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Hedging Stress

Cigars Ease the Tension for the Big Dogs on Chicago's Futures Exchanges
Alejandro Benes
From the Print Edition:
Pierce Brosnan, Nov/Dec 97

(continued from page 4)

The market risk has not been eliminated but rather assumed by futures brokers, who take a speculative stance, betting either that the price of soybeans will go up or down in six months. If they bet right, they can make a lot of money.

"Think of the futures contract as a pledge to deliver goods in the future at a pre-arranged price," explains former trader Ted Fishman, now a financial writer. The futures contract is not to be confused with an option, a different financial instrument though a variation of a futures contract. "An option is a right, not a promise. If you buy a 'call option,' you're buying the right to purchase something for a certain price. Only futures contracts obligate you to do anything. Options, like their name says, give you the option to buy something at a set price. The advantage of call options is that if the price goes down in the future, you don't have to use the option, you can just buy the stock at the cheaper market price and all you've lost is the premium."

In the trading pit, the proximity to others trading in the same product means that price discovery is at its most efficient. You know instantly who is willing to sell or buy and for how much. In many cases, the more the price moves, the more money there is to be made. With enough trades at small spreads (the difference between the bid and offer prices) a trader can make--or lose--a significant amount of money on any given day. Prices for agricultural products can be affected by any number of unpredictable factors--weather, disease, bugs--which in turn affect the price of the commodity. In the Treasury bond pit, the unpredictable factors affecting prices are, among other things, the perceptions of investors, the predictions of economists, financial analysts, the health of the economy, inflation, wars, politics and the policies of the Federal Reserve. All of these factors affect the price of money: interest rates.

"We're a hedge center between the Fed and the banks," says Zawaski. "They have to buy and sell and they need a place for liquidity to offset each one of these trades. That's what the bond pit is. Everything's totally connected, but we're kinda the big dogs. We're the interest rates. We're driven by interest rates. There's no bigger [market] in the world. The stock market even watches us. We're the big dogs."

The trader provides a risk-transfer service that most people don't recognize, appreciate or understand, says Paul R.T. Johnson Jr., a CBOT director and T-bond broker (a broker trades for clients while a "local," or "scalper," generally trades for himself). "It allows your and my home mortgage to be at a lower rate," Johnson says while smoking a Davidoff Double R after lunch at The Excelsior, across the street from the CBOT and down the hall from Jack Schwartz Importers where Johnson serves as vice president of the Jack Schwartz Cigar Club.

"The government has postponed [Treasury bond] auctions when we're not in," earnestly adds Johnson, whose "LSU" badge stands for his alma mater, Louisiana State University.

Johnson distinguishes between the exchanges and what he and many traders refer to as the "real" world. "I'm part of that which allows people to do real things out there," Johnson says, clearly focusing on important matters. "Like making cigars, so we can all enjoy our life; I really think it's a great part of life because you've really got to enjoy the pleasures. If you don't stop and smell the roses or sit back and relax and think about your fellow man, you're missing it all."

At 10:58 on that winter Wednesday, Zawaski is just climbing into the pit, a few feet and a mass of humanity from Baldwin. Three minutes later he is executing a trade. At 11:05, the pit erupts. The price is up slightly. At 11:08, there is a two-point drop. Then it's down another point just 11 seconds later, according to the numerous clocks and quote boards encircling the trading floor. The hits just keep on coming.

At 12:15, Avi Goldfeder, Johnson's partner, is ready for his midday meal. He reaches into his briefcase and pulls out a bottle of aspirin. "Well, here's my lunch," he says, taking out two pills and popping them into his mouth. No smoking on the trading floor.

Steve Horowich is standing on the top tier of the pit, looking out. He is trading for the brokers who have "decks," which are little more than consoles with as many phone lines as possible, which reach out to different clients around the world. Brokers are paid a commission for the trades they execute, and Horowich and his group make about a dollar per contract traded that they handle for brokers like Johnson and Goldfeder. On an active day thousands of trades are being made. To save time in communicating information in a pursuit where split-seconds count, Horowich stands back-to-back with one of his associates and leans backward to talk to him. The associate, at 6 foot 10 inches, is the tallest trader in the pit, which is a significant advantage.

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