Introduction:

• Centralised meeting place for investors
• Enhances liquidity
• Regulated and regulator (of their members)
• Exchanges are regulated, but can't authorise firms
• Transparent Markets
• Reporting

Products:

• Financials
• E.g. Shares, bonds, interest rates, FX
• Commodities
• E.g. Metals, energy, agriculturals, softs
• Exotics
• Weather, emissions credits, freight

Contract Specifications (Set by Exchange)

• Quality
• Size (E.g. One Contract (lot) = 1000 Barrels)
• Quotation (How is it priced)
• Tick Size
• Minimum price movement of a contract (E.g. FTSE 100 = 0.5pt)
• Tick Value
• Profit or loss for a one-tick movement (E.g. FTSE 100 = £5)
• Delivery Month
• Notice days
• Last trading days
• Delivery days
• Exchange Delivery Settlement Price (EDSP)
• Price paid for good delivery

Limit Order:

• Level One
• Touch Strip
• Level Two
• Market depth
• No guarentee of execution

• Limited Order - Sell 6000 at 210 Limit
• No worse than price, 211 yes, 209 no

Market Order:

• At best order
• Just fill the full order at the best price possible
• Market if touched
• Market order with an activation price

Stop (or Stop-loss):

• Uses a market order to close the position, to limit trading losses
• Activated when the market moves against a trader, past a certain point
• No guarantee on price once activated
• All positions will be closed

Stop Limit:

• Uses a limit order to close the position, also to limit trading losses
• Closes out a position when the market moves against a trader, past a certain point
• Once activated, the price is limited to a specified price or better
• Some positions may not be closed

Orders can be:

• Day order
• Order to buy or sell a contract that automatically expires at the end of the day if unfilled
• AKA Good for the Day (GFD)
• Good-till-cancelled (GTC)
• The order is firm until the client specifies otherwise

Limit or Market on Close:

• Limit order all day, if not filled buy Market price at closing period

Membership structure and trading rights

• Dealer Members
• Allowed to perform principal trades for their own accounts
• Broker member
• Allowed to perform agency trades for client accounts
• Duel Capacity
• Acts as a broker and a dealer member
• Cross trades
• The member takes both trades and enters into both sides of the trade (buy/sell)
• Then report into the exchange

Clearing Members:

• General Clearing Members (GCMs) can arrange clearing of trades on behalf of:
• Themselves
• Their clients
• Other exchange members

• Individual Clearing Members (ICMs) can arrange clearing of trades on behalf of:
• Themselves
• Their clients

• Non-Clearing Members (NCMs) cannot clear trades, so 'give up' trades to GCMs for clearing (they can have a a maximum of two agreements
• Process
• Pre-registration by the executing firm
• Registered to the clearing firm's accounts
• Final Registeration done by clearing house in clearing brokers name
• Give Up = Executing Broker + Clearing Broker = Different

Order vs Quote Driven Systems:

• Quote-driven - Designed for illiquid contracts (No natural liquidity, so guarteed liquidity through market makers)
• Price makers
• Bid/offer spreads
• Screen and phone based
• Open outcry (Physical, floor based trading)

• Order-driven: Designed for more liquid contracts
• Negotiated prices
• Electronic trading (More of a matching engine, due to high amounts of buyers and sellers)
• More likely to achieve a fairer price

Order Book (Straight Through Processing)

• Client to Broker
• Through the Electronic order book system
• To the clearing house

Open Outcry:

• Client to Broker
• Broker completes order slip to give to booth clerk
• Booth clerk then completes a dealing slip and passed to pit trader
• Trader gives dealing slip back to booth clerk after trades complete
• Booth clerk runs the matching process
• Broker sends to clearing house
• Dealing slip also has to be given to pit officals
• Pit officals are responsible for offical prices and quoting vendors

Open Outcry: Case Study

• London Metals Exchange
• Has open outcry, but also order book (LME Select)

LME Select open from 01:00 - 19:00

Open Outcry Session 1:

• Ring 1
• Ring 2 - Official LME prices set
• KERB 1

Open Outcry Session 2:

• Ring 3
• Ring 4
• KERB 2 - Closing prices set

In each Ring Session, each Metal trades for 5 minutes

In the KERB Sessions, all Metals trade together

• Also has 24 hour inter-office market
• Quote-driven platform

Electronic Order-driven Trading:

• ICE Connect, CME Globex and LME Select

If order is matched between Buyer (Clearing Member) and Seller (Clearing Member)

• The trade is then registered with the Clearing House
• Clearing house then become the Central Counterparty (CCP)
• CCP becomes the buyer to the orginal seller
• And the Seller to the orginal buyer