A CALL TO ARMS

Remarks before the Index Trading Coordination Committee ("ICC") meeting, offices of Salomon Brothers,
New York, New York,
September 30, 1986.

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With every passing week that showed an increase in the transaction volume of S&P 500 futures, there was a commensurate increase in the attack against them. This negativism was part of an increased attack on index investing, a relatively new investment methodology. The trend toward index investing was growing and perceived as a threat to orthodox equity investment strategies. It was the beginning of a difficult conflict between these two forces.

Index enhancement strategies utilize index futures and options. Consequently, our markets became the target. Since index futures were new, mysterious, and had no establishment constituency, they took the brunt of the attack. No one spoke up in our behalf, no one came to our defense, and no one explained our function or our necessity.

We developed a long-range strategy. However, we needed assistance from the financial establishment in order to initiate our short-range plans which involved an immediate counter-attack. We looked to our equity-based members who were index futures users and arbitrageurs. They understood the index market and the role of futures; they used our market to the benefit of their customers and their firms; and they understood that index futures were an outgrowth of modern investment strategies and had become an integral part of the equity market. These member firms had credibility with the media and we had to energize their voices. We implored that they assist us in a counter-attack.

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Anyone who is not aware that index investing—and consequently index futures markets—are under attack, is either dead, asleep, or living in Alice-in-Wonderland. In the past two weeks, I have heard and read more negative diatribe about index strategies, program trading, triple witching, and stock market volatility than I have in the past two years. Everyone, it seems, who has the power of the pen, and is even remotely connected with the financial arena, has felt compelled to expound upon the evils unleashed by index investment strategies and the use of index futures. And, let's face it. It is true that the new strategies are often connected to futures and options—instruments suspected as the work of the devil. The exchanges, where these mysterious instruments are traded, are predominantly located in Chicago—not a locale that is associated with virtuous finance or a place that inspires confidence. So why not attack the credibility of these markets? Why not question their necessity? Cast doubt their value?

I need tell no one in this room what the problem is. I need not explain that index investment methodologies are perceived to threaten orthodox investment strategies. I need not illustrate that this conflict boils down to income flows between two different profit centers. I need not illuminate that future markets have taken the brunt of this attack. That our markets are blamed whenever the equity market goes down but receive no credit when the equity market goes up. Even John Shad admitted recently that all the undesirable effects of program trading—the volatility and price swings on expiration dates—get all the publicity, while the desirable effects of their nature go unnoticed.

Imagine that! After four years of a bull market as great as any on record in the stock market, with a budget deficit larger than mankind has ever before witnessed and no relief in sight, with a record trade deficit, with economic forecasts and data that is rather sad, with interest rates ticking up, with inflation showing some sign of life, and with a tax reform package that penalizes you 18-1/2% for holding on to your investment, one still needs to find a culprit for a market correction. And, if a culprit is needed, why not blame it on index futures.

Represented in this room are members of our community who understand the problem, who are concerned about the problem, and who, we believe, can help us do something about it. We called you together because we feel you represent the predominant users of index futures and options, because you know the value of these instruments in index investment strategies, and because you can act as a source for our credibility with the media and the public. You are the professionals and experts the media respect. We asked you to join with us today so that we could: Underscore the severity of the problem; provide you with substantive facts and statistics with which to combat the problem; and, implore that you help us educate the media and aggressively come to the defense of the markets that you utilize.

Let's face it. The truth is that index enhancement strategies represent relatively new, cost-effective methodologies for equity investment. Our markets allow you to effectuate these innovative strategies in a rapid manner. Simply stated, our markets represent a marriage between, modern market strategies, modern portfolio management and present-day technology. The orthodox investment establishment does not like what we represent. They view us as a threat to status quo. In order to satisfy their preference, or those who simply fear change, we would have discard modern investment theory, destroy the computer chip, throw the cathode-ray tube out the window, abort the telecommunication revolution, and return to the day when the rotary telephone was our main link with the world.

Index investing, like block trading, like mutual funds, like futures, like stock options, like Treasury bill futures, and like the many other innovative and revolutionary ideas of the last twenty years, are indicative of the changing times. They are a result of the here and now. It is incumbent upon those of us who witnessed and participated in these changes and who understand the changes and the reasons for their necessity to stand up and be counted.

We are here to ask you to help us explain the virtues of our markets. We need assistance in educating the media about the function of futures in modern investment techniques. We need you to say why we are important to the marketplace. We need you to help us get the word out. Otherwise, all we will have in public view is the irresponsible, misguided, misinformed, and sometimes intentionally malicious impressions from those who do speak to the writers of financial columns who themselves know so little. Unfortunately, it does not end with the media. Remember, there are people who read this nonsense. The readers are the voters, voters affect the legislators, and legislators affect the regulations. And whether you like it or not, most people believe what they read. And if I'm paranoid, as the saying goes, it does not necessarily mean I'm wrong.

Remember, there are enemies of markets out there. Enemies who are against change, against innovation, against the free market system in general and against index investment strategies in particular. A misinformed press is powerful ammunition for their weapons. And if anyone here thinks I exaggerate, that I overestimate the danger, allow me to dislodge you from this notion. I am no newcomer to this scene. You are hearing it from someone who has been on the firing line for the past twenty years. I have encountered the enemy before. They use real bullets and they mean business.

We have a comprehensive defense strategy which includes both long-range and short-range plans. Our long range plans include a mass education program. Primarily this will focus on academic institutions. We need colleges and universities to include modern investment strategy and the use of our markets in their academic programs. We will also authorize and encourage studies about futures and their impact on volatility, investment, capital formation and the equity market. But such programs takes time.

Short range, we propose an immediate media counter-attack. To this end, we want you, your associates, and anyone else you can influence to assist us. We suggest you stop dodging the questions from reporters. Stop hiding. Become visible. We want you to even seek out the members of the financial press and give them your opinion. Educate them and get your viewpoint into print.

Explain to them the difference between triple witching—which occurs four days a year—and the use of futures in index investment strategies, the other 361 days. Explain what our markets are about. Explain that arbitrage is as old as mankind, that it serves an important purpose in leveling differences between different markets, that while by definition it is riskless, there are risks, and that it requires know-how as well as capital. Help us educate the media about the benefits our markets provide to investors—large and small. Explain to them how professional money managers use index markets to increase the return on portfolios on behalf of investors.

You can show them that small investors who invest in mutual funds benefit by these strategies. You can tell them that the world has changed and that we represent that change. You can tell them that you cannot go back in time. You can explain how our markets provide buyers when the sellers want to sell and vice versa. You can discuss fundamentals that affect market movement and that our markets—no different than cash markets—respond to supply and demand. And you can help us explain that these markets represent efficient, cost-effective and a modern-day techniques that work in harmony with the stock market. Explain to them that we are all one market and cannot exist without each other.

If you will all roll up your sleeves and become visible and make your voices heard, you will provide the immediate return of fire needed now. This will coincide with some of our other short-range plans which are aimed at educating the financial press. More important, your immediate actions will give us time to put in place our long-range strategy which is designed to permanently preserve our markets and your right to use them.

Reprinted by permission. Excerpted from Melamed on the Markets, by Leo Melamed. John Wiley & Sons, 1993

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