Chicago Mercantile Exchange: Definition, History, and Regulation

What Is the Chicago Mercantile Exchange (CME)?

The Chicago Mercantile Exchange (CME), colloquially known as the Chicago Merc, is an organized exchange for the trading of futures and options. The CME trades futures, and in most cases options, in the sectors of agriculture, energy, stock indices, foreign exchange, interest rates, metals, real estate, and even weather.

Understanding the Chicago Mercantile Exchange (CME)

Founded in 1898, the Chicago Mercantile Exchange began life as the "Chicago Butter and Egg Board" before changing its name in 1919. It was the first financial exchange to "demutualize" and become a publicly traded, shareholder-owned corporation in 2000.

The CME launched its first futures contracts in 1961 on frozen pork bellies. In 1969, it added financial futures and currency contracts followed by the first interest rate, bond, and futures contracts in 1972.

Creation of CME Group

In 2007, a merger with the Chicago Board of Trade created the CME Group, one of the largest financial exchanges in the world. In 2008, the CME acquired NYMEX Holdings, Inc., the parent of the New York Mercantile Exchange (NYMEX) and Commodity Exchange, Inc (COMEX). By 2010, the CME purchased a 90% interest in the Dow Jones stock and financial indexes.

The CME grew again in 2012 with the purchase of the Kansas City Board of Trade, the dominant player in hard red winter wheat. In late 2017, the Chicago Mercantile Exchange began trading in Bitcoin futures.

According to the CME Group, on average it handles 3 billion contracts worth approximately $1 quadrillion annually. In 2021 CME Group ended open outcry trading for most commodities, although outcry trading continues in the Eurodollar options pit. Additionally, the CME Group operates CME Clearing, a leading central counterparty clearing provider.

CME Futures and Risk Management

With uncertainties always present in the world, there is a demand that money managers and commercial entities have tools at their disposal to hedge their risk and lock in prices that are critical for business activities. Futures allow sellers of the underlying commodities to know with certainty the price they will receive for their products at the market. At the same time, it will enable consumers or buyers of those underlying commodities to know with certainty the price they will pay at a defined time in the future.

While these commercial entities use futures for hedging, speculators often take the other side of the trade hoping to profit from changes in the price of the underlying commodity. Speculators assume the risk that the commercials hedge. A large family of futures exchanges such as the CME Group provides a regulated, liquid, centralized forum to carry out such business. Also, the CME Group provides settlement, clearing, and reporting functions that allow for a smooth trading venue.

CME Regulation

CME is regulated by the Commodity Futures Trading Commission, which oversees all commodities and derivatives contracts in the United States. The CFTC is responsible for oversight of brokers and merchants, conducts risk surveillance of derivatives trades, and investigates market manipulation and other abusive trade practices. It also regulates trading in virtual assets, such as Bitcoin.

Chicago Mercantile Exchange vs. Chicago Board of Trade

The Chicago Board of Trade (CBOT) is another Chicago-based futures exchange, founded in 1848. The CBOT originally focused on agricultural products, such as wheat, corn, and soybeans; it later expanded to financial products such as gold, silver, U.S. Treasury bonds, and energy. The CME merged with the CBOT in 2006, in a move approved by shareholders of both organizations.

Example of Chicago Mercantile Exchange

Most commodities can be traded anywhere, but there's one you can only trade at the CME: weather. CME is the only futures exchange to offer derivatives based on weather events, allowing traders to bet on cold temperatures, sunshine, or rainfall. In 2020, the CME traded as many as 1,000 weather-related contracts per day. The total notional value of futures totaled $750 million, while the total notional value of options totaled $480 million.

The Bottom Line

The Chicago Mercantile Exchange is a key part of America's financial infrastructure. Originally a marketplace for settling agricultural futures, it is now a major trading hub for precious metals, foreign currencies, treasury bonds, cryptocurrencies, and many kinds of derivatives.