PowerPoint Presentation
IC301
Derivative Securities
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IC301 – Topic 10
Exotic options, ETFs & CFDs
ETFs – Exchange traded funds
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record high of nearly $4.3 trillion in assets by the end of July 2017. In addition to the ongoing trend of investors shifting to low-cost ETFs from actively-managed funds.
Three largest ETF providers (BlackRock, Vanguard and State Street), as evidenced by the fact that they together manage 70% of all ETF assets in the world.
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ETF marketplace
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Stack and roll problem ETFs (contango)
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Changing portfolios
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Include model portfolio of low cost ETFs plus pitfalls of ETFs (ownership, tracking etc.) Also ETFs can be bigger than the underlying trade or stock = problem managing risk & position
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SPDR S+P 500 – the largest ETF
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Move from active to passive to ETF trackers etc.
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CFDs
Contract for difference
Invented 1990s in UK
Spread betting & retail traders
No Tax
Margin trading
Pros and cons
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UK funds use the 50% margin v popular w/ hedge funds – more exposed w/ same capital = more risk for strategy = flexibility – no stamp duty, USA has no CFDs but RegT is 50% margin accts
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Pitfalls of derivatives
Perfect hedging and netting requires functioning markets. When one or more markets become dysfunctional then the situation is akin to a deck of cards which collapses quickly.
To function markets need : Demand = Supply and trust in the counterparty’s capacity to deliver.
Remember the weakest link in the chain and the loser in the derivative agreement has to pay up.
Most of these issues are largely untested as yet (central banks have supported the markets).
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Role of Central Banks
Lender of last resort
Bail out culture, moving on to bail in model
Is inflation or deflation our future?
What is quantitative easing?
Can currency devaluations rescue the situation – e.g. UK, Japan, China, Italy?
Should we expect more currency devaluations ?
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Is the system fragile ?
Could a derivatives crisis topple the banking system ?
Are derivatives here to stay ?
How would the world look without the banking system we are used to ?
Are banks too fragile?
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Case Study
XIV ETF February 2018 liquidation
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XIV collapse
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https://etfdb.com/etfdb-category/oil-gas/
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Low trade $16.88
Apr28 2020
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Binary or digital options
UK spread betting firms have popularised binary options with the retail public, quoting many markets on a 0 to 100 scale for a multitude of expiries, with GBP per point being the currency.
From the screenshot shown here:
FTSE 100 is 7,581 and the close-of-business binary option with a strike of 7,600 trades with a 12 bid and offered at 19.4
This means that if the FTSE 100 closes above 7,600, that option settles at 100 compared to buying at 19.4. If the FTSE100 closes below 7600, the option settles at 0, so the buyer would lose all of their stake.
On a £10 purchase, the cost is £194
Pay out would be £1,000 (100 * £10). The profit would be £1,000 –£194 = £806 (a 4.15:1 risk to reward ratio).
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