PRODUCT DISCLOSURE STATEMENT for Foreign Exchange Options issued by OM Financial Limited

Transcription

1 PRODUCT DISCLOSURE STATEMENT for Foreign Exchange Options issued by OM Financial Limited 22 nd May 2015 This document provides important information about Foreign Exchange Options to help you decide whether you want to enter into them. There is other useful information about this offer at Many derivatives are complex and high-risk financial products that are not suitable for most retail investors. If you do not fully understand a derivative described in this document and the risks associated with it, you should not enter into it. You can also seek advice from a financial adviser to help you make your decision. You should ask if that adviser has experience with these types of derivatives. OM Financial Limited has prepared this document in accordance with the Financial Markets Conduct Act Version: OMF FXOptions 1 F o r e i g n E x c h a n g e O p t i o n s

2 1. KEY INFORMATION SUMMARY WHAT IS THIS? This is a Product Disclosure Statement ( PDS ) for Foreign Exchange Options ( FX Options ) provided by OM Financial Limited ( OMF ). FX Options are derivatives, which are contracts between you and OMF that give the buyer the right but not the obligation to exchange money denominated in one currency into another currency at a pre-agreed exchange rate on a specified date. The value of the contract will depend on the value of the underlying currencies, the option s strike price, the prevailing interest rate differential in the currencies, the term of the option and the volatility of the currencies. The contract specifies the terms on which those payments and deliveries must be made if the option is exercised. WARNING Risk that you may owe money under the derivative: If the value of the underlying currency changes, you may suffer losses. In particular, unlike most other kinds of financial products, you may end up owing significant amounts of money. You should carefully read section 2 of the PDS (key features of the derivatives) on how payments are calculated. Your liability to make margin payments: OMF may require you to make additional payments in margin payments to contribute towards your future obligations under these derivatives. These payments may be required at short notice and can be substantial. You should carefully read section 2 of the PDS (key features of the derivatives) about your obligations. Risks arising from issuer s creditworthiness: When you enter into derivatives with OMF, you are exposed to a risk that OMF cannot deliver a currency as required. You should carefully read section 3 of the PDS (risks of these derivatives) and consider OMF s creditworthiness. If OMF runs into financial difficulty, the margin you provide may be lost. 2 F o r e i g n E x c h a n g e O p t i o n s

3 ABOUT OMF OMF is a 100% New Zealand owned and operated brokerage firm. OMF advises and facilitates trades on a full range of financial products available in the foreign exchange, carbon, options, equities, contracts for difference and futures markets. WHICH DERIVATIVES ARE COVERED BY THIS PDS This PDS covers FX Options. Under FX Options, the buyer has the right but not the obligation to exchange money denominated in one currency into another currency at a pre-agreed exchange rate on a specified date. The seller has an obligation to fulfil the contract terms. FX Options are traded over the counter ( OTC ) between you and OMF rather than through a recognised exchange. These are private transactions that can be specifically tailored to the investor s needs and allow investors to manage exchange rate risk; especially for foreign currency denominated transactions that you know will take place at a specific date in the future. FX Options carry limited risks for the buyer, but unlimited risks for the seller. The transaction must take place at the expiry date if the option has been exercised. 3 F o r e i g n E x c h a n g e O p t i o n s

4 TABLE OF CONTENTS This PDS contains the following sections: 1. KEY INFORMATION SUMMARY... 2 WHAT IS THIS?... 2 WARNING... 2 ABOUT OMF... 3 WHICH DERIVATIVES ARE COVERED BY THIS PDS KEY FEATURES OF THE DERIVATIVES... 5 KEY FEATURES OF FOREIGN EXCHANGE OPTIONS... 5 ENTERING A FORWARD AND RIGHTS TO ALTER TERMS OR TERMINATE AN OPTION RISKS OF THESE DERIVATIVES PRODUCT RISKS ISSUER RISKS RISKS WHEN ENTERING OR SETTLING THE DERIVATIVES FEES APPLICABLE FEES AND CHARGES FOR THESE PRODUCTS HOW OMF TREATS FUNDS AND PROPERTY RECEIVED FROM YOU ABOUT OMF HOW TO COMPLAIN WHERE YOU CAN FIND MORE INFORMATION HOW TO ENTER INTO CLIENT AGREEMENT GLOSSARY OF COMMON TRADING TERMS F o r e i g n E x c h a n g e O p t i o n s

5 2. KEY FEATURES OF THE DERIVATIVES KEY FEATURES OF FOREIGN EXCHANGE OPTIONS What is a Foreign Exchange Option? Foreign exchange ( FX ) is a term to describe the trading of currencies where one person buys a currency in exchange for another currency. Quotes for FX are for a currency pair, for example, NZD/USD. The first currency (NZD) is known as the base currency and the second currency (USD) is referred to as the quote currency. The price represents how much of the quote currency is needed for you to get one unit of the base currency. For example, NZD/USD means it takes 75 US cents to buy $1 NZD. Most currencies exchange rates are floating (they are not fixed or pegged at a particular level) and fluctuate according to the forces of supply and demand. An FX Option is a type of derivative used in FX trading and is a contract between you and OMF that gives the buyer of the FX Option the right but not the obligation to exchange money denominated in one currency into another currency at a pre-agreed exchange rate on a specified date. The contract specifies the terms on which those payments and deliveries must be made if the option is exercised. Example A company may buy an FX Call Option giving them the right to buy USD $1m six months from now at a NZD/USD rate of , rather than at today s spot exchange rate of The buyer will pay a premium to gain this right. Note that hedging this exchange rate using a FX Option means that the company, as the buyer, does not need to exercise the option and will receive the benefit of rate movements in their favour while providing a worst case buy level. At OMF, we can provide you with FX Option quotes through our 24 hour dealing desk. Key terms relating to FX Options FX Options have a number of key features and terms that clients should be familiar with before investing in FX Options. American and European Style Options American style options can be exercised at any time up to and including the day they expire as opposed to a European style option, which can only be exercised at expiry. FX Options are predominately European style. Calls & Puts There are two basic types of FX Options. An option with the right to buy currency is known as a call option, while an option with the right to sell currency is a put option. For both calls and puts there is a buyer and a seller of the contract. Buyer Seller Call Right to Buy Obligation to Sell Put Right to Sell Obligation to Buy 5 F o r e i g n E x c h a n g e O p t i o n s

6 Exercise price The exercise price or strike price is the pre-agreed exchange rate at which one currency will be exchanged for another currency if the option is exercised. So, for example, a trader may buy a 3 month put option on the NZD/USD at an exercise price (rate) of while the spot rate is If the option is exercised, the option buyer will sell NZD and buy USD at the exercise price of and while the seller of the put will buy NZD and deliver USD to the options buyer at the exercise price of Expire worthless If at the expiry date the option is out-of-the money, the buyer will abandon the option and it will expire without any remaining value. Expiry Date The expiry date of the option (also known as the declaration, maturity or expiration date) is the last day on which the option may be exercised by the buyer. Interest Rates The differential in interest rates between the base and the quote currency also affects the forward price of the currency and the option premium. A higher interest rate differential will lower the premium of a call and increase the premium of a put, all other things being equal. In-the-money A term commonly used to describe a profitable position in an FX Option. The buyer will exercise the option if it is in-the-money at expiry. Market volatility This refers to the price behaviour of the currency. A currency is more volatile if it has a history of rapid fluctuations over a wide range of rates relative to another currency that may have smaller movements over a narrower range. In general, the more volatile the currency, the higher the premium that the seller will require because the options, theoretically, have a better chance of ultimately being profitable expiring in-the-money. Out-of-the-money A term commonly used to describe a financial product subject to losses. The buyer will forego the premium and abandon an out-of-the-money option at expiry. Premium The premium is the cost or price of the option. It is expressed in the same units as the underlying currency and in FX Options is expressed in currency points (or Pips). In our example above the premium may be 65 Pips of USD which is USD $6,500 per NZD $1m face value. The buyer of the option pays the put seller the premium at the options inception. Option premiums are determined in the marketplace and are a function of supply and demand like any other financial asset or derivative. Strike price Referred to as the option strike, the level of the strike relative to the market rate (spot) will determine the value or cost of the option. Spot price (rate) As the spot price increases, the value of calls increases as it becomes more likely that calls will be exercised at expiry. In contrast, puts decrease in value, as the spot price is a more attractive exercise price of the option. Time to expiry All other things being equal, the greater the time to expiry, the higher the time value of the option. The more time there is left before expiry, the greater the chance that the option will be profitable 6 F o r e i g n E x c h a n g e O p t i o n s

7 Buying an Option If a person is of the opinion that a currency will move either up or down, then a straight purchase of a call or purchase of a put, respectively, may be the appropriate option strategy. This would provide a limited risk scenario. The buyer of an option (also termed as the taker) can lose no more than the option premium, whilst maintaining all the potential to benefits if the currency moves in the anticipated direction. Selling an Option The seller of an option (also termed as the granter or the writer) has the reverse position. They will receive the option premium paid by the buyer of the option. This is the only profit they can make from the trade. It would be the seller's view that the option would not be exercised and would expire worthless in the hands of the buyer. However, if the currency moves beyond the option strike price, the option will be exercised by the buyer. The seller must be prepared to enter into a currency position if the option buyer exercises the option. For this reason, the option seller is required to pay an initial margin as they have unlimited downside risk and pay the variation margin on the sold option position if the currency moves against their option position. The seller's losses will continue to increase as the option moves further in-the-money. Theoretically, this places the option seller in a position of unlimited loss with the potential for profit to be capped to the premium. Unlike the buyer, the seller has an obligation under an option contract and must deliver if the option is exercised. This raises the question of who is likely to sell options. Who would be willing to assume risk in return for a limited reward? There are two types of market participants who may be willing to sell options: 1) A trader who deals in the underlying currency. For example a bank or fund speculator may be willing to sell options and establish a hedge in the underlying currency, knowing that if the options were exercised, it could give or take delivery against the resulting sold or bought currency position. This considerably reduces the risks involved in selling options. 2) Speculative traders who sell options as part of a strategy and are fully aware of the risk characteristics of options and are happy to have currency called away from them or put to them if the options are exercised. Vanilla Options A vanilla option is a normal call or put option that has standardised terms and no special or unusual features. Example: Buying a Vanilla Call Option April 15 th - A currency trader buys a one month AUD/USD $1m European Call option that expires on May 15 th (Tokyo cut-off) for a premium of 65 pips ( or USD $6,500 per $1m face value) from OMF. The AUD/USD spot rate is This is a direction and time dependent out-of-the-money option. The currency has to move upward within one month. The option is 100 points out-of-the-money so the AUD/USD has to appreciate above for the option to be in-the-money and above to break even (strike premium ). By convention, currency options typically expire at either the Tokyo or New York cut-off times which are 3pm (Tokyo) and 10 am (New York) New Zealand time, respectively. 7 F o r e i g n E x c h a n g e O p t i o n s

8 So what type of trader may use this strategy: 1. A speculator with a bullish view of the AUD versus the USD. 2. A speculator that is short AUD/USD and wants to protect this position in the event the currency appreciates, and therefore buys the call option as a stop loss. 3. An exporter who hopes the AUD/USD will fall but wants to cap the exchange rate should the AUD/USD appreciates. 4. An importer who has locked in forward cover by selling an AUD/USD forward some time ago but now thinks the AUD/USD will appreciate and wants to take part in any upside if the currency increases above , thereby neutralising the forward. If at expiry (May 15 th ) the AUD/USD is above the call options buyer will exercise the option and take delivery of AUD $1m by delivering (selling) USD $785,000 to OMF. As it is a European option, it cannot be exercised early. All OTC currency options at OMF are deliverable. Should the AUD/USD be less than the strike price of , then the trader will abandon the option. The trader will have lost the premium below AUD/USD as it will be cheaper to transact the currency exchange in the spot market rather than at the relatively high level. The buyer s loss is never greater than the total premium. Simple European (or American) Options such as the example above have smooth payoffs. The options trader has the right to buy at AUD/USD and clearly will make a greater profit the more the option is in-the-money. Exotic Options One of the most attractive features of options is the ability to create a diverse number of strategies using single or combined puts and calls. It is possible to create an options strategy to suit any view on the market, whether the trader is of the opinion that the market will rise (bullish), fall (bearish), stabilise (neutral to price), trade in a definable range or move dramatically in either direction (i.e. trading a decrease or increase in volatility). Other more exotic options can be traded depending on the buyer s preference and the strategies are unlimited in variety. Exotic options may include more bespoke arrangements if they are exercised and all these variables are agreed to between OMF and the client at the point where the quote is made. The following are examples of two simple exotic options offered by OMF. 'One-Touch Option' A binary one-touch option is a type of exotic option that gives an investor a pay-out once the price of the underlying asset reaches or surpasses a pre-determined barrier. A barrier is another term for a given level, so in the case of the underlying currencies, the market rate. This type of option allows the investor to set the position of the barrier, the time to expiration and the pay-out to be received once the barrier is broken. Only two outcomes are possible with this type of option: 1) the barrier is breached and the trader collects the full pay-out agreed upon at the outset of the contract; or 2) the barrier is not breached and the trader loses the full premium paid to the options seller. 8 F o r e i g n E x c h a n g e O p t i o n s

9 This type of option is useful for traders who believe that the price of an underlying asset will exceed (for a call) or fall below (for a put) a certain level in the future, but who are not sure that the higher price (for a call) or lower price (for a put) is sustainable. Because a one-touch option only has one barrier level, it is generally slightly less expensive than a double one-touch option. Currency one-touch options have a fixed pay out of a pre-determined amount at expiry (the call ) if the currency trades above the strike for a call or below the strike for a put at any time during the life of the option. They are path dependent and are often called binary options because of the all-ornothing feature - you get all the return if the spot price touches the strike price OR nothing if it does not and the premium will be lost. Example: One-Touch Option A 3 month one-touch all-or-nothing EUR/USD put option with a strike price of , based on a spot price of EUR/USD , may cost a premium of say 10% of the pay-out that you want. If you want a pay-out of EUR 100,000, then you would pay EUR 10,000 in premiums. The option pays out EUR 100,000 at expiry if the EUR/USD touches at any time during the option s life. How far the currency falls below the strike price or whether it is above or below the strike price at expiry is irrelevant. As long as the EUR/USD has touched at any time during the option s life the buyer receives EUR 100,000. If the spot EUR/USD remains above for the life of the option, then the option remains out-of-themoney and the EUR 10,000 premium is lost. Knock Out and Reverse Knockout Options Knock-out options and reverse knock out options are exotic options with a built in mechanism to expire worthless, should a specified price level be reached. As knock-out options limit the profit potential for the option buyer, they can be purchased for a smaller premium than an equivalent option without a knock-out stipulation. Knock-Out ("KO") options are similar to Vanilla Options in that they have a strike, an expiration date and a face value. The unique feature of the KO vis-à-vis Vanillas is that the option has a barrier that is out out-of-the-money i.e.. If the spot level reaches this barrier at any time before the option expires the option disappears (extinguishes). Knock-out options are considerably cheaper than vanilla options, because of the risk that the option disappears during the option's life time. Like a Knockout option, a reverse knockout option (RKO) has a barrier but has one key difference; the barrier of the RKO is triggered at a level when the option is in-the-money. So for a call the barrier would be above spot, for a put below spot. If the barrier is not triggered the pay-out is the same as for a Vanilla option. Knock-Out options differ from Reverse Knockout by the fact that the barrier is out of the money with respect to spot (they are down-and-out for calls and up-and-out for puts). In the case of a call, the product is well suited to an investor who believes a currency will experience limited strengthening but is not expected to trade above the barrier level. And conversely for a put, it is well suited to an investor whose view is that the currency will depreciate, but not beyond the 9 F o r e i g n E x c h a n g e O p t i o n s

10 barrier level. Because the pay-out is limited by the barrier, a RKO option is significantly cheaper in general than the vanilla, and also cheaper than the KO option. Example: Reverse Knock-out Option The spot NZD/USD is trading at a trader buys a two week NZD/USD reverse knock-out ( RKO ) put and a knock-out at The RKO costs 20 pips or USD $2,000 per $1m face value. The option is path dependent as the trader is speculating that the NZD/USD rate will fall below (a movement of 50 pips) but believes it unlikely that it will fall below (a movement of 250 pips) before expiry in two weeks time. In two weeks time, there are three scenarios: 1. The NZD/USD spot rate is at or above and the RKO put buyer abandons the option. 2. The NZD/USD is between and and the RKO put buyer exercises the put and is now short $1m NZD at The NZD/USD trades below at any time up to and including the expiry and the RKO put will be knocked out (extinguished). Example: Knock-out Option The spot NZD/USD is trading at and a trader buys a one week NZD/USD knock-out ( KO ) put with a knock-out at The KO costs 15 pips on NZD $1,500 per $1m face value. This is a path dependent option as the trader makes money if the NZD/USD weakens and falls below the strike price of (a movement of 50 pips).the trader also believes that the NZD/USD is unlikely to strengthen above (a move of 70 pips above the spot price). In a weeks time, there are three scenarios: 1. The NZD/USD is above The KO put is out-of-the-money and will expire worthless. 2. The NZD/USD is below and the trader exercises the put and is short $1m NZD at The NZD/USD rallies above at or before expiry and is knocked-out 10 F o r e i g n E x c h a n g e O p t i o n s

11 Why Should Investors Consider FX Options? Investors often need to exchange foreign currency at some future date. Most currency exchange rates are floating (they are not fixed or pegged at a particular level) and fluctuate according to the forces of supply and demand. During trading hours, the exchange rates of major currency pairs can change by the millisecond, thus creating an unpredictable environment for businesses exposed to foreign currency. The main reasons for engaging in FX Options are: FX Options give you flexibility when hedging to limit the potential risk of fluctuating exchange rates. It provides the ability to fix an exchange rate now for the future delivery of a currency. This certainty of the amount payable on the future date provides improved money management of cash flows and costs. Unlike other FX derivatives, bought FX Options limit the loss of the buyer of the option to the premium, therefore there is certainty regarding the level of loss that the client can face. For speculative profits (investors predict whether a currency will devalue or increase in value against another currency over a period of time). They can be tailor-made for the particular risk that an investor wants to cover or speculate on. It is a simple way of managing future currency exchange risk by providing a worst case rate if there are any unfavourable movements in exchange rates. But unlike forwards they allow you to benefit should the exchange rate move in your favour How are FX Options Calculated? The premium of an option is made up of two separate components: the intrinsic value and the time value (extrinsic value). The intrinsic value is the difference between the spot price (exchange rate) and the exercise price. For a call option, the intrinsic value is the spot price less the exercise price, while for a put option it is the exercise price less the current share price. In other words, only in-the-money options have any intrinsic value. The time value for an option is made up of time to expiry, volatility and interest rates. An option which is out of the money (not profitable to exercise) has no intrinsic value but still has a time value because there is a chance it will become profitable before it expires. The more likely the option will become in-themoney, the higher the premium. In-the-money options have time value and intrinsic value. Therefore, the premium will depend on the value of the underlying currency, the option s strike price, the prevailing interest rate differential in the currencies, the term of the option and the volatility of the currencies. Of these factors, future volatility is the unknown variable, is not constant and is what is being traded. How are FX Option Price Quotes Expressed? FX Option prices are usually quoted in Pips points based on the underlying currencies and how the FX Option is calculated as per above. Therefore each FX Option is individually priced. To request a price for an FX Option, clients can call OMF s dealing desk. Margin Clients who wish to use an FX Option contract with OMF are required to post funds into their account. The buyer must pay the premium owed plus any applicable fees when they establish a position. The option s seller will receive premium upfront but will pay a margin. Margin at OMF consists of two types of margins: the initial margin and the variation margin. The margin is a calculated percentage of the transaction rather than the full cost of the sum required and is generally 5% to 10% of the notional face value. 11 F o r e i g n E x c h a n g e O p t i o n s

12 Initial Margin An initial margin is the amount of money that is required to be deposited for each sold contract that you have open, and covers the credit risk that you pose to OMF. This is held as security against adverse price movements in the market. It is important to note that the initial margin represents the minimum amount of money that OMF must collect from its clients. Initial margins are calculated by currency pairs and may vary. For example, on a $1m NZD/USD position the seller of a strike call or put will pay 5% of USD $760,000 or USD $38,000 initial margin plus any applicable fees and commissions. Often more than this amount is required to ensure sufficient funds are held in clients accounts to cover any adverse movements in the price (variations). Your OMF dealer can advise you of your initial margin requirements for any FX Options you wish to trade. Variation Margin and Margin Calls Variation margin is the term used to describe the change in the market price of the FX Option that has an impact on the amount of funds that are required to be held in a client s OMF trading account. Variation margin only has an impact on sellers of FX Options. Every day, the FX Options seller s strike price is compared to the spot price of each relevant instrument (mark-to-market) and the unrealised profit/loss is determined in respect of those positions. Where an unrealised loss erodes all, or part, of your initial margin, you will be required to supply additional funds (within 24 hours) to bring your account balance up to its required minimum. Should the market continue to move adversely, you will continue to be margin called to maintain the required variation margin. OMF s margin calls are calculated in NZD and are calculated by: Margin requirement = Balance of your OMF trading account (initial margin & fees) variation margin Margin calls are normally made at the beginning of the day for FX Options, but can be made at any time between 8:30am and 5:30pm New Zealand Time ( NZT ) Monday to Friday ( Business Hours ). You will be contacted by an OMF dealer by phone, text or to advise you of your margin call. In the event of a margin call you will be asked to either close out the FX Option or send additional funds to cover the margin call. It is your responsibility to maintain current margin requirements on your FX Option and meet your margin call within 24 hours. Failure to do so will result in OMF closing your FX Option and you will remain liable for any costs or losses. If you are travelling overseas, you should advise OMF as you have 48 hours to meet your margin call, however, if you cannot be contacted after this OMF, will be forced to close all or some of your positions. We strongly suggest that if you know that contact may be difficult, then you make alternative arrangements for payment in the event of a margin call. 12 F o r e i g n E x c h a n g e O p t i o n s

13 Example: Margin Call A trader has transferred to their OMF account NZD $10,000. They sell a three month NZD/USD FX vanilla put option with a face value of USD $100,000. Based on a spot rate of NZD/USD the three month European put is trading at 160 pips or USD $1,600. This means that the seller will receive USD $1,600 less NZD $100 in commission in their account at OMF at inception. The initial margin is 5% or USD $5,000. So the account would have the following: NZD USD Base Equivalent Deposit 10, CR 10, CR Premium 1, CR 2, CR Commission DR DR Initial Margin 5, DR 6, DR Overall Net Balance 9, CR 3400 DR CR The account has an excess balance of NZD $5, on day 1 as above. Additional margin will be deducted from the account should the spot NZD/USD fall below the strike. As this calculation occurs daily, it is appropriate to lodge excess funds in their account to cover daily margin calls, so having an excess balance as per this example is the norm. Margin calls may cause an FX Option to suffer losses that are greater than the total funds that are initially invested. This can lead to trading accounts becoming negative or in unlimited overloss. Example: Unlimited Overloss As per the margin example above, George has a credit balance of NZD $5, Should the NZD/USD fall 41 points or more below the strike, additional margin will be payable (i.e. 41 points at USD $100 points is USD = NZD $5, which exceeds the NZD $5, balance). If the client does not pay variation margin, then the FX Option will be closed out and any losses (plus costs) would be deducted from the initial margin held. Overloss occurs when the initial margin is less than the variation margin call. Please note that the examples provided above are for illustrative purposes only. They are each an example of one situation only and do not reflect the specific circumstances or the obligations that may arise under a derivative entered into by you. 13 F o r e i g n E x c h a n g e O p t i o n s

14 ENTERING A FORWARD AND RIGHTS TO ALTER TERMS OR TERMINATE AN OPTION The process below is a summary only of how to trade FX Options with OMF. OMF s General Terms and Conditions provide more detailed information about the obligations and rights of each party. Establishing an Account with OMF To enter into an FX Option contract (or any other derivative with OMF), you must become a contracted client of OMF. Upon account opening, you will decide whether you wish to open an online trading facility, OMFx24, as well as having access to OMF s dealing desk and traditional phone broking model. During OMF s account opening process, you must provide OMF with (at a minimum) the information that is required in the Client Application Form. From time to time, OMF may request further information to be provided by you to assist with the account opening. Once your account has been opened and funds deposited, your client advisor will provide an account number and a direct dealing telephone number to you. You will then be ready to deal. OMF does not offer discretionary services, which means all orders must be authorised by you (or a person authorised to trade on the Account) prior to arranging the derivatives contract. How to Enter Into a FX Option Once an account is approved, you become a client and you will be able to enter into a FX Option contract by instructing an OMF dealer. OMF uses a number of highly reputable counterparties (usually well-known international investment banks) to seek the best FX Option price for our clients. To place an order, you will request that OMF dealer to provide a quotation for: a) The currency pair b) The expiry date of the option including whether it is a Tokyo or New York cut-off c) The strike price/s d) The options type put or call e) European or American f) Features vanilla, one-touch, KO, RKO, etc If this is agreeable to you, you may immediately upon receiving the quote, instruct us to arrange the entry into the FX Option. This can be done verbally via the OMF dealer, depending on where the quote was provided. At this point, OMF will use our best endeavours to facilitate this Forward on your behalf, however, OMF has no obligation to accept your offer to enter into that contract and it only becomes binding when the Forward is accepted by OMF (i.e. traded). You must, amongst other things, ensure that you have enough cleared funds available in your OMF account to cover the premium and/or initial margin of that FX Option and you are trading within any limits set by OMF. When the FX Option Is Confirmed If you have placed a market order the deal will be confirmed verbally by the OMF dealer. If the order is a limit, stop or some other order type and your order is filled, you can instruct OMF to send a text or on fill. In all cases upon acceptance of the FX Option by OMF, your order is filled and forms a legally binding contract. You will receive a deal confirmation which details the terms of the contract agreed in a written confirmation. 14 F o r e i g n E x c h a n g e O p t i o n s

15 Confirmation of all trading activity is normally sent by on the business day following the transaction in the form of a daily statement. It is vital that you contact us as soon as possible if you do not receive a statement or if you disagree with its contents. The daily statement lists all open positions, with each position valued at the prevailing market rate. The current profit or loss on each position is also shown on the right of the page. Your net position is simply the result of summing the unrealised profits and losses of all open positions. The financial section outlines your cash balances, cash flows, initial margin requirements, unrealised profits/losses and the resulting equity. This is detailed by currency and summarised in your account s base currency for convenience. You may wish to convert your individual currency account balances from time to time. Altering or Terminating the FX Option Typically FX Options will either be exercised or expire worthless at the date of expiry rather than being altered or terminated. If an FX Option expires worthless, nothing effectively happens. This means that the client will lose their premium and the option will disappear or cease to exist. The client does not need to do anything; the FX Option will automatically be removed from their OMF account statement after the option has expired. If the FX Option is exercised, then this will automatically be transferred into a spot foreign exchange position. You will have to advise OMF if you wish to deliver the FX position or roll the margin position forward to a date in the future. If you wish to deliver the FX position, you will advise OMF (through your OMF dealer) of this and the position will be settled within 2 business days (spot). If you wish to roll the position, you will agree to an FX Margin contract, which is another derivative offered by OMF. You should familiarise yourself with this product in OMF s FX Margin PDS, which is available on our website at You should be aware that OMF does not offer cash delivery of FX Options (unless this forms part of the FX Option quote). Should you wish to alter or terminate the terms of the FX Option before the option expires, you must advise OMF. You cannot effectively terminate an FX Option, you can, however, request that OMF quotes for another FX Option which will effectively neutralise the risk of your option. If this occurs, then at the time of the requested sale, OMF will calculate at the prevailing option price and may require additional margin. Any profit or loss will be credited/debited to your OMF account. As part of the agreement between OMF and you ( Agreement ); either party may terminate the Agreement at any time by giving the other notice in writing to that effect. Termination will be effective upon receipt of the notice by the other party. Upon termination of the Agreement, all FX Options contracts will be matched out or abandoned. 15 F o r e i g n E x c h a n g e O p t i o n s

16 3. RISKS OF THESE DERIVATIVES Derivatives are often described as high risk investments as their value is determined by an underlying asset, which in the case of FX Options, are currencies. This section outlines the material risks in dealing in FX Options. You should therefore consider these risks very carefully to decide whether FX Options contracts are suited to your investment or hedging requirements. You should be aware of the differences in risks if you are the buyer of an option or a seller of an option. PRODUCT RISKS This risk is different for both buyers and sellers of FX Options. FX Options contracts carry a high degree of risk as exchange rates fluctuate, the leveraged nature of the facility will cause significant variations in the value of your position. These fluctuations can work in your favour or against you. It is important to understand that if you sell FX Options, major currency shifts can result in unlimited losses on your position that exceed your posted margin, resulting in additional variation margin to be paid, which have the potential to bring your OMF account balance into negative equity. FX Options buyers risk is limited to the premium payable at the establishment of the FX Option. However, to many professional traders the cost of option premiums may seem expensive, so they would prefer to receive the benefits of accurately predicting the market direction without paying out any premium and would therefore use forwards or margin FX to achieve their desired outcome. Margin call risk This risk is limited to sellers of FX Options only. Every day, the FX Options seller s strike price is compared to the spot price of each relevant instrument (mark-to-market) and the unrealised profit/loss is determined in respect of those positions. Where an unrealised loss erodes all, or part, of your initial margin, you will be required to supply additional funds (within 24 hours) to bring your account balance up to its required minimum. Should the market continue to move adversely, then you will continue to be margin called to maintain the required margin: this is called the variation margin. In this situation OMF is able to without limitation: terminate your agreement, debit damages from your account of an amount equal to any realised loss and take such other actions as a reasonably prudent derivatives broker would take in the circumstances to protect the personal obligations incurred when dealing on your behalf. Please consult the OMF General Terms and Conditions for further information. Volatility Risk This risk is limited to sellers of FX Options only. Typically, OMF will close out FX Options if the margin in your account is exceeded by losses, however, from time to time, major events in the currency market may cause a dislocation that is described as volatility risk. 16 F o r e i g n E x c h a n g e O p t i o n s

17 This volatility risk is used to describe a significant event in the financial market which leads to rapid instability and often has a negative impact on investors. In this event, an investor with a sold FX Option may suffer losses that are greater than the total funds that they initially invested, this leads their account to become negative or in overloss. There is no limit to how much an investor can enter into overloss, and in this event, the investor is in default with OMF. ISSUER RISKS This risk is applicable to both buyers and sellers of FX Options. When you enter any derivatives position with OMF you are exposed to the risk that OMF becomes insolvent and unable to meet its financial obligations. Your FX Option contract may cease to exist or be mandatorily closed by the liquidator in the event of insolvency. OMF s creditworthiness has not been assessed by an approved rating agency. This means that OMF has not received an independent opinion of its capability and willingness to repay its debts from an approved source. OMF s audited accounts are available to all clients free of charge. To avoid market risk, OMF will only act as a broker for client trading. What this means is that OMF hedges all our trading positions with reputable hedging counterparties and will not take uncovered principal positions (unlike a broker who acts as a market maker). RISKS WHEN ENTERING OR SETTLING THE DERIVATIVES These risks are applicable to both buyers and sellers of FX Options. There are a number of risks that you must be aware of when you enter into or settle FX Options. Delivery risk At expiry the FX Option s seller is liable to deliver and take delivery of the underlying currencies at the strike price. There is a risk that at delivery, the currencies may be unavailable to trade. Systems Risks Operational risks in relation to OMF s trading platforms are inherent in every FX Options contract. For example, disruptions in OMF s operational processes such as communications, computers, computer networks, software or external events may lead to delays in execution and settlement of transactions. Clients receiving a disruption to the trading platforms must call the trading desk in order to open/close positions. In the event that a disruption occurs on the OMF side, you may be unable to trade in an FX Option product offered by OMF and you may suffer a financial loss or opportunity to close a position. OMF does not accept or bear any liability in relation to the operation of the OMF trading platforms and acceptance of derivative orders are made on a best endeavours basis. Your acceptance of the quote constitutes an offer to OMF and the FX Option is binding at the point in which OMF accept this offer by placing it into our trading platforms. 17 F o r e i g n E x c h a n g e O p t i o n s

18 4. FEES APPLICABLE FEES AND CHARGES FOR THESE PRODUCTS OMF will charge clients commissions on FX Options depending on the volume of transactions and service requirements of the client. Fees are typically agreed between clients and their OMF dealer during the account opening process but can be re-negotiated at any time in the relationship. Standard Fees and Charges Commission: Commission rates are charged at a default rate of up to 0.10% of the nominal face value of the FX Option contract. Additional Charges FX Options may be subject to the following additional charges: Interest Rates Clients shall receive interest on accounts that are in excess. Typically the interest rate for accounts in excess will be a maximum of 2.0% below OMF's base rate, which is based the Official Cash Rates ( OCR ) of each country and are subject to change at any time. At month end, the interest calculated on each currency is converted to the accounts base currency (NZD unless otherwise instructed). Withholding tax is calculated and deducted from any interest earned. Default Interest Rates Clients shall pay default interest rates of a maximum of 2.0% above OMF's base rates for accounts in deficit which is calculated based on the margin deficit of each currency in negative. As with interest rates, default interest is based on the OCR of each country and is subject to change at any time. If a client s account is in debit in one currency and credit in another, it is the client s responsibility to manage the currency balances. At the client s request OMF are able to convert currency amounts within the account using interbank exchange rates. Termination or Alteration Fees There are no specific fees charged for closing a FX Option, however, as you effectively have to take the opposite position to neutralise the option risk, OMF will provide the client with a quote for this FX Option. Should the client agree to this FX Option, then they will receive any profits on the FX Option or be obligated to pay any losses on the FX Option. Examples regarding the termination or alteration of FX Options are provided in Section 2 of this PDS. 18 F o r e i g n E x c h a n g e O p t i o n s

19 The interest rates that differ from the above will be agreed on with the advisor when the account is opened. Holding Charges If the FX Option is exercised and the client chooses to roll the FX position, additional holding charges may apply if they are not delivered on their value date, which reflects the funding of not settling the two currencies. Clients will receive interest for the bought currency and pay default interest for the sold currency. For example, if the client has bought USD they will receive 0.25% and if they have sold NZD, they will have to pay 2.5%. This means they will be subject to a holding charge of 2.25% on the Forward. The holding charge will either be a debit or credit to the client s account depending on the currency pair not settled. The charge will apply every day until the open position is closed out. Clients should also be aware that the FX Option rate that we provide you may from time to time differ from the rate in which we obtain from our counterparty. This is because as a broker, OMF hedges all our client positions to mitigate risks to both our clients and the firm. This is commonly known as a spread. The spread is not a fee or commission payable by the client and the quotation price of an FX Option is not reflective of a spread, however, clients should understand that OMF may receive revenue from this. General Account Fees In addition to fees associated with FX Options, OMF may charge the following fees that are associated with the operation of your OMF account. Payment Fees OMF will charge payment fees on withdrawals from your OMF account if: The payment is a foreign currency transfer The payment is to an overseas beneficiary The payment is in NZD to a New Zealand bank account, but is a same day transaction These fees are typically a dollar figure amount and are charged at the time of the payment. Full details of these fees are available on OMF s website Cash Handling Fees As OMF is not a bank, we have a strict no cash policy for funds being deposited into OMF s client accounts. If physical cash is deposited, the client will be contacted and a 15% cash handling fee will apply to that cash deposit. For example, if NZD $10,000 cash is deposited into OMF s client account, then NZD $1,500 will be deducted as a cash handling fee. 19 F o r e i g n E x c h a n g e O p t i o n s

20 5. HOW OMF TREATS FUNDS AND PROPERTY RECEIVED FROM YOU How to Transfer Funds to OMF In order to trade FX Options with OMF, clients must deposit funds with OMF in one of our client trust accounts. OMF holds a number of client trust accounts in different currencies and these bank details are available 24 hours a day on our website. You are able to choose the currency in which you wish to transfer funds to OMF and the funds can be retained in that currency or you are able to instruct OMF to convert to another currency on your behalf. The currencies you hold in your OMF account do not have to relate to the same currency pair as the FX Option that you wish to trade, however, by doing so you are subjecting yourself to greater currency risk. Remember a negative currency balance is subject to default interest rates as explained in Section 4 of this PDS. OMF requires that funds transferred electronically from clients must originate from a bank account in the same name as the client s OMF account. Any deposits from third parties or of unidentified origin may be subject to additional compliance review or delays in allocating funds to your OMF account. OMF reserves the right to return any third party funds to the remitting bank. We only accept payments to one of our client trust accounts through electronic transfer and upon receipt of these, they are considered to be cleared funds and available for your trading use. To confirm whether funds have been received, you can contact OMF during Business Hours. It is our policy not to accept bank cheques or cash for trading FX Options at OMF and if received, will result in the funds being rejected and returned to the depositor. How to Withdraw Funds from OMF OMF requires that all clients provide verified details of at least one external bank account that is in the same name as their OMF account which can be linked as their Standard Settlement Instruction ( SSI ). OMF is able to transfer any surplus funds to this account upon client instruction to their OMF dealer during Business Hours. SSIs can be in any currency and OMF s clients are able to provide any number of SSIs to be linked to their OMF account upon completion of an OMF SSI Form. In order to do this, you must provide OMF with a copy of the verified bank details which include the account name, account number and the bank branding or be on the bank s letterhead. Withdrawals are processed within Business Hours and typically are processed on the same day however, cut-off times issued by OMF s bank may vary depending on the currency. From time to time, clients may require payments to third parties. In this instance, OMF will require a written and signed request on OMF s Third Party Payment Form. These payments may require additional documentation that supports the nature and purpose of the payment. Both the OMF SSI Form and the Third Party Payment Form are available upon request to your OMF dealer and your OMF adviser will be able to guide you through this process. Clients are unable to withdraw funds if they are on margin call and all funds must be cleared before OMF will release any payments. 20 F o r e i g n E x c h a n g e O p t i o n s

21 How Is My Money Held With OMF? OMF is currently required to comply with the Futures Industry (Client Funds) Regulations 1990 ( CFRegs ). The CFRegs require derivatives issuers to comply with strict legal provisions about where and how client funds and properties are held. The CFRegs were repealed as of 1 st December 2014 but apply to OMF until 1 st December 2015 by virtue of transitional provisions in the Financial Markets Conduct Regulations 2014 and, accordingly will be replaced for OMF by the Financial Markets Conduct Regulations 2014 from 1 December OMF will be transitioning to the new requirements and clients will be advised of these changes as of this date. All client funds deposited with OMF are held on trust in one of our client trust accounts where OMF acts as the trustee. These accounts are kept completely separate from OMF s own capital (money) to ensure your funds are protected should OMF become insolvent. Reconciliations of client assets are reported daily to the NZX, which provides proof that OMF is not using client funds to pay its bills or meet any of its proprietary obligations. All client funds are pooled together within the various trust accounts and are subject to independent checks by our external auditor. OMF is committed to prioritising the protection of client funds across all of our relationships and we only facilitate our client s trading with highly rated financial institutions and banks ( Counterparties ). For example, our client trust accounts for holding client funds are held with the Bank of New Zealand. In addition to our derivatives trading, OMF offers services for trading NZX equities. This service does not fall under the CFRegs but is governed by the Financial Advisers Act 2008 ( FAA ). Under the FAA, all client money that is identified as funds for NZX equity trading must be transferred to a separate client account, which is again separate from OMF s own capital. To ensure client confidence in our controls and procedures surrounding the safeguarding of client funds, and as prescribed by the CFRegs, OMF engages an external auditor to conduct independent reviews on a quarterly basis. The auditor must report any breaches immediately to the Financial Markets Authority ( FMA ). In addition to these audits, OMF are also subject to regulatory oversight and monitoring by the FMA and NZX. Our current external auditor is PWC. 21 F o r e i g n E x c h a n g e O p t i o n s