Dwayne Strocen, President of Genuine Trading Solutions says once upon a time a Commodity Trading Advisor was content to be known as a Portfolio Manager trading commodities and futures for a managed futures fund. There is no question today’s investor has become more sophisticated. In response, today’s selection of investment products has become ever more complex and varied, the need for the CTA to understand the uses and management of these products becomes even more acute.

So what exactly is the role of today’s Commodity Trading Advisor. Certainly trading of derivative products for a managed futures fund continues to be as important as before. A CTA has also become more involved with derivative analytics. This role is essentially focused upon becoming an analyst to structure and analyze the more multi-faceted requirements demanded by hedge funds, pension funds and structured products.

The use of derivative analytics to manage the adverse risk of an equity or bond portfolio brought about by adverse market conditions is critical in preserving asset growth. The uses of hedging to prevent volatility has long been understood by the largest institutions but is now available to the smaller sized company and to the individual investor. No doubt as products continue to evolve so too will the CTA evolve to meet the need of today’s professional money manager.

Derivative products are no longer limited to exchange traded commodities futures and options. There continues to be an ever expanding list of over-the-counter derivative products. These are SWAPS. SWAPS and privately transacted products transacted without the use of a recognized exchange. The difficulty is the buyer and seller must find each other to undertake such an arrangement, not always easy. The second problem is no liquidity. There is no one to sell this too should one of the parties wish to terminate the transaction prior to the agreed upon date.

A Commodity Trading Advisor’s role is no longer sufficient to be limited to trading. It is now imperative to understand the industry in a new light so to understand the changing investment environment. Analysis now becomes the catalyst to include a value added service to retain customers. This includes structured products, risk management and OTC derivatives. Continuing education has been and continues to be the hallmark of the best in the industry.

A groundbreaking collection on currency derivatives, including pricing theory and hedging applications. “David DeRosa has assembled an outstanding collection of works on foreign exchange derivatives. It surely will become required reading for both students and option traders.”—Mark B. Garman President, Financial Engineering Associates, Inc. Emeritus Professor, University of California, Berkeley. “A comprehensive selection of the major references in currency option pricing.”—Nassim Taleb. Senior trading advisor, Paribas Author, Dynamic Hedging: Managing Vanilla and Exotic Options. “A useful compilation of articles on currency derivatives, going from the essential to the esoteric.”—Philippe Jorion Professor of Finance, University of California, Irvine Author, Value at Risk: The New Benchmark for Controlling Market Risk. Every investment practitioner knows of the enormous impact that the Black-Scholes option pricing model has had on investment an (more…)

Economists use the term “global labor arbitrage” to refer to the tendency of manufacturing jobs to flow towards whichever country has the lowest wages per unit output at present and has reached the minimum requisite level of political and economic development to support industrialization. 

Sports arbitrage – numerous internet bookmakers offer odds on the outcome of the same event.  One problem with sports arbitrage is that bookmakers sometimes make mistakes and this can lead to an invocation of the ‘palpable error’ rule, which most bookmakers invoke when they have made a mistake by offering or posting incorrect odds.

 Exchange-traded fund arbitrage – Exchange Traded Funds allow authorized participants to exchange back and forth between shares in underlying securities held by the fund and shares in the fund itself, rather than allowing the buying and selling of shares in the ETF directly with the fund sponsor.  When a significant enough premium appears, an arbitrageur will buy the underlying securities, convert them to shares in the ETF, and sell them in the open market.  When a discount appears, an arbitrageur will do the reverse.As a result of arbitrage, the currency exchange rates, the price of commodities, and the price of securities in different markets tend to converge to the same prices, in all markets, in each category.  More generally, international arbitrage opportunities in commodities, goods, securities and currencies, on a grand scale, tend to change exchange rates until the purchasing power is equal.   At the heart of the Arbitrage philosophy is the belief that a man must capitalize on opportunities and take calculated risks in order to be successful.  In the end, we all must engage in Arbitrage.  ” In this sense, any trader who buys something in one market—whether it is a commodity like grain, financial Securities such as stock in a company, or a currency such as the Japanese yen—and sells it in another market at a higher price is engaged in arbitrage.  In economic theory, arbitrage is a necessary activity in any market, helping to reduce price disparities between different markets and to increase a market’s liquidity (ability to buy and sell). 

 Triangular arbitrage is a trading strategy involving placing three concurrent trades in three markets in an attempt to profit from imbalances between the markets.  Triangular arbitrage forces the cross-rates to be internally consistent.As indicated above, triangular arbitrage is a specific trading strategy that involves three currencies, their correlation, and any discrepancy in their parity rates. Thus, there are no arbitrage opportunities when dealing with just two currencies in a single market. Their fluctuations are simply the trading range of their exchange rate.

Triangular arbitrage opportunities do not happen very often and when they do, they only last for a matter of seconds.  Triangular arbitrage among currencies, once only a theory, is now common practice for those with access to large amounts of money

Using triangular arbitrage strategies on forex market has one salient advantage: Predetermined profits can be realized if the trades are executed smoothly. Unfortunately, the disadvantages of this strategy are numerous:• Higher Transaction Costs• Higher margin requirements• Precision timing is required• Complexity• Advanced monitoring techniques are usually required

***This article is strictly for  informational proposes  and does not provide individual, customized investment advice. The money you allocate to futures or forex should be strictly the money you can afford to risk. Detaileddisclaimer can be found at http://www.prolificinvestment.com/prolific.php?page=riskwarning

A derivative is a financial instrument that derives its value from the values of other underlying variables, which, in most cases, are the prices of the traded asset. Derivatives are traded since 1848 on the Chicago Board of trade (CBOT, www.cbot.com) to bring farmers and merchants together and standardize the quality and quantity of the goods exchanged. This is how the first futures contract was created, which led, in 1919, to the establishment of a rival futures exchange, the Chicago Mercantile Exchange (CME, www.cme.com). Today, derivatives are traded both in over-the-counter markets and exchange traded markets.

Most financial assets are traded in the spot market where ownership of the asset and the amount to acquire ownership are exchanged between buyers and sellers. However, in some cases, entering into a transaction immediately and exchanging the asset and the money at a future date, seems more profitable. Derivative securities, such as forwards, futures and options, have been introduced to shift the risk to market participants, who can bear it, and usually at a lower cost than investing in the cash market.

(a)    Forward Contract

A forward contract is an agreement between two parties to buy or sell an asset at a certain future time for a specified price. Forward contracts are traded on over-the –counter (OTC) markets, typically between financial institutions or between a financial institution and one of its clients.

The mechanism of a forward contract requires one party to buy the underlying asset assuming a long position at a certain future time for a specified price and the other party to sell the underlying asset assuming a short position at a certain future time for a specified price. However, as forward contracts are not standardized, they are not liquid. The buyer or the seller may withdraw from the forward agreement at any time and look for another party to make a forward agreement with if she thinks it would be more profitable. Also, forward contracts are susceptible to default or credit and they may not be executed as planned if the buyer cannot raise the cash needed to purchase the asset or the seller commits fraud and does not deliver the asset.

(b)   Futures Contract

A futures contract is an agreement between two parties to exchange (buy or sell) an asset at a certain future time for a specified price. Unlike, forward contracts, future contracts are traded on the exchange markets. This requires the exchange to set certain standardized features for the contract.

The mechanism of a futures contract obliges the owner to purchase the underlying asset according to the standardized terms and conditions set from the exchange concerning quality and quantity of the underlying asset and expiration dates. This allows futures contracts to have less liquidity risk than forward contracts and be traded like common stocks on secondary markets. In addition, futures contracts have less credit or default risk than forward contracts because both parties are requires to deposit funds in a margin account, which is typically the 3 to 6 percent of the value of the contract. These funds are added or subtracted from the margin account on a daily basis reflecting the daily price changes in the futures contract. Therefore, futures contracts are marked to market, meaning they are cash-settled daily.

(c)    Options

An option gives an investor the right to buy or sell an underlying asset at a specified price on or before a specified date. The right to buy the underlying asset assuming a long position by a certain date for a certain price is a call option. The right to sell the underlying asset assuming a short position by a certain date for a certain price is a put option. Options are traded both on exchanges and in the over-the-counter markets. The price in the contract is known as the exercise or strike price, while the date in the contract is the expiration date or maturity. 

The mechanism of an option contract does not oblige the holder to exercise the right. This is what distinguishes options from forwards and futures, where the holder is obliged to buy or sell the underlying asset. Buying an option carries a limited risk of loss, which is the cost of the premium price (the cost) of the option if it expires worthless and an unlimited opportunity for gains as the strike price and the price of the underlying asset diverge as the maturity date approaches. On the other hand, selling an option offers a limited opportunity for gaining the option premium if the option expires worthless, and the risk of unlimited losses, which depends on how much the strike price and the price of the underlying asset diverge.

Forwards, futures and options are used in a variety of ways from individual investors, but also from corporations. The main reason why derivatives markets are so attractive is because they attract different types of traders and have high liquidity. This means that when an investor wants to take one position of a contract, there is usually no problem in finding another investor willing to take the opposite position.

On the other hand, being highly versatile, derivatives provide unlimited leverage, which actually demands a liquidity that far exceeds the market’s potential. There are cases, that risk managers miscalculate volatility assumptions, typically resulting in large losses for the firm. Also, traders who have the authorization to hedge risks or follow arbitrage strategies may become consciously or unconsciously, speculators.

In conclusion, using derivatives in a well-diversified portfolio is a good way to leverage the risk associated with financial and commodity markets. However, the use of derivatives should be carefully structured.

Securities can be long term or short term, primary (like shares & bonds) & secondary (like options & warrants).

According to the character of concluded contracts we distinguish between two types of markets: spot markets & futures markets. In the spot market the buying & selling of goods, currencies or securities are available for immediate delivery. As for the futures markets, here the buying & selling goods, currencies or securities are for delivery at a future date for a price fixed in advance. If such a deal is standardized for fixed quantities & time periods, it’s called futures; if not, these individual, non-standard, over-the-counter deals between two parties are called forward contracts.

Making contracts to buy or sell a commodity or financial instrument at a pre-arranged price in the future aims to act as a protection against price changes, exchange rates, interest rates & so on is known as hedging. For example, if the prices of foodstuffs such as wheat, maize, tea or orange juice are frequently affected by droughts, floods & other extreme weather conditions. Consequently many producers & buyers of raw materials want to hedge, in order to guarantee next season’s prices. When commodity prices are expected to rise, future prices are obviously higher than (at a premium on) spot prices; when they are expected to fall, they are at a discount on spot price.

As well as businesses dealing with all these foodstuffs, many businesses want to buy or sell currencies at a guaranteed future price as in recent years exchange rates & interest rates have also fluctuate wildly. But even this step doesn’t protect from speculators, who are also active in currency futures markets, such as the London International Financial Futures Exchange (LIFFE).

Buying securities or other assets in the hope of making a capital gain by selling them at a higher price (or selling them in hope of buying them back at a lower price) is a very lucrative business, therefore, wide-spread.

As well as currencies & commodities, there is also a huge futures market in stocks & shares. & here there is a possibility for speculators to profit from movements in a stock’s price without holding the stock itself. I’m speaking about options – securities giving a right – but not the obligation – to buy & sell assets at a fixed price in the future. Options are classified as either call or put options. A “call” is an option to buy a particular asset whereas a “put” is an option to sell it. These options allow organizations to hedge their equity investments.

An investor anticipating a rise in a share can buy a “call” option which, for a specified period, gives him the right to buy this share at an agreed level. If he expects a fall he will buy a “put” option which entitles him to sell. A premium called “option money” is payable for the privilege. If the rise (or fall) in the share is greater than the premium, he will exercise his option & make a profit; if not, he will let the option lapse. In either case his risk is limited to the premium. In the “bull” market most options will be for the “call”, in a “bear” market most will be for the “put”.

The price at which the holder of a call/put option may buy/sell the underlying security is known as its exercise or strike price. A call (put) option has intrinsic value if its exercise price is below (above –for put option)  the current market price of the underlying share. Call options with an exercise price below the underlying share’s current market price, & put options with an exercise price above the share’s market price, are described as being “in-the-money”. On the contrary, call options with an exercise price higher than a share’s current market price, & put options with an exercise price lower than the share’s market price, are “out-of-money”.

Within the past fifteen years the use of options has grown in all financial markets. It seems quite likely that foreign exchange options will grow further in coming years.

One more way to profit from an expected drop in the price of a stock is short selling. It means a sale of borrowed money.

Options are merely one type of derivative instrument, I mean those, whose price depends on the movement of another price. Many companies nowadays also arrange currency or interest rate swaps with other companies or financial institutions. Swaps are transactions in which two parties swap financial assets by linking a foreign exchange transaction in cash to an opposite future business in the same currency.

Foreign Exchange Swap Markets have developed since the early 1980s. The oldest type of swap is the conventional foreign exchange deal whereby one currency is simultaneously bought spot & sold forward against another – meaning an immediate exchange of cash followed by a further reverse exchange at a specified date in the future.

The idea of swapping has now spread further. By far the largest business volume amongst swaps occurs in the so-called “vanilla interest rate swap”. A “plain vanilla”, or fixed-to-fixed foreign exchange, or currency swap is an exchange of a principal & interest payments associated with a fixed-rate loan in one currency for the principal & interest payments on a similar loan in a second currency. The first such swap between IBM & the World Bank was done in 1981. Since then the swap market has grown to over $1 billion &, in the process, has evolved several additional types of currency swaps.

All these things I talk about concerned profits one can get from derivatives. But I also have to mention about negative aspects of them. in the mid-1990s, various companies, local governments & financial institutions made spectacular losses with derivatives. The most famous was Barings Bank, which was bankrupted when a single trader in Singapore lost over $1 billion by speculating disastrously on futures & options on the Nikkei 225 stock index, which is traded in Osaka & Singapore. So managing derivative risk needs strong corporate governance, from the top, & the understanding of derivatives on the part of senior management. Peter Baring of this Barings Bank didn’t understand derivatives. & he doesn’t own a bank any more…

Financial Derivatives provides a thorough introduction to financial derivatives and their importance to risk management in the corporate setting. The book has two principal goals: to offer a broad overview of the different types of financial derivatives while focusing on the principals that determine market prices, and to present financial derivatives as a tool for risk management in a corporate setting rather than as instruments of speculation.

From the Inside Flap

Written for financial managers who need to know how to protect company assets in today’s volatile financial markets as well as for the individual investor seeking a basic understanding of these sophisticated financial instruments, Financial Derivatives explains in nontechnical terms how to use key tools such as swaps, options, and futures to manage many different kinds of risk–including bond defaults and adverse moves in interest rates, foreign exchange rates, and commodity and stock price (more…)

Everyday we listen  about Nifty Option price closing up or down,Call Option,Put Option, market bullish or bearish .We wonder how to trade in Nifty Option and earn profit with limited loss and unlimited profit. What are the points we have to keep in mind while trading Nifty Option, how to calculate the profit and loss.First of all we have to determine the direction of the market whether market will  be up or down.We can take the position in Nifty Option in the expected direction bullish or bearish.If we are bullish then we can buy Nifty Call Option and if bearish then we can buy Nifty Put Option.What trade we can execute and what would be our position in terms of profit and loss are explained below with examples.

If current price of Nifty is 2900 and Nifty Call Option Strike Price 3000 and Put Option Strike Price 2800 in January is 100=00 INRs and last date of expiry is on nth January. What trades we can do in Call and Put Option of Nifty and what will be our profit and loss position is as stated below.

 If bullish we can Buy Nifty Call Option

(1)Buy Nifty Call Option January Strike Price 3000@100 INRs.  Lot Size 50

Premium Paid=100*50=5000 INRs.

Maximum Loss=5000=00 INRs.

Maximum Profit=Unlimited

Break-even Price=3100

We can sell Nifty Call Option which we have bought anytime till last day of expiry i.e., nth January and can book profit or loss. If we do not sell Nifty Call Option we have bought till lasts day also then our trade will be automatically squared off at the settlement price of Nifty on last day of expiry decided by the exchange.

.Different Possibilities with our Nifty Call Option Buy position

(1) Nifty Call Option price 140 and sold before expiry then

140-100=40*50=2000.00 INRs. Profit

(2)Nifty Call Option price 60 and sold before expiry then

100-60=40*50=2000 INRs. Loss

(3)Nifty settlement price 3200 and we have not sold  Nifty Call Option till expiry then

3200-3000=200*50=10,000-5000=5000=00  INRs. Profit

(4)Nifty settlement price equals to or below 3000 and we have not sold Nifty Call Option till expiry then

5000=00  INRs Loss

This is the maximum loss we can have even if Nifty falls to any level beyond 3000.

(5)Nifty settlement price 3100 and we have not sold Nifty Call Option till expiry then

3100-3000=100*50=5000-5000=0.0 INRs. No Profit No Loss

If bearish we can Buy Nifty Put Option

(1) Buy Nifty Put Option Strike Price 2800.@100 INRs. Lot Size=50

Premium Paid=100*50=5000.00 INRs.

Maximum Loss=5000.00 INRs.

Maximum Profit=Unlimited

Break-even Price=2700

We can sell  Nifty Put Option bought anytime  till last day of expiry i.e., nth January and can book profit or loss.If we do not sell Nifty Put Option we have bought till lasts day also then  our trade will be automatically squared off at the settlement price of Nifty on last day of expiry decided by the exchange.

Different Possibilities with our Nifty Put Option Buy position

(1) Nifty Put Option  price 140 and sold before expiry then

140-100=40*50=2000.00 INRs. Profit

(2)Nifty Put Option price 60 and sold before expiry then

100-60=40*50=2000 INRs. Loss

(3)Nifty settlement price 2600 and we have not sold  Nifty Put Option till expiry then

2800-2600=200*50=10,000-5000=5000=00  INRs. Profit

(4)Nifty settlement price equals to or above 2800 and we have not sold Nifty Put Option till expiry then

5000=00  INRs Loss

This is the maximum loss we can have even  if Nifty rises to any level beyond  2800.

(5)Nifty settlement price 2700 and we have not sold  Nifty Put Option till expiry then

2800-2700=100*50=5000-5000=0.0 INRs. No Profit No Loss.

What is the advantage of buying Option compared to Future.Maximum loss is fixed and predefined.We cannot lose more then the premium paid to buy the Option under any circumstances and it is known to us before we trade.We can square up the Option  position anytime after buying just like Future.We have to pay only amount of premium and not the margin which is required for buying future.

Review

For those who desire timely reporting straight from the trenches, this book is a must. — Peter Carr, PhD, Head of Quantitative Financial Research, Bloomberg LPThis book has innovative ideas, state of the art applications, and contains a wealth of valuable information. — Peter Ritchken, Kenneth Walter Haber Professor, Department of Banking and FinanceThis state of the art text emphasizes various contemporary topics in fixed income derivatives from a practitioner’s perspective. The combination of martingale technology with the author’s expert practical knowledge contributes hugely to the book’s success. For those who desire timely reporting straight from the trenches, this book is a must. –Peter Carr, PhD,Head of Quantitative Financial Research, Bloomberg LP, Director of the Masters in Math Finance Program, Courant, Institute, NYU

Review

It is quite obvious that the authors have significant practical experience in sophisticated quantitat (more…)

An up-to-date look at the evolution of interest rate swaps and derivatives Interest Rate Swaps and Derivatives bridges the gap between the theory of these instruments and their actual use in day-to-day life. This comprehensive guide covers the main “rates” products, including swaps, options (cap/floors, swaptions), CMS products, and Bermudan callables. It also covers the main valuation techniques for the exotics/structured-notes area, which remains one of the most challenging parts of the market. Provides a balance of relevant theory and real-world trading instruments for rate swaps and swap derivatives Uses simple settings and illustrations to reveal key results Written by an experienced trader who has worked with swaps, options, and exoticsWith this book, author Amir Sadr shares his valuable insights with practitioners in the field of interest rate derivatives-from traders and marketers to those in operations.

From the Inside Flap

Interest (more…)