Tuesday, January 27, 2009

Special Post - CME Rate Impacts

I don't normally repost comments from prior posts in the main blog, yet I thought it might be helpful to repost a part of last night's dialogue that dealt with the impact my member commission rates have on the bottom line.

The impetus for the discussion was a fairly extensive audio viewpoint from an industry peer (Austin Passamonte) of my '08 performance ... which I'm of course trying very hard to forget as the past is past! If you're interested, I encourage you to first listen to the link, then continue to my response below. Austin and I exchanged emails this morning, and I thanked him for his perspective. I'll also add this to the Key Post index to the lower left for folks to reference from time to time when analyzing their own commission rates.

Anyway, here are my comments from last evening, with additional thoughts at the end as I've had some more time to reflect on them:

Hi Glen and thanks for the very insightful link of which I was not aware.

I'll touch on some of the comments over time (it's late here and I just checked the mail before heading to bed), but in the meantime here are a few immediate thoughts.

First, I thought his general commentary was very strong and he touched on several relevant points which mirror some of the things we've discussed here.

With respect to CME member rates benefiting me, there's no question about that, although we'd need to make one adjustment to the math as 8% of the total 637,766 contracts traded were related to Eurex that isn't related to CME membership and that I essentially considered continual "investment capital" in "learning" that market as I had a very small gross from it. The total CME # was actually 586,184.

However, even after adjusting the math, his point would remain relevant in that the savings in commission costs is a significant factor in generating the strong bottom line. No doubt about that as I'm often managing risk on speculative trades with scratches and re-entries while also providing liquidity at times which can quickly drive up trading volume.I also agree that becoming a CME member doesn't guarantee success, and thought he was right on point there as well.

One thought I'll add though is it doesn't take a huge trading volume to justify leasing a seat to get the lower costs. I currently pay $2,200/month, which based on an analysis I did some time ago, meant I had to "only" trade about 250 contracts a day to ensure the cost of the lease was covered by the savings in commissions over time. [When I became a member in early '04, I actually tracked my monthly volumes carefully for a while to ensure the lease was always justified.]

And yes, 250 can still be considered high for many, although it's only about 10% of my 2008 volume ... meaning one doesn't have to trade quite as frequently or with as much size to still benefit from the reduced rates. So justifying a lease could be more within reach for some than at first blush, although as he mentions, it's certainly no replacement for needing to acquire the skill aspect of the profession.

Yet the commission point remains relevant and I would make an analogy to running a store where cost control is paramount in generating the strongest margins. Ensuring one pays wholesale costs and overall cost control are critical.

One last thought on the commission issue is that the more both retail and wholesale traders push for reduced broker costs (the non-CME component of the fee), the more we'll hopefully see continued reductions in industry commission costs for both types of traders. And yes, we do have a voice with our wallets and choice of brokers in a competitive broker marketplace. [Even when I was "retail", I was able to pursue lower fees, although certainly higher volumes provide a stronger negotiating position.] Yet again, this thought addresses the non-CME part of the rate as the CME piece is set by the Merc.

A few other responses to what I again thought was an overall solid audio:

Prior teaching & products - Yes, as many know I used to teach and at one time wrote articles and developed simulation and other learning tools that were available at TradingMarkets [btw, my trading records over time have always been open to Larry Connors who had previously vouched for much of the "pre-blog" results]. I stopped doing so primarily to focus on my own trading. I believe the older material stock hasn't been replenished, and currently have no current plans to resurrect formal teaching. [Plus, I'm having a ball with the blog and I touch on many of the former concepts in my constant babbling here.]

His reinforcement that I currently have a supplemental non-trading income to pay bills is also of course true as we've discussed here. And yes, I'll continue to advocate that such income is a huge help in the mental pressure aspect, much like I imagine golf pros have sponsorships pay for their meals while they focus on executing and sharpening the skills of golf. Spousal income, part-time income, running other businesses are of course all options.

So does it help me mentally? Absolutely. Is it mandatory? Not at all as I've traded consistently successfully in the past when I was trading full-time and it was my sole income. It's of course hard to quantify how much reduced pressure impacts one's current bottom line -- including mine -- as it's an intangible concept.

So his points are again strong and reinforce much of what we've discussed here. A successful business requires both strong execution and cost management, which is true in the business of trading. [Perhaps that's where that costly MBA is finally paying off.] Subsequent thought: We can choose to be Wal-Mart or the local hardware store. Both are right, yet each has a different cost structure, margin, and bottom line. Yet the core principles of selling and running the business for both remain the same.

*** End of Response ***

A follow-up thought is that one of the mistakes I made early in my career was not pursuing a Merc seat lease given my particular style. One reason is that many brokers have vested interests in keeping their commissions high (arguably another one of the industry's dirty little secrets that puts money in other people's pockets), and thus there's very little published material out there on cost/benefit analysis. Plus, some vendors have relationships with brokers which further compounds the issue. So I had to learn the hard way by digging for myself and discovering that there were ways to drive rates down that no one had told me about.

Even for traders who can't justify a lease, I would argue that many retail rates out there, including some referenced in the clip, are far too high and there are better deals around. Like any consumer, I encourage folks to shop around and let the market -- not brokers -- set the rates. Some brokers for example will decrease rates as volume grows. Mine even gave me a grace period at one time in terms of keeping rates affordable before my volume grew to recent levels with the hope of future business.

Given the current economic woes, it's a buyer's market, and we should use that to our advantage when we're "buying" the necessary infrastructure for a successful business.

Lastly, I'm going to do a similar analysis to that presented in the audio clip for January when the month is over, which I think may be helpful in light of my reduced trading volumes during the month and very infrequent Eurex trading. I suspect the results will help show that while costs of course remain key, that it will make more sense for the less frequent trader.

It's a great and professional discussion/debate to have, and I thank Glen and Austin for their input.

We should all continue to question and challenge life, including discussions held in this continuing diary.


Ziad said...

Hey Don,

You had mentioned a while back that your current as a Merc member are less than $1. By that do you mean per full round turn, or per side?

Currently, I'm in the process of leasing a seat at CME (and IOM lease like yours) and I've calculated that my commissions will be $2.26 per round turn (and then that drops to $1.76 per round turn after the first 200 contracts each day).

If you meant your commissions are less than $1 per side, then our rates will be pretty similar. But if you meant per round turn, then the commissions you are getting charged by your broker are much less, probably around 60 cents or less per round turn.

Anyways, it would be great to know just so I can have some basis of comparison.



Don Miller said...

Ziad -

Per side.


E-Mini Player said...

Don, what does he mean when he says members can buy the bid and sell the ask? Can't retail traders do the same thing? I thought Globex worked the same way for members and non-members alike. Please clarify when you have a moment.

Geert said...


you were saying that only traders with a seat can buy at the bid, but i tought that the eminis were traded on globex electronically and that we also coul place a limit order at the bid, or am i wrong?

Don Miller said...

E-Mini -

You are correct. "Retail" traders can certainly trade Globex and list on the bid or ask -- essentially becoming a wholesale trader -- which I frequently did before joining the Merc.


Don Miller said...

Geert -

You are also correct ... see my comment to E-Mini above.


Glen said...

Thanks for the post Don, it clarified much for me.

It might appear to some that you win only because of these low commission rates. But I expect that you, and other expert traders, would be successful no matter what the commissions were, since trading is, like poker, a paramutuel game of opinion. Those with weak or wrong opinions provide fodder for the strong players.

Don Miller said...

Glen -

It's probably safe to say we all agree that reduced costs are always a component, but don't guarantee success, and one could possibly argue that it might entice one to over-trade by taking sloppy or low % trades and lose the forest for the trees.

So I thought he was right on in saying, "otherwise, everyone would be doing it (becoming members of the CME)".

I essentially play two market games: (1) providing liquidity, and (2) speculating. In my view, #1 definitely "requires" low costs, and #2 is certainly "helped" by low costs.

It would be interesting to try to break the results into the two pieces, as most traders likely fall into the second category. And while I don't have data to support any conclusions, my sense is that it may be fairly equally split.

I have no doubt that skilled traders (unfortunately the minority of those taking up the biz) can still do well with slightly higher costs ... been there, done that.

Yet any decrease in cost goes right to the bottom line, all things being equal.

For all the chatter in the industry about magic patterns, etc., I'm still amazed how little info there is on the cost side.

After all, this is a business.

Great dialogue.