‘Footsie’ Coming to CBOT : U.S. Traders to Get a Crack at British Futures

First there were futures contracts on hogs and wheat and corn.

Then there were futures on the West German mark, Japanese yen and other foreign currencies.

After that came futures on stock indexes such as the Standard & Poor’s 500, which opened the door to a billion-dollar world of stock portfolio transactions, including hedging, speculating and computerized program trading.

Now the Chicago Board of Trade is only a few months away from offering U.S. traders a futures contract on a major British stock index--the Financial Times-Stock Exchange 100 share index (FT-SE 100), called “Footsie” for short.

Futures contracts allow investors to speculate on the direction of prices of commodities, currencies or stocks. The new CBOT contract will be the first futures contract on a foreign stock index to trade in this country. And it will open a new set of billion-dollar doors to U.S. money managers seeking profit opportunities in the international arena.

The futures contract on the Footsie--now available only in London markets--also could become another key link in a 24-hour global trading network that experts say is spreading across the world’s financial markets.

Similar Proposal

A similar futures proposal from the Chicago Mercantile Exchange (CME) would offer U.S. traders a contract on the leading Japanese stock indicator--the Nikkei-Dow Jones index. However, many regulatory problems apparently must be solved before that contract will become available.

Gary A. Wolens, vice president of Salomon Bros. in London, said the futures contracts on the Footsie would encourage the continued “internationalization of the financial markets.”

“I think it will be another investment tool for the public and for the money managers,” he said.

Raymond Carmichael, vice president at the CBOT, said strategies for using the Footsie futures contract would include:

- Arbitrage, in which traders will try to take advantage of price differences between the Footsie contract in London and the contract in Chicago.

- Hedging, in which institutional investors who already hold a portfolio of British stocks will try to protect their gains, or prevent losses, by taking opposite positions in Footsie futures.

- Speculation, in which traders will try to profit by correctly guessing the direction of the British stock market and the Footsie index.

- Program trading, in which large investment institutions will try to profit from price differences between the 100 stocks that make up the Footsie index and the futures contract on that index.

As practiced in the United States, the computerized program trades are triggered by price changes between the stocks and the futures contracts.

Outlook in London

At least in the beginning, program trading activity in London is likely to be discouraged, Wolen said. The London Stock Exchange’s price reporting system and a relatively low level of liquidity in the London futures market will make it difficult to execute program trades, Wolens said.

The London financial markets, however, will undergo major changes Oct. 27--the so-called “Big Bang” day--when the financial community will move from fixed commissions to negotiated commissions and adopt new trading practices and revamped electronic systems.

American interest in foreign stocks has mushroomed rapidly in recent years. U.S. investment in British stocks rose from $2.7 billion in 1980 to $7.7 billion in 1984, the most recent year for which figures were available.

Mutual funds specializing in foreign stocks also have grown in popularity. Investments in international and global funds totaled $16.1 billion in August, compared to $6.8 billion in August, 1985. The mutual funds may play a major role in using the Footsie futures, an industry source said.

Frederick Grede, vice president at the CBOT, said he believed the Footsie 100 would attract widespread investor interest for three reasons:

- First, stock indexes have been “one of the most successful futures products,” he said.

- Second, institutional investors, who make heavy use of index futures, have stepped up their international investments.

- Third, U.S. firms are widening their role in British financial markets.

Even so, creating a new financial product, as index futures are called in the trade, is somewhat risky, Grede said. “You never know for certain.”

Notable Failure

The CBOT has had its share of failures, Grede noted. They include the NASDAQ 100, an index of over-the-counter stocks that failed to develop much interest among futures traders.

The Footsie is awaiting approval at the Commodity Futures Trading Commission.

A key problem has been the question of surveillance. A recent agreement between the United States and Britain to exchange confidential investigative information opened the way for CFTC consideration of the Footsie contract. The CBOT and the London Stock Exchange already have signed an agreement on the Footsie.

“We expect no difficulty,” Grede said.

Options trading on the Footsie is more popular in London than futures trading. Options on the Footsie are traded on the London Stock Exchange; futures on the Footsie are traded on the London International Financial Futures Exchange (LIFFE).

Volumes Compared

On a typical day last week, 2,824 options were traded on the Footsie, constituting 10% of all the options trading. Futures contracts on the Footsie range between 400 and 1,000 a day.

Carmichael said the CBOT would be happy if it reached 1,000 to 2,000 Footsie contracts a day in the first nine months. Footsie futures activity in London will grow rapidly in the freer trading atmosphere expected after Big Bang day, Carmichael predicted.

One feature of Big Bang will be a major increase in the role played by U.S. investment firms in the British markets and an influx of new capital.

Wolens said he expected the introduction of the Footsie contract in Chicago to vastly increase investors’ awareness levels of the contract.

Interest in stock index futures has grown rapidly in this country. In 1982, S&P; 500 index futures stood at 2.9 million contracts. Only three years later, volume rose to 15 million contracts.

The availability of a U.S. futures contract on a British stock index is expected to be especially attractive to institutional investors, such as large pension funds, which want to accomplish two things: diversify their holdings by moving into British stocks and use an “index” fund approach.

Indexing is based on the premise that it is difficult for most money managers to beat the popular stock averages. Thus, a pension fund may instruct a money manager to buy all of the 100 stocks on the Footsie list. This would guarantee that the fund’s performance will match the Footsie index performance.

However, to reduce the transaction costs and effort involved in buying all 100 stocks, the pension fund manager can invest most of his money in short-term securities and, instead of buying stocks, buy an equivalent number of Footsie futures contracts when they are selling below the price of the stocks.

Signal to Sell

When the price of the futures contracts rises above the stocks, the money manager can sell the futures, adding the return to the interest earned on his short-term investments.

To invest in futures, an investor needs only a relatively small amount of collateral, usually provided in Treasury bills that continue to pay interest to the owner.

The Footsie will be traded in dollars in the United States, and in pounds in London. The Footsie contract at the CBOT will not be adjusted for currency fluctuations. Traders will have to calculate the effect of currency shifts as they watch their investments.