Commodity Futures Trading Commission Research Articles

Trading Activity and Price Behavior in the Stock and Stock Index Futures Markets in October 1987

This paper discusses what actually happened during the October 1987 market break and the days immediately before. It attempts to lay out a set of stylized facts that describe differing categories of traders and how they behaved and reacted to each other during those days. We believe that this description of what actually happened provides a necessary starting point for financial economists interested in explaining the stock market break. Our discussion here will rely heavily on the report of the Presidential Task Force on Market Mechanisms, created by Ronald Reagan to investigate these events, as well as on the reports of the Securities and Exchange Commission and the Commodity Futures Trading Commission. [Both authors were staff members with the Presidential Task Force on Market Mechanisms.] We focus on trading activity on the New York Stock Exchange (NYSE) and on the S&P 500 stock index futures contract traded on the Chicago Mercantile Exchange (CME).

Studies of the 1987 stock market crash: Review and appraisal

Within four months of the stock market crash on October 19, 1987, there were six studies of what happened. The Brady Commission, the Commodity Futures Trading Commission, the Securities and Exchange Commission, the General Accounting Office, the New York Stock Exchange, and the Chicago Mercantile Exchange all produced reports that described and analyzed the Crash, and in some cases made recommendations for additional regulation. This paper examines the conclusions and analyses contained in these reports and provides a summary of their recommendations. Particular attention is given to the allegation that stock index futures trading was a significant factor in the Crash. In addition, the recommendations that higher margins be imposed on futures transactions and that formal trading halts be instituted in both the futures and stock markets are discussed in depth. A major conclusion of this review is that new market-making procedures are needed to cope with the growing institutionalization of trading in equity and equity-derivative markets.

Stock Index Futures and Stock Market Activity in October 1987

A Securities and Exchange Commission staff study of the stock market decline of September 11-12, 1986, attributed it to changes in fundamental economic perceptions; strategies involving stock index futures, the SEC found, contributed little to the magnitude of the decline, although they may have condensed the time period over which it occurred. But what of the much larger market decline of October 19? Of the firms in the Commodity Futures Trading Commission's large-trader reporting system, 12 brokerldealers and four portfolio insurers could be identified as principal futures market traders on October 19 and adjacent days; these 16 firms accounted for almost all stock index arbitrage and portfolio hedging by customers during the mid-October period. Data from them indicate that index arbitrage accounted for approximately 9 per cent of the NYSE's volume on October 19. Portfolio insurance strategies accounted for 12 to 24 per cent of short-side volume in SP as such strategies do not involve related trading on the NYSE, these data are not expressed in terms of NYSE volume. The CFTC is currently looking at the quantity and timing of arbitrage and portfolio insurance trading during the period surrounding October 19; the intraday level of stock and futures prices and the cash-futures basis; any evidence of a cascade effect, whereby futures market trading exacerbated stock market volatility; and the liquidity of futures markets.

Regulating Financial Services: How Severe are the Dangers?

The Financial Services Act has been variously criticised for obstructing competition and increasing operating costs for the producers of financial services in Britain. Robert R. Davis, Commissioner at the Commodity Futures Trading Commission in Washington DC, argues that there are ‘public‐goods’ considerations to justify the imposition of the Act, and that its internal guarantees will check the growth of regulation. Len Ross, Principal Lecturer in Economics at the Polytechnic of Central London, maintains his earlier charge that the Act will do immense damage to British trade in financial services.

An Analysis of the Role of "Insider Trading" on Futures Markets

Section 23(b) of the Commodity Exchange Act requires the Commodity Futures Trading Commission (CFTC) to examine the possession by futures traders of nonpublic information concerning other persons' cash market or futures activities and to report to Congress on the adequacy of the commission's authority to prevent resulting from those circumstances. This request for a study of represented a compromise between groups that wanted to outlaw insider trading and those who felt that current regulations in the area were adequate. Unfortunately, section 23(b) does not define material nonpublic information, or state what abuses are associated with its possession, or require the CFTC to produce a costbenefit analysis of the effects of increasing the CFTC's authority. This paper provides a framework in which to analyze the role of insider trading in futures markets. Within this framework it will be possible to provide meaningful content to the terms mentioned in section 23(b) and to consider what evidence could be collected regarding correctable associated with insider trading.

The Political Economy of Futures Market Regulation

Public regulation of futures markets has a long history. The cotton and the grain futures exchanges were already under some form of federal regulation by 1922. Jumping ahead in time, the formation of the Commodity Futures Trading Commission (CFTC) in 1974 was a response to the anticipated growth in the size of market and in the number of traded instruments and need for a coordinated policy for the regulation of futures markets. While futures markets have been regulated in one sort of a way or another for many years, little is known about the sources of support for regulation and precious little is known about the underlying reasons for the regulations. This paper offers both a brief historical account of the regional sources of support for futures legislation and a more contemporary account of the effects on membership seat prices of the recent jurisdictional conflict between the CFTC and the Securities and Exchange Commission (SEC). Public apprehension of futures markets and exchanges has a long history. Even though this

Regulatory Conflict and Entry Regulation of New Futures Contracts

When an automobile manufacturer decides to introduce a new product such as a new model of car, it is free to do so. It does not have to convince a regulatory body that the new model has an economic purpose or is in the public interest. Nor does it have to demonstrate that the car will not break down excessively or that consumers who purchase the car are making a sound financial decision. When an exchange that sells transactional services decides to offer a new product such as a new futures contract, however, it must convince one or more regulatory agencies that the proposed contract meets each of the above tests. Under guideline 1 of the Commodities Futures Trading Commission (CFTC),' every application by an exchange for a new futures contract must contain a description of the cash market, an analysis of the terms and conditions of the contract, an explanation of how the contract would fulfill an economic purpose, and a statement of how the contract furthers the public interest. As required by statute, the CFTC has focused primarily on the susceptibility of a particular contract to manipulation. The larger the deliverable supply, the lower the probability of manipulation.

Market Regulation and International Use of Futures Markets

One of the arguments given in favor of the creation of the Commodity Futures Trading Commission (CFTC) in 1974 was the need to extend regulation to previously unregulated commodities. Under the CFTC's predecessor, the USDA Commodity Exchange Authority, futures markets for such international commodities as coffee, cocoa, sugar, and the metals had been largely unregulated. The argument in favor of increased regulation for these markets was parity-all U.S. futures markets should be treated alike. In arguing against increased regulation, domestic exchanges trading futures contracts on international commodities stated that federal regulation would drive business to competitive markets overseas, where traders were unfettered by regulations which required filing reports on their positions and trading. In fact, a representative for three exchanges claimed that if any of the bills calling for the creation of the CFTC were passed, the three exchanges would go out of business in four or five years (Chapin, p. 472). More recently, the argument has been reversed. One of the reasons given for the rapid growth of U.S. futures markets compared to British markets is the greater investor protection in U.S. markets because of federal regulation (Hewson, p. 14). In addition, new legislation and/or regulatory bodies for futures markets are being considered in Canada, England, France, and Australia. The purpose of this paper is to consider the competitive effects of market regulation. Briefly, we will describe regulatory differences between U.S. and British futures markets and then, using intervention analysis, examine the level of activity on competing U.S. and British futures markets for cocoa, coffee, and sugar during the period 1970 to the present to see if important regulatory changes affect the volume of trading on these markets. Testimony provided to a Senate committee by the CFTC indicates that in the United States foreign traders make up a sizable proportion of all futures traders holding reportable positions in these commodities. The data revealed that about 30% of the long side and 45% of the short side of the total open interest in these commodities on 24 May 1983 was held by reportable foreign traders (Phillips). Commercial multinational firms are the predominant users of these futures markets. They are highly sophisticated traders who follow international prices and government policies closely and are experienced in dealing with foreign trade risks. As a result, it is assumed that they could shift their futures trading from one market to another if they wished to avoid regulation they considered too burdensome. It should also be noted that in addition to regulation, a number of other factors affect a trader's choice of futures markets, including exchange rate risk and foreign exchange controls, futures contract differences, taxation, and international and national commodity programs. This brief paper, however, does not allow us to consider these factors.

Regulatory structure in futures markets: Jurisdictional competition between the sec, the cftc, and other agencies

This paper studies competition among alternative regulatory bodies for authority over innovative financial contracts. In the United States, this rivalry embraces not only the Commodity Futures Trading Commission and the Securities and Exchange Commission, but state and federal deposit-institution regulators and various private regulatory cooperatives. From a political perspective, multipleregulators develop as a way of formally providing ongoing protection for the interests of diverse political constituencies. But from an economic perspective,competition resulting from overlaps in regulatory responsibility establishes an evolutionary mechanism for adapting regulatory structures to technological and regulation-induced innovation. Using both perspectives, this paper explains how interaction between governmental regulatory agencies and self-regulatory cooperatives produces more-efficient regulatory structures over time.The study also seeks to catalog the particular costs and benefits that may be associated with the regulatory tools used to control futures and securities markets(e.g., broker and trader registration, disclosure requirements, margin requirements,and contract-approval processes) and with changes in the distribution of jurisdiction over these tools. The analysis seeks to clarify the tradeoff between the perceived probability of various problems of market performance (e.g., contract nonperformance, widespread financial instability, and activities such as price manipulation by which corrupt or sophisticated operators separate naive investors from their wealth) and the implicit and explicit cost of reducing this probability.

The Determination of Spot and Futures Prices with Storable Commodities

This paper analyzes the effects of futures trading in a market for a storable commodity, in which producers and speculators are assumed to be risk averse and specifications of the aggregate supply and inventory demand functions are derived from explicit optimization. A critical aspect is how the parameters of these functions change with the introduction of the future market as it is through these induced parameter changes that the futures market exerts its influence on the spot price. The effects of the futures market on both the long-run average spot price and its variance are analyzed. While we are unable to draw any definitive conclusions on this issue, we find that in all cases considered the futures market stabilizes the spot price, as well as lowering its long-run mean. FOR MANY YEARS NOW, the question of the effects of futures trading on the stability of spot prices has been extensively debated. This topic has been discussed at various levels. For example, farmers and agricultural interest groups have claimed that futures trading destabilizes spot prices, thereby imposing welfare losses on the economy. In the United States, Congress has decided that futures trading can cause price destabilization and has subjected futures trading to the regulation of the Commodity Futures Trading Commission. At a more analytical level, economists have been investigating the issue, both empirically, and more recently, theoretically as well.

Options, futures, and business risk

Journal of Futures MarketsVolume 2, Issue 2 p. 141-149 Article Options, futures, and business risk James F. Gammill Jr., James F. Gammill Jr. Doctoral candidate in finance at the Sloan School of Management of the Massachusetts Institute of Technology. He served on the Chairman's staff at the CFTC during 1980 and 1981Search for more papers by this authorJames M. Stone, James M. Stone Commissioner and former chairman of the Commodity Futures Trading Commission in Washington, D.C. Dr. Stone received both his B.A. and Ph.D. in economics from Harvard University where he then taught as a lecturer on EconomicsSearch for more papers by this author James F. Gammill Jr., James F. Gammill Jr. Doctoral candidate in finance at the Sloan School of Management of the Massachusetts Institute of Technology. He served on the Chairman's staff at the CFTC during 1980 and 1981Search for more papers by this authorJames M. Stone, James M. Stone Commissioner and former chairman of the Commodity Futures Trading Commission in Washington, D.C. Dr. Stone received both his B.A. and Ph.D. in economics from Harvard University where he then taught as a lecturer on EconomicsSearch for more papers by this author First published: Summer 1982 https://doi.org/10.1002/fut.3990020205Citations: 2 AboutPDF ToolsRequest permissionExport citationAdd to favoritesTrack citation ShareShare Give accessShare full text accessShare full-text accessPlease review our Terms and Conditions of Use and check box below to share full-text version of article.I have read and accept the Wiley Online Library Terms and Conditions of UseShareable LinkUse the link below to share a full-text version of this article with your friends and colleagues. Learn more.Copy URL Share a linkShare onFacebookTwitterLinked InRedditWechat Citing Literature Volume2, Issue2Summer 1982Pages 141-149 RelatedInformation

The Pricing and Social Value of Commodity Options

Commodity options are the right to buy or sell a specified quantity of a commodity, or commodity futures contract, at a specified price. The publicity surrounding several boiler room scams involving unwary buyers has given commodity options a bad name. Currently, only a handful of firms sell legitimate commodity options. Commodity options can, however, offer social benefits not provided by other investment vehicles. For example, they have several advantages over futures contracts. Their prices reflect information more quickly and fully than the prices of futures contracts. They allow investors to eliminate the risk of margin calls by paying an option up front. They allow producers and investors to hedge quantity, as well as price, risk for seasonal crops; using futures contracts, a farmer can form a perfect riskless hedge only if he knows exactly how much of a commodity he will have after a future harvest. Furthermore, the distribution of returns on options, which ensures that only the premium is lost regardless of how much futures prices fall, may attract to commodity option markets investors who need to hedge their assets against volatile fluctuations in price. The Securities and Exchange Commission and the Commodity Futures Trading Commission have recently moved to allow exchange trading of commodity options. Organized exchange trading may be expected to increase trading in, hence expand the social benefits of, commodity options. Exchange trading might also improve price efficiency in option markets. Tests using a variant of the Black-Scholes formula for option pricing indicate that, under the current system of private firm market-making, commodity option prices do not always accurately reflect all available information.

The Pricing of Options on Debt Securities

In this paper we present a method for valuing American and European put and call options on debt securities. Although no exhange-traded options of this type currently exist in the United States, the Chicago Board Options Exchange plans to introduce option contracts on several government bonds, and the Chicago Board of Trade petitioned the Commodities Futures Trading Commission to allow the trading of options on the Ginny Mae futures contract. In addition to pricing put and call options, the model developed here can be applied to the valuation of other securities such as callable bonds and bank loan commitments.

A Regulator's Perspective on Regulatory Research

sources to developing a better understanding of the costs as well as the benefits of regulation. This will enable the political system to formulate regulatory policy more responsibly and it will help regulatory agencies implement that policy most efficiently. I am pleased to be invited to participate in this conference as I firmly believe that the application of economic analysis to this relatively new area of public policy has the potential for high social returns compared with other areas of work. When I came to Washington from Oregon State University nine years ago, I had little interest in regulation and no teaching or research experience. I soon learned that regulation was a priority area of work at the Council of Economic Advisers. The Council was active in advocating less regulation of surface freight transportation, commercial airlines and natural gas production. The Council was also conducting analysis of the newly-emerging environmental regulations. I first was exposed to the Council's regulatory analysis while I was on the staff. After I became a member, a major part of my responsibility was to coordinate the Council's regulatory analysis and represent the Council inside and outside government. Unfortunately, the amount of work which was needed greatly exceeded the capacity of the Council's small staff of two professionals in this area. This was especially true since new regulatory programs and requirements were proliferating rapidly in the early 1970s. During the past four years I have been deeply involved in establishing a new regulatory agency which oversees commodity futures trading. My remarks today, therefore, will be from my experience as a regulator-from the inside, so to speak. The Commodity Futures Trading Commission (CFTC) was created by Congress in 1974 when commodity markets were exceptionally turbulent. In addition, establishing new federal regulatory programs was fashionable during this period. Even though Congress is more skeptical about starting new regulatory programs today, I believe they would have to establish the CFTC now if they had not already done so. I know Congress considers effective regulation of futures trading to be desirable and essential for the protection of the hedging and pricing functions of futures markets as well as for the protection of those who use the markets. Let me make four general observations based upon my experience as a CFTC Commissioner. I hope my perspective will help you determine how to get a handle on regulatory research, which is not an easy task.

The Pre-emption Doctrine and the Commodity Futures Trading Commission Act: In Favor of State Law

The Pre-emption Doctrine and the Commodity Futures Trading Commission Act: In Favor of State Law

Discussion of Market Implications

The two papers presented at this session contain many points with which I can only agree, but also some thoughts with which one can take issue. In line with this, I would like first to share some thoughts that occurred to me while reading the two papers, and then add some observations made from my specific vantage point as financially-oriented researcher and investment analyst in a major agribusiness firm. The Barry/Fraser paper focuses on increased price variability for the farmers' products as an indicator that financial risk in primary agricultural production has increased. Furthermore, the paper discusses risk management primarily in terms of minimizing price variability and stabilizing expected returns. I contend that price variability, in itself and without reference to the corresponding cost of production, does not prove that the probability of incurring a financial loss has increased. It merely establishes the fact that it will statistically be more difficult to obtain the highest price possible. As a case in point, aggregate net farm income during the years 1973 and 1974 has reached unprecedented heights, both in absolute dollars and in relation to assets employed. This was not the result of a very sudden increased sophistication on the part of farmers to deal with the greater product price variability. The coefficients of variation for the annual mean prices shown in table 1 of the Barry/ Fraser paper are meaningless in my opinion because they are influenced heavily by the length of period selected for analysis and by the underlying secular trend in price levels. The paper points to a growth of over 1200% in debt per farm between 1950 and 1975 and a payback period of nearly three years for this debt as indicators of decreasing ability of the farm sector to absorb financial risks. But comparing statistics from the U.S. Department of Agriculture's Balance Sheet of the Farming Sector 1974 with comparable data for the Grain Processing Industry (SIC 2041) and the Agricultural Merchandising Sector, it beomes evident that these other sectors operate on a smaller gross profit margin and a much thinner cushion of financial reserves. This is what made it mandatory for them to devote major efforts to the task of risk management. Considering relative strength of net worth, it would take only a small fraction of the unhedged decline in the price of commodities to completely wipe out the net worth of a merchandising firm, compared to the decline necessary to completely dissipate the net worth of the farmer (see table 1). Barry/Fraser also suggest that more frequent sequential marketing can reduce risk, which is correct if we assume that risk aversion is the ultimate goal. But sequential marketing does not optimize prices. It is an averaging procedure that only guarantees that something better than the lowest price will be obtained. Maybe this explains why pooling results achieved by the cooperatives, as well as by the Canadian and Australian Wheat Boards, have been mediocre at best. Professor Gray's paper emphasizes institutional factors and the role of organized futures markets. I agree with his comments both in regard to the value of these institutions to our society and to the limitations still remaining. But in regard, for instance, to the lack of a sorghum futures contract, a broader definition by the Commodity Futures Trading Commission of bona fide hedging could do much to alleviate the present problem. Cross-hedging sorghum in corn futures gives essentially as much price protection as can be obtained hedging corn in corn futures. Another problem mentioned is the need for added margin calls to hedgers during periods of adverse price movements. It would seem there should be an objective reappraisal of using commodity options to deal with this problem. (Obviously, I would be opposed to dealing in naked options.) The hedger would in effect have already purchased with the option all additional margin potentially due if the market changes required it. Konrad Biedermann is the director of planning at the Continental Grain Company, New York.

The Role of the Commodity Futures Trading Commission under the Commodity Futures Trading Commission Act of 1974

The Role of the Commodity Futures Trading Commission under the Commodity Futures Trading Commission Act of 1974