INTO THE FUTURES
By Journal of Indexes Staff

CFE VIX Vooms

The CBOE Futures Exchange (CFE) posted a 170 percent volume increase in 2005, thanks largely to the impressive growth in the CBOE Volatility Index (VIX) futures. In December, VIX futures represented more than 90 percent of total futures volume, with more than 43,000 contracts trading hands. The VIX options contract, which trades on the CBOE, trades over 500,000 contracts per month.

ICE-BOT? NYCE? NYCE-BOT?

Whatever acronym they choose, the pending merger between the IntercontinentalExchange (ICE) and the New York Board of Trade (NYBOT) will transform the commodities futures trading landscape. Assuming it goes through, the merger will bring together the fastest-growing energy futures exchange with the dominant market for "softs" and other agricultural commodities.

Wall Street has been overwhelmingly bullish on the agreement. ICE's stock jumped 15 percent on the day it announced the merger— something that almost never happens for an acquiring company. And seat prices on the NYBOT are up fivefold over the past 12 months.

The merger will help ICE expand into the market for agricultural and "softs" contracts—an increasingly important segment of the market that is dominated by the NYBOT. The NYBOT also brings with it an established currency market, headlined by the wildly popular U.S. Dollar Index futures, as well as a small equity market lineup headlined by products tied to the Russell indexes.

One of the most interesting contracts, and the one that has garnered the most attention in the wake of the merger announcement, is sugar. The NYBOT sugar contract is a contract for international delivery, and is used as the benchmark in Japan, Russia, Australia, and many other countries. With the recent boom of interest in ethanol, this contract is being transformed from an agricultural product into an energy product. ICE executives envision arbitrageurs trading sugar side by side with traditional energy derivatives, playing the spreads between the two contracts. (In fact, the NYBOT is also home to the fledgling ethanol contract itself.)

The biggest factor driving the deal, curiously, has nothing to do with new markets; instead, it has to do with clearing. Clearing—vouching for, settling and finalizing contract trades—is a big business in the derivatives market, where trades are complicated, and where the creditworthiness of the opposing party isn't always a given. Currently, ICE generates zero clearing revenue for its massive energy futures business, while NYBOT does all its own clearing. By integrating into the NYBOT system, ICE CEO Jeffrey Sprecher expects to save over $40 million in annual costs.

Love Thy Neighbor?

One quirk with the ICE-BOT merger is that the NYBOT currently leases its floor space from ICE's archrival, the New York Mercantile Exchange (NYMEX). According to a provision in the lease, if the NYBOT is acquired, it cannot trade contracts that compete with products traded at NYMEX.

In a fit of pique worthy of a Mexican soap opera, as the ICE-BOT merger was being finalized, the NYMEX announced plans to launch six agricultural contracts that would compete directly with the NYBOT's key contracts. Assuming NYMEX follows through with the launches, it would put the lease provision in play, and would make the new merger much more complicated.

"We believe the NYMEX action is a transparent attempt to interfere with the merger of NYBOT and IntercontinentalExchange (ICE)," said NYBOT CEO Harry Falk at the time.

Goodbye, 2 And 20

Forget "2 and 20," the ugly hedge fund fee arrangement that charges investors 2 percent per year and 20 percent of any profits. Two professors from the Cass Business School in London think they can deliver the same returns for about 36 basis points per year.

Professor Harry Kat and Helder Palaro have launched a new project called "Fund Creator," which uses various algorithms to create synthetic futures portfolios designed to meet certain risk/return profiles. The computer program spits out trades on a regular basis, and investors can follow along to earn those returns. The group says the new strategy has outperformed real hedge fund managers 82 percent of the time over the past 15 years.

Goldman ART

Kat and Palaro aren't the only ones getting into the hedge fund replication game. Goldman Sachs has launched a new product called the "Absolute Return Tracker," or ART, that uses complicated algorithms to digest the performance characteristics of thousands of hedge funds and mechanically create a tracking portfolio. The group will charge just 1 percent in fees.

Merrill Lynch has also developed a mechanized hedge fund tracker. Can ETFs and index funds be far behind?