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In a message dated 1/27/02 1:55:51 AM Central Standard Time,
kentr@xxxxxxxxxxxxxx writes:
<< John, first won't the "investing" public be better off in equity mutual
funds? I still haven't seen a convincing argument from you that these
"funds" are anything other than an attempt by the CBOT (and in my opinion, a
poor attempt at that) to move volume back to the pits.
***** Kent, I am not in the mutual fund allocation business, so I can't
answer that part of your question. I have outlined several flaws that I see
in this new contract in several or my commentaries. One of them is that this
is not really a managed futures product, though by some accounts this is
supposed to attract people who are interested in that concept. The biggest
difference there is the time frame. I tell investors they need to give a
managed futures product 6 months to a year before making a judgement about
its performance. This product cash settles every 2 weeks. So to my way of
thinking it is not going to be sold to the same people or even by the same
people who are selling managed futures.
You have really created a substantial argument FOR these funds other than to
say that people will want to trade them because they are liquid. And you
don't think the managers of these funds will be able to create funds that
will consistently go up over the life of each contract, which to me seems
like the only possible appeal these funds could have.
****** We will not know if they go up over time until we get a least a year's
worth of results. Until that time you have to be trading them on something
else if you are going to trade them at all. I think the arbitrage potential
is one way to trade them. But not like the locals will arbitrage them to lay
off their risk. Arbitrage as taking profits on components over time. I have
argued that the CBOT ought to construct some longer time frame X-Funds
(30-days) or some static X-Funds (long bonds, 10s, 5s and 2), which would
then have other appeals. The truth is that no one knows if this will work.
But the CBOT is in good enough hands these days that they will be nimble
enough to make the adjustments to broaden the appeal and utility.
An analogy to these X-funds would be to say "Let's create a new ETF family
on the AmEx that is composed of randomly selected stocks and the ETF only
lasts for 2 weeks at a time." Let's put MSFT, DD, PG, and WMT into an ETF
that has a lifespan of 2 weeks and see what happens. Who would go for that?
It's hard enough to make money trading just ONE of those names. And if the
ETF's do have a tendancy to go up, that will get arbed out.
****** But someone invented ETFs where there was not that before. I agree
with you about the potential for market tendencies to be eliminated. And
actually, I am not sure who this will appeal to. I don't know that the CBOT
really does either. But sometimes when you are developing new innovations
the best audience is not your existing users. When some guys built a smaller
slow disk drive asked their customers if they wanted to use this new product,
they said know. The people who developed it then went out and found some
people who could use the product. And thus developed the personal computer
business. See "The Innovators Dilemma" by Clayton Christensen for a more
in-depth explanation of this phenomena.
Here are my arguments why I think these funds will be stillborn:
1) Mechanical traders will not trade these because it will be nearly
impossible to backtest against these things because a) the components are
selected using different methods which may vary over time, and b) the
underlying components are all going to have different behavior over time.
****** Actually, I see the mechanical traders as having a higher likelihood
of using these because they do have the tools, experience and data to be able
to analyze these X-Fund baskets. That may not be the mechanical retail
trader, but rather the mechanical professional trader. I will say though
that I brought my O-Fund concept to the Omega List because I think they are
potential users of this contract.
2) Discretionary traders will not trade them because it is difficult to get
one market at a time right. The number of traders who trade spreads is
substantially less than the number of people who trade a single vehicle and
those who do trade spreads are trading RELATED markets for the most part.
Those few who do trade Wheat against the Euro are doing so for commercial
hedging purposes and need something that lasts a little longer than 2 weeks.
****** I am not sure about the discretionary traders because many of the
floor guys who will be trading this are discretionary traders at heart. I
would agree that there are less people trading spreads, though this is the
type of vehicle that can help change that. The increase use of electronic
order routing and electronic matching increases the chance that the retail
trader can also efficiently lay all or part of their risk. There is a lot of
spreading and program trading that goes on. And hedge funds are always
looking for new markets to trade. The unification of Europe around the Euro
has decreased the different types of notes being offered, which has reduced
certain games for the hedge funds. Thus, this may have some interest for
them. And if you can get the hedge funds, and the locals, with the
commercials active in the component contracts, then all you are missing is
the public trader. They may be the last to show up.
3) The "investing" public won't trade these because they don't want to have
to call their broker and roll every 2 weeks or face a delivery notice for
$100,000 worth of wheat, 5-year notes, copper, and yen.
***** I should not have used "investing" public, because I believe futures
market participants are traders, not investors. But traders may want to try
this. And there is no delivery, it is cash settled. The only delivery
considerations would be if you had the opposing component positions on in an
arb and forgot to take them off.
One of the aspects about this is there is a need to intelligently unwind the
arbs. This is not something that just throwing huge sums of money at makes
you the best. Brains are favored over bucks. So this is going to appeal to
the professional trader.
4) The "investing" public will not be able to take advantage of these
vehicles which "go up" in value over their 2 week life span because if the
contracts do show a tendency to go up every contract, that "upness" will get
arbed out by the pit traders. And I agree with you that it is unlikely that
the managers will even be able to create funds every 2 weeks that will go
up.
****** That is the big question. But will they have utility anyway. I think
they can. But only time will tell on this question. Just think about 50
XFunds trading though and all of the chaos of the arbitrage and the
unwinding. It may not be so easy to arb out the tendencies.
5) They are traded in the pits. Everyone is going electronic. Sure the
pits can absorb volume. But the electronic markets are getting better at
doing this. And I would argue that a computer would be far better at
arb'ing an X-fund vs it's constituent contracts than any human 24/7 and no
coffee breaks.
******* Everyone is not going electronic. We would like to think so, but
that is not the case. And open outcry is outlasting some of its harshest
critics. What open outcry does exceedingly well is spread trades. Whether
it is the spreading between one month and the next, or arbitraging between
the pits and the option pits, open outcry facilitates spreading very well.
What the X-Funds do is take unrelated markets and put them into a basket and
then the spreading, arbing and trading takes place. The largest customer of
the NYSE is the CBOE. That is largely program trading. As much as 35% of
the weekly NYSE volume every week is program trading related. So there are a
bunch of people willing to trade not just on a flat price basis, and they
understand spreading, laying off risk and arbitrage. In this case the
spreads will be riskless. If I am long an X-Fund that is long bonds and I am
short bonds against this, there is no margin for the bond position.
**** Now that being said, the trend is towards electronic matching of trades
and there will be some markets in the X-Funds that will be electronically
traded. So if an X-Fund includes a 30-Year Bond, 10-Year Note, emini S&P,
emini Nasdaq, etc., there will be opportunities to electronically trade those
components versus the X-Funds. And you will see more and more side by side
electronic markets in the future.
***** And lastly, I have seen the matching engine that facilitates the future
you anticipate, with impressive spreading capability. So in my mind it is
just a matter of time for the technology to get in place and the users
trained in its use.
Can you refute these arguments?
****** I offered my comments. Nothing is for sure when starting a new
contract. But the enthusiasm level is high at the CBOT and that is a good
sign.
John, I respect you for your enthusiasm for the futures markets and for
publishing a free newsletter which has substantial content. But I honestly
think you are getting snowed by marketing hype on this one.
****** Thank you, I do have an enthusiasm for the markets. I think we are at
the most interesting and challenging times in the futures industry's history
and I am happy to be playing a part in chronically that. I don't think I am
being snowed. I am a pretty tough character who speaks his mind. I was the
one at the seminar last week correcting the real X-Fund manager about the
lack of risk of having a major report due in one of the components on the
morning an X-Fund starts to trade. So I think I have a pretty good
understanding of the concept.
Either that or you are trying to snow us and based on my observations of
your posts over time, I don't believe that is your modus operandi.
***** That is only for you to decide. I value my integrity, but I let others
gauge it for themselves.
If you want to help the CBOT find some volume for the pits, why not try to
find some contracts that people will truly have reason to trade. Personally,
I don't see whats in the pits for anyone outside the CBOT, but it seems to me
that finding
contracts that have some application to the real world is the way to go.
****** I have tried to do that with some of my suggestions about the X-Funds,
give more people a reason to use them. But this is not just about the CBOT.
These funds can include contracts on nearly all the U.S. futures exchanges.
And you could see a lot more volume generated at other exchanges than with
the CBOT X-Funds themselves.
I honestly respect you, John but I think your enthusiasm for these things is
coming from the pit traders and not from the utility of this concept.
***** The utility of any contract is always in question. The banks did not
think they needed to buy memberships at the CBOT when 30-Years were launched,
but 6 months later they were banging down the doors for memberships and desk
space. Thank you for your respect. I appreciate it. And BTW, most pit
traders think I am terribly skewed towards electronic trading. On days when
I do write something positive about open outcry I have been told I can start
my own car that day.
Why don't you create a brainstorming forum to toss around some ideas for some
real meat and potatoes? Like Enron did with weather and energy. Sure Enron
is gone, but energy trading lives on and this country is and will be better
for it. Here's some starter ideas: inflation, unemployment, insurance risk,
business risk, shipping, fresh water, pollution, professional sports, taxes.
There! 5 minutes and I've come up with 9 ideas that are all mo betta than
the X-funds!
****** There are some pretty smart people behind this idea. I am giving them
the benefit of the doubt for right now. But I am always looking for new
ideas to consider.
And if all else fails, if the CBOT wants to really get some volume in the
pits, answer this question: why do some people prefer electronic trading?
1) No rape. (or at least less rape, and since it's electronic it's over
really fast)
2) Instant fills.
3) More visibility.
4) Narrow spreads.
5) Level playing field.
****** I agree.
You want volume? Put these things in the pits and try to hold back the
volume.
***** You mean put them on the screen, right?
"To Serve Man": Some people think it's a cookbook. Some people think it's a
get rich quick primer. Why are you running for office, John?
Kent
***** I am not running for office anymore. The election I was a candidate
for I lost. Or are you making some other reference?
****** Kent, thanks for your input. The respect is mutual. You make a lot
of great points. Only time will tell, but I think an informed community of
traders is the best community of traders. And I have just been trying to
make the discussion of this new product interesting and engaging. I think it
has potential, in its current for or with some changes. We shall see.
Regards,
John J. Lothian
Disclosure: Futures trading involves financial risk, lots of it!
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