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Runner (level 1) · Lesson 3 of 13

The exchange

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The exchange

In Lesson 1 you learned that futures trade on an exchange. This lesson answers three questions: which exchange, where do the trades actually happen, and what stops the other side from walking away if the trade goes against them.

CME Group

The stock index futures this course focuses on are listed by CME Group, based in Chicago. CME Group was formed in 2007 when two old Chicago exchanges merged: the Chicago Mercantile Exchange (CME) and the Chicago Board of Trade (CBOT). It added the New York Mercantile Exchange (NYMEX) in 2008. Today CME Group is made up of four exchanges: CME, CBOT, NYMEX, and COMEX.

The exchange does two big jobs:

  1. It writes the contract. The exchange sets the standard terms for each product: its size, its smallest price move, the months it trades, and how it ends. You will learn those terms for each contract later in this level.
  2. It runs the marketplace where buyers and sellers meet.

Globex: where trades happen

Futures used to be traded by people shouting in a trading pit. That is where this course’s level names come from: Runner, Clerk, Order Filler, and so on. Starting in 1992, futures began trading electronically on CME’s platform called Globex, and trading moved from the pits to screens.

When you place an order from your trading platform, it travels to Globex. Globex keeps a list of everyone’s resting buy and sell orders, and when a buy price and a sell price match, a trade happens. Globex runs nearly 24 hours a day. You will learn the exact hours in Lesson 10.

You cannot connect to Globex by yourself. Individual traders reach the exchange through a broker, a firm that sends your orders to the exchange and handles the money flowing between you and the exchange. You will learn more about brokers in a later level.

The clearing house: the promise behind every trade

Here is the problem a clearing house solves. Say you buy a contract from a stranger, and the price moves in your favor. You are owed money. But what if the stranger cannot pay?

In a private deal, that is a real danger. It is called counterparty risk: the risk that the other side does not hold up their end.

Futures handle this with a clearing house. For CME Group products, that is CME Clearing. The moment a trade is matched, the clearing house steps into the middle of it:

  • To every seller, the clearing house becomes the buyer.
  • To every buyer, the clearing house becomes the seller.

So you never actually depend on the stranger. Your trade is with the clearing house, and the clearing house guarantees it. This is called being a central counterparty. It also means you never know or need to know who was on the other side of your trade.

To make that guarantee safe, the clearing house requires everyone to keep money on deposit to cover possible losses, and it settles gains and losses every day. Those are the topics of Lesson 8 (Margin) and Lesson 12 (Daily settlement).

Key ideas

  • CME Group lists the stock index futures in this course and writes their standard terms.
  • Globex is CME’s electronic marketplace where orders are matched. You reach it through a broker.
  • The clearing house becomes the buyer to every seller and the seller to every buyer, so you do not depend on a stranger to pay you.

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