Financial Markets Operations Management (9 page)

Before we look at exchange-traded derivatives (ETDs) in more detail, please refresh your memories regarding the definitions of two types of ETD, i.e. futures and options.

Let us examine the similarities and differences between futures and options.

1. A futures contract is an obligation to do something; an option is a right or choice to do something. We will see that, in many cases, the buyers and sellers of futures contracts do not wish to make or take delivery of the underlying asset. To remove their obligation, the buyers and sellers must “close out” their obligations by selling (by the original buyer) and buying (by the original seller) the same quantity of contracts and, most importantly, informing the counterparty that these are closing transactions.
   
2. Both types refer to “standard amounts” and “specified prices and dates”. This would suggest that an entity other than the buyers and sellers has previously specified what these amounts, prices and dates should be. In other words, these derivative contracts have been designed and specified by a third party. This third party is a derivatives exchange.
   

ETD contracts are designed by the exchange on which they are traded. The standard nature of each contract refers to the contract specifications set out in
Table 2.32
.

It is usual for there to be a derivatives exchange in a market that has a stock exchange either as two separate entities or one combined entity (see
Table 2.33
).

In November 2013, the Intercontinental Exchange Group (ICE) announced the successful completion of its acquisition of NYSE Euronext.
⁶
The stock-and-cash transaction had a total value of approximately USD 11 billion.

The combined company operates 16 global exchanges and five central clearing houses. ICE and NYSE Euronext businesses will continue to operate under their respective brand names. As previously announced, the company expected to conduct an IPO for the Euronext group of Continental European exchanges as a standalone entity (in 2014), subject to market conditions and regulatory approval.

Unlike the cash markets where there are finite amounts of shares and bonds in issue and available for trading and other purposes, ETD contracts are not issued. They are created as they are needed and destroyed when open interest decreases.

Every day, contracts are bought and sold. These trades either create an exposure (an open interest) or cancel an exposure (close) and in total represent volume in the contract being traded.
Open interest
is therefore the total quantity of contracts that have been traded but not closed or delivered on any particular day.

Open interest is not the same as volume, as illustrated in
Tables 2.35a
and
2.35b
.

There are two points to note here:

1. The volume is calculated so that one purchase plus one sale equals one quantity of volume.
   
2. Notice that the sum of the total open long interest and total open short interest is zero. This is a meaningless figure and so we only consider the open long interest figure, i.e. five in the example above.
   

We saw that exchanges such as CME Group handle a wide range of product types, most of which fall into two types of derivative: futures and options. We will look at these in turn, concentrating on a typical set of contract specifications and looking at an example or two of each type.