Federal Reserve may bring new life to Fed-funds options pit

CME Group, ThinkLeigh Photography

Futures trading pits in Chicago and New York have been under siege, with market participants favoring computers over flesh-and-blood traders.

In some markets, the pits have closed altogether, while a lack of demand for open-outcry execution has left others all but defunct.

But the Federal Reserve may breathe fresh life into at least one Chicago trading pit.

As bets pour in over when the central bank will announce its first interest-rate hike since 2006, and the first big change since the Fed cut rates to nearly zero in 2008, trading of Fed-funds options in the open-outcry pit is set to climb.

“Fed-fund options have been moribund for quite awhile,” said Bear Brokerage’s James Criner.

But heightened expectations that the Fed may lift rates—if not at the central bank’s policy meeting starting Sept. 16 then before the end of the year—for the first time in nearly a decade has created some buzz in the Fed-funds option pit.

When trading slowed, many Fed-fund options traders moved off the floor completely or moved to eurodollar options, said Phil Flynn, senior market analyst at Price Futures Group in Chicago. The market had “basically been dead” because everyone knew, since the central bank started quantitative easing in 2009, that rates weren’t going up soon, he said.

In 2009, CBOT Fed-fund options saw daily volume of around 29,557 contracts, with total volume at about 7.48 million, compared with daily volume of just 101 contracts and total volume of 25,533 last year, according to the CME Group.

Already Fed-fund options activity is on the rise again. So far this year, daily volume is at 1,340 contracts, with total volume at 230,394. About 90% of Fed fund options trading is executed via open outcry—a system of trading involving traders communicating via shouting and hand signals.

The table below illustrates how trading volume in Fed-fund options has changed over the past few years.

CME Group

“Most of the speculation on the course of Fed policy is typically expressed in eurodollar futures and options,” in part because of the low market liquidity in Fed-fund options, explained Criner.

Fed-fund futures  traders and eurodollar options traders were “praying for an interest-rate increase” and they will definitely see more activity going forward, said Flynn.

That would be a sight to see in the wake of the closures of most futures-trading pits earlier this summer. Read: Closure of futures trading pits will render a language extinct

In Chicago, the trading floor is better prepared for all those options traders.

Phil Flynn

The CME has “retooled the trading floor of the old bond room and brought in the options trading pits because the options traders do a better job at making markets than computers do,” said Flynn.

“To get a complicated spread [trade] done…there has to be an assumption of risk” and computers can’t do that, he said.

There could be 9 million trading combinations, with different years, months and different Fed meetings in different years, he said. Someone would “need to make a market for you and that’s what options traders do very well.”

The only key question left is when exactly Janet Yellen’s Fed will decide to pull the trigger on a rate increase.

Read: The Wall Street Journal’s Jon Hilsenrath says Fed can’t agree on September rate increase

Francine McKenna contributed to this article.