Have you ever had a trading idea that is not executable because the instrument you decide to trade is illiquid? You might have come up with a tremendous day-trading strategy only to determine that every time you try to enter a trade, the market moves? This situation is a sign of an illiquid market.

Liquidity is an important concept. It’s essential for institutional clients who transact sizeable trades. It is also necessary for short-term traders who are relying on small moves to generate their revenues. Liquidity can be defined as an asset with enough daily volume to accommodate an extensive exchange without a noticeable change in the asset’s price.

The Chicago Mercantile Exchange

If you plan to trade futures contracts, you want to find an exchange that provides liquid assets. One of the most popular exchanges is the Chicago Mercantile Exchange (CME). The future exchange provides an auction-style transaction arena for traders and hedgers worldwide. You can trade physically delivered products as well as financial futures on the CME. The CME was established in 1898 as the Chicago Butter and Egg Board. Approximately 21-years later, the company changed its name to the Chicago Mercantile Exchange.

The CME is the largest derivatives exchange globally. The assets that trade on the exchange include financials, such as bonds, notes, and bills. The exchange also facilitates trading equity indices, stocks, agricultural, energy, metals, and cryptocurrencies.

The CME allows brokers to transact on the exchange and has a central clearing system that helps remove counterparty risks. Transactions are conducted through electronic trading as well as open-outcry. Each broker that executes trades on the CME needs to be registered with the National Futures Association (NFA). Non-registered brokers need to become affiliated with NFA register brokers to execute trades on the CME.

During the last 20-years, the CME expanded rapidly by purchasing several other futures exchanges. This buying spree included buying its rival, the Chicago Board of Trade, in 2006. In 2008 the CME purchased the New York Mercantile Exchange to become the largest petroleum futures exchange. In 2010 and then in 2013, the CME purchased the Dow Jones Indices. In 2012, the CME bought the Kansas City Board of Trade to increase its agricultural presence. In 2018 the CME added the NEX group.

What Else Does the CME Offer?

The CME provides access to futures contracts. Futures contracts are beneficial for risk management and speculation. For the exchange to be successful, it needs buyers and sellers to transact futures contract trades, creating liquidity. The CME offers traders a regulated exchange, credit protection, and margin for leverage.

Who Regulates the CME?

The CME is regulated by the Commodity Futures Trading Commission, which was established in 1974. The CFTC is part of the Securities and Exchange Commission. The CME is also a self-regulatory body that has its enforcement department.

What Kind of Credit Protection Does the CME Provide?

One of the issues that investors avoid when they do not trade on an exchange like the CME, is credit quality. For example, when a company issues a corporate bond, a buyer would experience counterparty risk. Counterparty risk occurs in many transactions.

For example, if you make a bet with your friend, you run the risk that your friend decides not to pay his debt if you win. To avoid counterparty risk, the CME requires that each participant posts margin and has equity in their accounts to cover any losses they might experience on a futures contract trade.

Margin is the amount of capital the exchange requires you to post for each trade that you place. The margin covers any potential loss that you might incur daily. If the amount of equity in your account declines, you will need to post an additional margin.

When you trade on the CME, each buyer of a futures contract requires a seller. The buyer and the seller each need to post a margin, which allows the CME to certify that they will pay their debt. This concept eliminates credit risks. The CME also offers over-the-counter (OTC) margining through its clearing company Clearport.

What is Leverage on CME Futures?

Additionally, customers who use the CME can buy and sell (short) futures contracts using leverage. Leverage allows customers to trade assets with a portion of the value of the futures contract. The CME uses a calculation to determine the margin that is needed to buy and sell futures. This methodology evaluates how much you can lose on your trade and requires that you post that amount and have additional capital in your account.

For example, the value of one crude oil futures contract when the price is $70 per barrel is $70,000 since each futures contract provides the buyer with the obligation to purchase 1,000 barrels. The CME requires that the buyer and seller post $5,300 per contract for the initial margin at points in the past. This margin requirement allows you to leverage 13 to 1 ($70,000 / $5,300). Each futures contract that the CME offers can require a different margin requirement.

The CME will use the current and past volatility of these futures contracts movements to determine margin requirements. The goal is to make sure that you do not lose more than you have in your account. If you have losses in your account that reach a specific threshold, the exchange will require that your broker issues a margin call.

Since your broker is on the hook to the CME, your broker will make sure that the equity in your account stays above the required level. If you do not meet your margin call, your broker will have the right to liquidate your positions.

Leverage allows you to enhance your returns. Unfortunately, it cuts both ways. If you purchased one crude oil contract when the margin is $5,300 and the price rises from $70 to $71, you would generate a return of $1,000 / $5,300 or 19%. The small 1.4% move in the price of crude oil ($70 to $71) will allow you to generate a 19% gain using leverage. A decline from $70 to $69 will also cause a 19% loss on your capital.

Trading Volume At The CME

The CME provides liquidity, allowing traders to enter and exit some of the most popular futures contracts and options on the futures contracts. In 2020, the average daily volume increased to 19.1 million contracts, with more than 16-million traded in Q4 2020.

This 3.9-fold increase compares to the old record in 2019, where the average daily volume reached 4.9 million contracts. The CME has partnerships with several exchanges, including the Singapore Exchange Limited, the Malaysian Berhad, and the Dubai Mercantile Exchange.

How Does Volume Generate Liquidity?

The addition of several exchanges during the past two decades has allowed the CME to become a premium liquidity provider. Substantial volumes provide institutional investors with a platform to trade sizeable transactions. A liquid market is one where a significant trade can take place without moving the market substantially.

The movement of an asset when a trade is transacted is called slippage. Slippage can increase during volatile periods and when markets are illiquid due to several factors. Slippage can be very costly, especially for day-traders. If your goal is to profit from small-sharp movements in the price of a futures contract, you want to make sure that your slippages are minimal.

You also want to make sure you avoid periods when liquidity can slip. For example, during a holiday-shortened session, large trades can move the price of an asset substantially. Additionally, when new information becomes available, such as during economic or earnings releases, markets will often gap as liquidity initially dries up. What is essential to institutional traders is whether a market volume is considered liquid during normal market conditions. If you are trading after hours on an exchange, you might experience a decline in volume and less liquidity.

What are the Most Liquid Futures Contracts?

Providing liquidity is a critical goal of the CME. As mentioned prior, liquidity is the ability to enter and exit a trade without experiencing much slippage. The most liquid futures contracts on the CME are the interest rate futures contracts. The 10-year Treasury note is the most liquid interest rate futures, and the Eurodollar futures contracts are the most liquid strip of futures contracts.

The U.S. Treasury notes futures contract facilitates hedging as well as investment into the treasury market. The notional value of each bond is $100,000, and each tick is 50% of 1/32 of a point. The U.S. Treasury futures contract is deliverable into a U.S. Treasury note with less than 10-years left to maturity and more than 6.5 years left before it terminates.

While some investors and dealers might take delivery of these futures contracts, most traders exit before settlement. Other treasury futures contracts that are actively traded on the CME include the 2-year note futures contract and the 5-year note futures contract. Most of the CME treasury contracts trade around the clock on the Globex electronic platform. They are some of the most active futures at night.

Another interest rate product that experiences robust volume and liquidity is the Eurodollar futures contract. This interest rate futures contract is not to be confused with a currency futures contract. The Eurodollar futures contract is the obligation to purchase a product that references the London Interbank Banking Interest Rate (LIBOR). The Eurodollar futures contract is financially settled. A financial settlement means that at the maturity of the futures contract, the buyer will receive the difference between the purchase price and settlement price.

The Most Liquid Commodity Futures

The most liquid commodity markets are the crude oil markets. The CME facilities access to a host of different crude oils, including the U.S. benchmark West Texas Intermediate (WTI) crude oil and the European benchmark, Brent crude oil. The most liquid of these crude oil contracts is the WTI crude oil futures contract. The WTI futures contract trades around the clock. This futures contract is used for investment and hedging purposes.

The contract is deliverable, which means that the buyer is obligated to purchase WTI crude oil in Cushing, Oklahoma, if they hold the contract through the delivery period. Each contract has 1,000 barrels of light-sweet crude oil. While some oil producers or investors might take or make the WTI futures contract deliver, most are not taken to delivery. An alternative to the WTI futures contract is the micro WTI futures contract. This asset references 100 barrels of crude oil and is financially settled.

The Most Liquid Futures Markets in Agriculture

The most active commodity futures are the agricultural futures contracts. They represent the most liquid commodity markets. The most active futures include corn, soybeans, and wheat. The most traded futures contracts are the corn futures contracts. The corn futures contract offered by the CME is deliverable and is the most liquid grain futures contract.

The seller of the corn futures contract is obligated to deliver #2 Yellow Corn to a CME regulated warehouse. The most active futures are the prompt futures which have settlement dates that are nearby. Deferred futures contracts are generally less active and not considered the most traded futures contracts.

Soybeans are the second most liquid commodity futures traded in the agricultural space. Soybeans are often sold in conjunction with another of the most liquid grain futures called the soybean oil futures contract. The soybean meal futures contract makes up the balance of the soybean complex.

The soybean business surrounds the crushing of the bean into soybean oil and soybean meal. This grouping of protein products is referred to as the soybean crush. Crushers and refiners smash soybeans into meal and oil and sell them separately. Most of the soybean meal is used to feed chickens and cows. Most of the soybean oil goes into the biofuels process. Wheat is also a widely traded futures contract. The most liquid meat futures contract is feeder cattle.

The Most Active Futures in the Metals Market

The most liquid metals futures are gold, silver, and copper futures. Gold futures contracts are physically delivered. If the agreement is taken through the delivery process, the seller will need to provide 100 ounces of pure 0.99999 gold to a CME regulated warehouse. Silver is also one of the most liquid commodity markets.

Silver is also a physically delivered futures contract. Each contract holds 5,000 ounces of gold. The CME also other less liquid precious metals futures contracts that hold platinum and palladium. Copper is also a physically delivered futures contract and holds 25,000 pounds of copper. The CME also offers a copper mini-futures contract that contains 12,500 pounds of copper but is financially settled.

The CME Financials

In addition to interest rates, the CME also provides the most liquid stock index futures contract, the S&P 500 index e-mini contract. This financially settled futures contract is the most traded index future worldwide. The contract has an index value of $50 per point. The CME also offers an S&P 500 Emini-micro futures contract that is $5 per point.

The CME also offers futures contracts on the Dow Jones Industrial Average as well as the Nasdaq Composite. Additionally, the exchange provides an Emini-micro contract on the Dow Industrial Average and the Nasdaq. The CME offers a wide variety of stock index futures and individual equity futures contracts.

The CME is also very active in facilitating the trading of the most liquid currency futures. All major currencies are considered to be very liquid futures markets. This group of currencies includes the Euro, the Yen, the British Pound, the Australian Dollar, the Swiss Franc, and the Canadian dollar. Each currency futures contract is a fixed amount of currency (such as the Euro with 125,000 Euros). The CME also offers customers access to emerging market currencies.

The Bottom Line

The Chicago Mercantile Exchange is one of the largest and most recognized futures exchanges worldwide. It offers a wide variety of the liquid commodity futures, including energy futures, agricultural futures, metals futures, and soft futures.

Additionally, the CME offers futures instruments for interest rates. Investors around the globe use the U.S. Treasury bond futures contract to hedge their exposure to cash treasuries. The Eurodollar futures contract is the benchmark used to generate interest rate swaps that corporate treasurers and financial institutions use to hedge their interest rate risk.

The financial breadth of the CME is expansive. The exchange offers access to the Emini-S&P 500 futures contract, which is considered the benchmark for U.S. equity index trading. Investors use the Emini-futures agreement to take directional positions in U.S. equities and hedge their exposure to the broader markets.

The CME is one of the most actively traded currency futures markets worldwide, providing an outlet for hedging and speculation throughout the forex community. The CME also offers a wide breadth of options on futures contracts for nearly every liquid futures contract listed on its exchange. An option contract on a futures contract is the right to purchase the futures at a specific date at a certain price.