Nymex announced last week an expanded slate of natural gas products and services, including electronically traded Henry Hub swap contracts, large order execution (LOX) trading, an expanded listing of contracts (out to 72 months from 36), and a temporary program that will allow exchange of over-the-counter options positions for Nymex options positions.

Traders agreed that the expedited introduction of these products and services was a move by the exchange to capitalize on the shake-up in the online trading industry last week following the demise of market-maker Enron and its highly trafficked EnronOnline trading system. Trading of the futures contracts going six years out began last Thursday night, and LOX and options-for-options trading followed by debuting Friday. Swap trading was set to start on Sunday night in Access trading.

However, even before these innovations were introduced, Nymex experienced a trading boom last week. The exchange announced that last Wednesday’s expiration-day activity set a new all-time volume record at 228,728 surpassing the July 23, 1999 record of 203,807. “[Wednesday’s] trading session is a clear demonstration of the desire of the trading community for a safe, reliable venue to lay off risk and the recognition by the marketplace of the financial safeguards of the exchange and its clearinghouse that provide a uniquely secure environment,” said Exchange President J. Robert Collins, Jr.

In a memo sent to its member firms last week, Nymex restricted trading with Enron until further notice or “unless such floor member has received express written authorization from an exchange clearing member carrying an Enron account that such clearing member agrees to accept any and all orders placed directly by Enron.”

Henry Hub Swaps

Henry Hub swaps transactions will have specifications that are to be similar to those of futures trading, except that the swap will be settled financially and no one will be forced to make or take physical delivery of a swap transaction. It will be settled using the corresponding futures price.

A risk manager for a large Houston trading company said the rapid introduction of the swap contracts is a move by Nymex to try and usurp trading volume that has previously been done primarily on the online trading exchanges of EnronOnline, Intercontinental Exchange and DynegyDirect.

“Robert Collins, who built a name for himself in risk management at El Paso, knows the liquidity that Nymex has been missing by virtue of these over-the-counter OTC instruments,” the risk manager said. “In an attempt to take advantage of Nymex’s change to for-profit status, he has pushed through and expedited a number of products since he became the Nymex president. The OTC market is a huge profit center and he knows that.”

A month ago, the exchange began offering exchange of futures for swap (EFS) transactions, which work similarly to exchange of futures for physical transactions (EFP). Two parties are allowed to privately negotiate the execution of an integrated over-the-counter swaps and related futures transaction on pricing terms agreed upon by the involved parties. The transaction must involve approximately equal but opposite side-of-market quantities of futures and swap exposures in the same or related commodities and are permitted until two hours after trading terminates in the underlying futures contract.

However, traders believe that the introduction of Henry Hub Nymex swaps somewhat obviates the need for the EFS transactions. In the past, traders were sometimes forced to enter into one more transactions near the end of the month. Typically a EFS transaction was needed to balance out their physical and financial position. “Now you will be able to get out of your swap by simply buying or selling the offsetting position on Nymex. It keeps your trades on the same plane,” the risk manager explained.

It is believed that Nymex will be successful in chiseling away at the OTC dominance online trading exchanges have enjoyed over the past year or so. Nymex had previously hoped to introduce Henry Hub swaps after the first of the year, and sources speculate that Enron’s demise has helped to speed its introduction. Additionally, there are certain banks and financial institutions that have not utilized OTC products before but will now that they are monitored, margined and controlled by a third party such as Nymex. “This is a way for some of the more conservative and probably the more financially oriented organizations to be able to represent that their transactions are Nymex-based and that allows them to legitimize them to their stakeholders,” the source said.

Large Order Execution

The decision to launch LOX trading was driven by customers, a Nymex spokesperson said. “The interest came from both natural gas companies and hedge funds. It’s something that is available on other futures exchanges, and it’s something we wanted to do in keeping with our overall plan to introduce some of the over-the-counter type instruments to our market.”

LOX trading will be permitted during regular open outcry session hours, matching buyers and sellers willing to trade lots of between 250 and 5,000 contracts. Similar to the current open-outcry trading for smaller lots, LOX trading will be conducted in the Nymex pit. LOX trading will be supported by a LOX book holder who will announce quotes, match buyers with sellers and facilitate the order execution.

LOX addresses the two common problems — time lag and price risk — that traders have when they execute their large lots under the current open-outcry system. Because LOX trades are settled in lump sum at a price transparent to the trader, it could help to minimize the trader’s price risk.

And while LOX trading is available on other exchanges, Nymex is taking it a step further by allowing local traders — many of whom trade for their own books and by doing so augment the market’s liquidity — the ability to “piggyback” on LOX trades. For example, if a local or group of locals wants to get in on a 500-lot offer put out there by a large trader, they will have the ability to participate in the trade and realize that price. In this way, the local trader is not shut out of a potentially large portion of the trading activity.

The key question for locals, according to local Ira Hochman, is how seamlessly they will be able to lay-off their risk. “If you or a group of locals get long through one of these trades and everyone in the ring knows you are long, the powers that be may try to push down the price to see if they can flush you out. However, if they did not know that you were one of the ones in on the LOX or if you can hedge your risk by selling another month at the same time, your risk is minimized. The net effect of this is that it will probably increase spread trading,” he said.

Floor traders wishing to participate in LOX must verbally submit a request for quote (RFQ) to a Nymex employee who will act as a book holder and announce the it to the floor. Once a response to the RFQ is formally recognized, the requesting member has 30 seconds to react to the market. There will be a $2.50 per contract charge for any RFQ that receives a responding quote. If the RFQ results in a trade, the fee will be reduced to $1.50 per contract.

Exchange of Options for Options

EOO transactions will work similarly to exchange of futures for physical and exchange of futures for swaps transactions. Two parties are allowed to privately negotiate the execution of on- and off-exchange options positions on pricing terms agreed upon by the involved parties. The transactions must involve approximately equal but opposite side-of-market quantities of options exposures in the same or related commodities. EOO will end on Dec. 28.

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