Floor trading for the financial exchanges has been a dying business for some time. Whether this was the CME, the CBOT, the NYSE or others, the reality is that the electronic age has been killing the exchanges’ floor trading volumes. The CME Group Inc. (NASDAQ: CME) decision to close a large portion of its trading floor and open outcry operations in New York and Chicago may not come as a surprise to many investors.

24/7 Wall St. has two key questions here. The first is what CME will save in dollars by closing trading the floors. The second question, and perhaps the more important one, is what new risks this poses for investors and exchanges.

CME said that open outcry futures trading volume is now only 1% of its total futures volume. CME’s closing date for most of its futures trading pits in Chicago and New York is set to be on July 2, 2015. A minimal amount of floor trading will still occur. The CME statement said:

The floor-based S&P 500 futures market, which continues to provide an important venue for trading the underlying futures contract for the open outcry S&P 500 options on futures contract, will remain open on CME Group’s Chicago trading floor. … Options on futures contracts, which continue to trade actively on both the floor and the screen, will remain open on both trading floors except for the DJIA ($10) and NASDAQ-100 open outcry equity index options markets which are designed to deliver into floor-based futures contracts.

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CME has also said that it plans to assist its floor traders with the transition by attempting to make booth space available to those who want to trade electronically after the trading pits close.

So, What Will the CME Actually Save in Operating Costs?

CME’s net income was $976.8 million in 2013, with income from operations of $1.047 billion.

Open outcry volumes fell to less than 9% of total volume by 2007 and less than 2% by 2011, according to Reuters. So open outcry volume has been cut in half in the past four years or so. The 2013 annual report showed that the last big drop in open outcry volumes was in the 2011 to 2012 period, when volume tanked by 25% to 1,045,000 contracts per day.

Even in 2013, CME had said it considered pit (open outcry) trading services as a profitable within the business. The problem is that CME total annual operating margin had been in decline, according to the 2013 annual report. That operating margin fell to 56% in 2013, down from 58% in 2012 and from 62% in 2011, due to operating expenses rising more than revenues.

The 2013 annual report also showed occupancy and building operations was up 2% to $78.3 million.

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So, on what CME will save here by the move? A CME spokesperson told 24/7 Wall St. over the phone that the closure of the futures pits announced this week will save roughly $10 million in annual operating expenses. This was said to represent roughly a quarter of all operating costs tied to floor operations.

And What Risks Are Being Taken On?

The current belief, which has built up for years now, is that trading floors and open outcry systems just no longer add much value. This has been an ever louder argument each year for more than a decade. Sadly, it is true — on most days. The problem is that program trading market swings and the flash crash are not too distant in memory. In fact, there are literally no assurances, even after trading rules and mechanisms have been put in place, that another smaller version of a flash crash in other non-equity markets, nor exchange-wide trading outages, will not take place again.

The Wall Street Journal said:

The existence of skilled floor traders was useful last April when a technical glitch at CME halted electronic trading in 31 commodities, including corn. Floor traders scrambled to fill orders using hand gestures and shouts.

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By eliminating floor trading, there is arguably some risk for what happens when the next trading scandal (crash, outage, hack and more) takes place — and history dictates that we likely have not seen our last electronic trading outage.

Do the savings justify the added risk of fewer humans being in place? Maybe, and maybe not. Time will tell.

History and Nostalgia

The current CME Group was formed in 2007 after the merger of cross-town rivals Chicago Mercantile Exchange and Chicago Board of Trade. The Chicago Board of Trade was founded in 1848, and the CME was founded in 1898.

The 2013 CME Annual Report showed (on page 30):

Our members have been granted special rights, which protect their trading privileges, require that we maintain open outcry trading until volumes are not significant.

It goes without saying that 1% is no longer statistically significant.

On a personal note, it is sad to have grown up in an era when floor trading was prominent and has continued to disappear. It has historically been that if you wanted to see an exchange’s trading floor you would go there. Now it is becoming almost entirely just a series of zeros-and-ones that make up the code on your screens.

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One last bit of history and nostalgia from having officed in the CBOT building in the past decade. My own favorite quote I ever heard from a floor trader right after the close of trading: “Hey, someone just got stabbed in the shoulder with a pen!”

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