A US investor has purchased Sterling Treasury bills and wishes to hedge against the falling value of Sterling. Buying the out-of-the-money put (strike price $1.8500) will protect against a fall below that figure. The sale of the out-of-the-money call at $1.8900 will mean that the investor will benefit from any rise in Sterling to $1.8900 but not above that figure. The cost of buying the put is off-set by the revenue from writing the call, resulting in this instance in a zero cost strategy.

The reader will note that if Sterling rises above $1.8900, the written call position will make a loss. This is off-set by the rising value in dollar terms of the underlying Sterling investment. Conversely, if Sterling falls below $1.8850, the puts make a profit which off-sets the currency losses on the investment in the Sterling Treasury bills. Read more »

Posted: June 22nd, 2008 under Commodities Futures, Currency Futures, Equity Futures, Future Fund, Futures Contracts, Futures Options, Futures Spreads, Futures Trader, Futures Trading System, Managed Futures, S&P Futures.
Comments: 4

This section explains two of the many uses of options that rely upon the ability of the option buyer to abandon the option at no extra cost. The first is the purchase of options to insure against a fall in the value of a currency. The second is the hedging of the currency risk in a foreign currency tender.

Purchasing options as a form of insurance

If a US investment manager has strong expectations of a rise in the value of Sterling but wishes to insure against being totally wrong, slightly out-of-the money puts will provide the required insurance. Read more »

Posted: June 21st, 2008 under Commodities Futures, Equity Futures, Foreign Exchange Futures, Future Fund, Future Investing, Futures Options, Futures Prices, Futures Spreads, Futures Trading System, Managed Futures, Stock Futures, Stock Market Futures.
Comments: 5

Average rate currency options are based upon the average exchange rate of the underlying currency as distinct from the exchange rate on a single date — the expiry date.

The advantage of an average rate option is that the volatility of a moving average of a variable is less than the volatility of individual observations of that same variable. With daily observations, and with the volatility levels seen in the currency markets, the volatility of the moving average is in the order of 60% of that of the raw observations. Consequently, the price of an average rate option with a given exercise price will be less than an otherwise identical standard European currency option. Read more »

Posted: June 21st, 2008 under Equity Futures, Future Market Trends, Futures Market, Futures Options, Futures Spreads, S&P Futures, Stock Market Futures, Swap Futures, investment.
Comments: 5

Bonds are frequently purchased to fund future liabilities because of the relative certainty of the cash flows which are set contractually. However, the certainty as to the value of the terminal value of those future cash flows depends upon two factors:

the rate at which the future coupons can be reinvested remaining unchanged;

if the bond has a maturity longer than the desired holding period, the level of interest rates is the same at the beginning and end of the holding period. Read more »

Posted: June 17th, 2008 under Crude Oil Futures, Futures Options, Futures Prices, Futures Spreads, Short Futures, Silver Futures.
Comments: 6

Term structure based option-pricing models

Term structure models of pricing contingent claims have followed one of two approaches. One approach followed by Cox, Ingersoll and Ross (1985) actually model the expected returns from movements in the term structure in order to price the contingent claims. In effect, the term structure becomes endogenous to the pricing of the contingent claim.

The second approach followed by Ho and Lee (1986), Heath, Jarrow and Morton (1989), Black, Derman and Toy (1990) and Hull and White (1990) utilizes the volatilities of the various sectors of the term structure to derive a probability distribution of an arbitrage-free binomial, trinomial or multinomial lattice of the term structure. From this lattice, contingent claims are priced. These models all have one thing in common: they allow for the whole-term structure to be stochastic instead of the price of a single underlying instrument or a single interest rate. The whole-term structure is represented at each node of the binomial, trinomial or even multinomiaf lattice. Read more »

Posted: June 15th, 2008 under Currency Futures, Future Fund, Future Management, Future Trading, Futures Index, Futures Market, Futures Prices, Futures Spreads, Futures Trader, Futures Trading System, Managed Futures, S&P Futures, Stock Futures, investment.
Comments: 3

Asset swaps are different, in that they are linked to the purchase of an asset and the swapping of the cash flows of that asset. They are therefore used synthetically to engineer an asset structure rather than a liability structure.

The idea behind an asset swap is to enhance returns to the investor rather than hedging or lowering costs to a borrower. The objective is to find some underpriced fixed rate bond which is then purchased by an investor that would prefer a floating rate investment. The coupons are then swapped with a bank that has fixed rate liabilities at a lower cost. The bank thereby receives a fixed payment that is higher than the cost of its existing fixed rate debt. Read more »

Posted: June 8th, 2008 under Future Management, Futures Index, Futures Market, Futures Options, Futures Prices, Futures Spreads, Futures Trading System, Managed Futures, Swap Futures.
Comments: 3

Advertising

Beyond the requirement for agents (discussed below), fund groups undertaking retail sales tend to support their marketing efforts with fund advertising. Advertising regulations are both complex and highly variable between different countries but that does not mean that effective campaigns cannot be developed.

One problem to be faced here is that the most effective marketing statement— the expected performance of a new fund—is the one most difficult to get past the regulations. (Past performance is no guarantee of future results, for example.)

Fund Structure

Retail orientated managed derivatives funds may often differ from their institutional counterparts. The best example of this is in the employment of guarantees of return of capital. So-called guaranteed funds appeared in the mid-1980s and have thus far escaped the best efforts of numbers of regulators (outside the USA) to force a name change to something less overtly promotional (assured capital funds and so on).

Guarantees have their supporters and detractors but they do sell to retail investors and investors who (in most, but not all, countries) like the assurance of a guarantee when trying a new type of investment vehicle and are less swayed by comments about performance dilution than are the institutions. Furthermore, from a marketing standpoint, the presence of a guarantee or more accurately a guarantor creates the opportunity to include the name of a bank (often a major bank) as an additional sales incentive.

Marketing Materials

There is no proof of the assertion that retail investors are more swayed by brightly coloured marketing materials than are institutions. What is clear, however, is that the content of such materials should spend time introducing the concepts of derivatives and of managed derivatives at a more basic level. One worry expressed by many fund groups is the inclusion of the notorious word commodities within documentation about a diversified fund and various awkward attempts have been made at euphemism.

In fact it is probable that commodities — pictured rather than discussed— have a positive rather than negative sales impact since they are much more readily comprehensible than certain classes of financial instruments. When a retail investor understands that the natural way to invest in oil or (tax-free) gold is through derivatives he or she is often on the way to becoming the purchaser of a certain type of fund.

Joint Ventures

Creating joint venture arrangements between a fund group and a financial group capable of distributing product is one of the most efficient ways to obtain investment capital, but at a price. The key requirement in arranging joint ventures is not marketing but having a clear understanding of the financial structure of the proposed fund and the income consequences of various splits of the managed or sales fees or brokerage commissions.

Marketing can help initiate discussions, however. Here, a high profile in the press is desirable, particularly if supported by occasional conference platform speeches (see below). It may also be helpful for a member of the fund management team to be an active member of a derivatives or managed derivatives trade association—to give more strings to the marketing bow.

Posted: February 12th, 2008 under Future Fund, Future Management, Futures Spreads, Futures Trading System.
Comments: 4