Equity Derivatives
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Customer copy 1 (3) INFORMATION SHEET, as stipulated in the Swedish Securities Market Act -November 2012 Equity derivatives Introduction Equity forwards/futures Derivative instruments are complex financial instruments and this is a An equity forward/future is an agreement between two parties which means collective term for options, futures, swaps and much more. that both the buyer and seller agree to buy or sell equities at a predetermined price with delivery or cash settlement at a later date. The value of a derivative is based on the underlying instrument asset; for example, it can be an equity, a commodity, an exchange rate or a fixed Forwards - future contracts with payment and delivery on the expiry date. income instrument. Other factors can also influence the value of a derivative, Futures - contracts with a daily settlement. such as remaining maturity, changes in interest rates and volatility (a measurement of price fluctuation in an underlying asset). Equity swaps Different derivative instruments have different risk levels and factors that A swap is an agreement between two parties where the parties have agreed affect yield. It is important that you find out what applies for the derivative that to exchange the yield on two assets with each other. you will be investing in. In an equity swap, one party receives the total yield, that is, the change in How equity derivatives work price including any dividends, on a single equity, on a basket of equities, or on an index. The same party pays interest compensation to the counterparty. • An equity derivative can be used to increase or reduce exposure to a The interest is calculated on the nominal value of the swap (number of single equity or stock market. equities/units multiplied by the start price). • It can be used to protect existing shareholdings against falls in share prices or to lock in profits. An equity swap is a non-standardised financial instruments and is not traded • It can be used for a more efficient capital utilisation, since you can over a marketplace; instead, it is a transaction between two parties via the assure yourself of a future price by buying or selling equities or an equity so-called OTC (Over-The-Counter) trade. index on forward contracts. The contract is an agreement between two parties and cannot be freely Transactions in certain equity derivatives require that you pledge collateral; transferred. and as the price of the underlying asset changes, the collateral requirement also changes. Risk General Equity options In an investment context, risk signifies the probability that the invested capital An equity option is an agreement between two parties which gives the holder: will fall in value. Greater risk-taking will usually mean greater potential for a • The right but not the obligation to buy (call option) or sell (put option) higher yield, but at the same time the risk of losing money increases. equities at a predetermined price (strike price) at a predetermined date • With higher risk, you can expect greater fluctuations in value. (expiry date). • With lower risk, you can expect smaller fluctuations in value. • If the price on the final date is lower (call option)/higher (put option) than or equal to the strike price, the option expires as worthless and all the There may be a very large variation in risk among different derivatives. invested capital is lost. Derivatives can be used to both increase or reduce a risk. An equity option is an agreement between two parties which gives the issuer: By using an equity derivative, you can avoid the risks involved in future equity price changes. You are taking a higher risk if you choose to use equity • The obligation to sell (put option) or buy (call option) equities at a derivatives for speculative purposes. predetermined price (strike price) at a predetermined date (expiry date). • If the price on the expiry date is higher (call option)/lower (put option) There is a risk that the counterparty in an equity derivative will not fulfil its then the strike price, the issuer must sell/buy the equities at the strike obligations. price. Options The price of the option is called the premium and is paid by the holder of the • Price fluctuations may be greater for the option than its underlying asset. option (buyer) to the issuer (seller) of the option. • The buyer of an option can at most lose the premium paid. Different types of options: • The seller of an option may run the risk of unlimited loss. American options are contracts that can be redeemed at any time during the option’s life, for example standardised equity options in Sweden. Futures European options are contracts that can be redeemed only on the option's • In general, the risk in a future is the same as for the underlying asset. expiry date; for example, most of the exchange-traded warrants and • The difference between the price of a future and the price of the certificates in Sweden. underlying equity depends on the interest rate and expected dividends When the underlying asset’s value rises or falls, the relative value of an during the future’s life. investment in an option can be influenced more than the relative value of an investment in the underlying asset (leverage effect). www.handelsbanken.com Customer copy 2 (3) Swaps If you need help in finding the risk level that suits you, our advisers will • The risk in a swap is the sum of the swap’s different parts. An equity be pleased to assist. swap has the same risk as the corresponding holding of equities, on a 100 per cent margin. A buyer of an equity swap (the one that receives Always ask for supplementary marketing material or further information with more details about the financial instrument you are interested in. the yield on the underlying equity) risks losing the nominal amount of the entire swap. For a seller of a swap, the risk is unlimited. If you would like to read more about risk, see the agreement “Trading in financial instruments and currencies”. The agreement is available from your branch, or at www.handelsbanken.com Advantages and disadvantages of equity derivatives • Investments in derivatives require you as an investor to have sufficient knowledge of the derivative’s properties in order to make investment decisions in line with your risk appetite and market expectations. • They can provide returns regardless of whether the stock market rises, falls or remains unchanged. • Suitable as a risk diversification instrument: o can be used to protect a holding o can give higher yield with a smaller amount of capital than would be needed to make the same transaction directly in the underlying asset. o create the opportunity to realise a profit in an underlying asset, while also profiting from further price rises. • Can require extensive monitoring of the price performance. • Some derivatives require that you pledge collateral in order to carry out a transaction, and value changes can also lead to increased collateral requirements during the transaction’s term of maturity. • The risk of loss may be unlimited. Important information • The historical return of a financial instrument is not a guarantee of future return. The value of financial instruments can rise or fall, and it is not certain that you will get back all the capital you have invested. Trade in certain equity derivatives may result in losses that exceed the invested capital. • You must familiarise yourself with Handelsbanken’s agreement – “Trading in Financial Instruments and Currencies,” as well as the other agreements and conditions that may apply to trading in financial instruments. • Check the information on the contract slip and if there are any errors, immediately inform us. • You should regularly monitor your holdings and positions. • You are responsible for investigating the taxation consequences that owning the instrument may entail for you. • You are responsible for taking any action necessary to reduce the risk of losses. www.handelsbanken.com Customer copy 3 (3) Appropriateness test By law, financial institutions are obliged to ascertain whether you have sufficient knowledge and/or experience to understand the risk involved in trading in financial instruments. If you as a customer are classified as a retail client, and are buying equity derivatives through Handelsbanken for the first time, we will need to go through the following questions with you: 1. Do you have previous experience of, and sometime during the last two years trading in equity derivatives, and/or knowledge of this group of instruments? 2. Are you familiar with the risk involved in trading in complex derivatives? If you do not have sufficient experience and/or knowledge to understand the risks, we can take you through the workings of equity derivatives, as well as the risk involved in investing in them. Equity derivatives Answer Knowledge Yes No ? 1. Does the issuer of an option pay a premium? 2. Is collateral required to issue/sell a standardised option? 3. Does the price of a put option increase if the price of the underlying asset falls, provided that other market parameters are unchanged? 4. Can equity derivatives be traded on a stock exchange? 5. Does the holding of a call option give the right but not the obligation to buy the underlying equity? 6. Does an equity call option require the issuer to sell the underlying equity? 7. As the holder of a European option, can you demand its redemption at any time? 8. Is the buyer of an equity future obliged to buy the underlying equity on the expiry date? 9. Is a forward paid on the expiry date? 10. Does the future have a daily settlement? 11.