Introduction to Equity Derivatives on Nasdaq Dubai

Transcription

1 Introduction to Equity Derivatives on Nasdaq Dubai

2 CONTENTS Introduction to Derivatives» Introduction to Derivatives (Page4)» Benefits of Equity Futures (Page 5) Trading Equity Futures» Trading Equity Futures (Page 7)» Bullish and Bearish Market View (Page 8)» Pay Off Examples (Page 9) Hedging» Hedging (Page 11)» Hedging: Protect oneself against the drop of price of an underlying (Page 12)» Index Futures (Page 13) Margin on Futures» Margin on Futures (Page 15)» Before you Trade (Page 16) Contract Specifications» Proposed Equity Futures Contract Specifications (Page 18)» Proposed Index Futures Contract Specifications (Page 19)» Trading Steps (Page 20)» Which equity futures will be available? (Page21)» Risks of Futures Trading (Page 22)» About Nasaq Dubai (Page 23)» Glossary (Page 24)» Disclaimer (Page 25) PAGE 2 OF 26

3 INTRODUCTION TO DERIVATIVES

4 INTRODUCTION TODERIVATIVES WHAT ARE DERIVATIVES Derivatives are financial products that derive their value from an underlying asset, such as equities. Two of the most common types of derivatives are futures on equities and options on equities. Every year, billions of dollars of equity derivatives change hands on exchanges around the world. For example, futures and options trade on Microsoft, Apple, Samsung and on the shares of many other companies. Derivatives can be traded by institutions or individuals through a broker, just like equities. Nasdaq Dubai s derivatives market initially offers equity futures on shares that are listed in the UAE. Other equity futures, as well as equity options, will be added at a later date. FUTURES AND OPTIONS Both futures and options allow the holder to buy or sell the underlying asset (i.e. the equities) in the future, eg in 2 months time. W ith a future, both parties are obliged to fulfill the contract to buy or sell, unless they trade out of their position beforehand. With an option, an investor has the right to buy or sell the underlying asset, but no obligation to do so. Investors can make use of derivatives if they have a bullish or bearish view of the underlying asset, or for arbitrage, or for hedging an existing position. Investors should be sure they fully understand a derivative before trading. As leveraged products, derivatives can offer high rewards, but also high risks. EQUITY FUTURES TRADABLE ON NASDAQ DUBAI Nasdaq Dubai will provide investors and brokers with facilities and infrastructure to initially trade equity futures on shares of a number of household name UAE companies. Market participants from the outset will include leading UAE brokers. Market making services will be provided to promote liquidity. PAGE 4 OF 26

5 BENEFITS OFEQUITY FUTURES 1 HEDGING Investors with equity assets in their portfolio can use equity futures to reduce or limit the risk of a fall in the value of their portfolio. Example: If a share price falls, selling futures would offset the loss of value of the portfolio. 2 LEVERAGED TRADING Futures contracts are highly leveraged financial instruments which permit achieving significant gains using a limited amount of invested funds. Investors should be aware that large losses can also be incurred. 3 PROFIT WHETHER STOCK PRICES RISE OR FALL Traditionally, stock investors profit only in rising markets. If they believe a stock price will fall, their choices have been either to sell their shares or to take no action and wait for the market to recover. However they can use equity futures to profit from falling equity markets as well as rising ones 4 PORTFOLIO MANAGEMENT Futures markets are often used to increase or decrease the overall market exposure of a portfolio without disrupting the balance of investments that may have taken a significant effort to build. 5 EFFICIENT USE OF CAPITAL FOR SMALLER INVESTMENT COMPANIES Companies with limited access to large capital sums can benefit by the leverage offered by equity futures. By using limited capital resources, equity futures help traders to gain access to more leverage than they would be able to obtain if they were trading directly on equity markets. 6 LOW COMMISSION CHARGES Commission for futures trading can be small compared to other types ofinvestments. PAGE 5 OF 26

6 TRADING EQUITY FUTURES

7 TRADING EQUITYFUTURES WHAT DO WE MEAN BY LEVERAGED? Initial cash outlay to take a futures contract position amounts to just a small percentage of the value of the contract. Therefore if the underlying price moves in your favour, the percentage return you make from trading the futures contract will be significantly higher than the percentage movement in the underlying stock. Investors should be aware that leveraged exposure can also lead to substantial losses. If the share price moves adversely thelosses on the futures trade would be magnified and greater in percentage terms than the decline in the underlying stock. BUYING SHARES BUYING SINGLE STOCK FUTURES PAY AED 20,000 Exposure to 4,000 AED 5.00 valued at AED 20,000 PAY AED 20,000 MARGIN Exposure to 40,000 AED 5.00 valued at AED 200,000. Margin 10% is AED 20,000 Three months later share price rises to AED 5.50 Sell on open AED 5.50 Receive cash of 5.50 x 4,000 = AED22,000 Difference between final price and spot price on 40,000 shares is paid to investors ( )*40,000 = AED 20,000 PROFIT AED 2,000 Return = 10% (2,000/20,000) PROFIT AED 20,000 Return = 100% (20,000/20,000) PAGE 7 OF 26

8 BULLISHANDBEARISHMARKETVIEW BULLISH MARKET VIEW BEARISH MARKET VIEW The investor buys a futures contract with a bullish view on the underlying stock, intending to use leverage and make a magnified profit without buying that underlying asset. Example: You can buy a futures contract by posting an initial margin that is only 10% of the contract value. If the underlying share price goes up, it will provide amagnified positive return to the investor, and any adverse price change will magnify a negative return. The investor sells a futures contract with a bearish view on the underlying stock, intending to use leverage and make a magnified profit without selling that underlying asset. Example: You can sell a futures contract by posting an initial margin that is only 10% of the contract value. If the underlying share price falls, it will provide a magnified positive return to the investor and any adverse price change will magnify a negative return. PAGE 8 OF 26

9 PAY OFFEXAMPLES Futures contracts of X company shares are trading at AED 3. Investor with bullish view will go long on X company futures by buying 100 futures contracts; and investor with bearish view will go short on X company futures by selling 100 futures contracts. Pay off will be as follows: One futures contract = 100 shares futures margin = 10% INVESTOR WITH BULLISH VIEW Equity Futures Payoff when price rises to AED 4 INVESTOR WITH BEARISH VIEW Equity Equity futures futures Payoff Payoff when when price price falls falls to AED to AED 2 2 PAY AED 4,000 MARGIN Exposure to long 10,000 AED 4.00 valued at AED 40,000 PAY AED 4,000 MARGIN Exposure to short 10,000 AED 4.00 valued at AED 40,000 Difference between final price and spot price on 10,000 shares is paid to investors (4-3)*10,000 = AED 10,000 Difference between final price and spot price on 10,000 shares is paid to investors (3-2)*10,000 = AED 10,000 PROFIT AED 10,000 Rate of Return = 250% PROFIT AED 10,000 Rate of Return = 250% PAGE 9 OF 26

10 HEDGING

11 HEDGING HEDGING USING SINGLE STOCK FUTURES Hedgers seek to reduce risk by protecting an existing share portfolio against possible adverse price movements in the underlying market. Hedgers have a real interest in the underlying shares and use futures as a means of preserving their performance. It is now January 1 and Company Y is trading at 6.5 per share. You own 1,000 shares of Company Y stock and believe that a short-term (threemonth) drop in price is likely. You decide to sell at 10 March Company Y future (= 100 shares) which is currently trading at If the stock does decline in price, you will incur a loss on your stock position. This loss, however, will be offset by a profit from a decrease in the price of your short future. On the other hand, if the price of the Company Y stock rises unexpectedly, any loss incurred from your short futures contract can be offset by the increase in value of your shares. STOCK PRICE DOWN STOCK PRICE UP» Two months after you sell your March futures contract, Company Y stock has decreased in price and is currently trading for 5.9 pershare.» You think the stock price has stabilized, and decide to buyback (close) your short futures contract for an available price of 6.2. The 0.6 per share unrealized loss of your Company Y stock ( ) will be offset by a 0.6 profit ( ) on your short future position.» Two months after you sell your March futures contract, Company Y stock is up and currently trading at 7.0 per share. At this point you buy (close) your March contract at a market price of 7.3.» The 0.5 loss (7.3 purchase price 6.8 sale price ) you have incurred on the short future will be offset by a 0.5 profit per share (7.0 current price - 6.5) on your long stock position.» Once the short future position has been closed out (purchased), your Company Y stock is un-hedged. You will suffer a loss if it declines in price, but will profit if it increases in price. PAGE 11 OF 26

12 HEDGING: PROTECTAGAINSTDROPPRICEOF AN UNDERLYING - It is now January 1 and Company Y is trading at 6.5 per share. - You own 1,000 shares and believe that a short-term (three-month) decrease in price islikely. - You decide to sell 10 Company Y futures contract (=1,000 shares) which is currently trading at6.8. SCENARIO 1 SCENARIO 2 Two months after you sell your March Company Y contract: Two months after you sell your March Company Y contract: Stock price at 5.9 Stock price at 7.0. You decide to close out the short futures contract for an available price of 6.2. You decide to close out the short futures contract for an available price of 7.3. The 0.6 per share unrealized loss on your stock ( ) will be offset by a 0.6 profit ( ) on your short future position. The 0.5 loss (7.3 purchase price 6.8 sale price) you have incurred on the short future will be offset by a 0.5 profit per share (7.0 current price - 6.5) on your long stock position. Note : In practice, there might not be a perfect hedge, as there might not be exact correlation in movement of futures price and stock price. There will be a small difference in value which can be positive or negative. PAGE 12 OF 26

13 INDEX FUTURES As with equity futures, trading equity index futures can help to preserve the value of a portfolio Investment in a particular market. Assume you hold a stock portfolio that trades in line with the FTSE Nasdaq Dubai UAE 20 Index, which is based on 20 stocks listed in the UAE. By selling the index futures, you can lock in the value of the portfolio until the maturity of the futures contract. If a stock declines in price in your portfolio you will incur a loss but the loss will be offset by a profit from a related drop in the price of your short index future. If the price of the index rises, any loss incurred from your short futures contract can be offset by the increasing value of your stocks in the portfolio. PAGE 13 OF 26

14 MARGIN ONFUTURES

15 MARGIN ON FUTURES INITIAL MARGIN Initial Margin (IM) is essentially the deposit you have to make to open a long or short futures contract. The amount of Initial Margin is calculated based on volatility and other factors relating to the underlying asset. The exchange and the broker will calculate and provide the Initial Margin amounts for each underlying. Initial Margin serves as the starting point for a new futures position. From that, profits will be added on and/or losses deducted daily. Initial Margin is a kind of guarantee that you have the money to pay for your losses, in case of losses from the very first day you traded the futures. Initial Margin calculation is done by mostly by a system called SPAN (Standardized Portfolio Analysis of Risk). VARIATION MARGIN Variation Margin is the second type of margin on futures. Variation Margin, also known as Mark to Market Margin, is an additional amount of cash you are required to deposit to your futures trading account if your futures position has taken sufficient losses to bring it below the Maintenance Margin. You will be notified to provide Variation Margin whenever your margin balance goes below the Maintenance Margin level during the daily settlement or mark to market process. In futures trading, this process happens daily at the close of each trading day. When this happens, your broker gives you a notification known as a Margin Call telling you exactly how much cash needs to be provided in order to meet Variation Margin requirement. If you have sufficient cash remaining in your futures trading account, the cash needed to meet Variation Margin requirement will be automatically deposited. SPAN is the most common methodology used to calculate Initial Margin. It applies a complex formula based on the historical movements of the futures underlying PAGE 15 OF 26

16 BEFORE YOU TRADE RECOMMENDED STEPS BEFORE TRADING FUTURES Nasdaq Dubai Equity Futures are the only equity derivatives traded on-exchange in the region. Investors trading the local equity markets may not be familiar with these products and the risks associated with trading them. Below are some recommendations before you start to trade. Understand the products and risks associated with them by doing some simulated trading. Pick a few equity futures contracts and practice. Pick the right maturity months to suit your trading. Nasdaq Dubai is planning to offer 1-, 2- and 3-month contracts. Understand the contract specifications. One futures contract relates to multiples of the underlying equity. In single stock futures listed on Nasdaq Dubai, each futures contract will be equal to 100 underlying stocks. Liquidity is key in trading any products. Make sure you are trading within the liquidity available to avoid any potentially unwanted liquidity risks. Watch the daily volumes traded to monitor the liquidity of the futures. Volatility can be higher in the futures than in the underlying equities. Consider the volatility for your trade and take the position that suits your volatility tolerance levels. Check the bid and offer spread on the contract you are choosing to make sure you are not taken by surprise when you want to close out an open position. Futures are highly leveraged products. Make sure the leveraged exposure you are taking is within your risk limits. Monitor your stop losses to make sure that you are not holding a position when it has breached your loss level. Understand the margining on futures. Margins need to be posted frequently if the underlying is moving against you. Make sure you have sufficient cash to cover the margin requirement. Make sure you follow the expiry of the contracts and roll them over before expiry if you want to continue the position. On expiry remember that the futures on Nasdaq Dubai settle in cash against the closing price. PAGE 16 OF 26

17 CONTRACT SPECIFICATIONS

18 PROPOSED EQUITYFUTURESCONTRACTSPECIFICATIONS Contract specifications for equity futures on shares traded on Dubai Financial Market, Abu Dhabi Securities Market and Nasdaq Dubai Parameter Trading Platform Currency Contract Size Maturity Settlement Type Expiration Day Settlement Day Cash settlement price on Expiration Day Trading hours Trading days Listing of new contract month Specification DFM X-Stream trading platform AED or USD 100 shares 1,2 and 3 months Cash Settled 3rd Thursday of the expiry Month Business day following Expiration Day Average closing price of underlying equity using last 30 minutes volume weighted average 10:00 am to 14:00pm Sunday to Thursday Thursday prior to maturity PAGE 18 OF 26

19 PROPOSED INDEXFUTURESCONTRACTSPECIFICATIONS Contract specifications for index futures on shares traded on Dubai Financial Market, Abu Dhabi Securities Market and Nasdaq Dubai Parameter Trading Platform Currency Contract Size Maturity Settlement Type Expiration Day Settlement Day Cash settlement price on Expiration Day Trading hours Trading days Listing of new contract month Specification DFM X-Stream trading platform AED or USD 10 (DUAE Index) 1,2 and 3 months Cash Settled 3rd Thursday of the expiry Month Business day following Expiration Day Average closing price of underlying equity using last 30 minutes volume weighted average 10:00 am to 14:00pm Sunday to Thursday Thursday prior to maturity PAGE 19 OF 26

20 TRADING STEPS 1 Contact a broker to set up a trading account for Derivatives on Nasdaq Dubai. This may require an additional agreement on top of an agreement to trade equities. 2 Place an order with your broker to either buy or sell one or more futures contracts. 3 The trade is placed by the broker with Nasdaq Dubai and if a matching price is available it will beexecuted. 4 The resulting trade is registered with Nasdaq Dubai for clearing. 5 For the futures trade, you do not pay or receive the full value of the trade, but only an Initial Margin which is a percentage of the contract value. This margin will have to be maintained through the life of the contract. 6 You will have the option to close out your open position by entering into an opposite position in the same contract. 7 During the life of the contract, any profit or loss that you make on account of a change in the market price is settled on a daily basis as Variation Margin. 8 Once a position is closed, any margin related to this position after profit or loss will be adjusted in your account 9 If you hold your position until maturity, it will automatically be settled on maturity day through the cash settlement method, under which the difference in the futures price and expiration price is settled via cash payment or receipt. PAGE 20 OF 26

21 WHICH EQUITYFUTURESWILL BE AVAILABLE? During its Initial phase, Nasdaq Dubai will offer equity futures on stocks traded on DFM, ADX and Nasdaq Dubai. These will be rolled out in phases with at least 5 liquid names in the initial phase. PHASE ONE PHASE TWO PHASE THREE PHASE FOUR Equity Futures on 5 to 10 well known and liquid single stocks listed in UAE Include Equity Index Futures and other liquid single stocks in UAE Include Equity Index Futures on other regional markets Launching a standadised options platform PAGE 21 OF 26

22 RISKSOFFUTURESTRADING Futures are highly leveraged products. There is a risk that you may lose much more money than the amount you have initially committed, as a result of leverage. There are many types of risks associated with financial products. Here are some of the risks you are taking when you trade an equity futures contract: MARKET RISK Market risk is the risk inherent to the market underlying. This type of risk is both unpredictable and impossible to completely avoid. This risk is taken by an investor whether he holds a stock or a futures contract. UNDERLYING PRICE RISK When an investor invests in a single stock future there is a risk of the price moving against the view taken by the investor. This risk, too, is not specific to futures. COUNTERPARTY RISK The investor takes a risk on trading with a counterparty, on whether the counterparty will be able to deliver or settle cash as and when required by the contract. In the case of Nasdaq Dubai futures, Nasdaq Dubai acts as a Central Counterparty (CCP) and mitigates this risk by taking margin on all futures contracts. LIQUIDITY RISK This is the risk that there may not be sufficient volumes at competitive prices. Futures are based on the underlying asset, and the liquidity of the underlying is a key to the liquidity in the futures. Nasdaq Dubai intends to have one or more market makers to provide continuous pricing, to mitigate the liquidity risk for investors. SETTLEMENT RISK Settlement risk is a risk similar to counterparty risk, but on actual settlement taking place in a timely manner. Margins are required by Nasdaq Dubai to mitigate this risk. PAGE 22 OF 26

23 ABOUT NASDAQ DUBAI Nasdaq Dubai is the international financial exchange in the Middle East. Our unique market enables companies to list under an international brand name, with easy access for both regional and international investors. The standards of Nasdaq Dubai are comparable to those of leading international exchanges in New York, London and Hong Kong in terms of global best practice of corporate governance, supervision and transparency. The exchange represents a globally unique platform for companies to raise money and for investors to find exciting opportunities.» 11 years of organic growth» Largest IPO in the region at the time with DP World s USD 4.96 billion» Leading global exchange for Sukuk by value» Since 2006, total capital raised of USD 70 billion» Best Exchange of the Year Middle East Award 2014 from The Global Investor» Multi-asset class options with on-exchange fixed income trading platform and Murabaha Islamic financing option» Nasdaq brand known for innovation and performance PAGE 23 OF 26

24 GLOSSARY Contract Size Tick Size Expiration Day Settlement Day Bullish Bearish Long Short Leverage Volatility SPAN Mark to Market Open Interest The deliverable quantity of equities, goods or commodities underlying futures. The minimum price movement of a trading instrument. The day on which a futures contract is no longer valid and therefore ceases to exist. The date by which a buyer must pay for the securities delivered by the seller. Believing that a particular sector, security or the overall market is about to rise. Believing that a particular sector, security or the overall market is about to fall. One who has bought a contract to establish a market position and who has not yet closed out this position through an offsetting sale. One who has sold a contract to establish a market position and has not yet closed out this position through an offsetting buy. A general term for any technique to multiply gains and losses. A measurement of change in price of the asset over a period of time a methodology used to calculate Initial Margin applying a complex formula based on the historical movements of the Futures Underlying At the end of each trading day the exchange will set the settlement price for the futures contract based on the closing price range. This is known as marking to market. Total number of futures contracts for a specific month, long and short, that have been entered and not yet closed out or expired. Each trade has a buyer and seller, but for Open Interest only one side is counted. PAGE 24 OF 26

25 DISCLAIMER The information provided in this document ( Information ) is provided by way of general information and comment only. While reasonable care has been taken in producing this Information, changes in circumstances may occur at any time and may impact on the accuracy of the Information. The Information does not constitute professional advice or provision of any kind of services and should not be relied upon as such. Nasdaq Dubai Limited and/or its affiliates, officers or employees (together Nasdaq Dubai ) do not give any warranty or representation as to the accuracy, reliability, timeliness or completeness of the Information now or in the future. Nasdaq Dubai shall not be liable for any loss suffered, directly or indirectly by any person acting in reliance upon the Information contained herein. No part of the Information provided is to be construed as a solicitation to make any financial investment. Information, including forecast financial information and examples should not be considered as a recommendation in relation to holding, purchasing or selling securities or other instruments. The information does not take into account any investor s individual investment objectives, financial position and particular investment needs. As such, before making any decision, investors should conduct their own due diligence and consult their financial advisors. The performance of trading securities or instruments is not guaranteed and past performance is not an indication of future performance. Unless otherwise stated, Nasdaq Dubai Limited owns copyright in the Information contained herein. The Information may not otherwise be reproduced and must not be distributed or transmitted to any other person or used in any way without the express approval of Nasdaq Dubai Issued by Nasdaq Dubai Limited Regulated by thedfsa 001/2016 Introduction to Equity Derivatives on Nasdaq Dubai 2016 Nasdaq Dubai Limited PAGE 25 OF 26

26 FOR MORE INFORMATION ADDRESS Dubai International Financial Centre The Exchange Building 5, Level 7 PO Box Dubai United Arab Emirates TWITTER LINKEDIN nasdaq-dubai