Investments, tenth edition

Prediction markets for the 2012 presidential election.  Contract on each party pays $1 if the party wins 

the  election. Price is in cents.

0

Date

10

20

30

40

Price

50

60

70

80

90

100

01-Jul-11

19-Jul-11

06-Aug-11

24-Aug-11

11-Sep-11

29-Sep-11

17-Oct-11

04-Nov-11

22-Nov-11

10-Dec-11

28-Dec-11

15-Jan-12

02-Feb-12

20-Feb-12

09-Mar

-12

27-Mar

-12

14-Apr

-12

02-May-12

20-May-12

07-Jun-12

25-Jun-12

13-Jul-12

31-Jul-12

18-Aug-12

05-Sep-12

23-Sep-12

11-Oct-12

08-Nov-12

Democrat 

Republican

Source: Iowa Electronic Markets, downloaded January 25, 2013.

776

 The impetus for this shift originated in Europe, where electronic trading is the norm. 

Eurex, which is jointly owned by the Deutsche Börse and Swiss exchange, is among the 

world’s largest derivatives exchanges. It operates a fully electronic trading and clearing 

platform and, in 2004, received clearance from regulators to list contracts in the U.S. In 

response, the Chicago Board of Trade adopted an electronic platform provided by Eurex’s 

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Final PDF to printer

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  C H A P T E R  

2 2

 Futures 

Markets

777

European rival Euronext.liffe,  

1

   and the CBOT’s Treasury contracts are now traded elec-

tronically. The Chicago Mercantile Exchange maintains another electronic trading system 

called Globex. The electronic markets enable trading around the clock.  

 The CBOT and CME merged in 2007 into one combined company, named the CME 

Group, with all electronic trading from both exchanges moving onto Globex. It seems 

inevitable that electronic trading will continue to displace floor trading. 

 Once a trade is agreed to, the  clearinghouse  enters the picture. Rather than having 

the long and short traders hold contracts with each other, the clearinghouse becomes the 

seller of the contract for the long position and the buyer of the contract for the short posi-

tion. The clearinghouse is obligated to deliver the commodity to the long position and to 

pay for delivery from the short; consequently, the clearinghouse’s position nets to zero. 

This arrangement makes the clearinghouse the trading partner of each trader, both long 

and short. The clearinghouse, bound to perform on its side of each contract, is the only 

party that can be hurt by the failure of any trader to observe the obligations of the futures 

contract. This arrangement is necessary because a futures contract calls for future perfor-

mance, which cannot be as easily guaranteed as an immediate stock transaction. 

  Figure 22.3  illustrates the role of the clearinghouse. Panel A shows what would happen 

in the absence of the clearinghouse. The trader in the long position would be obligated to 

pay the futures price to the short-position trader, and the trader in the short position would 

be obligated to deliver the commodity. Panel B shows how the clearinghouse becomes 

an intermediary, acting as the trading partner for each side of the contract. The clearing-

house’s position is neutral, as it takes a long and a short position for each transaction.  

 The clearinghouse makes it possible for traders to liquidate positions easily. If you are 

currently long in a contract and want to undo your position, you simply instruct your bro-

ker to enter the short side of a contract to close out your position. This is called a  reversing 

trade.  The exchange nets out your long and short positions, reducing your net position to 

zero. Your zero net position with the clearinghouse eliminates the need to fulfill at maturity 

either the original long or reversing 

short position. 

 The   open interest 

 on the con-

tract is the number of contracts out-

standing. (Long and short positions 

are not counted separately, meaning 

that open interest can be defined 

either as the number of long or short 

contracts outstanding.) The clear-

inghouse’s position nets out to zero, 

and so is not counted in the compu-

tation of open interest. When con-

tracts begin trading, open interest 

is zero. As time passes, open inter-

est increases as progressively more 

contracts are entered. 

 There are many apocryphal sto-

ries about futures traders who wake 

up to discover a small  mountain of 

  

1

 Euronext.liffe is the international derivatives market of Euronext. It resulted from Euronext’s purchase of LIFFE 

(the London International Financial Futures and Options Exchange) and a merger with the Lisbon exchange in 

2002. Euronext was itself the result of a 2000 merger of the exchanges of Amsterdam, Brussels, and Paris.