Market quality and price discovery: Introduction of the E-mini energy futures


Market quality and price discovery: Introduction of

the E-mini energy futures

Yiuman Tse *, Ju Xiang

Department of Finance, College of Business, 501 West Durango Blvd., University of Texas at San Antonio,

San Antonio, TX 78207, United States

Received 1 April 2004; received in revised form 1 November 2004; accepted 1 April 2005

Available online 20 September 2005

Abstract

In mid-June 2002, the New York Mercantile Exchange (NYMEX) introduced E-mini futures contracts

on natural gas and crude oil, a natural response to information technology developments and investor

interest. The transition data allow examination of the effects of the new contracts on market quality and

price discovery. Bid–ask spreads on the regular futures have been reduced significantly since introduction

of the E-mini futures, showing improved market quality from competition effects. The E-mini market

contributes more than 30% to the price discovery process, although it represents less than 1% of the volume

of the regular futures with the same underlying. E-mini futures have several advantageous characteristics

over regular futures, which should explain these significant results.

D 2005 Elsevier Inc. All rights reserved.

JEL classification: G15

Keywords: E-mini futures; Price discovery

1. Introduction

Energy products and energy markets have played essential roles in the U.S. economy since

the Industrial Revolution. Energy markets have been much more volatile than the stock markets

in recent years. During the 5-year period of 1997 through 2001, the variances of daily returns of

natural gas and cruel oil were 0.00230 and 0.00071, while that of the stock index was only

0.00016 (source: Commodity Systems Inc. (CSI) daily market files). Gas and oil prices since

1044-0283/$ - see front matter D 2005 Elsevier Inc. All rights reserved.

doi:10.1016/j.gfj.2005.04.001

* Corresponding author. Tel.: +1 210 458 2503; fax: +1 210 458 2515.

E-mail address: yiuman.tse@utsa.edu (Y. Tse).

Global Finance Journal 16 (2005) 164–179



deregulation in the 1970s have been considerably more volatile than other commodity prices at

most times.
1

Gas and oil prices are volatile because they are affected by many supply and demand factors,

such as compacts among the Organization of Petroleum Exporting Countries (OPEC) and other

oil-producing countries, the general economic environment, season of the year, storage

circumstances, regulatory changes and so on. Susmel and Thompson (1997) find that broad

regulatory changes from the 1980s through the 1990s had great impacts in the natural gas spot

market, including increased volatility of prices and risks of market participation. In the 1970s,

OPEC cut oil production significantly, which led to the so-called energy crisis or oil crisis. More

recently, investors have worried about labor strife and subsequent supply disruptions in

Venezuela and Nigeria. The possibility of terrorist attacks targeting energy facilities, natural

incidents such as Hurricane Lily in 2002, and Middle East conditions in 2003 have also greatly

affected production and storage.

Economic entities such as energy producers, distributors, and financial institutions depend on

efficient spot and futures markets for risk management and price discovery. Energy futures

contracts were introduced at the New York Mercantile Exchange (NYMEX) after the 1970s

mainly to hedge increasing energy risks. Futures exchanges constantly introduce new financial

products in response to developments in information technology and to meet the various needs

of investors. A recent innovation is the use of E-mini futures, including equity index futures like

E-mini SP 500, Nasdaq 100 and Dow 30 as well as commodity futures. An E-mini futures

contract is smaller than a regular futures contract with exactly the same underlying pool of

assets, and is usually traded electronically.

On June 17, 2002, NYMEX and the Chicago Mercantile Exchange (CME) introduced two

smaller sized energy futures, natural gas E-mini and light sweet crude oil E-mini futures [called

e-miNY Energy Futures(SM)]. E-mini natural gas and crude oil futures contracts are 40% of the

size of the regular futures contracts; that is, 2.5 E-mini futures contracts equal one regular futures

contract. They are traded through CME’s electronic trading platform (GLOBEX), and not on the

open outcry market where regular futures are traded.
2

According to NYMEX, the smaller sized E-mini futures were designed to appeal to individual

speculators–not NYMEX’s typical customer–in the energy markets. The margin requirements of

E-mini futures are smaller than those for the regular contracts. Therefore, E-mini futures are

more affordable to individual investors who were previously unable to trade at NYMEX. Unlike

their regular counterparts, the E-mini contracts are cash-settled. Some commercial entitles may

use the E-mini futures for hedging odd lots. The appendix provides detailed specifications of the

two futures contracts and two news articles by Securities Week (2002a, 2002b) describe the

benefits of E-mini futures to individual investors.

We examine the impact of introduction of E-mini futures on the regular futures. E-mini

products might have multiple effects on the regular products since E-minis are both

electronically traded and smaller in size. Whether market quality will be improved through

competing trading systems depends on two opposite effects: competition and fragmentation

1
During the same 5-year period, the variances of gold, live cattle, and soybean daily returns are 0.00007, 0.00014, and

0.00018, respectively. The gas markets are also more volatile than other commodities and the S&P index during the

longer period of 1990 through 2001. Results are available upon request.
2
Members of the NYMEX and CME have access to one another’s electronic system for E-mini trading. CME members

are granted access to NYMEX ACCESSR to trade NYMEX Division products. Those trades receive discounts and are
guaranteed by a NYMEX clearing firm. Similarly, NYMEX members receive trade access, discounts, and clearing

guarantees for products listed on CME’s GLOBEX.

Y. Tse, J. Xiang / Global Finance Journal 16 (2005) 164–179 165



https://isiarticles.com/article/12660