Investing Answers Building and Protecting Your Wealth through Education Publisher of The Next Banks That Could Fail
Investing Answers Building and Protecting Your Wealth through Education Publisher of The Next Banks That Could Fail

Chicago Mercantile Exchange (CME)

What it is:

The Chicago Mercantile Exchange (CME) is a commodities futures and options exchange. Several dozen types of contracts trade on the CME, and the exchange facilitates hundreds of millions of these trades each year.

How it works (Example):

The Chicago Mercantile Exchange (ofter referred to as "The Merc")  trades futures contracts and options on futures contracts for agricultural and financial products such as cattle, fertilizer, milk, hogs, lumber, butter, cheese, foreign currencies, indexes such as the S&P 500, energy and alternative investment products, and interest rates.

CME traders buy and sell contracts by bidding or offering a price and a quantity of contracts. For most of the CME's life, trading took place via open outcry in one of the CME's trading pits. The traders in the pit announce the number of contracts they want to buy or sell and the price they want to pay or receive. They use their fingers to denote the quantity of contracts. When the trader's palm faces out, he is trying to sell contracts. When the trader's palm faces in, he is buying. This open outcry system is one of the most well-known images associated with the financial world. In recent years, however, the CME has introduced electronic trading. Although the CME's members can only trade via open outcry from 7:20 AM to 3:15 PM Monday through Friday, the CME's electronic trading day is 23 hours long.

Like the New York Stock Exchange (NYSE), one must have a membership to trade on the CME. The CME's class B shares are associated with these trading rights, and holders can lease their trading rights to a third party. The CME's Class A shares of which there are millions, trade on the NYSE and represent equity ownership in the CME. But the Class B shares only number in the thousands and are not listed on the NYSE. The CME's shareholder relations division controls the trading of these shares. There are four types of Class B shares; each gives the holder rights to trade different types of contracts on the exchange.
 

Why it Matters:

The CME and the futures market it facilitates is important because it gives its participants a way to manage risk. These participants, called hedgers, buy or sell futures contracts to protect themselves against unfavorable price changes (these people might be hog farmers wanting to sell their hogs for a certain price, for example). But there is another type of participant in the market, too: the speculator. Speculators simply bet on which way prices are going to go. Although they don't want to physically possess any of the products they're trading (that is, they don't really want a truckload of cheese in two months), their trading activity is important because it brings liquidity to the market.