Zero-Sum Game

The Rise of the World's Largest Derivatives Exchange

Erika S. Olson

• Publisher: Wiley
• Year: 2010
• Print ISBN: 9780470624203
• eBook ISBN: 9780470937075
• Edition: 1
• Topic: Business
• Subtopic: Investments & Securities
• Index: Business

In 2007, a stranger-than-fiction multibillion-dollar bidding war for the Chicago Board of Trade (CBOT) erupted between the Chicago Mercantile Exchange (CME) and Atlanta's IntercontinentalExchange (ICE). Zero-Sum Game: The Rise of the World's Largest Derivatives Exchange takes readers behind the scenes of this battle to tell the gripping—and often comical—story of how the historic merger between CME and CBOT almost didn't happen.

Author Erika S. Olson, a managing director at CBOT during the bidding war, delivers a blow-by-blow account of the fight for the world's oldest futures exchange, taking you inside CBOT's landmark Chicago Loop headquarters, onto the high-octane trading floor, and into executives' offices.

Through the lens of the CME/CBOT deal, Zero-Sum Game:

• Introduces the colorful and outspoken personalities who call the shots in this close-knit and frequently misunderstood industry
• Details the reasons behind the recent, spectacular growth of a market that's existed for over 160 years
• Explains how derivatives affect the lives of average consumers worldwide by influencing everything from interest rates on credit cards to the cost of a cheeseburger to the price of a gallon of gas
• Reveals the inner workings of futures exchanges, and differentiates the various types of derivatives that are routinely lumped together and vilified by the media

Erika S. Olson is a former managing director of the Chicago Board of Trade and spent over ten years working in and consulting to the financial services industry. She received her MBA from Harvard Business School and her BBA from the University of Michigan Ross School of Business.

Chapter 1

Welcome to the Jungle

July 11, 2006

“The floor” is a marvel of chaos, and one of very few places in this world that truly must be seen to be believed, especially at 1:14 P.M. every weekday. When the clock hits 1:14, an ear-piercing bell rings to remind everyone that only 60 seconds remain before the floor closes and all trading must stop. The bell sounds . . . a split-second passes . . . and then all hell breaks loose. What was already a loud buzz of traders shouting bids and offers at each other escalates into a deafening roar. The throbbing sea of colored jackets transforms into a pressure cooker of sporadic explosions—bodies jump, arms flail, hands frantically clap and wave, and every once in a while, a fist flies. Time seems suspended as brows bead with sweat, elbows jostle for position, and mouths open even wider in the final throes of trading ecstasy. And then suddenly—as quickly as it had begun—the mayhem ends. Shredded trading cards launch toward the sky as unfortunate souls pack up and try to convince themselves they’ll do better tomorrow. Those who were successful might flash a quick smile as they head out, but otherwise their faces reveal no sign of what they just went through, except for perhaps a faint red glow.

I looked down at it all with awe. I had never laid eyes on a trading floor before—unless you count the scene from Ferris Bueller’s Day Off where Ferris and Sloane contemplated marriage as Cameron mimicked traders not too far from where I now stood. For the first five years I lived in Chicago, I had neglected to visit the rowdiest 92,000 square feet in the city. For the next five years, however, I couldn’t have seen the floor even if I tried. After the September 11 attacks, security was beefed up and the pits had been closed off to the public.

It was only because I was in the building for an interview that I got to witness the craziness in person. Merely watching the process from behind a glass window on the executive floor exhausted me, but I was hooked. I had to get this job.

The job in question was the managing director of marketing at the Chicago Board of Trade (also known as CBOT, sometimes pronounced “see bot”), the world’s oldest futures and options exchange. If I succeeded in securing the role, I’d be leaving the financial powerhouse of JPMorgan Chase, where I’d spent the past three years after earning my MBA at Harvard Business School.

Preparation for my first meeting with Chris Malo, executive vice president of business development and marketing, had occupied the majority of my time for days. I had studied textbooks that explained futures markets, exchanges, and derivatives. I had subscribed to a daily industry newsletter compiled by John Lothian (a broker for Price Futures Group) and developed a list of questions based on the latest headlines. I had read annual reports, analysts’ evaluations, magazine articles, message boards—anything I could find about the industry.

Moments into the interview, however, it became evident that those efforts might not have been enough. While Chris prefaced our meeting by saying that he was “probably the second-nicest, if not the nicest guy” at the exchange, he had perfected the art of the poker face. If I cracked a joke, there was no response. If I made what I thought was an insightful comment . . . nothing. While he was unfailingly polite, he stared straight ahead with no expression when he answered questions. His face was still friendly despite its lack of animation, though, and he had a thick head of wavy dark hair that complemented his tanned skin. He could have easily passed for a leading man from Hollywood’s heyday—striking, fit, and impeccably dressed, although not quite as tall as the other men who passed by on the executive floor. I guessed him to be in his mid-forties, but I learned later that he had recently turned 50.

His office was spacious, probably 250 square feet. All of the furniture and cabinets were a rich, dark wood. There was a flat-screen TV tuned to CNBC on one of his two substantial desks, and framed pictures of his wife and college-age children were plentiful. Overall, he seemed organized—only one small pile of papers was visible in a tray beside his phone.

As my interview progressed, I attempted to show him that I was up on industry news by mentioning some of the things I’d read in Lothian’s newsletter. I figured this would impress him, but my plan totally backfired. He could barely restrain himself from jumping out of his chair as he snapped, “You’ve been reading Lothian?”

Unbeknownst to me, John Lothian was one of just a handful of people in the world who could make my future boss’s blood boil. Sensing that I was in dangerous territory, I changed tactics and posed what I considered to be a humorous question about CBOT’s main competitor, the Chicago Mercantile Exchange, known colloquially as CME or “the Merc.”

“So, is the Merc going to buy this place, or what?” I asked.

Chris finally broke out in a smile and chuckled. “There has certainly been speculation about that, but those rumors have been around for years—decades, even. I can’t promise you that the Board of Trade isn’t going to get bought out by some company, but quite frankly, I don’t think we’d ever join up with the Merc.” He seemed genuine. I would later learn that he really could not fathom a merger with CME at the time of my interview. This was probably because a year and a half prior, Bernie Dan, CBOT’s CEO, had lured Chris away from Cargill Investor Services—where they’d worked together in the 1980s and 1990s—to help the exchange with its IPO and hone its business development and marketing operations. If anything, Chris, Bernie, and the rest of CBOT’s executive team were probably hoping to get the exchange in position to make an acquisition—not be acquired.

Eventually, I ran out of questions. Chris and I shook hands, he made some parting comments, and as I headed back toward the elevators, I took one last look down at the trading floor. It was completely deserted.

July 20, 2006

I returned to CBOT’s celebrated Art Deco building at the end of the LaSalle Street corridor nine days later to meet with the three senior managers who reported to Chris and would consequently be my peers, should I get the position. When I arrived at the reception desk, however, I learned that Bob Ray, senior vice president of business development, would have to reschedule as his mother had passed away.

My interviews with Julie Winkler, vice president of product development, and Maria Gemskie, managing director of communications, were still on. Julie headed the group of economists who created new futures contracts for the exchange; Maria’s team trumpeted the success of those contracts to anyone who would listen.

A contract (also referred to as an exchange product) is not much more than a set of specifications pertaining to something that can be traded. For example, one Wheat contract represents 5,000 bushels of a designated type of soft red winter wheat. The twist—and the reason why futures contracts are called futures in the first place—is that the buyers and sellers of contracts agree to complete the physical exchange of goods in the future (on one of many predesignated dates), even though they’re locking in their prices today.

Who would be interested in such an arrangement? Farmers and food manufacturers are two of the most obvious answers. Kraft Foods, for example, will have to continue buying wheat three months, six months, and a year from now in order to keep up with the ongoing demand for products like Wheat Thins, Ritz Crackers, Oreos, and Macaroni & Cheese. Grocery shoppers expect the prices of those goods to stay pretty much the same, week in and week out, and will find substitutes if things get too expensive. Therefore, Kraft wants to make sure it’s always monitoring how much it costs to produce its most popular items. The company is motivated to lock in a price for wheat today so that it can manage the risk of wheat prices skyrocketing because of a freakish drought that might occur a few months from now. So Kraft has a brokerage firm buy Wheat futures on its behalf, and makes sure the settlement dates are spread out so the business is covered for a long time.

What about the wheat farmer? He likes this arrangement, too, because while Kraft is worried about the price of wheat going up over the next six months, the farmer is worried about it going down. What if the weather is perfect, resulting in bumper crops across the major soft red winter wheat-producing states? Such an event could result in an oversupply, and he’d be groveling to unload his product on the cheap. Unless, of course, he offsets a potential drop in the price he’ll eventually get for his crop by selling futures contracts through a broker and locking in a price today.

Farmers and food manufacturers represent hedgers—parties who have a vested interest in a certain type of commodity and would therefore be adversely affected should the price of that commodity swing wildly. They use futures contracts to limit their exposure to price movements and even out business costs and revenues so that the prices for their end products, which line grocery store shelves across the world, remain relatively stable as well.

Then there are speculators. Speculators are people and firms who don’t have any intention of ever actually producing or owning the products they’re trading—they simply think they know which way prices will move, so they buy and sell various contracts accordingly and profit if their guesses turn out to be correct. Speculators have been around as long as futures markets have been around, and they play the critical role of providing liquidity in the market. If a farmer is looking to sell contracts at a certain price but there are no other hedgers who want to buy, chances are a speculator will be on hand, happy to take the other side of that trade.

Julie’s team was responsible for providing both hedgers and speculators several moneymaking—and money-preserving—opportunities each year in the form of new future contracts. The economists she managed also regularly made subtle changes to products that had already launched. Julie had worked at the exchange since graduating college and knew almost everything there was to know about how CBOT operated. The executives asked for her opinion constantly, but it didn’t seem to go to her head; she had a reputation for modesty, keeping to herself, and being extremely fair when called upon to settle disputes. Therefore, although Julie was only 32 years old, she was one of the most respected people in the company.

As our interview commenced, it became immediately clear that Julie was all business, all the time. Her sterile surroundings, run-of-the-mill black suit, translucent skin, and no-nonsense, pixie haircut couldn’t have led to any other conclusion. Wilted tulips drooped in a vase on her desk, heightening the dreary atmosphere of her office, which was void of any personal effects and could have certainly been mistaken for a storage room.

She kicked off our meeting with several questions about the client research engagements I had spearheaded throughout my career. Her questions were direct and she had a formal air about her. It was as if she had taken a lesson from Chris; her expression remained blank no matter what I said. Finally, a homework assignment I’d given past focus group attendees piqued her interest. Her eyebrows arched as I described sending Polaroid cameras to research participants and instructing them to shoot pictures that captured their typical workday so that I could get a sense of how they interacted with various products and services.

A shocked expression crossed her face so suddenly that I snapped my mouth shut and looked over my shoulder in alarm. When she saw how I’d misinterpreted her look she quickly explained, “It’s just that I would never give a Polaroid camera to any of our traders. The pictures we’d get back would be very, very disturbing.”

I burst out laughing, probably louder and harder than I should have, but from that point on our talk was much more relaxed. When Julie saw that our hour together had ended, however, her serious demeanor returned and she offered me a stiff handshake goodbye.

Next was my talk with Maria. She’d been at the exchange for seven years and previously worked in Washington, D.C., as a congressman’s communications director, so she was adept at handling all of the politics that ran rampant in both the company and the futures industry.

Born and raised on the northwest side of Chicago, Maria was the epitome of Midwestern friendliness. However, she looked like she’d just jetted in from California: long, straight blond hair accentuated her sun-kissed face. Demonstrating her comfort in sky-high heels and a designer suit that was perfectly tailored to her athletic frame, she wheeled her chair across the room and positioned it next to me after I entered her office. “It seems too formal when I sit over there,” she proclaimed, waving her hand dismissively toward her usual spot behind a majestic wooden desk.

Maria’s lavish, sizable office was the opposite of Julie’s. It was decorated with pictures and memorabilia from trips around the world, all of which seemed to be for industry-related events. A full-size couch, several framed works of art, a TV tuned to CNBC, a variety of plants, and a multitude of boxes from Ann Taylor lined the perimeter of the room. There was no doubt that she was an absolute workaholic and essentially lived in her office on the sixth floor of CBOT’s 141 W. Jackson building, in the heart of Chicago’s Loop.

At the end of our meeting she asked suspiciously, “So, why do you want this job?” I later found out that the management team was shocked that not one, but two Harvard MBAs were jockeying for the marketing position. CBOT had been a publicly traded firm for less than a year, and its executives were struggling to break the company out of its “member-run” (read: old, white guys) stereotype. It was not a place that normally attracted recent business school graduates. I rattled off a list of serious reasons why I was interested in the exchange, and ended by saying that I also simply thought the Chicago Board of Trade seemed like a pretty cool place to work.

She beamed. “It is cool, isn’t it?”

I had no idea I was talking to the person who loved the Chicago Board of Trade more than anyone else I would ever meet. In her mind, there were no truer words I could have spoken.

July 24, 2006

Finally, my rescheduled interview with Bob Ray arrived. Bob was tall, in his early fifties, and had a handsome, friendly face with twinkling eyes and a devilish grin that betrayed the fact he was constantly thinking up his next politically incorrect joke. He could have been actor Bill Murray’s better-looking, higher-spirited brother. It was instantly obvious to me that Bob was always the life of the party—his sharp suit couldn’t hide the fact that he emanated energy.

We met in his office, which was close to Julie’s on the tenth floor, but about four times the size. Half of the room seemed to be set up for small group meetings—there was a circular table with four chairs surrounding it, in addition to two padded leather chairs across from Bob’s desk. His personal space took up the far side of the room; he perched on a wheeled Aeron chair situated in the cradle of a large U-shaped desk. In that area also sat a small television—tuned to CNBC, of course—and on top of it was a strange glowing ball that signaled whether the stock market was up or down (and doubled as a funky decoration). A gigantic whiteboard displaying a rainbow of scribblings dominated one side of the room; the wall opposite the whiteboard showcased expansive windows, though the view they provided of a neighboring building was utterly unspectacular. A vodka bottle with handcuffs draped over its neck sat proudly on display near the window ledge, pictures of Bob in humorous poses at landmarks around the world hung on the wall behind his desk—Bob donning an oversized mouton ushanka in Red Square, Bob sporting his CBOT cap in front of Tiananmen Gate in the Forbidden City, Bob lunging at a Godzilla statue in Tokyo, and so on—and teetering stacks of magazines and papers were absolutely everywhere else.

At the beginning of our interview, I offered my condolences about his mother’s passing, and he responded by launching into a few stories about his relatives. He was from a large Irish Catholic family, and quipped that it was always chaotic when they all came together, even under the recent circumstances. He went out of his way to make light of the situation, and I got the distinct feeling he had a tendency to do that in any situation.

After the obligatory small talk, he excitedly began to share his thoughts on how to promote both the exchange and its products. His voice was raspy and breathless as he explained that by and large, any person or company who wanted to trade futures at CBOT needed to enter their...

Table of contents

• Title Page
• Copyright Page
• Dedication
• Preface
• Cast of Characters
• Chapter 1 - Welcome to the Jungle
• Chapter 2 - Into the Groove
• Chapter 3 - This Is How We Do It
• Chapter 4 - Don’t Speak
• Chapter 5 - Wanna Be Startin’ Somethin’
• Chapter 6 - Dirty Laundry
• Chapter 7 - Under Pressure
• Chapter 8 - ICE ICE Baby
• Chapter 9 - War
• Chapter 10 - Suspicious Minds
• Chapter 11 - Land of Confusion
• Chapter 12 - Fight for Your Right
• Chapter 13 - Down Under
• Chapter 14 - Take the Money and Run
• Epilogue
• Notes
• Glossary
• References
• Acknowledgments
• About the Author
• Index