The Allure of Merc Markets

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Investing in a futures and commodities exchange might seem odd to many people, but the Chicago Mercantile Exchange (NYSE: CME) markets products and services not all that different from, say, Goldman Sachs (NYSE: GS), Morgan Stanley (NYSE: MWD), Merrill Lynch (NYSE: MER), or even E*Trade (NYSE: ET).

The CME's products are particularly well-positioned, given all the economic volatility we've seen over the past few years. With ongoing concerns about terrorism, many commodities soaring, interest rates likely at a turning point, and the dollar abnormally down, there's a significantly increased need to hedge risks. In addition, the recovery in the markets over the past 18 months has renewed interest in index futures, such as the S&P 500 futures and similar E-mini.

Yesterday, the exchange reported that net earnings for the first quarter rose 77% to $46.1 million, or $1.35 a share, and revenue increased 32% to $166 million. Average daily trading volume climbed 19% to 2.83 million contracts. Electronic trading volume grew 29%, surpassing 50% of the total volume for the first time in March.

So what happens to the CME when there's a bumper crop next year and the dollar strengthens? First off, that's just more volatility. Secondly, even if prices level off to relative historical norms, people and companies sensitive to such economic swings are left with the realization of how far events can move prices against them, which will likely mean demand for hedging risks will remain strong for a long time to come.

Increased hedging activity also leads to increased speculation. That means more activity on the futures and commodities exchanges and higher profits for the Chicago Mercantile Exchange. And with an increase in operating margin to 46.5% from 34.7% a year earlier, it indicates the exchange has plenty of room to expand its offerings.

What's in store for the CME in the quarters and years ahead? Check out our Chicago Mercantile Exchange discussion board and give your opinion.

Fool contributor Mark Mahorney doesn't own shares of any companies mentioned.