Thinking Outside the Index

Terry Flanagan

CME Group is trying to extend its footprint into the OTC and cash equities markets. To that end, the Chicago-based exchange operator’s focus is generating new opportunities outside of the major U.S. index complex, according to Tim McCourt, executive director and global head of equity products at CME.

“We’re looking for continued international growth, not necessarily only new product offerings, but how do we implement new market structures that allow CME Group to compete in adjacent markets like the OTC swap market and the cash equity market,” McCourt told Markets Media.

Index futures are one of the most important trading tools in the equity market. In terms of daily notional trading volume activity, index futures dwarf the cash market in the U.S.

Tim McCourt, CME Group

Tim McCourt, CME Group

Currently, almost 90% of all CME Group Equity Index Futures Volume is electronic traded on the Globex platform, which has seen a dramatic increase in Average Daily Volume over the past 12 years.

More recently, a main theme has been the persistent low volatility of the current market. McCourt noted this is a cyclical aspect of the market that happens maybe once per decade, but this time it’s more protracted.

Some of CME’s new products are complementary to the broad-based index, such as S&P Select Sector futures, which are effectively the nine select sectors of the S&P 500 that have corresponding State Street SPDR ETFs.

“So effectively, those ETFs like XLE, XLF, XLU, we have broad-based index futures on those same indices that those ETFs are designed to track,” said McCourt. “In a persistent, one-way bull-run equity market, this is one area that’s beneficial because it allows investors to more finely tune express sector-specific views, and they can do sector overlays on top of the parent index.”

Money managers, both on the institutional and hedge-fund side, are looking for ways to generate alpha beyond just the S&P benchmark return. “We’re trying to push for both the buy and sell side to adopt CME’s investment vehicles in the futures and options complex from a risk perspective and from a margin perspective,” McCourt said.

One theme that will continue is awareness of OTC clearing for the equity space. “That has been in the market since the implementation of Dodd-Frank, but equity had the distinction of being the last asset class that would be addressed,” McCourt said. “So as we’re moving through FX, chatter on the equity topic will increase in the marketplace in 2015.”

Add to that the Basel 3 implementation, which means the sell side is paying more attention to capital and leverage ratios, and “it lends itself to a different conversation with respect to how customers are using futures and how much of the OTC market is portable to the futures space,” said McCourt. “Our job is to help customers navigate that uncertainty over the next year.”

Another thing on CME’s plate for 2015 is the expansion of its BTIC mechanism, or basis trade index at close. That allows counterparties on a futures contract to agree on the basis between the future and the cash.

“For the S&P, for example, say we thought that futures should be 9 index points under the cash index,” said McCourt. “We could have that type of transaction and then that basis of minus 9 gets applied to the cash transaction, and then that basis of minus 9 gets applied to the cash close at the end of the day. This way you have the perfect underlying cash index close in future form.”

Currently, the BTIC is available for the sector futures, Dow Jones U.S. real estate, and CME’s Brazil contract. In 2015 it will expand to some of the more prominent U.S. indices. CME will create that functionality on Globex and “create a basis-traded order-book product, as opposed to just allowing it as a block vehicle,” said McCourt.

Featured image via James Thew/Dollar Photo Club

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