AMTD TD Ameritrade Holding Corporation

By Alexander Osipovich 

Regulators have given the green light to a startup exchange that wants to attract individual traders to the risky world of futures.

The Small Exchange, a venture led by a former executive of TD Ameritrade Holding Corp., won approval from the Commodity Futures Trading Commission on Tuesday to become the newest U.S. futures exchange.

The CFTC's decision comes as fallout from the coronavirus epidemic has sent futures markets into a stretch of wild volatility, with oil futures suffering their steepest one-day drop in decades on Monday and S&P 500 futures smacking into their daily 5% price-move limit -- a rare occurrence -- twice this week.

The Small Exchange would let traders place bets on such moves. Although established futures exchanges such as CME Group Inc. and Intercontinental Exchange Inc. can be used by retail traders, too, they have historically been dominated by large participants such as banks, energy companies and commodity trading firms.

Futures are contracts that traders can use to bet on whether a particular market -- such as oil, gold or U.S. stocks -- will go up or down. One reason they haven't traditionally been used by individuals is because a bet that goes badly can cause a trader to lose more money than he or she invested in the first place, potentially leading to bankruptcy.

Trading futures "is a volatile, complex and risky venture that is rarely suitable for individual investors," the CFTC warns on its website.

Donald Roberts, president and chief executive of the Small Exchange, expects his customers to be sophisticated day traders, rather than mom-and-pop investors. Still, he says the Small Exchange won't hide the risks of trading futures.

"We're going to have a concerted effort to educate the public about the risks of our products," said Mr. Roberts, who previously oversaw TD Ameritrade's futures and foreign-exchange business.

The Small Exchange faces an uphill battle. Previous efforts to build new futures exchanges from scratch have often failed to gain traction.

Adding to the challenges, Chicago-based exchange giant CME has made a push recently to attract day traders, although they remain a tiny slice of its business. In 2016, CME began airing a TV commercial that shows a cheerful dad touting the benefits of futures trading. Last year, CME launched a bite-size version of its flagship stock-index futures geared for individuals, who can't bet as much money as institutional customers.

"The biggest problem that the Small Exchange could have is that they'd invite CME to take notice and start competing with them," said Neal Wolkoff, an exchange-industry consultant and former executive at the New York Mercantile Exchange, which was acquired by CME in 2008.

CME is the world's largest exchange operator by market value, with revenue of $4.9 billion last year. It has a history of quashing competitors that make runs at its business. A CME spokesman declined to comment.

Based in Chicago, the Small Exchange hopes to launch in April. It plans to offer futures linked to oil, the U.S. dollar, stocks, the yield on 10-year U.S. Treasury notes and precious metals.

As the Small Exchange's name suggests, its contracts will be smaller in dollar value than the best-known contracts at established futures exchanges, so people won't have to put down as much money to trade them.

To buy or sell futures, traders must post cash, called "margin," with their brokers to cover the risk of potential losses. The amount of margin required depends on how big the contracts are, among other factors.

CME stole some of the Small Exchange's thunder in May 2019 when it debuted a suite of "Micro E-mini" futures contracts linked to the S&P 500 and other stock-market indexes. The contracts are essentially the same as CME's heavily traded E-mini S&P 500 futures, but smaller in size, making it easier for individuals to post margin to trade them. More than 128 million Micro E-mini equity-index contracts have been traded since they launched, according to CME.

Mr. Roberts described the Micro E-mini launch as a "pre-emptive strike" against his startup. CME executives have said they were pushing into retail already, and the Small Exchange's plans didn't factor into the decision to introduce Micro E-minis.

CME has other advantages, too. It has long-term, exclusive licensing arrangements to list futures on the best-known stock indexes, including the S&P 500 and Dow Jones Industrial Average. That means the Small Exchange had to cook up its own indexes, such as the "Small Stocks 75" index.

Still, the Small Exchange has support from some major market players. Two of the biggest electronic trading firms, Citadel Securities and Jump Trading, each invested $5 million in the venture last year, and they are expected to quote prices on the Small Exchange when it goes live, potentially boosting its volumes.

Other investors in the upstart exchange include Tastytrade Inc., a financial-media firm that caters to day traders, and Chicago-based Peak6 Investments.

Write to Alexander Osipovich at alexander.osipovich@dowjones.com

(END) Dow Jones Newswires

March 10, 2020 17:34 ET (21:34 GMT)

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