Volatility still plaguing cattle futuresVolatility still plaguing cattle futures
August 8, 2016
DESPITE implementing some changes, cattle industry leaders and CME Group continue to work towards fixing volatility within the cattle futures markets.
National Cattlemen's Beef Assn. (NCBA) vice president of government affairs Colin Woodall recently provided Feedstuffs with an update on current efforts to stabilize the markets.
According to Woodall, concerns began in 2015 when market activity became extremely volatile, sometimes moving to limit-up or limit-down within the first few minutes of daily trading.
"We were seeing these pretty significant swings in the prices, but there was nothing in the marketplace that was driving it. There weren't any weather issues, we weren't being locked out of any countries, we didn't have any disease issues or any food safety issues. Things that drive the market, from a fundamental standpoint, just weren't happening," he said.
At the time, NCBA concluded that the cause was CME's transition from open-cry pit trading to all electronic, or automated, trading.
"It's obvious that the computers are the ones that are really driving this market to these extremes based upon the technical components of the market rather than the fundamentals of the market," Woodall said.
CME, on the other hand, has argued that automated trading — particularly high-frequency trading (HFT), which is a subset of automated trading — is not the problem.
"We believe that there are a number of factors that have contributed to recent market volatility, including, but not limited to, increasingly opaque cash markets, low exports, high inventories in cold storage and a backlog of cattle in feedlots," CME explained on its website.
CME said it has done an extensive analysis of the live cattle futures market over the past several months, primarily focusing on the limit-up/limit-down days.
"On these days, our observation is that manual point-and-click traders — not algorithmic and not HFT traders — led the market moves. On average, in 2015, HFT firms accounted for just 10% of the total live cattle futures volume," CME said.
In fact, during some of the significant market moves, CME noted that manual traders represented more than 80% of all aggressive trades. "We further observed that as a market trended toward the limit, manual traders more aggressively traded the market, further contributing to the price volatility," it explained.
At NCBA's conference in January, CME executive chairman and president Terry Duffy met with cattle producers to discuss cattle market performance. From there, the two organizations established a working group.
Messaging, which occurs when a buyer or seller enters a new order, modifies an existing order or cancels an existing order on the CME electronic trading platform, was the first item addressed, because cattle contracts didn't have a cap on the number of messages that any one firm could make in a single day.
On Feb. 1, less than a week after the NCBA conference, CME added livestock products to its messaging efficiency program, which implemented a cap on the number of messages that could occur per fill. The program is designed to ensure efficient messaging — that someone doesn't continually enter orders, modifications and cancellations without trading.
After the cap was implemented, CME reported that the ratio of messages to orders filled in the live cattle futures market decreased by 15% between January and April, while overall volume was relatively unchanged.
Woodall said for about six weeks after the cap was implemented, the markets calmed down, but he noted that the volatility has since returned.
CME also reduced livestock futures and options trading hours to align with the period of greatest liquidity in the markets: Roughly 87% of trades occurred between the hours of 8:30 a.m. and 1:05 p.m. (CT) during 2015.
Additionally, starting June 6, CME began offering an additional pre-open period for customers to enter, cancel and modify livestock futures and options orders on CME Globex during 2:30-4:00 p.m. (CT) Monday through Friday.
Woodall said the changes haven't really made any significant impact.
"This was a major discussion point of NCBA's recent summer business meeting," he said.
The next hurdle is getting information about who's in the marketplace. Woodall said NCBA asked CME for the data, but due to legal reasons, the exchange is unable to provide the information.
Woodall said NCBA's next step is working with the U.S. Commodity Futures Trading Commission to get that information so the group can see the categories of active participants in the marketplace.
"Any further action will rely on NCBA knowing who is in the marketplace, so the process is currently stalled," he explained.
While trading continues, there have been anecdotal stories about people who have stopped trading because of the volatility.
"It's made a lot of our members mad," Woodall said. "They are mad that the futures markets aren't working the way they should because the whole reason they exist is to be a risk management tool for cattle producers. It's our view that, at this point in time, they're just not working that way."
Overall, NCBA's goal isn't to go back to open-outcry trading but, rather, to make the new automated system work better.
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