TOMORROW'S TECHNOLOGICAL TIDAL WAVE

Presented at the Seventh Annual London International Finance Symposium Conducted Jointly by the Chicago Board of Trade and the Chicago Mercantile Exchange,
London, November 7, 1991.

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Futures markets, as their name implies, should provide a glimpse into the future. In truth, they often don’t. The future is habitually too clouded and burdened with too many imponderables to be seen clearly.

For instance, here we are at the end of the twentieth century in the midst of a global rebirth, one that should offer an unequivocal picture of a bright tomorrow. Communism slain, the tyrannical order of the Soviet Union dismantled, East European nations freed, market economic order embraced by all, apartheid in retreat, emerging nations in the Pacific Rim, the European Economic Union about to commence. Good stuff.

And, yet, something gnaws at making an unguarded optimistic prediction for the world. Perhaps it is because we know of the contradictory and uncertain nature of mankind. Perhaps it is because we know the steep price tag of all that lies before us. Perhaps it is because we are concerned that the global credit spree of the 1980s will demand payment in the 1990s.

So instead, allow us to stay clear of the unknown. Allow us to talk about the inevitable. Allow us to predict that whatever ensues, the role of futures and options will be significant. Allow us to predict that whatever ensues, our markets are about to be engulfed by a technological tidal wave.

Robin Maxwell settled back and buckled the safety belt around her as the British Airways 787 taxied out to the runway at Kennedy. She pulls from her briefcase an IBM IAM-Port, her interactive multimedia portable system, and turns it on. After the screen in front of her comes to life, she executes a few directions using the system’s electronic mouse and is instantly connected to the Equity Information Center at her Goldman Sachs office in New York. A few more clicks on the mouse gives her the information she requested as well as an online data feed to various markets around the world. Robin studies the information, then calls up a trader friend in Chicago, who appears on her online video screen for a brief discussion of her market theory.

As the airplane levels off at 35,000 feet, Robin checks the time in London, calls up for a Globex connection on the screen, and initiates orders to buy December S&P 500 contracts on the CME, sell March FTSE contracts at the LIFFE and CAC-40 contracts on MATIF, a complex DAX/Nikkei options spread on the Deutsche Terminbörse and Osaka exchanges, and to buy February U.S. Bond puts at the CBOT.

When she is finished with the transaction, Robin watches the market for a while, sends a fax to her London office, takes a sip of the coffee the stewardess provided, and asks her IAM-Port to review the current crop of plays showing in London so that she can make reservations for that evening.

Science fiction? Don’t bet against it. Interactive multimedia—a multidimensional vehicle of communication representing the coalescence of key communications technologies: television, telephone, personal computers and laser storage systems—is coming. When these technologies merge, life as we know it will never be the same.

While Robin Maxwell’s interactive multimedia system is not yet available, what is available is quite amazing. Robin can easily install a calling card that provides her with 24-hour real-time market information in stocks, futures, options, and mutual funds.

Or she can install a real-time spreadsheet system which will display, analyze, and monitor continuously current financial data with electronic online data feeds.

Or she can install a portfolio information management system designed to document and control transactions and positions in actively managed portfolios or funds.

Or she can install a software product providing a host of analytical calculations, regression analysis, and exponential smoothing from single or multiple databases.

Or she can install a software providing daily investment performance calculations by account, currency, group, sector, and industry.

I could go on and on, but you get the point. These are not esoterica of a future tomorrow. I am describing a bit of present day avant garde technology. A few years ago, these systems were but on programmers’ drawing boards. A dozen years ago, they were someone’s overactive imagination. And 20 years ago? Well, let me tell you.

In 1972, the markets of futures and options were among the very first to discern the meaning as well as potential of the coming new financial age, an age that above all was to be directed by a new technological standard. The new technology, while still then in its infancy, was to instigate an information revolution that would dramatically change the scope, nature, and structure of financial markets forever.

As Walter Wriston then predicted, by virtue of the information revolution we would be witnessing a galloping new system of international finance, one that differed radically from its precursors in that it “was not built by politicians, economists, central bankers or finance ministers...it was built by technology...by men and women who interconnected the planet with telecommunications and computers.”

The results were spectacular. As a consequence today we live in one interrelated, interdependent world economy. Distinct divisions based on time zones have vanished. Geographical borders that once could limit the flow of capital are history. Internal national mechanisms that once could insulate one’s population from external price influences are impotent. Financial markets are now virtually unencumbered, continuous, and worldwide in scope.

Because the markets of futures and options understood the consequences of the new technology, embraced and adapted to its demands, our markets blazed the trail for much of what has since followed in world capital markets. We established that there was a need for a new genre of risk management tools responsive to institutional money management and modern telecommunications; we introduced the idea of risk management as a regime; we fostered the concept of financial engineering as a commercial necessity; we became the catalyst for the invention of a multitude of new products, both on and off exchanges; we caused the acceptance and integration of futures and options into the infrastructure of the financial establishment; and, we engendered the development of futures markets worldwide.

But that was the first phase. And while exciting and highly successful, it was only the beginning. The evolution of our markets is a continuous living thing and cannot stop. Nor, I daresay, will the breathtaking speed of technological innovation. I speak not of the good or bad of it, I speak only of its inevitability. Indeed, as the guy said, “You ain’t seen nothing yet.” What is coming down the technological trail in the very near future will again completely transform our marketplace and make trading unrecognizable from what it is today. What is coming is a computerized trading competence undreamed of but a mere decade ago.

Some of it is structural. Computer-aided systems engineering, the so-called CASE, represents a new wave in programming. CASE moves systems development away from its traditional art form and more into the realm of science. It applies engineering discipline and computer support to systems building. It allows software development to focus on solving business problems. Its applicability is boundless. The Paris Bourse, for example, used CASE to overhaul and streamline its clearing system in order establish a competitive edge in Europe. Similarly, Paine Webber, by enlisting CASE, will become one of the first wire houses to attempt to retool itself for the 1990s with a state-of-the-art distributed computer system that will provide round-the-clock online availability for trading, marketing, and customer data.

Some of it is being developed by the exchanges. For instance, on the Chicago Mercantile Exchange and the Chicago Board of Trade, systems are being jointly developed to accept trading instructions from market participants worldwide and deliver them electronically directly into the trading pits. Orders will be routed through the CME’s TOPS or the CBOT’s EOS system for electronic switching to the proper pit broker who will utilize a computerized broker’s workstation to organize and instantly report trade status back to the customer. Independent traders in the pits will utilize the latest innovations in handheld technology with which to do their proprietary trading and to instantly report their trades for clearing. These so-called AUDIT terminals will use advances in pen-based handheld computers including handprint recognition.

But most of it is in software. Intelligent agents will “reside” in computers to create a world we can hardly envision. As Craig Torres of the Wall Street Journal recently reported, during the past five years, major American market participants have spent millions of dollars to advance their computing potency. Indeed, one estimate says U.S. securities firms will spend some $7.5 billion on technology in 1991. Firms the likes of Morgan Stanley, First Boston, O’Conner & Associates, Salomon Brothers, Kidder Peabody, and Goldman Sachs and others are using automated development tools to build brand-new software programs. They are venturing to achieve a new generation of “analytics”—sophisticated mathematical computer models that can act as giant think tanks in order to identify hundreds of never-before-imagined trading strategies in securities, futures, and options.

While the trend is still in its infancy, its direction is unmistakable. Until now computers were used mostly as spreadsheets, or as fast calculators, or to analyze risk, or to run accounting or other programs. In the coming age, computers will no longer act within the framework of their traditional competence, they will have gained artificial intelligence. The next generation of analytics, now in development at sophisticated research laboratories, seeks to apply brand-new financial theories and allow the trader to apply them to markets on an ongoing basis. The evolving new mathematical formulas will imitate how traders think and look at markets—but several thousand times faster than humans can. In fact, a new supercomputer has just been unveiled that runs at a speed of one “teraflop,” a trillion floating point operations per second.

As a consequence, computers are on the verge of generating a wave of pristine trading strategies that will offer heretofore unheard-of opportunities. Computers are searching for price correlations and connections between markets that human traders never thought possible or never thought about at all. Computers will invent virgin tactics within a complex set of transactions inconceivable for the human mind to have perceived. Computers will create synthetic options and futures far beyond human imagination. Computers will find ways to blend these new analytical transactions with traditional strategies to produce even more complex possibilities. And while the bulk of the new wave of technological transactions will be utilized off exchanges—within the cash markets—the markets of futures and options are bound to be substantial beneficiaries as well.

For example, computers recently created a synthetic option on the Nikkei Index. It was produced out of a combination of Nikkei stock index futures and exchange-traded stock index options. The synthetic Nikkei option cost less than the real thing and allowed traders who recently used it to make $500,000 on a single trade.

In another instance, a managing director of a major securities firm recently created a two-year option that gives an investor the right to buy the S&P 500 stock index at its lowest point of 1991 in Swiss francs. Without analytics, such products could not even be imagined.

IBM’s mathematical sciences department, very much involved in the development of analytic market math, is working on a mathematical model that will allow investors to assemble hundreds of portfolios in seconds and have various shadings of investment risk and reward.

Anticipating a constant 24-hour market, IBM has also been working on a mathematical model for the past two years that will scan the trading pattern of stocks or bonds around the world and around the clock. Says the department’s director, “Time shouldn’t be measured by how the clock ticks, but by the level of trading activity.” By creating a model that uses trading activity as a measure of time, IBM hopes to create a new vantage point for spotting price trends.

As one would expect, competition in this emerging field will be fierce, every new analytic a most closely guarded secret. Remember, the only proprietary component for the inventor is the mathematical formula he devised which offers unique profit opportunities in markets that are extremely efficient and extremely competitive. Consequently, while many of the major firms are working feverishly to develop analytic competence, much of it is hush-hush and most of it behind secured doors.

But the secret is out anyway. New computer-generated mathematical analytics are coming whether we like it or not. Says Myron Scholes of the coming new age in trading, “People who don’t have analytics are going to be relatively obsolete.” What he didn’t mention is that not only will analytics achieve a myriad of new trading opportunities, they will also result in a myriad of new regulatory concerns, issues, and problems. How will these new transactions be regulated? Will they be regulated? Can they be regulated? And, in any event, what dangers do they pose for the financial structure of the world? Those are legitimate and important issues yet to be recognized by the federal regulatory bodies of the world as well as, I might add, the traditional exchanges. Sad to say, very few understand the full scope and nature of the technological tidal wave coming, let alone comprehend what its ramifications will be or how to cope with them.

Finally, it is important to note that as IBM suggested, the new technological trading competence will be structured to capitalize on the coming global 24-hour market. Yes, the revolutionary Globex concept fostered by futures markets has now become establishment even for the securities markets and even before our own international system is functional. Thus, you not only see the NYSE moving in the desired direction with after-hours trading sessions, you see the launching of NASDAQ International, a trading system for U.S. stocks on an electronic screen; you see the Japanese over-the-counter market launching a similar system; you see the Italian securities market leaving the traditional open-outcry stock trading for computerized screens; and, of course, you see similar systems such as at LIFFE, MATIF, Sidney Futures Exchange, TIFFE, SOFFEX, and DTB springing up all over the world.

The coming new technological age, when combined with more globalization, instant informational flows, 24-hour trading, immediate access to markets of choice, and intensified competition, offers immense opportunities for the markets of futures and options. In a world where financial risk is constant, where financial volatility is commonplace, where innovation is rewarded, where demand for unique risk management strategies will increase, where financial engineering is prized, where opportunities will rapidly appear and disappear on a constantly changing financial horizon, and where professional management will continue to demand efficient instruments of trade, in such a world, the role of futures and options is fundamental.

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