Working with Options and Futures In This Chapter

Transcription

1 Working with Options and Futures In This Chapter Options and Futures At a Glance Setting Up Option Instruments and Futures Entering Transactions for Options and Futures Exercising and Assigning Options Working with Forward Commodities

2 5 Working with Options and Futures Options and Futures At a Glance 1 Set up options and futures. Learn how to set up option instruments and futures, including right/warrants, currency options, and bond futures that price by yield. See Setting Up Option Instruments and Futures on page Enter 3 Exercise 4 Learn transactions into Geneva. Learn about the different kinds of Geneva transactions that affect options and futures. See Entering Transactions for Options and Futures on page 102. and assign options Record portfolios exercising options that they hold or have underwritten. See Exercising and Assigning Options on page 104. about forward commodities Learn about forward pricing and price lists for forward commodities. See Working with Forward Commodities on page

3 Working with Options and Futures 5 Setting Up Option Instruments and Futures Details in Help future investments, defining option investments, defining right or warrant investments, defining This chapter describes three kinds of investments. Use To set up Choose Define Investments Futures Options Agricultural, commodity index, currency, bond, and interest rate futures and forwards. Call and put options. For setting up currency options, see Setting Up Currency Options on page 100. Future Option Instruments Option Rights/Warrants Subscription rights and warrants. Note: You enter the right/warrant s subscription ratio on its Pricing tab. For details, see Understanding Warrant Subscription Ratios on page 100. Option Instruments Right/Warrant For all option instruments and futures, you specify an expiration date, strike price, and underlying investment. You can also specify whether an option or future is a regulated futures contract subject to 60/40 capital gains treatment (Section 1256); and whether an option or right/warrant is a call or a put. For options, you can also specify if they use American- or European-style exercise. Note: When you define an option or right/warrant, Geneva automatically enters an Expire transaction for it in the Geneva Dependent Transaction Pool (GDTP) portfolio. For details, look up Expire transaction in Geneva s Help index. In addition, futures have several other features, described in the following Closer Look. A Close Look at Setting Up Futures B A C E Allows the investment to override the Cross Zero On Futures accounting parameter, so that transactions for investment can either always or never cross zero. (For details, see Crossing Zero on Futures on page 104.) F Select this check box to indicate that the investment is a forward commodity. For details, see Working with Forward Commodities on page 107. G For futures whose underlying investment is a bond, specify whether you want to enter explicit prices or 100- yield prices. For details, see Understanding Bond Futures That Price By Yield on page 101. Setting Up Option Instruments and Futures 99

4 5 Working with Options and Futures Setting Up Currency Options Currency options require the following settings. Tab Field Enter the Pricing Trading Factor Number of units of the underlying investment currency received when the option is exercised. Option Specific Local Basis Currency Strike Price Underlying Investment Currency used to price the option contract; this is the settlement currency in exercise and assign transactions for the option. Amount of local basis currency that the option holder pays to purchase (or sell) one unit of the underlying investment currency. Represents the direct rate of exchange between the option s local basis currency and its underlying investment currency. If the option s underlying investment currency is the same as its local basis currency, enter 1. Medium of exchange investment that the call option holder purchases (or that the put option holder sells) when the option is exercised. Understanding Warrant Subscription Ratios A right/warrant s subscription ratio is the fraction that determines the number of shares of the new investment that the portfolio receives, based on the number of shares of the right or warrant that it holds, where new shares are the numerator and old shares are the denominator. You use the following fields on the Pricing tab to define the right or warrant s subscription ratio. In this field Shares of Underlying Shares of Right/Warrant Enter the subscription ratio s Numerator: The number of shares received. Denominator: The number off right/warrants held. To exercise a right/warrant, you use an Exercise (Buy or Cover) or Assign (Sell or Short) transaction, or a Global Exercise transaction or distribution, and enter the right/warrant s ID in the Option ID box. These transactions use the right/warrant investment s subscription ratio to calculate the correct number of new shares that the portfolio receives as follows. Transaction Exercise or assign Geneva Multiplies the option quantity by the subscription ratio to determine the number of shares of the underlying investment that the portfolio buys or sells. Geneva does not round the underlying quantity. If you do not want the transaction to produce fractional shares, you must specify an option amount that divides evenly by the subscription ratio. 100 Setting Up Option Instruments and Futures

5 Working with Options and Futures 5 Transaction Global Exercise Geneva Divides the option quantity by the subscription ratio s denominator, and then uses the transaction s Round Method as follows. NoRound: Geneva multiplies the result by the subscription ratio s numerator to determine the number of shares of the underlying investment that the portfolio receives. RoundDown: Geneva rounds the result down to the nearest whole number, and then multiplies the result by the subscription ratio s numerator to determine the number of shares of the underlying investment that the portfolio receives. Finally, Geneva divides any fractional shares in the underlying investment by the subscription ratio to find the number of exercised rights or warrants, and subtracts this from the Option Quantity to determine the number of rights or warrants remaining unexercised. Exercising a Right/Warrant: An Example A portfolio holds 100 shares of Right investment B with a subscription ratio of 2:7, which entitles the portfolio to receive two new shares of Equity investment A for every seven shares of the right. You enter a Global Exercise transaction for the portfolio with Round Method defined as RoundDown. 1 Geneva divides the number of rights by the subscription ratio s denominator: 100 / 7 = Geneva multiplies the whole number by the numerator of the subscription ratio: 14 2 = 28. Therefore, the portfolio is entitled to 28 shares of A. 3 To receive 28 new shares of A, the portfolio must exercise 98 rights ((28/2) 7 = 98). Geneva subtracts this number (98) from the original number of rights held (100) to determine the number of remaining rights (2), which do not meet the required ratio of seven rights to receive two new shares. Understanding Bond Futures That Price By Yield Geneva supports bond futures, such as Australian bond futures, whose prices and markets are value based on the yields that investors forecast for the bond that underlies the future. These futures typically trade prior to the issue date of the bill or bond that underlies the future. The price these bond futures is reported as 100 minus the projected YTM (100 yield) of the underlying bond, expressed in percent per annum. Example: The YTM of an Australian government bond that underlies a future contract is 5%. The SFE subtracts the yield from one hundred, and reports the future s price as 95. Geneva uses the underlying bond s 100 yield price as of its dated date to calculate the future s price prior to the dated date of the underlying bill or bond; after the dated date, Geneva calculates the price based on the 100 yield value that you enter in opening transactions for the future. Transactions that open or close lots of the future, as well as in Mark to Market transactions, display a HundredMinusYield field, where you enter the future s price as a 100 yield value; Setting Up Option Instruments and Futures 101

6 5 Working with Options and Futures you cannot enter a value in the Price field. Receive Long/Short transactions display a Receive Date Yield field for the receive date, and a HundredMinusYield field for the tax lot date. You cannot enter values in the Receive Date Price or Tax Lot Price fields, although you can enter a commission amount in the Tax Lot Cost field that Geneva will use to calculate contributed cost and price gain/loss. When you enter a price for a bond future that prices by yield, enter HundredMinusYield in the price s Denomination field, and a 100 yield value in the Price field. Geneva converts the 100 yield values (Example: 95%) that you enter into a straight yield (Example: 5%), and then converts the straight yield into a currency- denominated price using the settings that you specified for the underlying bond. Geneva then multiplies the resulting price by the future s trading factor to derive the price that Geneva records for the transaction in the AGA. Geneva calculates these bonds market value as Quantity Derived price Pricing factor, and the lot s cost as Quantity Derived unit cost. When you run a report on a bond future that prices by yield, Geneva converts the derived price back into the 100 yield value. Bond futures that price by yield require the following settings. Investment Tab Field Enter Underlying bond Bond Specific Coupon Frequency Semi Annual Future Future Specific Expiration Date The underlying bond s issue date. Strike Price Underlying Investment Price By Preference 0 (the default). The underlying bond. HundredMinusYield Pricing Pricing Factor 1000 Entering Transactions for Options and Futures Details in Help Look up the transaction in the Geneva Help index. A portfolio can hold long lots of a call or put option or right/warrant, as well as write options that a counterparty holds. Portfolios typically pair off long and short futures lots at the end of the day. You use exercise and assign transactions to record option lots being exercised. Use this transaction To record the portfolio Buy Sell Short Pairoff Multiway Pairoff Opening a long lot of a future, call or put option, or right/warrant. Writing a call or put option or right/warrant, or opening a short lot of a future. Closing a single long future lot against a single short future lot. The lots must have the same trade date and price. Closing one or more long future lots against one or more short future lots. The lots need not have the same trade date or price. 102 Entering Transactions for Options and Futures

7 Working with Options and Futures 5 Use this transaction Exercise (Buy, Sell, Cover, Short) Assign (Buy, Sell, Cover, Short) To record the portfolio Exercising an option or right/warrant that it holds. Assigning (that is, the counterparty exercising) an option or right/warrant that the portfolio has written For more information about exercise and assign transactions, see Exercising and Assigning Options on page 104. In addition, two asset servicing transactions specifically affect options, right/warrants, and futures: Use a(n) Mark To Market transaction To Mark a future, option, or right/warrant to market. Doing this: Adjusts the cost basis to the mark to market price. Realizes a gain/loss from the previous cost basis to the mark to market price. (You can also select the Cash Settlement check box to credit or debit realized gain/loss to cash, rather than adjusting the cost basis. This check box is typically selected for futures.) Resets the lot's holding period. Geneva adjusts the first mark by any commissions and fees in the opening transaction. Expire transaction Expire an option or right/warrant. Geneva automatically creates an Expire transaction for an option or right/warrant when you commit it. Excluding Commissions from the Cost of Future Contracts By default, Geneva includes commission amounts in the cost of Future investments on reports. However, the Exclude Commission in Cost of Future Contracts setting allows you to exclude commissions from the cost of a Future investment on reports. When you exclude commissions from the cost of a Future investment, Geneva offsets the expense to cash by crediting the FuturesCommissionExpense financial account. Example: A Buy of 10 lots of futures investment DOWJ with a $150 commission creates the following journal entry. Investment Inv. State Financial Account Denom. Quantity Local Book DOWJ OnHand OnHand USD USD OnHand OnHand USD DOWJ FuturesCommissionExpense USD You can exclude commissions from the cost of future investments in Buy, Sell, Sell Short, and Cover Short transactions. To do this, select the Exclude Commission in Cost for Future Entering Transactions for Options and Futures 103

8 5 Working with Options and Futures Contracts check box in a set of accounting parameters, and then assign the set to those portfolios whose cost for Future investments does not reflect commission expenses. Note: If you select a transaction s Net Trade check box, Geneva correctly treats the commission expense as implied. As a result, this feature does not exclude commissions from cost for transactions where you select Net Trade. Crossing Zero on Futures If you use a Buy transaction to close short Futures lots, in certain circumstances, Geneva s transaction processing priorities can interfere with the IntraDayThenFIFO closing method. Example: A portfolio that crosses zero on futures and uses IntraDayThenFIFO to close futures begins with a short futures position. On a given day, you enter two Buys for one futures contract each, and one Sell for two contracts of the same future. Because Geneva processes Buy transactions before Sell transactions, it uses the Buys to close against the existing short position, because it is not yet aware that you have also entered Sell transactions on the same day that it should close (instead of the existing position) according to IntraDayThenFIFO rules. Reorganizing Options After the Underlying Splits If an option s underlying investment splits, you must create a new investment that represents the options for the underlying investment, and then reorganize the old option in to the new option. The following table shows the new option and transaction settings for the most common splits, 2:1 and 3:2. For more information on other types of splits, go to the Chicago Board Options Exchange (CBOE) Web site, Split ratio Reorganization New Shares/ Old Shares New option s strike price New option s trading factor 2:1 2/1 1/2 original strike price: (Old underlying shares Old strike price)/new underlying shares 3:2 1/1 2/3 original strike price: (Old underlying shares Old strike price)/new underlying shares 100 (original trading factor) 3/2 original trading factor: (New underlying shares Original trading factor)/old underlying shares Exercising and Assigning Options The specific exercise or assign transaction that you use depends on whether the portfolio or counterparty holds a call or put option, and whether the portfolio holds the option s underlying investment. Choose Transactions Exercise (or Assign) <transaction>. 104 Exercising and Assigning Options

9 Working with Options and Futures 5 If the portfolio holds a Enter an To exercise the option to Call option Exercise Buy Buy the underlying. Call option, and holds the underlying short Exercise Cover Buy the underlying to cover the short. Put option, but not the underlying Exercise Short Sell the underlying short. Put option, and holds the underlying long Exercise Sell Sell the underlying. If the portfolio has written (sold short) a Enter an To record the counterparty exercising the option to Put option Assign Buy Sell the underlying to the portfolio. Put option, and holds the underlying short Call option, but does not hold the underlying Assign Cover Assign Short Sell the underlying to the portfolio. The portfolio covers its short with the underlying it purchases. Buy the underlying from the portfolio. The portfolio must sell the underlying short. Call option, and holds the underlying long Assign Sell Buy the underlying from the portfolio. You can also use a Global Exercise transaction to have a portfolio exercise all of the lots of a particular call option or right/warrant that it holds. Choose Transactions Asset Servicing Global Exercise. Crossing Zero on an Option s Underlying Investment For portfolios that cross zero on an option s underlying investment, you can: Use an Exercise Buy or Assign Buy transaction Exercise Sell or Assign Sell transaction To exercise the option and close (cover) all or a portion of a Short position in the option s underlying investment. If the number of options purchased is greater than the short position, Geneva crosses zero to open a new long position in the underlying investment. Long position in the option s underlying investment. If the number of options sold is greater than the long position, Geneva crosses zero to open a new short position in the underlying investment. Example: A portfolio holds 10 put options to sell 1000 shares of equity XYZ. On 02/28/2003, the portfolio holds only 800 shares of XYZ, but enters an Exercise Sell transaction to exercise all of its options. Geneva sells the 800 on-hand shares, and creates a new short position for 200 shares of XYZ. Exercising and Assigning Options 105

10 5 Working with Options and Futures How Splits Affect Underlying Investment Quantities By default, Geneva calculates the Underlying Quantity in exercise and assign transactions as Quantity Trading Factor. This amount will not be correct, however, if the underlying investment has undergone a split. In such a case, you must manually enter the correct quantity of the underlying investment. Working with Index Options To set up an index option, define an investment, typically an equity, to represent the underlying index. Because index options settle to cash when you exercise them, rather than entering an exercise or assign transaction, use a Sell transaction (or, for an option that the portfolio has underwritten, a Cover Short transaction) to close the option lot when it is exercised. The price in the closing transaction is typically the market price of the option at the time it s exercised. Exercising and Assigning Right/Warrants For Right/Warrant investments, you can enter only exercise and assign transactions that the portfolio or the counterparty use to open a long position in the underlying investment, or to close a short position, as follows. If the Opens a long position in the underlying, enter an Closes a short position in the underlying, enter an Portfolio Exercise Buy Exercise Cover Counterparty Assign Sell (the portfolio sells the underlying) Assign Short (the portfolio shorts the underlying) Lot Closing for Exercise and Assign Transactions Exercise and assign transactions feature an Option Lots tab, which you can use to specify the closing method that the transaction uses to determine which lots of the option to exercise, or to select specific lots or portions of lots to exercise. In addition, Exercise and Assign Sell and Cover transactions feature and Investment Lots tab, which you can use to specify the closing method that the transaction uses to determine which lots of the underlying investment the portfolio sells or covers when it exercises the option, or to select specific lots or portions of lots of the underlying to close. Note: Unless the portfolio bypasses closing rules, exercise and assign cover and sell transactions close only against lots in the same custodian account and strategy as the option being exercised or assigned. Exercise and assign buy and short transactions always open the new lot of the underlying in the same custodian account and strategy as the option being exercised or assigned. 106 Exercising and Assigning Options

11 Working with Options and Futures 5 Details in Help Global Exercise distribution Distributing a Global Exercise Transaction As with dividends, you can distribute a Global Exercise transaction to multiple portfolios, or to specific custodian accounts and strategies within those portfolios, to exercise all of the lots of a call option or right/warrant in those portfolios, custodian accounts, or strategies. You can also use a Global Exercise distribution to override a GDTP Global Exercise transaction in multiple portfolios. To distribute a Global Exercise Transaction 1 Choose Transactions Transaction Distribution Utilities Asset Servicing Distribution Global Exercise Distribution. 2 Enter the values for the model transaction on the General tab, or To override a GDTP Global Exercise transaction, click the Override Transaction tab, then enter the ID of the overridden transaction in the Override Transaction field. Geneva automatically defines the values on the General tab the same as those in the overridden transaction. 3 On the Allocation Info tab, click Find Holding Portfolios to see the list of portfolios that hold the investment on the transaction s trade date. Select the portfolios that you want to exercise the option or right/warrant, or (to override a GDTP Global Exercise transaction) where you want to override the GDTP transaction. 4 If more than one custodian account or strategy in a portfolio holds the option on the trade date, the table displays one row for each custodian account/strategy combination in which the portfolio holds the investment. This allows you to exercise the option positions in specific custodian accounts and strategies. Working with Forward Commodities You can select a future s Forward Commodity check box to indicate that the investment is a forward commodity. Opening and closing transactions for the investment allow you to enter Working with Forward Commodities 107

12 5 Working with Options and Futures an expiration date to identify the specific tax lot (contract) that the transaction opens or closes. Geneva uses this date to find or interpolate forward prices for that lot. Using Forward Price Lists In order for Geneva to be able to determine the value of forward commodities that the portfolio holds, you must set up forward price lists to store forward prices for the investment. If you value a forward commodity a number of days before the lot s (opening transaction s) expiration date: That Is equal to the forward interval of one or more price lists in the portfolio s price schedule Does not match the forward interval of any of the price lists in the portfolio s price schedule Geneva Searches for a forward price in those forward price lists, in the same way that it looks for a spot price. For details, look up price lists, multiple prices lists in the Geneva Help index. Interpolates a forward price for the valuation date, as described in the procedure For details, see How Geneva Interpolates Forward Prices and FX Rates on page 122. To set up a forward price list 1 Choose Define Prices Price Type, and create a forward price type for each type of forward price that you want to store. Enter an ID and description for the price type, and then specify its forward interval by selecting an interval type (days, weeks, months, or years) and an interval length (the number of days, weeks, months, or years) (Example: 30 days). 2 Assign the forward price type to a price list that will store forward prices of that type. 3 Assign the forward price list to a price schedule for portfolios that hold forward commodities. Make sure that the price schedule includes forward price lists for all the forward intervals that you want to use to price your forward commodities (Examples: 30- day, 60-day, 90-day, 180-day). 4 Assign the price schedule to the accounting parameters of portfolios that hold forward commodities. 5 Enter forward prices for each forward commodity in the appropriate forward price list. For example, if, for a given date, you have 30-day, 60-day, 90-day forward prices for a commodity, enter the 30-day price in the 30-day price list, the 60-day forward price in the 60-day price list, and the 90-day forward price in the 90-day price list. 108 Working with Forward Commodities

13 Working with Options and Futures 5 Interpolating Forward Prices If a portfolio holds forward commodities, the portfolio s Valuation On and Interpolation settings determine how the portfolio interpolates forward prices for the investment. For details, see How Geneva Interpolates Forward Prices and FX Rates on page 122. Working with Forward Commodities 109

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