CME Group’s Fred Malabre and Don Mendelson chart the history of electronic commodities trading and discuss the recent improvements in FIX for commodities, including fractional pricing, trading listed strategies and faster market data.
Adoption of FIX for Commodity Trading
Products traded on CME Group exchanges have many underlying asset classes, including commodities, interest rate instruments, foreign exchange and equity indexes. Although the largest share of products traded today on our platforms are financial futures, the history of our markets began with agricultural and livestock commodities. The underlying physical commodities include the petroleum complex, agricultural products such as soybeans, wheat and corn, and metals such as gold and copper.
Listed contracts in all of our markets include futures and options on futures. The futures contracts can be physically settled, meaning that a seller has an obligation to physically deliver the commodity to the buyer when the contract expires at a delivery point specified by the contract, or cash settled, which are products that could not be settled to an index.
Back in 2001, we were at a crossroads. At this time, futures contracts were primarily traded via open outcry – brokers shouting and waving arms in trading pits. At that time, CME launched its first FIX compliant interface to electronically match orders for a wide range of asset classes ultimately including equity indexes, FX, interest rates, real estate, weather, economic events, energy, metals and agriculture. The question arose: how do we represent orders and execution reports and transmit them between firms and the exchange? We had earlier put out its own order routing API, but it had some drawbacks, including the high level of software developer support required. Firms were running several different computing platforms, for example.
At that time, the FIX Protocol had begun well in the equities world. It was attractive because it was not an API, but rather a standard for message exchange. From the exchange’s perspective, this was an attractive proposition: we would develop our side of the conversation, and firms would develop theirs. From the firms’ perspective, their software developers could achieve high performance, only limited by their own imagination and skills.
It seemed that with a few adjustments, FIX could be adapted for futures and options trading. In version 4.2, fields were added to support derivatives, including expiration and strike price. We participated in working groups to standardize those changes, and later helped spawn FIX-based solutions for market data and FIXML for clearing.
An example of a problem with adapting an equities standard to commodities is fractional pricing. Traditionally, agricultural prices were stated in fractions. To this day, soybean futures are quoted in increments of ¼ of one cent per bushel. US equities made a leap from fractional to decimal pricing in 2001. Although trade pricing stuck with tradition, we decided to follow FIX conventions with decimal pricing in messages.
We added some custom indicators within our FIX interface to facilitate conversion to a fractional display. One indicator represents the main fraction and another represents the sub-fraction. For example, for a product ticking in ½ 64th, we would send the main fraction as 1/64 and the sub-fraction as ½. These indicators could then be used to convert a decimal price used over our FIX interface as 105.0390625 which would then be converted to a screen display as 105 2.5/64th. We found that the FIX Protocol is easy to extend to add custom features and can easily be extended for legacy needs with negligible impact to customers not using new tags such as the custom indicators talked about previously.
Market makers use a FIX Mass Quote to set prices for option series. Mass Quote was introduced in FIX version 4.3, but back-added into the iLink FIX 4.2 interface.
Most futures and options on futures are traded in strategies. The simplest is a calendar spread, playing on the difference in price between two delivery months. Similarly, a butterfly spread is based on three contract months. Another type of spread is inter-commodity spread. A classic example is the crush spread, which has three legs based on the relative value of soybean products: unprocessed soybeans, and two derived products, soybean oil and meal. At CME Group, futures strategies are listed and can be traded just like outright contracts.
Options strategies can be quite complex. Rather than list all the possible combinations, traders initiate creation of a strategy by sending a FIX Security Definition Request. Once created, the new strategy becomes a listed contract for anyone to trade. However, complex option strategies are still heavily traded in the pit; less than half of our commodity option volume is traded electronically.
Another difference from equities markets is the nearly 24 hour trading cycle. Our trading system starts up on Sunday afternoon and runs continuously through Friday. Trading sessions run past midnight so they are not concurrent with calendar days. Customers accustomed to daily shutdown cycles typically have to make some adjustments for a week-long session.
We replaced the previous proprietary market data format with a FIX-based format, the efficiency of which enabled firms to dramatically cut the network bandwidth needed, consequently cutting costs to firms. The market data feed includes Implied prices, which are determined by combination of contract order books at the match engine. Implied prices for listed calendar spreads are determined by the actual prices of its outright contracts. At the same time, the price of an outright is inferred from the best possible combination of calendar spreads that the contract is part of plus another outright price.
It is safe to say that the usage of FIX in commodities trading will evolve, and CME Group will apply its FIX technology to other markets around the world. This year we successfully deployed our FIX enabled electronic platform to cover derivatives trading in Brazil, and we expect plenty more to come.