Read Financial Markets Operations Management Online
Authors: Keith Dickinson
Financial Markets Operations Management (9 page)
Before we look at exchange-traded derivatives (ETDs) in more detail, please refresh your memories regarding the definitions of two types of ETD, i.e. futures and options.
Let us examine the similarities and differences between futures and options.
- A futures contract is an obligation to do something; an option is a right or choice to do something. We will see that, in many cases, the buyers and sellers of futures contracts do not wish to make or take delivery of the underlying asset. To remove their obligation, the buyers and sellers must “close out” their obligations by selling (by the original buyer) and buying (by the original seller) the same quantity of contracts and, most importantly, informing the counterparty that these are closing transactions.
- Both types refer to “standard amounts” and “specified prices and dates”. This would suggest that an entity other than the buyers and sellers has previously specified what these amounts, prices and dates should be. In other words, these derivative contracts have been designed and specified by a third party. This third party is a derivatives exchange.
ETD contracts are designed by the exchange on which they are traded. The standard nature of each contract refers to the contract specifications set out in
Table 2.32
.
TABLE 2.32
Contract specifications
| Contract Specification | Description |
| Underlying asset: | The name of the asset that would be delivered/received |
| Contract size: | The quantity of the asset represented in one contract |
| Delivery details: | (Also known as Expiry) The process for delivering the underlying asset, e.g. the date(s) when delivery can be made, the price at which deliveries will be made and who initiates delivery (the buyer or the seller) |
| Trading details: | Details such as the first and the last trading dates, exchange trading hours and the ways in which trading takes place (i.e. open outcry or electronic or a combination of both) |
| Pricing details: | The currency in which the contract will be traded, pricing style and the minimum price movement (known as the minimum tick value) |
It is usual for there to be a derivatives exchange in a market that has a stock exchange either as two separate entities or one combined entity (see
Table 2.33
).
TABLE 2.33
Examples of derivatives exchanges
| Country | Exchange Name |
| Australia | ASX and ASX24 |
| Belgium | Euronext Brussels (ex BXS) |
| Brazil | BmfBovespa-Derivatives |
| Canada | ICE Canada, Montreal Exchange (MX) |
| China | Shanghai Stock Exchange and Shenzhen Stock Exchange |
| China | China Financial Futures Exchange |
| France | Euronext Paris (ex MATIF MONEP) |
| Germany | Eurex |
| Hong Kong | Hong Kong Futures Exchange (HKEx Group) |
| India | National Stock Exchange and Bombay Stock Exchange |
| Italy | Italian Derivatives Market (IDEM) |
| Japan | Japan Exchange Group (Tokyo Stock Exchange, Osaka Securities Exchange) and Tokyo Financial Exchange |
| Korea | Korea Exchange |
| Malaysia | Bursa Malaysia |
| Mexico | Mexican Derivatives (MexDer) |
| Netherlands | Euronext Amsterdam (ex AEX) |
| Russia | Moscow Exchange MICEX-RTS |
| Singapore | Singapore Exchange Derivatives Trading (SGX-DT) |
| South Africa | Johannesburg Stock Exchange |
| Spain | Mercado Español de Futuros Financieros (MEFF) |
| Sweden | NASDAQ OMX Stockholm |
| Switzerland | N/A (Stake in Eurex sold to Deutsche Börse in 2011) |
| Turkey | Turkish Derivatives Exchange (TurkDex) |
| UK | NYSE LIFFE UK |
| UK | ICE Europe |
| USA | CME Group |
| USA | NYSE LIFFE US |
| USA | NYSE ARCA Options |
| USA | International Securities Exchange |
| USA | Chicago Board Options Exchange |
| USA | OneChicago |
In November 2013, the Intercontinental Exchange Group (ICE) announced the successful completion of its acquisition of NYSE Euronext.
6
The stock-and-cash transaction had a total value of approximately USD 11 billion.
The combined company operates 16 global exchanges and five central clearing houses. ICE and NYSE Euronext businesses will continue to operate under their respective brand names. As previously announced, the company expected to conduct an IPO for the Euronext group of Continental European exchanges as a standalone entity (in 2014), subject to market conditions and regulatory approval.
Although it is not the intention to examine each and every derivatives exchange in any detail, it is nevertheless a good idea to look at perhaps the largest exchange, CME Group (
www.cmegroup.com
). The Group was formed from the merger of two Chicago-based exchanges in 2007: the Chicago Mercantile Exchange and the Chicago Board of Trade.
In terms of products listed on the exchange, there are in excess of 1,800 contracts, divided into ten categories. These categories, together with some examples, are shown in
Table 2.34
.
TABLE 2.34
Products listed on CME
| Sub-Categories | Examples | |
| Agriculture |
|
|
| Energy |
|
|
| Equity index |
|
|
| Foreign exchange |
|
|
| Interest rates |
|
|
| Metals |
|
|
| Options |
|
|
| OTC |
|
|
| Weather |
|
|
As you can appreciate, the CME Group covers a wide variety of products and sub-categories. You may also have noticed that some of these are based on commodities, a topic that is not covered in this book.
7
In addition to providing products, derivatives exchanges provide the facilities for trading (mostly electronic trading platforms with some exchanges providing physical trading by open outcry). The exchanges will provide pricing data that are either real time or delayed, together with volume and open interest information.
We will cover the clearing and settlement in Chapter 9, but derivatives exchanges either maintain their own clearing services or have links to third-party clearing systems. In the case of CME, clearing is handled by CME Clearing.
Unlike the cash markets where there are finite amounts of shares and bonds in issue and available for trading and other purposes, ETD contracts are not issued. They are created as they are needed and destroyed when open interest decreases.
Every day, contracts are bought and sold. These trades either create an exposure (an open interest) or cancel an exposure (close) and in total represent volume in the contract being traded.
Open interest
is therefore the total quantity of contracts that have been traded but not closed or delivered on any particular day.
Open interest is not the same as volume, as illustrated in
Tables 2.35a
and
2.35b
.
TABLE 2.35a
Open interest and volume
| Day | Trading Activity | Open Interest | Volume |
| 1 | A buys one contract from B and B sells one contract to A | 1 | 1 |
| 2 | C buys five contracts from D and D sells five contracts to C | 5 | 5 |
| 3 | A sells one option to D (to close) and D buys one option from A | â1 | 1 |
| 4 | E buys five contracts from C and C sells five contracts to E (to close) | 0 | 5 |
| Totals: | 5 | 12 |
TABLE 2.35b
From the individual traders' perspective
| Trader | Contracts Purchased | Contracts Sold | Open Long Interest | Open Short Interest |
| A | 1 | 1 | 0 | 0 |
| B | 0 | 1 | 0 | â1 |
| C | 5 | 5 | 0 | 0 |
| D | 1 | 5 | 0 | â4 |
| E | 5 | 0 | 5 | 0 |
| Totals: | 12 | 12 | 5 | â5 |
There are two points to note here:
- The volume is calculated so that one purchase plus one sale equals one quantity of volume.
- Notice that the sum of the total open long interest and total open short interest is zero. This is a meaningless figure and so we only consider the open long interest figure, i.e. five in the example above.
We saw that exchanges such as CME Group handle a wide range of product types, most of which fall into two types of derivative: futures and options. We will look at these in turn, concentrating on a typical set of contract specifications and looking at an example or two of each type.