SECTION IVDERIVATIVES

DERIVATIVES

FUTURES AND OPTIONS CONTRACTS RISK MANAGEMENT TOOLS THEY ARE THE AGREEMENTS ON

BUYING AND SELLING OF THESE INSTRUMENTS AT THE AGREED-UPON PRICE AND ON THE AGREED- UPON DATE.

DERIVATIVES

IN TURKEY CMB REGULATIONS SPECIFY 5 VEHICLES UPON WHICH THE DERIVATIVES CAN BE TRADED:– COMMODITIES– SECURITIES– GOLD AND PRECIOUS METALS– FOREIGN EXCHANGE– INDEXES

DERIVATIVES

CASH MARKET:– SPOT MARKET– FORWARD MARKET.– FUTURE AND FORWARD CONTRACTS ARE

SIMILAR HOWEVER THERE ARE ALSO DIFFRENCES BTW THEM.

– FUTURE AND FORWARD CONTRACTS ARE DIFFERENT FROM OPTIONS CONTRACTS.

DERIVATIVES

SOME OF THE BEST-KNOWN WORLD FUTURES AND OPTIONS EXCHANGES ARE:– Chicago Board Options Exchange (CBOE)– Chicago Mercantile Exchange (CME)– London International Financial Futures Exchange

(LIFFE)– EUREX of Frankfurt– MATIF of Paris– SIMEX of Singapore

CHAPTER 9FUTURES

FUTURES

A futures contract is an agreement between two parties that commits one party to sell a commodity or security (underliers) to the other at a given price and amount and on a specified future date.

FUTURES

Futures exchanges in U.S. are listed below;– Chicago Board of Trade (CBOT)– Chicago Mercantile Exchange (CME)– New York Mercantile Exchange (NYME)– Commodity Exchange (COMEX)

EVERY EXCHANGE HAS A CLEARING HOUSE.

FUTURES

FUNCTIONS OF THE CLEARING HOUSE;– IT GUARANTEES THAT THE TWO PARTIES

WILL PERFORM THE TRANSACTIONS.– AT THE END OF THE TRADING DAY, IT

MATCHES EACH PURCHASE WITH THE CORRESPONDING SALE AND COMPUTES EACH PARTIES GAINS AND LOOSES: “MARK TO MARKET”.

FUTURES

FUTUES AND OPTIONS

– TRADED ON O.E.– PRICE, AMOUNT, DATE

ETC. ARE STANDARTIZED BY THE EXCHANGE

– DAILY SETTLEMET– REQUIRES MARGIN

ACCOUNT– REGULATED

FORWARD– TRADED ON OTC

MARKETS– NOT STANDARD– SETTLED ONLY AT

DELIVERY– DOES NOT REQUIRE A

MARGIN ACCOUNT– UNREGULATED

FUTURES

MOTIVES FOR ENTERING INTO FUTURES MARKET;– HEDGING– SPECULATION AND – ARBITRAGE

FUTURES: LONG AND SHORT POSITIONS

THE BUYER OF A FUTURES CONTRACT IS SAID TO BE LONG, AND HAS A LONG POSITION.

THE SELLER OF A FUTURES CONTRACT IS SAID TO BE SHORT, AND HAS A SHORT POSITION.

FUTURES; L&S POSITIONS

A PURCHASE CAN BE EXIST TO CLOSE OUT A SHORT POSITION OR A SALE CAN BE EXIST TO CLOSE OUT A LONG POSITION.

FOR EVERY LONG POSITION THERE IS A SHORT POSITION.

ZERO-SUMS GAME.

FUTURES; L&S POSITIONS

LONG POSITION: “LONG HEDGE” SHORT POSITION: “SHORT HEDGE”

FUTURES: LEVERAGE

USE OF CREDIT OR BORROWED FUNDS TO IMPROVE ONE'S SPECULATIVE CAPACITY AND INCREASE THE ROR FROM AN INVESTMENT,AS IN BUYING SECURITIES ON MARGIN.

THE LEVERAGE OF FUTURES TRADING REFERS TO ONLY A SMALL AMOUNT OF MONEY IS DEPOSITED TO BUY OR SELL A FUTURES CONTRACT.

LEVERAGE

INITIAL MARGIN IS 5-15% OF THE VALUE OF THE UNDERLYING SECURITIES.

THIS LOW INITIAL MARGIN MAGNIFIES THE PERCENTAGE OF LOSS OR PROFIT POTENTIAL.

FUTURES: MARGIN

A DEPOSIT THAT CAN BE DRAWN UPON BY THE BROKERAGE FIRM TO COVER LOOSES THAT MIGHT BE INCURRED IN THE FUTURES TRADING.

BOTH THE BUYER AND THE SELLER OF A FUTURES CONTRACT ARE REQUIRED TO PROVIDE MARGIN.

FUTURES: MARGIN

MIN. MARGIN REQUIREMENTS FOR EACH CONTRACT ARE SET BY THE EXCHANGE.

THERE ARE TWO TYPES OF MARGINS;– INITIAL (ORIGINAL) MARGIN– MAINTENANCE MARGIN

FUTURES

COMMODITY FUTURES FINANCIAL FUTURES OPTIONS ON FUTURES INDEX FUTURES

COMMODITY FUTURES

AN AGREEMENT COVERING THE PURCHASE AND SALE OF PHYSICAL GOODS FOR FUTURE DELIVERY ON A COMMODITY EXCHANGE.

IT REQUIRES THE SELLER TO DELIVER A SPECIFIED QUANTITY OF A COMMODITY TO A DESIGNED LOCATION TO THE BUYER AT A SPECIFIED PRICE AND ON A SPECIFIED DATE

COMMODITY FUTURES

THEY ARE USED BY;– PRODUCERS– CONSUMERS– INVESTORS– EXCHANGE-FLOOR TRADERS

COMMODITY MARKET

IN THIS MARKET THERE ARE MANY BUYERS AND SELLER, NONE OF THEM IS LARGE TO DETERMINE THE PRICES

PRICES ARE DETERMINED BY THE MARKET DEMAND AND SUPPLY, EFFECTED BY POTICAL AND ECONOMICAL FACTORS.

COMMODITY FUTURES

ONLY ABOUT 2% OF ALL FUTURE CONTRACTS RESULT IN DELIVERY. THEY CHANGE HANDS IN MANY TIMES.

FINANCIAL FUTURES

THEY ARE INTRODUED AFTER 1970’S THERE ARE 3 MAIN TYPES OF FINANCIAL

FUTURES;– INTEREST RATE FUTURES– CURRENCY FUTURES– STOCK INDEX FUTURES

FINANCIAL FUTURES

INVESTORS CAN USE THEM FOR HEDGING AND SPECULATION PURPOSES:

INVESTORS CAN HEDGE AGAINST CHANGES IN STOCK PRICES OR AN INVESTOR CAN MAKE PROFIT FROM DECLINING PRICES BY SELLING AND FROM RISING PRICES BY BUYING

BORROWERS CAN HEDGE AGAINST HIGHER INTEREST RATES, LENDERS AGAINST LOWER INTEREST RATES.

FINANCIAL FUTURES

TRADES IN FUTURES CONTARACTS ARE SETTLED BY ENTERING INTO AN OFFSETTING POSITION:– A CONTRACT SOLD IS CLOSED OUT BY A

PURCHASE AND – A CONTRACT BOUGHT IS CLOSED OUT BY A

SELLING CONTRACT.

FINANCIAL FUTURES

THEY ARE TRADED ON EXCHANGES. THE EXCHANGE CLEARING HAUSE ACT AS THE THIRD PARTY AND GUARANTOR.

DELIVERY RARELY OCCURS.

OPTIONS ON FUTURES

AN OPTION ON A FUTURE CONTRACT GIVES THE BUYER THE RIGHT, BUT NOT THE OBLIGATION, TO BUY OR SELL A PARTICULAR FUTURES CONTRACT AT A STATED PRICE, AT ANY TIME PRIOR TO A SPECIFIED DATE.

THERE ARE TWO TYPES;– CALL OPTIONS– PUT OPTIONS

OPTIONS ON FUTURES

The buyer of a call option buys the right, but not the obligation, to purchase a particular futures contract at a stated price at any time during the life of the option.

The buyer of a put option acquires the right, but not the obligation, to sell a particular futures contract at a stated price at any time during the life of the option.

OPTIONS ON FUTURES

If the option is exercised, settlement is either through physical delivery or cash settlement.

Options on futures involve two sets of relationship;– The one between the futures contract and the

underlying commodity, security, or index– The one between the option and the future

contract

OPTIONS ON FUTURES

Any options strategy can also be applied to futures options. Example;– If interest rates are expected to decline, calls can

be purchased or the investor can write (sell) puts to earn premium.

– If interest rates are forecasted to rise, puts can be bought or calls can be written to earn the premium.

INDEX FUTURES

IT IS A CONTRACT TO BUY OR SELL THE FACE VALUE OF A STOCK INDEX.

TWO PRINCIPAL STOCK INDEX FUTURES CONTRACTS ARE TRADED IN U.S.A.– S&P 500 STOCK INDEX CONTRACT AT THE

CME– S&P MINI INDEX CONTRACT AT THE CME