The Development of Futures Exchanges

This history is useful when staff who work in futures and options trading, settlement, or collateral management need to explain where exchange contract standardization, margin, and clearing arrangements came from.

What happened

The Chicago Board of Trade (CBOT) was founded in Chicago in 1848 as an organization for trading forward contracts in grain. It later became an exchange that handled futures. In the second half of the 20th century, it also began to handle futures and options on currencies, interest rates, and equity indexes. In the 1990s, electronic trading spread alongside trading on the exchange floor (open outcry), where traders gather and trade by voice and hand signals. Exchanges also formed alliances and reorganized.

This page uses "founding" for the creation of an exchange as an organization and "start of trading" for the day the first trade took place.

The mechanics of futures themselves are covered in Forwards and Futures.

Chicago was not the only home of futures exchanges. Japan Exchange Group says the Dojima rice market in Edo-period Osaka is regarded as the origin of Japan's exchanges and is widely known as a pioneer of organized futures exchanges¹.

Background: grain price risk and Chicago

One reason a futures exchange grew in Chicago was how grain was moved. A canal completed in 1848 made it cheap to ship corn from the interior by water. But grain harvested in late autumn or early winter could not move once the waterways froze. It stayed in riverside grain warehouses until the spring thaw. The warehouse operators bore the risk of price changes over the winter. They therefore began, in late autumn, to sell grain at a price fixed then for delivery in May². A trade that fixes today the price for a future delivery is a forward contract.

After the exchange was founded, rules were developed on trading conduct and on the grades of grain that could be delivered².

Key events

Figure description

A timeline of the main milestones in the development of exchanges, in chronological order. The filled circles mark the founding or opening of an exchange (CBOT and CBOE). The year the clearinghouse that netted members' payments (separate from the clearing corporation) was established differs by source, so the figure leaves it out, and the table below gives both years. Intervals are not drawn to scale.

How clearing and margin arrangements developed

An exchange needs a way to make sure sellers and buyers keep their promises. At CBOT, these arrangements came together gradually³.

At first, the penalty for a member who broke a promise was to be shut out of the trading floor. By 1873, CBOT had adopted a resolution on members whose ability to pay was in doubt. If such a member refused to let the exchange inspect the member's books, CBOT could expel the member. Around the same time, it also set rules requiring deposits of initial margin and variation margin, along with deadlines for making them.

Sources differ on the year the clearinghouse was established: some give 1865 and others 1883³². This clearinghouse netted the payments and receipts among members to reduce the work of settlement. It did not promise to take over settlement of a trade if a member could not pay.

The 1925 clearing corporation corresponds to a central counterparty that becomes the counterparty to every trade on the exchange. Members bought shares in the clearing corporation and deposited margin, and if a member could not pay, the clearing corporation took over settlement. If losses exceeded the margin, they were covered from the clearing corporation's capital, including capital contributed by other members³.

Figure description

A diagram of the clearing corporation CBOT established in 1925. In the figure, "Buyer" and "Seller" are the buying member and the selling member. The arrows show them each depositing margin with the clearing corporation. The clearing corporation faces both as the counterparty to every trade (the note in its box). The diagram shows the form of the arrangement at that time, not the detailed workings of a clearinghouse today.

Some exchanges built clearing arrangements before any in the United States. A member of the Federal Reserve Board said in a 2006 speech that a number of coffee and grain exchanges in Europe had some form of clearing arrangement in the late 19th century. That was well before any US exchange⁷. How clearing works today is covered in Central Counterparties: JSCC, LCH, CME and Others.

From agricultural products to financial futures

Trading volume at the Chicago exchanges grew sharply as financial futures were added. Combined volume at CBOT and the Chicago Mercantile Exchange (CME) was about 25 million contracts in 1976 and more than 73 million in 1981. The share of financial futures in that volume rose from about 2% to about 39%⁸.

In 1972, the International Monetary Market (IMM), newly created within CME, began trading futures on foreign currencies. This was the start of futures on currencies rather than on physical commodities such as grain⁴.

Futures then spread to interest rates. The main examples are GNMA futures in October 1975, futures on 90-day US Treasury bills in January 1976, and futures on long-term US Treasury bonds in August 1977⁴. Interest rate futures greatly increased trading volume at the Chicago exchanges. In 1981, the daily trading value (face value) of CBOT's long-term Treasury bond futures and CME's 90-day Treasury bill futures reached USD 27.7 billion. That was USD 3 billion above the daily average of spot trading in US government securities among the 36 reporting dealers⁸.

Eurodollar futures introduced cash settlement: at expiration, only the difference is settled, with no delivery of the underlying. Cash settlement made futures possible on things that cannot be delivered, such as an equity index. Equity index futures on the S&P 500 began trading on the IMM in April 1982. Within about six months, their daily volume matched that of 90-day Treasury bill futures, which had been the most heavily traded contract on the IMM⁴.

Listing options on an exchange

The Chicago Board Options Exchange (CBOE) opened on April 26, 1973. Cboe says it was the world's first exchange to list and trade options, which are exchange-traded derivatives⁵.

Until then, stock options were over-the-counter trades in which the parties negotiated the terms. Finding a counterparty and agreeing on terms took effort. The exchange made options a market for standardized contracts, with uniform terms⁵. When CBOE opened, it listed call options on 16 stocks and no put options. By the end of 1981, calls were listed on 120 stocks⁹.

In 1981, CBOE accounted for about 53% of the number of option contracts traded on US exchanges. The American Stock Exchange and the Philadelphia Stock Exchange began trading stock options in 1975, and the Pacific Stock Exchange in 1976. Competition grew stronger. Even so, CBOE's share exceeded 50% in 1981⁹.

Electronic trading and cross-border expansion

In the 1990s, trading on exchanges began to move from the floor to electronic systems. A review as of January 1998 summarized the position as follows¹⁰.

• CBOT, CME, and London's LIFFE, among the world's largest futures exchanges, still used open outcry on the trading floor.
• The number of exchanges that traded futures and options on electronic systems grew worldwide from 8 in 1990 to about 40 in 1997. Many of them were outside the United States.
• The share of global futures exchange volume traded on electronic systems rose from 7% in 1989 to 18% in 1996.
• In trading of German government bond (Bund) futures on Germany's electronic exchange (DTB) and on the open outcry exchange in London (LIFFE), DTB's share of the combined volume rose from 19% in 1991 to about 42% in 1997.

Exchanges that kept floor trading also used electronic systems when the floor was closed (CME's Globex, CBOT's Project A, and LIFFE's automated pit trading system)¹⁰.

As of May 1999, the structural changes at exchanges included mergers between domestic stock exchanges and derivatives exchanges, alliances among exchanges in different countries, and the separation of exchange ownership from membership (demutualization). Examples included the common trading platform Eurex in September 1998 and the Globex alliance between CME and a French exchange. Another was a 1999 resolution by LIFFE to allow shareholders who are not members¹¹. One factor driving these changes was technological advance. Compared with a trading floor, electronic trading was seen as loosening the limit on how many firms can participate directly. It was also seen as reducing the need to be physically near the exchange¹¹.

Notes

1. Japan Exchange Group, "Dojima Rice Market" (in Japanese): the opening paragraph under the heading "Pioneer of futures exchanges in the world." ↩

2. Kasriel and Merris (1983), section "Chicago's past in futures" (PDF pp. 1–2). This section gives 1865 for the clearinghouse, and Kroszner (2006) gives 1883. ↩ ↩² ↩³ ↩⁴ ↩⁵

3. Randall S. Kroszner, "Central Counterparty Clearing: History, Innovation, and Regulation" (Federal Reserve Board, speech of April 3, 2006), section "Historical Development of Futures Clearinghouses," paragraphs 2 to 4. ↩ ↩² ↩³ ↩⁴ ↩⁵

4. Kasriel and Merris (1983), second half of the section "Chicago's past in futures" (PDF pp. 2–3). ↩ ↩² ↩³ ↩⁴ ↩⁵ ↩⁶ ↩⁷ ↩⁸ ↩⁹

5. Cboe Global Markets, "The Creation of Listed Options at Cboe" (March 1, 2024), paragraphs "From Theory to Reality" and "The Vision for Listed Options." ↩ ↩² ↩³

6. Claire Williamson, "Structural changes in exchange-traded markets" (Bank of England, Quarterly Bulletin, May 1999), section "Structural changes" (PDF pp. 1–2). ↩

7. Kroszner (2006), first paragraph of the same section. ↩

8. Paul L. Kasriel and Randall C. Merris, "Chicago: city of the big straddles" (Chicago Fed, January/February 1983), section "Futures trading today" (PDF p. 1). The source's CBT is the same exchange as CBOT here. ↩ ↩²

9. Kasriel and Merris (1983), the last paragraph of the section "Chicago's past in futures" (PDF p. 3) and the paragraph on option competition (PDF p. 4). The 1981 share is also in the opening paragraph (PDF p. 1). ↩ ↩²

10. Asani Sarkar and Michelle Tozzi, "Electronic Trading on Futures Exchanges" (New York Fed, January 1998), section "Open Outcry Trading" (PDF pp. 1–2). ↩ ↩²

11. Williamson (1999), the Introduction and the section "Structural changes" (PDF pp. 1–2) and "Factors driving these structural changes" (PDF pp. 2–3). The LIFFE resolution was in February 1999, with implementation in April. ↩ ↩²