also small revealing stories of hubris and the perpetual battle between fear and greed, which is the essence of trading and was felt every day in a visceral way in the trading pits.
These are stories of our industry and although the pits are going away, as with so many other institutions with the march of progress, their lessons live on. It is helpful and educational for us to remind ourselves of them.
While many recollections come from extraordinary events, slow markets produced just as many amusing stories. While we try and avoid comparing trading to gambling, folks on the floor liked action, and if the markets didn’t provide it some strange contingency bets would fill the need. Can a trader drink a gallon of milk in an hour? One member claimed he could eat 10 Big Macs. Action was pouring in from all over the country.
One trader who moonlighted as a stand-up comic would pull the same joke every month. How did I find out? A customer from New York called me up and told me to watch for it in the 10-year pit. The trader stood on the corner of the pit and yelled with outstrentched hands, “100 bid that I will get laid this weekend.” Everyone took his action and we all had a good laugh.
Here, we only scratch the surface; it would take longer and include hundreds of anecdotes, but perhaps it will spark memories for those who read it. As we put this together I am reminded of stories of unemployment reports—a day to be dreaded. As Joyce Selander writes about a bad day a friend of hers had, I can recall that feeling in the pit of my stomach before the unemployment report came out. I wasn’t even a trader, but the feeling that traders and clerks had before that number is indescribable. You knew what was at stake and you knew what could happen. It was uncontrollable and scary.
Whenever people are put together in adverse conditions, unusual things can happen. Sportscasters like to say “adversity doesn’t build character, it reveals it.”
If that is true for a golfer with a four foot putt to win a tournament, or a basketball player shooting a free throw to win a game, it is doubly so for the people who worked on the trading floor. After all, there was a lot more at stake. A broker or local could go bankrupt in certain market conditions. A clerk could lose his job for one bad error at the wrong time.
I recall how many would-be traders got wiped out in the night bond session with the launch of the first Gulf war. Night bonds, similar to the Mid-America Exchange, was a place where clerks leasing less expensive memberships could learn the ropes of trading in a little less stressful and less risky environment. But on the evening of Jan. 16, 1991, U.S. forces launched operation Desert Storm at 6:38 p.m. Eastern time to remove Iraqi forces from Kuwait. It occurred during the night bond session. Undermanned clerks and inexperienced traders were taken by surprise by the huge influx of business. They did not have the capacity to handle the order flow and many trading careers ended that night.
Shortly after coming to Futures I profiled a friend who was a successful Eurodollar trader. His story, like so many others, is unique to the Chicago trading community. He was starting out trading in the Mid-Am Exchange.
A big trader saw his talent and helped him get started, but his trading wasn’t going well. His account had gone negative a couple of times and friends had kept his slim hopes alive, but he had basically given up and was going to call his parents back East to ask if they could pay for his plane ticket home. In what he thought would be his last day of trading he was bidding on six mini-bonds when a bond local stuck him with 60. He may not have had money in his account to cover the margin for six let alone the 60 when traders from the big bond pit flooded the Mid-Am after 2 p.m. There was some news on a Fed auction and the traders continued to bid up the bonds. My friend had gone from the edge of quitting and going home with his tail between his legs to sitting on a substantial winner. After being rescued by that fortuitous event he began trading spreads and a few years later was one of the larger and most successful locals in the Eurodollar pit, consistently earning seven figures a year.
While dramatic, my friend’s story is not unique. Well, not unique in Chicago’s trading community. There are many stories like it, which cannot be replicated in the new world of trading.
These conditions can create extraordinary stories.
Mark Ritchie shared the following tale. “One day a consultant asked if I could give a tour of the CBOT to a few dignitaries from Brazil. We stood in the visitor’s gallery overlooking the grain room and I explained that the madhouse was one of America’s greatest gifts,” he notes. “Every price is voiced publicly. Everyone: Bread maker, exporter or farmer is represented in that pit. No one can buy below the market price.”
He told the group, “I’ve never been to Brazil, but I can guess that when a soybean grower takes his crop to the market, he faces many stops along the way, a small fee here, small toll there, a small tax at the next point, and an occasional gift under the table. By the time he gets his beans to the market, his profit margin is highly eroded.”
His guests were surprised that someone who had never been to Brazil could describe it so accurately.
He told the group, “In America any wheat farmer can sell in that pit at the same price as everyone else. We call it, “open outcry.” It means freedom from price manipulation; freedom from oppression.”
We’ve highlighted that there is indeed crying in trading. Ritchie adds, “If you’d like to see a grown man cry, come and interview me on the day the pits close.”
Who shot the grain market?
By Peter Kelly
In January 1980 I was 26 years old and awaiting the birth of my first child in April. I was a broker-trader in the soybean oil pit at the Chicago Board of Trade and I was also trading corn for my own account. I was short corn on a particular Friday. I thought that the corn market was acting very heavy so I doubled up and sold more corn taking it into the weekend.
That evening we had dinner with another couple at their house and after dinner we were watching the TV show “Dallas” when President Jimmy Carter came on the television and announced that because of the Soviet invasion of Afghanistan we were going to embargo trade with them.
At the time the Soviets were our biggest customers of agricultural goods. When President Carter made his announcement I had to check with my friend to see if I had heard correctly. The commercial grain companies sued to keep the grain markets from opening on Monday, and when we finally opened on Wednesday, corn was down the limit. As a result I was able to replace my unreliable six-year-old car with a new reliable one. Then my son was born three months later.
Note: For more on 1980 grain embargo see “Russian grain embargo,” page 19.
Peter Kelly is a CBOT Class B shareholder and soybeal oil trader.
There is crying in trading
By Harold M. Hutchings
One day a friendly new fellow, about 40 years old, walked into the pit. His father died and left him three large apartment buildings on the North side of Chicago. He sold them for the cash to open a trading account.
I asked why anyone would leave a stable income for this kind of life. He said property was a headache and proudly stated he’s been studying the markets. I knew right then with his over-confidence that he wouldn’t last. He started with one-lots and by the next day’s afternoon he was trading 5-lots. He was trying to make back losses not by being smarter but by trading larger.
It was coming—the “blowout.” His third day was a Friday when the employment situation report was released. His first unemployment release; I suggested he sit this one out. He affirmed he knew how to watch himself. The pit opened at 7:20 a.m. CST. The report came out at 7:30 a.m. By 9:30 a.m., when the roar of the economic indicator eased into the day, we all noticed this brave and foolish grown man holding his face in his hands as he crouched in a kneel in the center of the pit—he was crying quietly to himself. No one knew what to do. We just let him get it out. Twenty minutes later he turned his cards in and quietly walked away with a few goodbyes. He couldn’t handle nor figure out the unemployment release. In just three days as a floor member he lost his father’s inheritance to his only son.
Laughter is the best medicine
By Joyce Selander
It was one of those mornings when you wake up too early and your gut tells you it’s not going to be a good day. Acid gurgled in the pit of my stomach; I was tired and nauseous. To make matters worse, this week the markets were all over the place because interest rates and inflation were so volatile. The previous day’s bond trading had been hyperactive with sporadic spikes and breaks. People were edgy and cautious with the impending release of Retail Sales and several other reports.
The silence before the opening bell could be gut-wrenching. The pit has an obvious, almost contagious tension like a herd before it stampedes. It’s so quiet you can hear a pin drop even though clerks are running orders into the pit and brokers are signaling orders. There is all this commotion without any sound. About 30 seconds before the opening bell, there’s a low rumble as brokers begin communicating bids and offers. This is the market indication of the opening call. This alerts traders and their customers to the market’s direction and intensity—if they’re paying attention—and I was. I’d put in years of study on these numbers. Unfortunately, many traders had no idea how to interpret them. They acted like the reports were a big mystery, but the only mystery was why more people didn’t make the effort to study. Bottom line, I often saw things others didn’t, as my friend Terry found out.
Terry, a fun Irishman, was a third generation CBOT trader and a large bond trader who mostly scalped for short-term profits. On occasion, he would take large positions on market direction. That morning he came in long. He’d bought bonds the day before an important economic report. I didn’t feel too good about the report and I saw Terry glance at me when it was released.
I hesitated as the report didn’t seem right. Then I searched for some type of revision and there it was on the Reuters board. Hesitation gone, my hands immediately went up in the sell position. Traders glanced at each other looking to confirm what they saw. This was the quiet before the storm! Suddenly, traders and brokers started yelling, waving hands, pushing and shoving. The sound was deafening as clerks began screaming quotes to the desks, and desk clerks started yelling orders to their brokers or shouting “you’re off!” which are not words you wanted to hear, especially Terry. He had a large position so he rushed to get out. It was one of those life flashing before your eyes moments. You could see it in Terry’s face. The rumor was he’d lost $250,000 in mere seconds. If you don’t know the feeling—that sweaty trickle of fear down your back—you don’t want to.
Catching up with Terry at the end of the day, I said “Terry, I feel so upset about what happened to you today. I wish there was something I could do to make you feel better. ‘Thanks, JOY!,’” he replied.
“Are you sure there’s nothing I could do to make you feel better?” I purred in my best suggestive voice with a big smile on my face.
“Well, maybe...” Terry, that crazy Irishman, winked.
Then we both cracked up. Terry had been so depressed all day that our little therapy session made him laugh even harder. Here we were, standing in the middle of the CBOT lobby, laughing so hard tears were rolling down our cheeks and our stomachs ached. People walked by, knowing what had happened in the pit that day, and they probably thought Terry had lost his mind along with his money. Finally, he turned to me, tears streaming down his face.
“Joy, only you could make me laugh so hard on the worst day of my life. Thank you.” Terry smiled as he said goodnight.
Joyce Selander is a former floor trader, CBOT member and author of: “Joyce, Queen of the Mountain.”
Russian grain embargo
By Mark Andrew Ritchie
Jan. 9, 1980, 9:25:00 a.m.: Only once in a lifetime does one stand at the vortex of a political maelstrom. I stood at my usual spot between the meal and oil pits, 20 feet from the giant bean pit. We’d had a two-day “cooling off” period; regulators assumed we traders needed it. Maybe; maybe not.
9:26:00: President Carter had done it this time. He had finally learned “more in the last week about Russian intentions than in a year of high-level talks.” So he announced a grain embargo against Russia. This was a personal epiphany for me; I thought these “high level” politicians knew something we didn’t know. As a boy I had ridden my bike across Kabul and looked up at the Russian grain silo—enormous, mysterious, empty. How much genius was required to discern these intentions? In the 20 years since returning from Afghanistan, I did not discuss my boyhood there. It was a rare American who knew the location of the country. Now we were boycotting the Olympics and cutting off grain exports. And I was required to buy and sell in this environment.
9:27:00: I was allowing all this to swirl through my head instead of focusing on the numbers that would determine proper price; big mistake. Proper price? The president had threated the livelihood of every farmer. Would there be a buyer anywhere today? I had traded for kites and pigeons in the bazaars around Kabul. But, this was crazy.
9:28:00: And I’m still doing it—not focusing on my numbers, with a mere 120 seconds left. Only one job was critical before the 9:30 a.m. bell—figure out where this thing was going to open and be ready to buy or sell if it was out of line. No time in the trading session was as critical as the opening bell, no time more erratic and no time more advantageous for the trader. Obviously, no time with greater risk.
9:28:00: And here I was recalling my childhood, venting against a president, and participating in self confusion. I got in the pit, got my arms in the air, and eyed the clock.
9:29:00: There was little to calculate. Everyone knew where this would open: LIMIT DOWN. The only question was how many days it would be limit down, and what would I do with anything I sold. Most traders do not carry positions; we spread them off against something else. But what grain would not be limit down today? That would be a concern to worry about after the opening.
9:29:30: For now, we assumed that value was far below the lowest possible limit for this day. So the goal was to get a position from which one could dominate the pit and give any buyer, in the extremely unlikely event that there would be a buyer, the most obvious possible target to execute a foolish trade.
9:29:00—9:29:55: There is nothing illegal about having your arms in the air, but you are not supposed to say anything until the actual bell, now five seconds away. It is customary to jump the gun by a few seconds; three seconds being the typically allowable time and almost always led by the bean pit.
9:29:56: So when we heard the beginning of a roar go up in the bean pit, the clock-watching was over. “SELL LIMIT!” It’s impossible to imagine whatever happened to 9:29:57 and the two seconds following. And we surely never heard the bell either. The point was to give any broker with a buy order the easiest target. I certainly never noticed that morning that I had taken a position that just happened to be facing the fifth floor visitor’s gallery, where a Milwaukee Sentinel photographer stood.
Mark Andrew Ritchie is author of God in the Pits (Macmillan, 1989), a contributor to Jack Schwager’s Market Wizard series, and is soon to release My Trading Bible: Lose Your Shirt, Save Your Life, Carry on Trading.
The flood
By Daniel P. Collins
April 13, 1992 started out as a normal day on the floor of the Chicago Board of Trade financial room but about an hour into the day, some strange rumors started floating around the floor regarding a flood of sorts. We did not have to wait long; soon an announcement was made that there was a flood in the basements of the CBOT and throughout the Loop and the floor would be closing shortly. We were given time to notify customers and a new closing time and amended post-close session were set.
It was an impromptu holiday, but slowly word of the seriousness of the situation spread. Most of the workers were stuck as the mass transit lines were shut down due to the flood. I, along with several friends from the floor, moseyed on to Alcocks across the street. The bar situated between the CBOT and CBOE was a regular spot for traders and clerks from the floor. Before we could finish our first drink, we were informed that the bar also was being closed by the city but ended up getting a reprieve. There was somewhat of a holiday spirit as a group of a half dozen clerks played a dice game (ship, captain, crew) for $5 a round. Soon it became clear that the situation was so serious that it was unlikely the exchange would be able to open the following day. Many of us simply enjoyed the late morning and afternoon break, only moderately worrying about how to get home. It was opening day for the Chicago White Sox and many of us were in the same seat rolling dice with folks headed to the game when those same folks returned after the game was over. Few were in shape to make it into work if the CBOT was able to open the next day.
News reports showed live power churning a flooded CBOT sub-basement that was cooking fish from the river. Power had to be turned off and millions of gallons of river water were flowing into Loop basements. The Chicago River was emptying itself into a series of tunnels beneath the river that were created to move coal a century prior, but now were used for fiber optic lines. In fact, it would be several days for full power to return to the CBOT building. This created a problem as the exchange, by rule, could not be closed for four consecutive days. The flood occurred on a Monday. The following day markets were closed and Friday was a holiday. If the CBOT could not open before Friday it would be closed for more than four consecutive days.
This led to perhaps the most surreal day of my time on the floor. The exchange announced that it would be open for an abbreviated session. There was only auxiliary power. Traders and clerks with offices on the top floors had to walk up multiple flights of stairs to get their trading jackets. There was no interior power—there were strings of light bulbs draped across the entrance way guiding traders up to the fourth floor trading room. The escalators were not working. The room was dark and extremely warm but the market opened and there was trade.
Downtown was even more strange--full of closed storefronts with hoses emptying water pumped from basements into street-level sewers and dozens of people scurrying around with computers to whatever office space had power. But the CBOT managed to close for only one day.
Here we go again
By Scott Shellady
I am not that old but I must admit, it feels as though I have written two obituaries about my career choice of the last 27 years.
It started in Chicago in 1988. I had an awful time as a newly graduated finance major securing any employment within my field of study. The crash of 1987 had just happened the previous autumn and job prospects for finance majors were not good.
I was lucky enough to land a position as an ‘options trader trainee’ for the princely sum of $125 per week the spring of 1988. I was able to leverage that into a position as a partner and was sent to London in August 1990 where the London International Futures Exchange (LIFFE) was just starting to gain some traction.
Those were the busy years and on some days the LIFFE volume eclipsed the CME and CBOT volume as the busiest futures exchange in the world. All the while, lurking in the background, EUREX was beginning to flex its muscles. The German exchange wanted its Bund contract back home in Germany. The plan of attack was via electronic trading. In seven short years, it worked.
In 1997 we shut down the entire exchange. It wasn’t without tumult, and as you can imagine, a lot of careers came to a sudden end. We migrated what we could and began to trade and execute futures and options upstairs on the screen; 4000 LIFFE floor employees competed for roughly 400 upstairs positions--a 90% attrition rate. It was nothing I wanted to see happen again. Except I did.
I am now experiencing my second open-outcry shutdown.
On Feb. 4, 2015 CME Group announced it was closing the futures pits and migrating the options onto one trading floor. Any reasonable person can deduce that it won’t be long until the same happens to the options pits.
As an ex-college football player I embraced the pits, loved the sweaty competition and thrived in an athletic environment that rewarded quick good thinkers and punished those for hesitating. Ready, shoot, aim was the mantra. We used to say that we could get things right sooner if we got them wrong even faster first. A little convoluted but it worked.
So, after seeing September 11 in Chicago as well as the high grain prices and economic collapse of 2008, we are shutting off the lights in the futures pits once again. I have seen this movie once before and I am saddened by its ending. I am reasonable and understand the advantages of electronic trading. I appreciate its reach as it brings more customers to our market. It’s change and it’s change that the most customers want. I get it. The inevitable march of time. After all, I don’t have the obsolescence market cornered--just ask the buggy whip makers, stockyard staff and pager manufacturers. You either adapt or you die.
My father started trading grains in 1962 and moved to the floor in 1970. I followed in his footsteps 18 years later. I wear the cow jacket that he made famous. I shared a lot of things with him except for one. He was a fan of playing the game in real life. He didn’t like video gaming or video machines. He wanted to look the competition square in the eyes; not square in the screen. I have been part of the closing of two trading floors. He was lucky enough not to close any. In a way that makes me happy as he is not with us anymore, but his last sweaty, heart racing memories will endure forever.
I have a feeling my last memories won’t be as sweet as they are sad or as loud as they are quiet.
Scott Shellady has been a member and trader of CBOT and LIFFE.
The Sting
By Gary Phillips
Chicago had always “enjoyed” a much publicized bad-boy reputation, which some Chicagoans felt, was better than no reputation at all. Before Michael Jordan, Oprah and Obama, Chicago was best known for being the home to the mob and Al Capone. If you screwed the wrong people they would get back at you one way or another--either physically, or if they were powerful and had friends in the government, they would find a way to seek retribution through the court system. Duane Andreas was the chairman of Archer Daniels Midland, one of the largest food processors in the world. He was also one of the largest and most prominent campaign donors in the country, contributing millions of dollars to both parties. ADM had been investigated for price-fixing and would eventually be assessed the largest antitrust fine in United States history. Nevertheless, it was Andreas who complained to Federal prosecutors that the Chicago futures exchanges were ripping him and the public off out of millions of dollars.
The Federal government’s response was to launch an undercover probe of floor trading practices at both the CME and the CBOT. The sting operation would not be easy to pull off. The floors of both exchanges were like a boy’s club. Guided by a set of unwritten rules and a bond of trust, we were able to make trades with each other, sometimes risking millions of dollars, on nothing more than our word. The FBI agents would have to infiltrate our tight- knit group, and then fool us into becoming their trusted friends. The best way to break into our fraternity, they reasoned, was to become one of us. The FBI sting was to become as intricate and complex as the 1973 movie of the same name. Four FBI agents, two at the CME and two at the CBOT, posed as traders, and taped conversations, both on and off the floor, with the real floor traders and brokers. They created lives for the agents that duplicated the typical trader lifestyle. The agents dressed like us, lived in luxury apartments, drove exotic cars, ate at the same restaurants, joined the same health clubs, and bought memberships on the exchanges.
Each agent traded in a different pit. At the CBOT, one agent was trading beans and another was in the bond pit. At the Merc, it was the yen pit and the S&P 500s. During a two-year period, the agents befriended traders and brokers, going out for meals with us, playing basketball at the East Bank Club and partying with us. At all times, however, the agents were wired; recording every word of every conversation they had with the real traders.
By the time the sting operation was terminated, the FBI had spent millions of dollars. The agent/traders lost an undisclosed amount of money attempting to trade, but were alleged to have made a profit when they sold back their memberships. In all there were 47 indictments; a small fraction of that number actually resulted in convictions. The alleged millions of dollars in customer losses turned out to be in the thousands. One trader was indicted for trading after the closing bell and another for changing the price on an order, which turned out to cost the customer $62.50. Of course, the government response was, “No infraction or loss is too small when it comes to protecting the public. The message has to be sent that these kinds of actions will not be tolerated, and in the final analysis, operations like these save customers millions of dollars.”
It was a classic Chi-town example of hypocrisy, and misuse of power and influence. But, Duane Andreas had gotten what he wanted. He convinced a politically ambitious prosecutor to spend millions of taxpayer dollars to investigate Chicago’s “corrupt” futures exchanges, while at the same time, he manipulated the markets on such a large scale that he was eventually fined $100 million. And in order for the exchanges to maintain their self-regulatory status, they tightened up their audit trail and increased the penalties for breaking their rules. But, nothing really changed as far as the way business was transacted on daily basis in the pits; we were just more careful about whom we trusted.
Gary Phillips contributes to the blog: “Daily Speculations.”
O’Hare spread gone bad
By Daniel P. Collins
Lee Stern says he was on his way to Florida with his wife on the worst day of his 65-year trading career. They had just built a house in Florida. Stern called the office after getting off of the plane and noticed his secretary sound funny. He asked her what was wrong and she suggested he talk to his son, Danny.
“He told me we had a problem in the bond pit.
I didn’t understand, we didn’t do business in the bond pit,” Stern says.
At first he thought his son was having him on, but he slowly understood the seriousness of the situation. “The clearinghouse guys called me up. They said they want me to put up $5 million.”
What occurred was a variation of the “O’Hare Spread Trade” (put on a huge position, leave town if it is a loser or collect if it is a winner) perpetrated by two marginal traders: Darrell Zimmerman and Anthony Catalfo. Zimmerman had traded marginally for years, busting out several times, and later acknowledged that he secured access to the pit with a bad check written to Lee B. Stern & Co. the day before.
Their scheme was for Catalfo to buy up puts forcing the bonds lower, which Zimmerman was already shorting. They put on thousands of contracts and built up profits of several million before it blew up in their faces. Why they thought they would be able to simply collect ill-gotten profits is a testament to their ignorance as well as their criminality. It was a toxic mix.
Stern rushed back to the CBOT and was confronted with disaster. Not only did the clearinghouse want
$5 million but also wanted to suspend the firm’s memberships.
”I said we are the victims of illegal activity on the floor. They said they needed the commitment. We brought in the FBI. [The exchange] insists that they are going to suspend us,” Stern says.
The loss to Stern’s firm from Zimmerman’s bond trades was roughly $8.5 million, but they got back about $2.5 million from Catalfo’s profitable option positions, that he executed through another clearing firm.
Both were later convicted of wire fraud, though Zimmerman skipped town and had to be extradited from Canada to serve a jail term.
“All I know is I wrote checks,” Stern says adding,
“All my customers stayed.”
When all this was worked out Stern’s memberships were reinstated and the record expunged. However, Stern’s firm never would be a clearing member of the CBOT again. He is still upset at how the entire episode went down because no broker should have accepted orders from Zimmerman or Catalfo.
Other than the support he received from CBOT Chairman Billy O’Connor, Stern felt he was let down by the institution.
“Fortunately we were able to weather the storm. I didn’t clear anymore. I could have but there was no way I was going to put any more money into the business when the exchange failed to remedy the situation. The fact remains that all the brokers were never held responsible,” Stern says.
“It was illegal trading by unqualified members and brokers who violated CBOT rules resulting in losses of close to $9 million in my clearing firm. Brokers were never held responsible for the illegal trades,” Stern rumbles.
On the floor it was like a slow motion car crash. There was no news that justified the huge move. People knew relatively quickly that something strange was going on but not quick enough for Stern.
“I will never forget it,” Stern says. “Fortunately we stayed in business and we kept our reputation.” Beware of parallels in dollar rally
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[tr][td][p=30, 2, left]By [url=http://www.futuresmag.com/author/ashraf-laidi]Ashraf Laidi[/url][/p][p=30, 2, left]May 15, 2015 • [url=http://www.parsintl.com/clients/]Reprints[/url][/p]
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[p=30, 2, left]The growing parallels between 2015 and 1998 in global market forces—[url=http://www.futuresmag.com/tag/dollar]soaring U.S. dollar[/url], plummeting oil prices, rising equities, rising volatility and flattening U.S. yield curve—are startling.[/p][p=30, 2, left]They also have been bolstered by the rise in mergers and acquisitions in the oil and gas industries as falling energy prices force “big oil” to seek economies of scale through strategic tie ups (see [url=http://www.futuresmag.com/2015/05/15/future-fracking]“The future of fracking”[/url]). Knowing the repercussions of U.S. dollar strength in 1998, should we be concerned with today’s dollar advances? [/p][p=30, 2, left]Last month’s announcement from Royal Dutch Shell to buy BG Group for $70 billion was the first oil and gas mega-merger agreement in more than a decade. The deal will be the year’s biggest and the largest in the oil sector since Exxon paid $82 billion for Mobil in 1999. You may recall 1998 also saw BP’s $55 billion takeover of Amoco, Total’s Long straddles or time valued spreads
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[tr][td][p=30, 2, left]By [url=http://www.futuresmag.com/author/dan-keegan]Dan Keegan[/url][/p][p=30, 2, left]May 15, 2015 • [url=http://www.parsintl.com/clients/]Reprints[/url][/p]
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Question:[p=30, 2, left][b]How do you trade your opinion that a substantial move in either direction in a particular market is imminent?[/b][/p]Answer:[p=30, 2, left][b]Long straddles or time valued spreads.[/b][/p][p=30, 2, left]During the past six years, the Federal Reserve, headed by Ben Bernanke and now Janet Yellen, has arguably been printing money through various quantitative easing programs. In spite of this, the dollar over the last year has rallied sharply against other currencies, particularly the euro. Recently the European Central Bank, headed by Mario Draghi, has engaged in its own QE program. [/p][p=30, 2, left]Over 2,000 years, gold has acted as an unofficial, and sometimes official, reserve currency. Gold is currently serving in the former capacity, despite the occasional call for the latter. Inflation has been tame, despite all of the money that has been created. Should the velocity of money increase then inflation could explode. [/p][p=30, 2, left]In May 2005 gold traded as low as $421. By August of 2011 it had risen as high as $1,917, a nearly five-fold increase in a little over six years. Gold is trading somewhere near the middle of those respective prices at $1,210. You can almost draw a straight line from five years ago to today. If inflation ignites, the price of gold must go up. If the recent economic gains, although anemic, begin to reverse, there could be another deflationary spiral. This means gold is in a strange situation where a sizable move in either direction is possible. To cover both bases some kind of options strategy is needed. [/p][p=30, 2, left]One strategy would be a long straddle on gold futures. The June 1210 call strike is trading at 19.30 and the puts are trading at 24.00, which makes the cost of the straddle $4,370. This means that the upside breakeven point would be 1253.70. The downside breakeven point would be 1166.70. The maximum loss on this trade is limited to the premium paid, $4,370. [/p][p=30, 2, left]The negative aspect of this trade is the premium decay that occurs on a daily basis. The rate of decay is exponential. Each day the premium decays a little more rapidly than the day before, until the expiration week where it explodes. If gold doesn’t move above or below the two breakeven points, the trade is a big loss. Another way to compensate for the daily decay is to scalp a futures contract against your existing straddle position. [/p][p=30, 2, left]For this to be an effective strategy you would need to be long 10 straddles; a $43,700 commitment as futures rarely move in a straight line. As the market goes up you could sell futures against your options position. Your long calls would protect against an explosion to the upside. If gold retraced, you could buy futures back for a profit. Likewise if the futures headed south, you could buy a futures contract against your options position. When it retraced you could sell the futures out for a profit; your long puts would protect against a sharp tumble to the downside.[/p][p=30, 2, left]Another strategy is the long time value spread. This involves selling options in one expiration cycle against the purchase of options in a further out expiration cycle of the same strike. The sweet spot for this trade is at the strike price when the nearby option is expiring. You want every option that you sell to go out worthless. You want every option that you buy to go to infinity. [/p][p=30, 2, left][attach]6757[/attach]If you have a long time value spread on and gold went to infinity, the spread would be zero. Likewise if gold dropped to zero. Let’s look at the GLD (SPPDR ETF) July-June 126 call time value spread established for a 0.35 ($35) debit. Because GLD trades at one-tenth the value of gold, you trade the spread one hundred times for a commitment of $3,500. If GLD is trading at 126 at the June expiration, your long July calls are at their maximum value, while the short, expiring calls still go out worthless. If you are looking to capitalize on a downward movement, you can establish the GLD July-June 106 put time value spread for a 0.38 ($38) debit. Going long the spread 100 times would cost $3,800. If GLD is trading at 106 at June expiration, your long July puts are at their maximum value, while the short, expiring puts still go out worthless. The near term options also decay much more rapidly than the further out options. For $7,300 you have a much more affordable position when you are hoping for volatility. [/p][p=30, 2, left]The beauty of options is they are three-dimensional; you can profit on direction or volatility. Volatility spikes in gold can be so extreme that it’s easy to lose money being right on the direction, but off on timing. Options can be used to better define risk and reward. [/p][p=30, 2, left][b]Correction:[/b] [i]April’s Option Strategy was written by Randall Liss, not James Cordier. Futures regrets the error.[/i][/p]About the Author[p=30, 2, left][i]Dan Keegan is an experienced options instructor and founder of the options education site optionthinker. [/i][/p]
[/font][/color] Metals change course
[p=30, 2, left]Metals, both precious and base, say a lot about the direction of the global economy. They are the foundation of economic growth, and gold—besides being used as a currency and store of value—is the original fear gauge.[/p][p=30, 2, left]Crises, quantitative easing and global macroeconomics all affect the metals market. Knowing what fundamental drivers move these markets helps metals traders anticipate where they should be priced today and in the coming years.[/p][p=30, 2, left]Every year the metals markets face a different set of challenges. This year, gold traders are plagued with the U.S. Federal Reserve and European and Far East central banks going in different directions. The Fed is looking at tightening in 2015, the Eurozone is rolling out its version of QE and China—which is now the largest gold producer in the world—is attempting to stimulate its economy. [/p][p=30, 2, left]“With the U.S. dollar spiking upward this year and the Fed expected to tighten monetary policy at some point in June or September, it’s a challenging environment for gold prices,” says Patricia Mohr, vice president, economics, and commodity market specialist at Scotiabank. She expects gold to trade lower in 2015. [/p][p=30, 2, left]China is always a factor. “A lot of metals traders are worried about China’s economy. They’re throwing their hands up in the air and saying, ‘China is going to slow down; the world is coming to an end,’ but it’s not so,” says Pete Thomas of Zaner Precious Metals.[/p][p=30, 2, left]“China’s economy is like everyone else’s; it’s going to get hot, it’s going to get cold. The thing is, people in China strongly believe they need to own gold—that demand will always be there,” Thomas says.
[/p]Gold as last resort [p=30, 2, left]“Many years ago I knew this Chinese gentleman who would purchase gold coins every month,” Thomas says. “I asked him why and he said he used to be a police officer in a province in China where there was a revolution, and his home and police station were burned to the ground. He moved his family to Hong Kong. All he had when they arrived were a few gold coins. He would pay for rice, clothing and shelter with shavings from those coins. Since then he’s never been without gold coins. It goes to the underlying fundamentals of gold—that it always holds value. It can be traded anywhere, anytime for goods or services.” [/p][p=30, 2, left]Here in the West we can debate the usefulness of gold as a last resort currency, but there are enough people in the world with this gentleman’s perspective to support demand. [/p][p=30, 2, left]“[url=http://www.futuresmag.com/2015/03/02/top-20-largest-gold-reserves-country-through-2014]Why gold?[/url] Because it’s the only real currency there ever was,” Thomas says. “The only paper money that hasn’t gone to zero at least one time or another in its history is the U.S. dollar—and our turn will come,” he jokes, seriously.[/p][p=30, 2, left]Now that Iran and the United States have created a framework for a nuclear accord, it will allow the Middle East the ability to trade gold as never before—and it’s going to lead to a monstrous shift for gold trading to the Middle East, according to Thomas. [/p][p=30, 2, left]Gold traders hedged their bets in the run-up to the framework of the deal, which Thomas expected would be positive for gold. “The Iranian people love gold and after the agreement was reached, gold turned slightly higher. Now I expect Iranians will flood into the gold market as buyers and the price of gold will [keep going higher] due to this increased demand,” Thomas says. [/p][p=30, 2, left]This could work out well for all our refiners and recyclers, as a new solid recurring source of demand will throw a floor under the metals in short order. [/p][p=30, 2, left]The U.S. dollar also is playing its role in moving the gold market. The dollar has softened from the surprisingly weak March employment situation report (see “Complex relationship,” below). [/p][p=30, 2, left][attach]6758[/attach][/p][p=30, 2, left]“We had a debasement of currencies due to political events in various parts of the globe,” says George Gero, vice president of Global Futures RBC Capital Markets and long-time gold trader. “This saw investors turn to gold, which is liquid, portable and has no political allegiance.”[/p][p=30, 2, left]Even New York Fed President William Dudley said the first quarter looked weak and the Fed seems to be in no hurry to raise rates, which means that instead of June, we’re now looking at September for rate increases.[/p][p=30, 2, left]When the market believes that the Fed will delay monetary policy tightening, gold prices rally.[/p][p=30, 2, left]“The Fed has recently indicated that it will look at a variety of financial and economic factors—as well as employment conditions and inflation—in deciding upon the timing of any Fed funds rate hike,” Mohr says. “This probably means the Fed has been concerned over the strength of the U.S. dollar and the negative impact on U.S. exports and employment.”[/p][p=30, 2, left]“However, the general concern over when the Fed will tighten will continue to restrain gold prices in 2015—more specifically, this is why I expect gold prices to average less in 2015 than in 2014,” she says. [/p][p=30, 2, left]The Fed will, most likely, need additional weak economic numbers to alter its course but the soft Q1 numbers have supported gold. [/p][p=30, 2, left]“This has caused gold to go up $20 alone in trading on the first trading day of the second quarter (April 6),” Gero says (see “Gold edges up,” below).[/p][p=30, 2, left][attach]6759[/attach][/p][p=30, 2, left]Gold performed poorly during the first quarter of 2015 because of interest rate fears and a very strong dollar. But traders looking at higher crude prices and seeing a softer dollar and continued lower interest rates are now looking at gold as an asset allocation during the first week of the second quarter, when they weren’t looking at it in this way last quarter.[/p][p=30, 2, left]Gero expects gold to trade between $1,200 and $1,300 an ounce by the beginning of the third quarter. [/p][p=30, 2, left]He says soft economic data is creating the possibility the Fed will delay the timing of the initial Fed funds rate hike, which lifted gold back to $1,185 in late March. Gold had dropped as low as $1,143 in mid-March when the euro fell just below $1.05. [/p][p=30, 2, left]Mohr sets $1,185 as an average in 2015, down from $1,266 in 2014. “Gold may stay a little bit lower in the next 12-18 months, but by 2017 gold prices could very well start rising again,” she says. [/p][p=30, 2, left]Meanwhile, Thomas expects gold prices to take one more brutal dip this year around June, but will find a floor around support at $1,000, which he expects will hold until the market starts to creep back up to $1,500 to $1,600.[/p]
Copper and China[p=30, 2, left]Copper is a bellwether for economic growth. It is affected by automobile and home sales and economic stimulation in the United States, the Far East and in Europe. The average house has 400 pounds of copper and the average car has 40 pounds, so home and auto sales are very important to copper traders.[url=http://www.resourceinvestor.com/tag/copper]Copper traders often look to China[/url] as a guide to where copper is headed.[/p][p=30, 2, left]What’s going on in China is having even an even greater effect on copper than gold right now, according to Gero. [/p][p=30, 2, left]China has implemented fiscal stimulus and there is some expectation that the People’s Bank of China may ease monetary policy further near-term to achieve stronger corporate banking lending and its gross domestic product growth target for this year. [/p][p=30, 2, left]China’s national reform and development commission has set its GDP growth target for this year at 7%. Last year they set it to 7.5% and it actually grew 7.4%. China has a peculiar way of nearly always hitting its targets, so the point is that they are anticipating sluggish growth. Growth is slower than it was, which is to be expected, because for about five years it had near double-digit growth. Its potential to grow is gradually slowing over time, which is just a natural development (see “Emerged,” below). [/p][p=30, 2, left][attach]6760[/attach][/p][p=30, 2, left]“We had some economic indicators for China in January and February that weren’t particularly robust...” Mohr says. “...with the industrial activity decelerating in China to only 6.8% year-over-year when a year ago it was growing at about 10%. I expect China’s industrial activity will pick up a little in the first quarter, but definitely as we move into the second quarter because China has a seasonal pattern.”[/p][p=30, 2, left]Concerns about growth prospects in China have less to do with its GDP growth target, and more to do with the idea that China will be growing at a slower pace. But it’s important to note that doesn’t mean that raw material demand is declining, it’s still moving at a solid pace, particularly in copper (see “Copper leads,” below). It’s the pace of increase that’s slowing and therefore the demand in raw materials also will slow.[/p][p=30, 2, left][attach]6761[/attach][/p][p=30, 2, left]“This makes the metals and financial markets in London and New York a little nervous because China is responsible for about 47% of world consumption in the four key base metals, while the United States is responsible for less than 9%,” Mohr says.[/p][p=30, 2, left]The sentiment for base metals as a group is going to be a little on the soft side, according to Mohr. “But although the base metals are currently on the weak side, they are due for another bull run later this decade.” [/p][p=30, 2, left]She adds, “Base metals prices have actually inched down this year because unlike previous years, we’ve started this year with very poor sentiment on the outlook for global economic growth. This is unusual because usually at the beginning of every year financial markets become optimistic about the outlook for global growth accelerating, and then in the fall GDP forecasts have been marked down; that’s one of the reasons we typically get a correction in equities markets in September.”[/p][p=30, 2, left]However, she adds that this year things have been quite different. Financial markets actually have had soft expectations for global GDP growth and that has impacted price.[/p]Mining factor[p=30, 2, left]Recently gold production slowed down because of cost when crude oil and diesel prices went up because it became more expensive to run the equipment to mine. Then the cost of mining came down substantially and gold crashed from $1,900 to $1,150. It took the market a while to adjust. [/p][p=30, 2, left]“Of course, gold prices will continue to be driven by demand, but mining will be able to keep up and meet demand as far as I can tell,” Thomas says. “What is going to be the driving factor for the next five years is how much demand is going to come out of China, Singapore and India.”[/p][p=30, 2, left]Mohr agrees, “China probably has an even greater gold market than India. China is a huge gold miner. A lot of gold miners have deferred production of gold, and gold prices may lag until mining ramps back up.”[/p][p=30, 2, left]It should be noted that miners in Canada are benefitting from double-digit currency depreciation and low diesel costs, offsetting much of this year’s weaker prices for both gold and base metals, according to Mohr.[/p]Platinum and palladium’s turn[p=30, 2, left]Many traders don’t know that platinum is used for cracking crude oil into heating oil and gasoline by the oil industry, says Gero. [/p][p=30, 2, left]“So it’s not just jewelry sales and automobile production that have helped platinum. Also, Russian sanctions have led the oil industry to stockpile platinum. So the price difference between platinum and gold is starting to narrow,” Gero says. [/p][p=30, 2, left]He says copper and platinum will see higher prices this quarter—around $2.70 to $3.00 for copper and $1,175 to $1,200 for platinum.[/p][p=30, 2, left]“A lot of people are writing off platinum because they’re saying they’re going to find another metal that will have the same reactive properties, but I don’t see anybody changing the periodic table anytime soon,” says Thomas. [/p][p=30, 2, left]He said that just recently, the South African government announced they need 1,000 metric tons of platinum for its electrical program and platinum rebounded.[/p][p=30, 2, left]He says platinum and palladium will experience increased demand this year and they are worth following. [/p][p=30, 2, left]Mohr is optimistic on the outlook for zinc, which is her favorite base metal for investors. She expects zinc to perform much better than copper because of current zinc mine depletion. “While zinc may be soft now, prices will start to move higher and it will perform relatively well in the next two to three years,” she says. [/p][p=30, 2, left]As always, the price performance of the metals is going to depend greatly on interest rates, the price of crude, the price of currencies and the behavior of interest rates. But metals traders also should keep an eye on China and Iran this year to see how they move the markets.[/p] Sustainable Investing and Environmental Markets: Opportunities in a New Asset Class
By Jay Sorkin
May 15, 2015 • Reprints
[p=30, 2, left][b]Sustainable Investing and Environmental Markets: Opportunities in a New Asset Class[/b]
by Richard Sandor, Murali Kanakasabai, Rafael Marques, Nathan Clark.
World Scientific Publishing Co. Pte. Ltd. 2015
$68.00
380 pages.[/p][p=30, 2, left][attach]6762[/attach]Many commodity traders have found success in being trend followers. Not many have done so by being trend-setters, but you can count Richard Sandor among the few. Sandor’s glittering resume includes developing the first financial futures contract in the 1970s, the concept of environmental markets in the 1980s and the introduction of the first sulfur dioxide (SO2) auction in the 1990s, which led to the cap-and-trade markets in carbon, nitrogen and other emissions markets. In his spare time Sandor founded the Chicago Climate Exchange to trade weather-related and environmental markets, and his current project, Environmental Financial Products. He also maintains academic affiliations (currently teaching at the University of Chicago) and has written other books. [/p][p=30, 2, left]In sum, Sandor is an intellectual force to be reckoned with. This latest volume examines environmental issues with more than just an eye toward conservation and increasing the societal benefit. In true Chicago style, he and his co-authors explain how to develop tradable markets around these issues and, more importantly, how to make money doing so. Incentivize them, and they will come.[/p][p=30, 2, left]The emphasis here is on how to price the asset and allow the free market to determine the types and magnitudes of the reductions. While not directly taking governmental interference to task, the authors show a clear preference for traveling with just a carry-on, rather than the bulky baggage that government programs seem to require. There is a place in the system for regulation of these programs, but it should be more for the authorization of the market and enforcement of the rules, not the implementation.[/p][p=30, 2, left]One example is the original sulfur dioxide auctions. Enabled by the Clean Air Act Amendments of 1990, the first auction was held through the Chicago Board of Trade in 1993. Since then, SO2 (and nitrogen oxide) emissions are more than 75% lower than 1980 levels. [/p][p=30, 2, left]Just as important, health costs for lung disease were lowered, as were smog levels, forest damage and acidification of lakes and rivers. This was accomplished because regulation helped create the functions that enabled a market to emerge: It legalized the asset class as a commodity; it produced the property rights needed; and it established the infrastructure to allow for transfer of the asset. Then the market took it from there. [/p][p=30, 2, left]In the past 20 years, cap-and-trade has been burdened with a great deal of political baggage, primarily from those whose oxen will be gored by change, as is often the case. Yet there are now enough programs operating to ensure that their benefits will continue to grow.[/p][p=30, 2, left]But this is not a book about cap-and-trade programs or policies. Nor does it purport that cap-and-trade is the only way to go. This is a roadmap on how to develop markets to allow for other environmental assets to be priced and traded. Early on, the authors outline a seven-stage market development process that is needed. It is no surprise that the first three are similar to the three requirements outlined by Francis Fukuyama in his recent book, “The Origins of Political Order,” in which he says that a political state needs infrastructure, laws, and accountability in order to survive. So it is with a market as described here, albeit writ small. But the ideas presented here are not small.[/p][p=30, 2, left]The first step is the recognition that the structure currently in place needs to be changed due to demand factors. Later explanations bring into play such examples as the “tragedy of the commons,” a concept articulated by many, but notably by Mancur Olson (see “The Logic of Collective Action: Public Goods and the Theory of Groups”). It is here that we find the root of a market. Public goods vs. private goods and collective decisions vs. individual decisions are what make a market. Large groups operate differently than small groups and still more so than individuals. Their resulting decisions are based on the economic pressures affecting each of them, and by the incentives each is given. This is what makes a market. [/p][p=30, 2, left]Secondly, there must be rules, preferably developed by the needs of the market. Chief among these is that the commodity must be transferable. This requires that someone can own it and then be able to sell it to someone else. This notion of property rights has come up before. Almost 30 years ago Hernando de Soto Polar’s book, “The Other Path, championed property rights as a means out of third-world poverty.”Ownership allows for buying and selling and, more importantly, establishing a value and price for doing so. If you don’t own it, its value doesn’t matter, and you don’t take care of it. As Larry Summers famously said, “No one ever washes a rented car.”[/p][p=30, 2, left]The third component is accountability. We are careful here to distinguish between the rules that the market needs in order to work, and the regulations the market overseers need to ensure a level playing field. In Washington, this means regulation and enforcement. In Chicago, this means clearing: a neutral third party to ensure that buyers pay and sellers collect. [/p][p=30, 2, left]Covering such diverse asset classes as emissions, renewable energy, weather-related events and water, and even global fisheries, this book details the necessary steps to develop each into a tradable market. Once a market is created, it can establish a price for the underlying commodity. This price will then become the driver for individual and collective behavior, because the price will factor in all the tangible and intangible (read societal) inputs from the disparate market participants. [/p][p=30, 2, left]Sandor’s three co-authors all have a long history of commitment to environmental issues. They have each been Managing Directors of Environmental Financial Products (EFP) and were involved in the Chicago Climate Exchange (CCX). Murali Kanakasabai is a Ph.D whose work stretches from the first emissions auctions to designing some of these new products. Rafael Marques has been in all phases of research and development of environmental products for over 15 years, and his portfolio has included the broadening of international growth and relationships for the Climate Exchange and now EFP. Nathan Clark also spent many years with the CCX and EFP before moving on to become a vice-president of Wabashco, LLC, a clean fuels, carbon offset and renewable energy development company. These are four men who have proven their dedication to helping the planet. [/p][p=30, 2, left]Sustainable Investing and Environmental Markets: Opportunities in a New Asset Class is an important book in an important emerging field. We are currently at a place in the history of commodity markets similar to that of the 1970s when the first financial products were introduced. Back then the corn and pork belly traders couldn’t understand how you could trade money and debt. That success may ease the way a bit for this new asset class, but market participants are a sticky group. [/p][p=30, 2, left]They will not embrace a new market until it has proven itself to be viable. [/p][p=30, 2, left]Are we facing, as Shakespeare wrote, “a tide in the affairs of men/Which, taken at the flood, lead on to fortune?” The market will tell us, because that is what a market does.[/p][font="]About the Author[p=30, 2, left]Jay Sorkin is a 40-year veteran of the futures and options markets. He traded at the Chicago Board of Trade and the Chicago Board Options Exchange, and later was on the management team of two start-up electronic exchanges. He has taught futures and options for more than 30 years.[/p][/font] Detrended: Modifying price oscillators
[p=30, 2, left]The detrended price oscillator (DPO) is designed to filter out the underlying trend to highlight the underlying cycles of price movement. Detrended prices should allow the trader to identify cycles and overbought/oversold levels more easily. The DPO is used to remove trend from price so you can do so more effectively.[/p][p=30, 2, left]The DPO typically is not aligned with the most current prices. It is shifted backward in time; in practice, it is shown that this helps to remove the current trend. Because the DPO is offset to the past, it is not considered a momentum oscillator. It only measures past prices against a simple moving average as a way to gauge a cycle’s high/low range, as well as the cycle’s typical duration.[/p][p=30, 2, left]Long-term cycles are made up of a series of short-term cycles. Analyzing these shorter-term components of the long-term cycles can be helpful in identifying major turning points in the longer-term cycle. The DPO helps with this as well.[/p]Calculation[p=30, 2, left]To calculate the DPO, you specify a time period. Cycles longer than that period are the ones that are removed from price, and cycles shorter than that period are the ones that remain.[/p][p=30, 2, left]First, create an n-period simple moving average (where “n” is the number of periods that you desire in the moving average). Now, subtract the moving average calculation from so many days ago ((n / 2) + 1) from the closing price. [/p][p=30, 2, left]The result is the DPO.[/p][p=30, 2, left][b]DPO = Close – (Moving Average ((n / 2) + 1)) days ago)[/b][/p][p=30, 2, left]The distance the oscillator is shifted depends on the calculation (n / 2) + 1. For example, a 20-day DPO would use a 20-day simple moving average (SMA) that is displaced by 11 periods ((20 / 2) + 1 = 11). This displacement shifts the 20-day SMA 11 days to the left, which puts it in the middle of the look back period.[/p][p=30, 2, left]The value of the 20-day SMA is then subtracted from the price in the middle of this look back period. In short,
DPO (20) equals the price from 11 days ago minus the 20-day SMA. The DPO is most effective with indicator periods of 21 days or less.[/p]Trading with the DPO[p=30, 2, left]There are several ways to analyze stocks with the DPO.[/p][p=30, 2, left]1. The real power of the DPO is in identifying turning points in longer cycles:[/p][list][*]When it shows a higher trough, expect an upturn in the intermediate cycle.[*]When it experiences a lower peak, expect a downturn in the intermediate cycle.[/list][p=30, 2, left]2. You can set overbought and oversold levels based on the observation of past price behavior:[/p][list][*]Go long when the DPO crosses below and then back above the oversold level.[*]Go short when the DPO crosses above and then back below the overbought level.[/list][p=30, 2, left]3. Use the DPO to identify the direction of the trend, and then only trade in that direction:[/p][list][*]Take only long trades when it crosses below zero and then turns back above.[*]Take only short trades when it crosses above zero and then turns back below.[/list][p=30, 2, left]Divergence is another powerful way to apply the DPO. When divergence appears between a detrended price and the current price, it indicates a high probability that the current trend will end soon.[/p][p=30, 2, left]Using this analysis, a buy signal is generated when a new low is formed below the previous low and a corresponding detrended price value is higher than the previous value. Likewise, a short signal is generated when a new high is formed above the previous high and a corresponding detrended price value is lower than the previous value.[/p]
Identifying turning points [p=30, 2, left]Cycles are created in the DPO because the indicator is displaced back in time. The historical peaks and troughs in the DPO provide approximate windows of time when it is favorable to look for entries and exits, based on other indicators or strategies.[/p][p=30, 2, left]In the example “Monthly moves” (below), the stock International Business Machines (IBM) is bottoming approximately every 24 to 30 trading days. Upon noticing the cycle, a trader would look for buy signals that align with this time frame. Peaks in price are occurring every 35 to 41 trading days; likewise, the trader might look for sell/shorting signals that align with this cycle.[/p][p=30, 2, left][attach]6763[/attach][/p][p=30, 2, left]Consider how the DPO helps with timing both long and short trades in the S&P 500 (see “Broad market cycles,” below). When the DPO is above the zero line, it means that price is above its moving average; this is a bullish sign. Similarly, when the DPO is below the zero line, it means that price is below its moving average, a bearish sign.[/p][p=30, 2, left][attach]6764[/attach][/p][p=30, 2, left]Looking at the S&P 500 chart, we see that on Oct. 16, 2014, the S&P 500 made a low of 1820 and showed an intraday recovery before closing at 1862. The DPO was in the oversold zone, and on Oct. 21, the indicator closed above the zero line, suggesting longs could be initiated at 1941 with a stop loss of the previous day’s low. Profit booking could be done at 2017 on Nov. 4 when the DPO reached an overbought zone. [/p][p=30, 2, left]On Dec. 9, the S&P 500 made a low of 2054 and closed at 2060, while the DPO crossed below its zero line. This suggests that shorts could be taken with a stop loss of the day’s high. Profit booking could be done at 1982 on Dec. 16 when the DPO reached its oversold zone.[/p][p=30, 2, left]Nike (“Turning two ways,” below) provides a good example of using divergence to predict a turning point. In this case, a short signal is generated when a new high is formed above the previous high and a corresponding detrended price value is generated that is lower than the previous value.[/p][p=30, 2, left][attach]6765[/attach][/p][p=30, 2, left]Between Feb. 26 and March 18, 2014, Nike was trading in the range of 78-80, making higher highs. However, the DPO was making lower lows, as shown in the chart. This divergent behavior suggests that there was a high probability that the end of the current trend was imminent. On March 21, that end came when Nike opened with a gap lower at 77. By April 7, it made a low of 70. [/p][p=30, 2, left]The DPO shows the difference between a past price and a simple moving average. In contrast to other price oscillators, it is not a momentum indicator. Instead, it simply is designed to identify cycles with its peaks and troughs. Cycles can be estimated by counting the periods between peaks or troughs. Users can experiment with shorter and longer DPO settings to find the best fit.[/p][p=30, 2, left]In all cases, however, it’s important to remember that this is just one indicator. No single indicator can make up an entire trading strategy. Your trades should be confirmed by additional signals, and it’s always important to follow strict rules regarding loss management.[/p]
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