Futures Leverage for sophisticated traders
FSR TERMINOLOGY CHANGES ASX has changed its business framework for trading, clearing and settlement. As a result there have been changes to the terminology used in this document. OLD TERM Options Clearing House Pty Ltd OCH ASXF Pty Ltd ASX Futures Exchange ASXF Exchange ASX Business Rules SCH Business Rules OCH Business Rules OCH Derivatives Clearing Rules OCH Clearing Rules ASXF Exchange Business Rules ASXF Business Rules Broker ASX PO Participating Organisation RIOT Non-Broker Participant (NBP) Limited Purpose NBP NSSP Non sponsoring settlement participant Security Securities Shares Derivative DTF or Derivatives Trading Facility Clearing Participant Only (currently derivatives only) Third Party Clearer Non-CHESS Approved Security Foreign Portal Dealer Participating ASX Security Participating Foreign Security Participating Foreign Exchange NEW TERM Australian Clearing House Pty Ltd ACH ASX ASX Market Rules ASTC Settlement Rules ACH Clearing Rules ASX Market Rules ASX Market Participant or Market Participant (may also be a ACH Clearing Participant and/or ASTC Settlement Participant) Market Participant / Trading Participant (may also be a ACH Clearing Participant and/or ASTC Settlement Participant) ASX Market Participant or Market Participant (Trading Participant only for selected products) and Market Maker General Settlement Participant Specialist Settlement Participant Account Participant Financial Product (except for overseas products) Financial Product DTP or Derivatives Trading Platform Direct Clearing Participant General Clearing Participant Non-CS Approved Product Overseas Portal Dealer Participating ASX Traded Product Participating International Financial Product Participating Overseas Exchange For further details of the Financial Services Reform terminology changes, please visit www.asx.com.au/fsr.htm.
Introduction Sharemarket investors are using an increasing range of investment strategies and products including exchange traded options, LEPOs and warrants. ASX now offers Mini Index Futures futures contracts based on leading share price indices. ASX Mini Index Futures offer a simple and efficient way to exploit short term trading opportunities while at the same time giving you substantial leverage. They offer a level of exposure that can be tailored to suit your portfolio. The benefits of ASX exchange traded options and LEPOs also apply to ASX Mini Index Futures, including: market makers providing a liquid, competitive market; the ability to use shares as collateral to cover your initial margin obligations; and ASX s world-class derivatives trading, clearing and settlement systems. 1
What are ASX Mini Index Futures? 2 ASX Mini Index Futures are similar to the popular e-mini futures on the S&P 500 Index and the Nasdaq 100 Index in the US and the Mini FTSE 100 Index futures in the UK. Index futures contracts currently offered by ASX are: ASX Mini50 futures; ASX Mini200 futures; and ASX Mini200 Property Trust futures. The dollar value of each ASX Mini Index Futures contract is based on a $10 per index point multiplier. For example, if the futures contract is trading at 3290 points, the contract value is $32,900. The S&P /ASX50 Index and S&P /ASX200 Index represent around 75% and 90% of total ASX domestic stockmarket capitalisation respectively. The choice of futures contracts over these two indices enables you either to focus your strategy on the market leaders (the S&P/ASX50 Index), or to trade a view on a more broadly-based index (the S&P/ASX200 Index). Mini 200 Property Trust futures give you exposure to the Property Trust subsector of the S&P/ASX200 Index. How are futures different from other derivatives products? Futures are relatively straightforward compared to other derivatives products. The broad definition of a futures contract is an agreement to buy or sell a particular asset (or cash equivalent) on a specified future date at a price agreed upon today. Like many derivatives products, futures are short-term contracts with a number of maturity dates available for trading at any one time. However, there are a number of differences between futures and products such as exchange traded options, including: there is no exercise price for a futures contract you simply buy or sell a contract with the maturity date of your choice at the market price at the time; you do not pay a premium when you trade a futures contract instead you pay a small deposit or initial margin; futures represent an obligation to either buy or sell the underlying value rather than just a right to do so. Both buyers and sellers have significant exposure should the market move against them, and therefore must pay an initial margin and subsequent variation margins; futures give you more direct exposure to the underlying value in simple terms, they are like trading an exchange traded option with a delta of approximately 1. Both buyers and sellers of futures contracts may be margined. An initial margin is payable when a futures contract is traded. The initial margin is similar to the risk margin paid by writers of exchange traded options. Variation margins may also be payable as the futures position is settled to market on a daily basis. The variation margin is similar to the premium margins paid by option writers.
Benefits of ASX Mini Index Futures Exposure to the broad sharemarket ASX Mini Index Futures enable you to trade a view on the broad sharemarket, or on a sector of the market, in one transaction. Instead of trying to construct a portfolio of shares that make up an index, you can simply and efficiently take a position using an index futures contract. Leverage ASX Mini Index Futures provide you with leveraged exposure to moves in the underlying index. Your initial outlay when you trade a futures contract is a small percentage of the value of the contract. Therefore, if the market moves in your favour, the percentage returns you make from trading the futures contract will be significantly higher than the percentage movement in the underlying index. Example Buying futures to gain exposure to a rise in the market Assume it is early August, and the S&P/ASX50 Index is trading at 2900. You believe the market will rise over the next few weeks, and decide to buy a September ASX Mini50 future. A week later, the index has risen to 3030 points, and you decide to close out your position by selling the September futures contract. The example demonstrates the leveraged exposure you gain by trading futures. Because your outlay at the time of the opening transaction is limited to the initial margin ($900), the percentage return made on the futures contract is much greater (at 43.3%: $1,290 profit on $900 outlay) than the price movement of the underlying index (at 4.48%:2900 to 3030). It is important to understand that the leveraged exposure provided by futures can also lead to substantial losses. If the market moves against you, the losses you suffer from trading futures will be greater in percentage terms than the movement in the underlying index. You should discuss whether this risk is appropriate to your circumstances with your investment adviser. Note that the example above does not include brokerage, exchange fees or any interest charges. It also does not show the daily variation margins you would have paid or had credited to you. More information on margining is provided later in this brochure. 3 Example Date 2 August % move % return on in index futures trade Opening trade Buy 1 September ASX Mini50 future Index level 2900 Futures price/ value 2946/ $29,460 Initial margin paid $900 Date 10 August Closing trade Sell 1 September ASX Mini50 future Index level 3030 Futures price/ value 3075/ $30,750 Initial margin refunded $900 Profit $1,290 4.48 143.3 Note: the initial margin assumed in this example is $900. Initial margins are determined by ASX s clearing house according to the volatility of the underlying index and are reviewed regularly.
4 Trade declining markets With ASX Mini Index Futures it is just as easy to go short the market as it is to go long. You can trade a bearish view on the market by selling index futures. If the market falls as predicted, you can then take profits by closing out your position, or alternatively receive a cash settlement when the contract matures. It is as simple to sell a futures contract as it is to buy one. In both cases, you pay an initial margin on opening your position. There is no need to own shares or to have the full cash value of the contract in order to sell a futures contract. Example Selling futures to gain exposure to a fall in the market Assume it is early February, and the S&P/ASX200 Index is trading at 3000. The market has risen sharply over the previous six weeks, and you believe the index may fall back during the next month. You therefore sell a March ASX Mini200 futures contract. Two weeks later, the index has fallen to 2920 points, and you close out your position by buying back the March futures contract. Hedge a physical position You can use ASX Mini Index Futures to hedge your share portfolio. For example you may have a broadly based share portfolio that trades approximately in line with the S&P/ASX200 Index. By selling ASX Mini200 futures you can lock in the value of your portfolio for the life of the futures contract. It is important to realise that the success of a hedging strategy will depend in part on how closely movements in the value of your Example portfolio track movements in the index underlying the futures contract. This is often referred to as basis risk. You may already be familiar with the use of put options to protect your shareholdings. There are some important differences between selling futures and buying put options to hedge a portfolio: in selling futures you do not incur the expense of the premium you must pay when you buy a put option; and in selling futures you do not have the possibility of benefiting from a rise in the value of your shares, as any increase in their value will be offset by a loss on the futures contract; in contrast, buying a put option still allows you to benefit from a rise in the value of your portfolio. Integrated ASX derivatives markets ASX Futures are traded and cleared using the same ASX systems that are used in ASX s options and LEPO markets. Depending on how your accounts with your broker are set up, you may be able to: implement combinations and spreads employing different derivatives products, as well as shares; reduce the cash you might need to provide for margin obligations by using your shares as cover; lodge shares as collateral to cover all your open positions in options and futures; and offset the credit premium of bought option positions against futures initial margin liabilities. Date 4 February % move % return on in index futures trade Opening trade Sell 1 March ASX Mini200 future Index level 3000 Futures price/ value 3013/ $30,130 Initial margin paid $900 Date 15 February Closing trade Buy 1 March ASX Mini200 future Index level 2920 Futures price/ value 2930/ $29,300 Initial margin refunded $900 Profit $830 2.67 92.2 Note: the initial margin assumed in this example is $900. Initial margins are determined by ASX s clearing house according to the volatility of the underlying index and are reviewed regularly.
Pricing ASX Mini Index Futures? When you buy an ASX Mini Index Future, you agree to buy the index underlying the futures contract on a specified date in the future. Your profit or loss depends on how far the price of the futures contract at maturity, or when you close out, is above or below the price at which you bought the contract. Price /level Futures price When you sell a future to open a position, you agree to sell the index on a specified date in the future. Again, your profit or loss depends on the difference between the price of the futures contract at maturity, or when you close out, and the price at which you sold the contract. The full value of the futures contract is not paid or received when the position is opened instead both buyer and seller pay an initial margin. The traded price is the basis on which profit or loss is calculated at maturity or on closing out the position if this takes place before maturity. Before maturity, the futures contract typically trades at a premium to the level of the underlying index. The difference is often referred to as the cost of carry. This amount reflects the cost of holding the shares over the life of the futures contract, less the amount that the shareholder would receive in dividends on those shares during this time. As maturity approaches, the price of the futures contract and the underlying index tend to converge. The following chart shows the typical relationship between the price of the futures contract and the level of the underlying index over time. Note that it is also possible for a futures contract to trade at a discount to the underlying index. Still, convergence of the futures price and the index level will take place as maturity approaches. Example Market price of an ASX Mini200 future You buy one December ASX Mini200 futures contract in early October and hold it to maturity. Example Date Opening trade Index level Time 9 October Buy 1 Dec ASX Mini200 future Index level 3050 Futures price/value 3070/$30,700 Futures maturity At maturity on 20 December, the futures contract is cash settled. Date 20 December Futures price/value 3160/$31,600 Profit = value of future at maturity traded price = $31,600 $30,700 = $900 Your profit is the difference between the futures settlement price of 3160 at maturity and the price you paid for the contract, multiplied by the index multiplier of $10 per index point. The example shows a contract held until maturity. You may of course choose to close out your futures position at any time prior to the maturity date. 5
Maturity and settlement 6 ASX Mini Index Futures mature on the third Friday of the maturity month, provided this day is a trading day. The last trading date is the day preceding the maturity date. Expiry dates for index option contracts coincide with ASX Mini Index Futures maturities. All ASX Mini Index Futures remaining open at maturity are cash settled. The settlement price used is the ASX Futures Opening Price Index Calculation (OPIC). The OPIC is based on the opening price of each stock in the index on the morning following the last trading day. As the stocks in the relevant index open, the first traded price of each stock is recorded. Once all stocks in the index have opened, an index calculation is made using these opening prices. This method is used to settle major index futures contracts internationally, including contracts over the S&P 500, the S&P 100 and the Dow Jones Industrial Average in the United States, and over the Nikkei 225 and Nikkei 300 in Japan. The OPIC method is regarded as an effective way to manage volatility often associated with the maturity of index futures contracts. Because the Australian market staggers the opening of stocks, it is not possible for the entire market to be traded in one hit during the opening period. Further, market opening is typically a time of high liquidity, and therefore the time the market is best able to absorb orders placed by traders looking to unwind index arbitrage strategies. Nevertheless, investors should be aware that trading patterns around maturity time often exhibit higher than average volatility.
Contract specifications ASXF Mini Index Futures contract specifications Underlying index Contract size/multiplier Quotation/tick size Contract months Maturity date Last trading day Trading hours Cash settlement amount Settlement method Initial margin Daily variation margins Margin cover/collateral Contracts are over the S&P/ASX200 Index, the S&P/ASX50 Index, and the S&P/ASX200 Property Trusts Sector Index. A current list of all ASX Mini Index Futures is available at www.asx.com.au/futures Valued at AUD $10 per index point. Prices are quoted as a number of index points with a minimum price movement of 1 index point tick size $10.00. March/June/September/December cycle. The third Friday of the maturity month, provided this day is a trading day. The business day preceding the Maturity date. Normal trading 6.00am to 5.00pm and 5.30pm to 8.00pm (Sydney time). Overseas trading 8.00pm 5.30am. Cash settlement is based on the opening prices of the stocks in the Underlying Index on the morning of the maturity date. An index calculation [(the Opening Price Index Calculation (OPIC)] is made using these opening prices. The OPIC is used by Options Clearing House Pty Ltd (OCH) to settle open index futures contracts. The cash settlement amount is calculated by the calculation agent (Standard & Poor s) based on the OPIC. The settlement amount is then paid or received net of margins on the next business day. Initial margins for both buyers and sellers are determined by OCH according to the volatility of the underlying index and are reviewed regularly. Volatility levels used by OCH are published in circulars which are available on asx.com.au/futures All futures positions for both buyers and sellers are settled to market each day and subject to variation margins. An intra-day margin call may also be made by OCH. Settlement to market margin obligations must be settled daily by the payment of cash. Cash or collateral such as shares, other options and futures positions and, other ASX traded securities, bank guarantees and Austraclear pledged securities may be lodged to cover initial margin obligations. 7 Overseas trading is the period for transactions where a Trading Participant is acting for a client who is not resident in Australia, and the instruction from the client is received outside normal trading hours.
Margins and collateral All futures contracts traded on ASX are registered, cleared and settled by ASX s wholly owned subsidiary Options Clearing House Pty Ltd (OCH). Both buyers and sellers of ASX Mini Index Future contracts must pay an initial margin, which is determined by OCH according to the volatility of the underlying index. Details of current initial margins can be found at www.asx.com.au/futures Both buyers and sellers are also liable for daily variation margin calls. The contract is settled to market on a daily basis, with variation margins either payable to or returned by OCH. The total profit or loss on the trade is equal to the net variation margins received or paid. In the example, the profit on the trade is $1,020. Margin offsets with options Traders can offset the credit premium of bought option positions against futures initial margin liabilities. This means you have less of your assets tied up in the transactions. 8 Using collateral to cover initial margins Over 120 CHESS sponsored stocks and 750 warrants are accepted by OCH as collateral for initial margin obligations. Other options and futures positions may also be used as collateral. A list of eligible collateral can be found at www.asx.com.au/futures Note that variation margins must be paid in cash. Example The following table shows the margining process for the seller of a December ASX Mini200 future. In this example the initial margin assumed for the ASX Mini200 future is $900. The seller of the futures contract may lodge either cash or eligible collateral to cover the initial margin. Example Date/ Trade Price Initial Margin Settlement to market (cash) 9 Oct Index 3050 Pay $900 Nil Sell 1 future Future 3070 10 Oct Index 3061 Pay $110 Future 3081 ($30,810 $30,700) 11 Oct Index 3033.5 Receive $280 Future 3053 ($30,530 $30,810) 12 Oct Index 2968.1 Receive $660 Future 2987 ($29,870 $30,530) 15 Oct Index 2945.4 Receive $230 Future 2964 ($29,640 $29,870) 16 Oct Index 2949.5 Initial margin reversed: Pay $40 Buy 1 future Future 2968 Receive $900 ($29,680 $29,640) Received $1,020
Getting started The first step to trading ASX Mini Index Futures is to contact your ASX Futures Broker. While you may already trade other ASX derivatives products, or SFE products, ASX Futures Business Rules require that you sign an agreement document with your broker prior to being able to trade. More information ASX offers a range of booklets on derivatives trading as well as various courses. If you would like more information on these products and services, phone ASX on, email ASX at futures@asx.com.au or visit www.asx.com.au/futures If you wish to use the one broker for both trading and clearing, you will only need to complete one set of documents. However, if your broker provides trading services only, you may need to complete a separate set of documents with your clearing broker. Your broker will then open a futures trading account with ASXF for you. Before you can place an order to buy or sell futures, your broker will generally require you to deposit cash or collateral to cover potential margin obligations. 9 While you can place an order with any adviser, only an Accredited Futures Adviser can give you advice about what orders to place.
This material is general and summary information only. Any advice or recommendation, (including relating to financial products) should be obtained from an Australian financial services licensee or other professional adviser. To the extent permitted by law, no responsibility for any loss arising in any way (including by way of negligence) suffered by anyone acting as a result of this material is accepted by ASX. copyright 2003. ASX Operations Pty Limited ABN 42 004 523 782. ( ASXO ). All rights reserved. This publication should not be reproduced, stored in a retrieval system or transmitted in any form, whether in whole or in part, without the prior written consent of ASXO. Edition 2 printed March 2003
Futures toll free information line: Internet: www.asx.com.au/futures