Equity Derivatives. FAQs & Glossary

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1 Equity Derivatives FAQs & Glossary :.

2 1. FAQs Q: How do I access the equity derivatives market? Firms can access the market directly by either becoming an accredited derivatives market participant or by trading via a NZX accredited derivative market participant. A list of accredited derivative market participants can be found on our website Most individual traders access the market via an accredited market participant. Q: What does it cost me to trade? (margin and fees) The Initial Margin required for index futures is approximately 6% of the notional value of the position, with Variation Margin received or paid daily. If buying options, the trader is required to pay the one-off premium for the cost of that contract. The trading fees for options are $0.36 and $0.48 for futures contracts, and clearing fees for options are $0.54 and $0.72 for futures contracts. Q: What are the advantages of options and futures trading? Options may allow investors to profit from volatility in the market and capture price movements in the underlying asset without trading the asset itself. Options over equity securities may expose you to movements in the share price for a fraction of the cost of purchasing the shares themselves. You should seek advice from your financial adviser or other professional adviser before making any decision to invest in equity derivatives. Q: What is the risk involved in trading equity derivatives? Like any investment, derivatives come with their own set of risks. When purchasing exchange traded options, risk may be measured as the cost of the option, however when selling/writing options the potential losses can be substantial. Selling/writing calls is particularly risky if you do not own the underlying shares, as losses can be unlimited if the stock price rises dramatically and you are obligated to sell at the agreed strike price. This is also the case for writing puts if the stock price falls dramatically. Index futures can pose a risk if the position is unhedged and the index moves in the opposite direction to the price at which the futures position was entered. There may be other risks associated with trading equity derivatives. You should seek advice from your financial adviser or other professional adviser before making any decision to invest in equity derivatives. EQUITY DERIVATIVES: FAQS 2 of 6

3 Q: How is the S&P/NZX 20 Index calculated? The S&P/NZX 20 Index is calculated using a Free Float Market Capitalisation methodology with a 15% weighting cap applying for any one constituent. Details of the Index Methodology are available at Q: Why list futures on the S&P/NZX 20 Index instead of the S&P/NZX 50 Index? To create liquidity in a futures contract a number of factors have to be in existence. One of the most important factors is the liquidity of the underlying asset, in this case shares listed on the NZX market. The liquidity in the underlying market goes directly to levels of participation in the futures market. In assessing what index would be utilised for futures contracts, a key factor was the liquidity of each individual constituent of that index. All of the constituents in the S&P/NZX 20 Index display quite high levels of liquidity compared with the S&P/NZX 50 Index where there are a number of relatively illiquid constituents. The S&P/NZX 20 Index also has a ~98% correlation to the S&P/NZX 50 Index (April 2012 April 2014) providing a good liquid underlying market while also providing a good hedge to the benchmark index. Q: Is the S&P/NZX 20 Index Gross calculated or Capital calculated? The S&P/NZX 20 Index is a Capital index and is calculated based on the share prices of the S&P/NZX 20 constituents. Q: How often are changes made in the underlying S&P/NZX 20 Index? A Quarterly Index Review is conducted on the first Friday in March, June, September and December each year. Indices are rebalanced after market close on the third Friday of each month, with resulting index changes effective on the next business day. Q: What can I post as collateral to the Clearing House? Both cash and S&P/NZX 20 Index securities will be accepted as collateral to cover margin requirements. Margin will be calculated according to the overall risk exposure of the Clearing Participant s outstanding positions. The margin method combines options and futures positions as an integrated portfolio and the calculation incorporates the portfolio effects among different positions. NZX s Clearing House will value all the collateral collected from Clearing Participants on a daily basis. EQUITY DERIVATIVES: FAQS 3 of 6

4 Q: Where can I see quotes for these contracts? Quotes are available from any information provider such as Thomson Reuters, Bloomberg or on NZX s website Q: Can I submit quotes to the market? Yes, quotes are able to be submitted to the market via any derivative trading participant. Q: Where can I find educational information on how to trade these contracts? Information on index futures and exchange traded options which outline the risks, potential returns and characteristics of index futures and exchange traded options can be found on the website EQUITY DERIVATIVES: FAQS 4 of 6

5 2. Glossary of Terms Call option: The right without obligation to buy the underlying asset at the strike price Capital index: Reflects the price of shares in the index Free float market capitalisation: The method by which the S&P/NZX 20 Index is calculated. Free-float market capitalisation is calculated by multiplying the stock s current market price by the number of shares that are freely tradable. Large, non-traded share holdings will be classed as strategic and excluded from the free float. Gross index: Reflects the price of shares and dividends paid out by companies in the index Initial margin: The percentage of the notional value of a listed derivatives contract that an investor must deposit to open a position. Put option: The right without obligation to sell the underlying asset at the strike price Variation margin: Price changes in the underlying asset are reflected by debits or credits to an investor s margin account. An investor may be required to top up their margin account if it falls below the maintenance margin used. Writing an option: Selling the right to buy/sell an underlying asset at the strike price. EQUITY DERIVATIVES: FAQS 5 of 6

6 Disclaimer: This document is provided for general information purposes and is not intended as, and shall not constitute, investment advice nor an offer, invitation, inducement, solicitation or recommendation to acquire or dispose of securities. Although NZX Limited (NZX) has taken care to ensure the accuracy of the information as at the date of publication, NZX does not give any warranty or representation as to the accuracy, reliability or completeness of the information in this document. To the maximum extent permitted by law, NZX and its subsidiaries, employees, officers and contractors shall not be liable for any loss or damage (whether direct, indirect, consequential or otherwise) arising in any way (including by way of negligence) from or in connection with any information provided or omitted or from anyone acting or refraining to act in reliance on this information. The reader of this document should seek independent advice before acting on any information in this document. NZX Derivatives Market is a licensed market operated by NZX, a licensed market operator regulated under the Financial Markets Conduct Act The "S&P/NZX 20 Capital Index" is a product of S&P Dow Jones Indices LLC or its affiliates ("SPDJI") and NZX Limited ("NZX"). Standard & Poor's and S&P are registered trademarks of Standard & Poor's Financial Services LLC ("S&P"); Dow Jones is a registered trademark of Dow Jones Trademark Holdings LLC ("Dow Jones"); NZX is a registered trademark of NZX Limited and these trademarks have been licensed for use by SPDJI. S&P/NZX 20 Index Futures are not sponsored, endorsed, sold or promoted by SPDJI, S&P, Dow Jones or their respective affiliates and none of such parties make any representation regarding the advisability of investing in such product(s) nor do they have any liability for any errors, omissions, or interruptions of the S&P/NZX 20 Capital Index. EQUITY DERIVATIVES: FAQS 6 of 6