I. What are derivatives and the derivatives market
An exchange is a platform, where trading in various assets is organized in an organized manner. There are basic and derivative types of assets..
The underlying asset can be: stock, bonds, Commodities, stock indices, currencies and interest rates.
Derivative financial instruments (Derivatives) call the contract, by which the parties obtain the right or undertake to perform specified actions with respect to the underlying asset. Actions include: purchase opportunity, sales, Provide, receipt of goods or securities.
Derivative financial instruments are traded on the derivatives market.
II. Why an investor needs derivatives
Try to mitigate market risks, arising from transactions with underlying assets - that is, using a hedging strategy, where you can make a deal on pre-agreed terms.
The derivatives market provides ample opportunities for implementing various trading strategies, including speculative.
There are additional options here.: you do not need to pay the full cost of the contract to complete the transaction, providing only the amount of the guarantee (GO). For example, it can be about 10-20% of the transaction amount. The size of the GO is set by the exchange.
By blocking only GO, the so-called leverage effect appears - compared to buying the underlying asset for the same amount, you can buy more derivatives. Risks and returns are proportionally increased.
Important: speculative aggressive strategies entail increased risks. It is worth carefully assessing the share of capital, which the investor is willing to risk. An important condition, especially for a novice investor, it is the ability to relate and manage risks within the framework of your portfolio strategy. It is necessary to monitor the adequacy of funds for civil defense, to broker did not close the position forcibly.
Derivatives market instruments can help you not only speculate or hedge your liabilities (for example, foreign currency loan), you can still use an arbitration strategy. Arbitrage is a series of logically related transactions in order to profit from the difference in prices for the same (or related) assets: at the same time in different markets (spatial arbitration) or in the same market at different times (provisional arbitration).
III. Popular derivatives
Futures is an arrangement (the contract) between the seller and the buyer on the delivery of the underlying asset after a specified period of time and at a predetermined price. Main: futures implies obligations for both parties: the seller is obliged to sell, and the buyer will buy the selected asset on the agreed terms.
Option is a contract, by which the option buyer gets the right to buy / sell an asset (product, security, currency, etc.) at a certain point in time at a predetermined price.
Main: it is an obligation of one party and a right of the other.
One of the organizers of trading on the derivatives market is the Moscow Exchange. The exchange acts as a guarantor of the fulfillment of obligations. Clearing is carried out by National Clearing Center JSC.
IV. Who are derivatives financial instruments suitable for?
Derivatives provide investors with many opportunities:
– trade "the whole market" using futures on the Moscow Exchange or RTS index
– invest indirectly in goods, the purchase and storage of which is associated with high costs (gold, oil, wheat, etc.)
– play out world news
– win back the formation of prices for goods
– implement arbitration strategies with global commodity and stock markets
– hedge an investment in stocks
– hedge currency risks, etc..
V. How futures work
Key features of futures
Subject of a futures contract (what is bought / sold) called the underlying asset. By underlying asset, allocate:
– futures of the stock section of the Moscow Exchange: on promotions, baskets of bonds, indices, investment units;
– futures of the money section of the Moscow Exchange: for currency pairs, on interest rates;
– futures of the commodity section of the Moscow Exchange: for Brent and Light Sweet Crude Oil, natural gas, gold, silver, copper, platinum, palladium and others.
Moscow Exchange statistics show, that more 50% volume is made up of futures trading on foreign exchange underlying assets; the rest of the volume falls on commodity and index - approximately equally.
Futures contracts have predetermined expiration dates.. The moment of futures execution is called expiration. Monthly and quarterly contracts are traded on the Derivatives Market of the Moscow Exchange. The transaction imposes an obligation on the participants to fulfill the terms of the contract on the day of expiration of the futures (expiration).
The main conditions for the circulation of a futures contract are standardized by the exchange and enshrined in the Futures Specification. The document includes the main characteristics: contract execution date; amount of underlying asset, which is delivered upon execution of a deliverable futures; the size of the exchange commission for buying / selling or when executing a futures; settlement methods; futures price currency, etc..
The parties are liable to the exchange until the futures are settled or the positions are closed..
Find out the current futures quotes, date of performance, the amount of the collateral can be found in the Specifications and in the Instrument Parameters on the official website of the Moscow Exchange.
Classification of futures
By the type of execution, futures are deliverable and settlement..
Deliverable futures - on the date of the contract, the buyer must purchase, and the seller sells the specified amount of the underlying asset. Delivery is carried out after expiration at the estimated price, fixed as of the last trading date. If you close a futures position before the expiration day, the underlying asset will not be delivered.
Current (non-deliverable) futures - only cash settlements are made between the participants in the amount of the difference between the contract price and the settlement price of the contract on the date of execution without physical delivery of the underlying asset. That is, the investor or the profit is accrued, or the loss is written off.
Futures life cycle
Several futures for one asset can be traded at the same time - the nearest and with a longer expiration period. For the most liquid futures, there may be 8 contracts with quarterly expirations. Brent oil is traded 12 monthly contracts.
Usually, the further the expiration date, the less liquidity of the instrument.
VI. How options work
Key features of options are similar to futures. Therefore, for understanding, let's figure it out, what is the main difference between an option and a futures.
This is the unevenness of the obligations of the parties to the transaction.. Everything is the same for an options seller., as in a futures transaction: it is an obligation to transact the underlying asset in the future at a specified price and on specified conditions. But for the buyer - this is the right (no obligation) within the period specified in the conditions to buy or sell on certain conditions a certain amount of the underlying asset. That is, the buyer can both agree, so waive this right.
To balance the positions of the parties, the option has an additional characteristic, which the futures do not have - this is the option price, or option premium. It is paid to the seller and remains with him, no matter, will the contract be executed.
The option premium is divided into two subtypes:
Call option - the right to buy for the buyer and the obligation to sell for the seller
Put option - the right to sell for the buyer of the option and the obligation to buy for the seller.
These options are traded differently. The bottom line is, that they have different awards, or rather, its size, market value.
Basic options parameters
Prize, or option value - market price, on which the deal goes.
Strike, or strike price - price, according to which it is possible to exercise the rights and obligations under the option.
Expiration date, or maturity date - the period until the expiration of the contract.
Contract volume is measured in terms of the underlying asset.
Option premium is determined as a result of exchange trading. Formed from two main parts:
Intrinsic value - arises then, when the price of the underlying asset of the option exceeds the strike price (in case of growth), and represents the difference between these two values.
Time value is the expectation that the value of the underlying asset will change in the future.. It depends on the volatility of the underlying asset and the option exercise date.
Options are more flexible, than futures and stocks. They enable traders to reflect absolutely any view of the market.: height, the fall, limited rise or fall, stagnation, increased volatility (Hesitation) market prices without a significant final price change, other market behavior.
so, the seller is obliged to fulfill the terms of the transaction. And it is important for the buyer to "want" to realize it. Consider the cases, in which the buyer will benefit from it.
Depending on the ratio of the price of the underlying asset and the price of the strike, there are three types of options.:
– In-the-money option = the exchange will execute them automatically
for Call option: when the current price of the underlying asset is greater than the strike price of the option (strike);
for the Put option: when the current price of the underlying asset is less than the strike price of the option (strike).
– Option "at the money": when the current price of the underlying asset equals the strike price of the option (strike) = the exchange automatically fills it in half.
– Out-of-the-money option = exchange executes them only on the order of the buyer.
for Call option: when the current price of the underlying asset is less than the strike price of the option (strike);
for the Put option: when the current price of the underlying asset is greater than the strike price of the option (strike).
When buying options, the loss in this situation will be limited by the size of the premium - this is what was the subject of bargaining and the strategy when concluding the option, increasing the predictability of investments. That is, the seller's financial result is a limited profit with a potentially unlimited loss. (!).
Options are monthly and quarterly.
What are options for?
By purchasing an option, both parties assess the magnitude of the risk of an unfavorable change in the price of the underlying asset, which is included in the premium.
Buyers, usually, use an option to hedge (reductions) risks or profit. Sellers pursue a goal - to make money on its implementation. To do this, they set (or calculated by a certain formula) fair option premium.
Differences between an option and a direct buy (sales) asset:
– limited risks to the buyer (no more than the option price);
– set deadlines for mutual settlements;
– lower costs of transactions in the derivatives market.
More useful information for investors you will find on BCS Express.
