High Trading Volumes Could Lead To A Profitable Year-End For CME

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Leading global derivatives exchange operator CME Group (NASDAQ:CME) recently reported its monthly trading metrics for the month of November. After witnessing record trading activity in the month of October (17.6 million contracts traded a day), trade volumes slumped to just under 13 million contracts per day through November. However, trade volumes were about 4% higher than the year ago period. Interest rate and equities derivatives saw the largest sequential drop among the various asset classes traded on CME’s platform, while energy derivatives trading volumes continued to rise. On a year-over-year comparison, all asset classes witnessed a rise in trading activity with the exception of interest rate and equities contracts.

CME Group witnessed 7% annual growth in clearing and transaction fee revenues in the most recent quarter, with trading activity rising for interest rate and foreign exchange (FX) derivatives during the quarter ending September. [1] Growth in trading activity has continued through Q4, despite a sequential drop in trading volumes in November. Below we take a look at CME’s November performance across key asset classes.

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Trading Activity By Asset Class

CME’s combined trading volumes across all derivative classes – including interest rates, energy, equities, metals and foreign exchange products – in November fell by 26.4% sequentially to 12.9 million contracts traded per day. [2] However, trading volumes were still about 4% higher than November 2013 levels.

October was a positive month for interest rate derivatives, with average daily volume of 9.2 million trades per day – up from 7.2 million contracts per day in Q3 and 4.8 million contracts per day in October 2013. The rise in trading activity for interest rate derivatives began in August, as traders began to speculate when the Fed will start raising interest rates in 2015. This speculation led to a record 211 million interest rate contracts traded during the month of October. At the end of October, the Fed announced that it was ending the QE program and has confirmed that interest rates will rise, though with no clear indication as to when. [3] Subsequently, interest rate derivative trading slowed down in November, with only about 6.2 million contracts traded per day during the month, about 4% higher than November 2013 levels. However, interest rate derivative trading has picked up again in December thus far, with an average of 8.6 million contracts traded per day in the first half of the month. The surge in interest rate derivatives trading seems to have regained momentum, at least for now. We currently forecast CME’s interest rate derivatives trading volumes for the full year to be 12% higher than the prior year period at 6.7 million contracts per day.

Unlike interest rates, trading activity for energy products did not slow down in November. The volatility across oil prices helped the exchange operator in terms of the trading of natural gas and oil contracts through the month. On average, over 1.9 million energy derivative contracts were traded on CME’s platform in November – 9% higher than the previous month and the prior year period. The surge in energy trading has continued through the first half of December, with an average of 1.9 million contracts traded per day. Furthermore, CME realizes a higher rate per contract from trading of energy derivatives (~$1.30 per contract) compared to interest rates (~$0.48 per contract), equities (~$0.71 per contract) or foreign exchange (~$0.82 per contract). As a result, a higher mix of energy derivatives could help the company boost its trading-based revenues. In addition to the existing rise in trading volumes of energy contracts, CME announced the launch of European natural gas contracts on its CME Europe. [4] The contracts will be made available on both the Clearport and Globex platforms. The addition of European natural gas derivatives could further contribute to the growth in the energy segment. We currently forecast the average daily volume of energy contracts on CME’s platform to rise from about 1.6 million contracts per day in 2014 to 1.9 million through the end of our forecast period.

Commodities trades on CME’s platform rose by 30% y-o-y to 1.3 million contracts per day in October. The exchange operator witnessed high volumes for commodity products through November and the first half of December at about 1.3 million contracts per day. Additionally, metal derivative trading rose sharply in November to 480,000 contracts trades a day, 44% higher sequentially and 26% higher than the year ago period. The company anticipated growth in metals trading, due to which it raised the position limit for Copper in November to 1,000 lots from 400 previously. [5] Furthermore, the company started low-grade iron-ore futures in December, to further boost volumes. [6] As a result, metals trading in December thus far have been about 27% higher than prior year levels at about 372,000 contracts traded per day. We forecast commodities and metals combined to trade an average of over 1.4 million contracts for the full year.

December volumes thus far have picked up to nearly as high as October levels, with the month to date average of over 17 million contracts per day. As a result, CME could end the year on a high, with interest rate, energy, commodities and metal derivatives likely to boost Q4 revenues. With higher trade volumes through the end of the year, CME could post healthier margins than the comparable year-ago period. We currently forecast CME’s adjusted EBITDA margin to be around 65% for the full calendar year 2014, and expect margin to rise gradually to about 70% through the end of our forecast period. We have an $80 price estimate for CME’s stock, which implies a 10% discount to the current market price. CME’s market price has risen by about 12-13% since the company released its Q3 earnings in late October.

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Notes:
  1. CME Group Q3 2014 Earnings Call Transcript, Seeking Alpha, October 2014 []
  2. CME Group Monthly Trade Metrics For November, CME Group Investor Relations, December 2014 []
  3. Yellen Says Rate Rises Could Increase Financial Volatility, Wall Street Journal, November 2014 []
  4. CME Group Announces the Launch of a Suite of European Natural Gas Contracts on CME Europe, Market Watch, December 2014 []
  5. CME hikes copper spot-month position limit to 1,000 lots, Shanghai Metals Market, November 2014 []
  6. CME says to launch low-grade iron ore futures, Shanghai Metals Market, November 2014 []