Futures Options: Universe of Potential Profit
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Section 1256 and Foreign Currency Derivatives
Section 1256 and Foreign Currency Derivatives Viva Hammer1 Mark-to-market taxation was considered “a fundamental departure from the concept of income realization in the U.S. tax law”2 when it was introduced in 1981. Congress was only game to propose the concept because of rampant “straddle” shelters that were undermining the U.S. tax system and commodities derivatives markets. Early in tax history, the Supreme Court articulated the realization principle as a Constitutional limitation on Congress’ taxing power. But in 1981, lawmakers makers felt confident imposing mark-to-market on exchange traded futures contracts because of the exchanges’ system of variation margin. However, when in 1982 non-exchange foreign currency traders asked to come within the ambit of mark-to-market taxation, Congress acceded to their demands even though this market had no equivalent to variation margin. This opportunistic rather than policy-driven history has spawned a great debate amongst tax practitioners as to the scope of the mark-to-market rule governing foreign currency contracts. Several recent cases have added fuel to the debate. The Straddle Shelters of the 1970s Straddle shelters were developed to exploit several structural flaws in the U.S. tax system: (1) the vast gulf between ordinary income tax rate (maximum 70%) and long term capital gain rate (28%), (2) the arbitrary distinction between capital gain and ordinary income, making it relatively easy to convert one to the other, and (3) the non- economic tax treatment of derivative contracts. Straddle shelters were so pervasive that in 1978 it was estimated that more than 75% of the open interest in silver futures were entered into to accommodate tax straddles and demand for U.S. -
Buying Options on Futures Contracts. a Guide to Uses
NATIONAL FUTURES ASSOCIATION Buying Options on Futures Contracts A Guide to Uses and Risks Table of Contents 4 Introduction 6 Part One: The Vocabulary of Options Trading 10 Part Two: The Arithmetic of Option Premiums 10 Intrinsic Value 10 Time Value 12 Part Three: The Mechanics of Buying and Writing Options 12 Commission Charges 13 Leverage 13 The First Step: Calculate the Break-Even Price 15 Factors Affecting the Choice of an Option 18 After You Buy an Option: What Then? 21 Who Writes Options and Why 22 Risk Caution 23 Part Four: A Pre-Investment Checklist 25 NFA Information and Resources Buying Options on Futures Contracts: A Guide to Uses and Risks National Futures Association is a Congressionally authorized self- regulatory organization of the United States futures industry. Its mission is to provide innovative regulatory pro- grams and services that ensure futures industry integrity, protect market par- ticipants and help NFA Members meet their regulatory responsibilities. This booklet has been prepared as a part of NFA’s continuing public educa- tion efforts to provide information about the futures industry to potential investors. Disclaimer: This brochure only discusses the most common type of commodity options traded in the U.S.—options on futures contracts traded on a regulated exchange and exercisable at any time before they expire. If you are considering trading options on the underlying commodity itself or options that can only be exercised at or near their expiration date, ask your broker for more information. 3 Introduction Although futures contracts have been traded on U.S. exchanges since 1865, options on futures contracts were not introduced until 1982. -
Options Strategy Guide for Metals Products As the World’S Largest and Most Diverse Derivatives Marketplace, CME Group Is Where the World Comes to Manage Risk
metals products Options Strategy Guide for Metals Products As the world’s largest and most diverse derivatives marketplace, CME Group is where the world comes to manage risk. CME Group exchanges – CME, CBOT, NYMEX and COMEX – offer the widest range of global benchmark products across all major asset classes, including futures and options based on interest rates, equity indexes, foreign exchange, energy, agricultural commodities, metals, weather and real estate. CME Group brings buyers and sellers together through its CME Globex electronic trading platform and its trading facilities in New York and Chicago. CME Group also operates CME Clearing, one of the largest central counterparty clearing services in the world, which provides clearing and settlement services for exchange-traded contracts, as well as for over-the-counter derivatives transactions through CME ClearPort. These products and services ensure that businesses everywhere can substantially mitigate counterparty credit risk in both listed and over-the-counter derivatives markets. Options Strategy Guide for Metals Products The Metals Risk Management Marketplace Because metals markets are highly responsive to overarching global economic The hypothetical trades that follow look at market position, market objective, and geopolitical influences, they present a unique risk management tool profit/loss potential, deltas and other information associated with the 12 for commercial and institutional firms as well as a unique, exciting and strategies. The trading examples use our Gold, Silver -
Bankruptcy Futures: Hedging Against Credit Card Default
CONSUMER LENDING Bankruptcy Futures: Hedging Against Credit Card Default by Russ Ray his article discusses the new bankruptcy futures contract to be launched by the Chicago Mercantile Exchange and examines the mechanics and contract specifications of this innovation, illus- trating its hedging potential in the process. ometime during the latter half of 1999 or early Credit-card debt is becoming particularly burden- 2000, the Chicago Mercantile Exchange intends some. The average credit-card balance is approximately to launch an innovative new futures contract that $2,500, with typical households having at least three dif- will offer consumer-lending institutions, particularly ferent bank cards. The average card holder also uses six credit-card issuers, a hedge against the bankruptcies additional cards at service stations, department stores, filed by their borrowers. Bankruptcy futures—contracts specialty stores, and other vendors issuing their own cred- to buy or sell a cash-valued index based upon the cur- it cards. rent number of actual bankruptcies—will enable con- Commensurate with such increases in consumer sumer lenders to transfer default risk to other lenders debt is an ever-growing rise in consumer bankruptcies, and/or speculators holding opposite expectations. which, in turn, represent an ever-increasing proportion Significantly, this new contract also constitutes a proxy of total bankruptcies. In 1998, 96.9% of all bankruptcy variable for banks' confidence in the value and liquidity filings were personal—not business—bankruptcies. (In of their own loan portfolios, just as other proxy vari- terms of dollar volume, however, businesses continue to ables now measure consumer and investor confidence. -
Derivative Securities
2. DERIVATIVE SECURITIES Objectives: After reading this chapter, you will 1. Understand the reason for trading options. 2. Know the basic terminology of options. 2.1 Derivative Securities A derivative security is a financial instrument whose value depends upon the value of another asset. The main types of derivatives are futures, forwards, options, and swaps. An example of a derivative security is a convertible bond. Such a bond, at the discretion of the bondholder, may be converted into a fixed number of shares of the stock of the issuing corporation. The value of a convertible bond depends upon the value of the underlying stock, and thus, it is a derivative security. An investor would like to buy such a bond because he can make money if the stock market rises. The stock price, and hence the bond value, will rise. If the stock market falls, he can still make money by earning interest on the convertible bond. Another derivative security is a forward contract. Suppose you have decided to buy an ounce of gold for investment purposes. The price of gold for immediate delivery is, say, $345 an ounce. You would like to hold this gold for a year and then sell it at the prevailing rates. One possibility is to pay $345 to a seller and get immediate physical possession of the gold, hold it for a year, and then sell it. If the price of gold a year from now is $370 an ounce, you have clearly made a profit of $25. That is not the only way to invest in gold. -
Form 6781 Contracts and Straddles ▶ Go to for the Latest Information
Gains and Losses From Section 1256 OMB No. 1545-0644 Form 6781 Contracts and Straddles ▶ Go to www.irs.gov/Form6781 for the latest information. 2020 Department of the Treasury Attachment Internal Revenue Service ▶ Attach to your tax return. Sequence No. 82 Name(s) shown on tax return Identifying number Check all applicable boxes. A Mixed straddle election C Mixed straddle account election See instructions. B Straddle-by-straddle identification election D Net section 1256 contracts loss election Part I Section 1256 Contracts Marked to Market (a) Identification of account (b) (Loss) (c) Gain 1 2 Add the amounts on line 1 in columns (b) and (c) . 2 ( ) 3 Net gain or (loss). Combine line 2, columns (b) and (c) . 3 4 Form 1099-B adjustments. See instructions and attach statement . 4 5 Combine lines 3 and 4 . 5 Note: If line 5 shows a net gain, skip line 6 and enter the gain on line 7. Partnerships and S corporations, see instructions. 6 If you have a net section 1256 contracts loss and checked box D above, enter the amount of loss to be carried back. Enter the loss as a positive number. If you didn’t check box D, enter -0- . 6 7 Combine lines 5 and 6 . 7 8 Short-term capital gain or (loss). Multiply line 7 by 40% (0.40). Enter here and include on line 4 of Schedule D or on Form 8949. See instructions . 8 9 Long-term capital gain or (loss). Multiply line 7 by 60% (0.60). Enter here and include on line 11 of Schedule D or on Form 8949. -
Financial Derivatives Classification of Derivatives
FINANCIAL DERIVATIVES A derivative is a financial instrument or contract that derives its value from an underlying asset. The buyer agrees to purchase the asset on a specific date at a specific price. Derivatives are often used for commodities, such as oil, gasoline, or gold. Another asset class is currencies, often the U.S. dollar. There are derivatives based on stocks or bonds. The most common underlying assets include stocks, bonds, commodities, currencies, interest rates and market indexes. The contract's seller doesn't have to own the underlying asset. He can fulfill the contract by giving the buyer enough money to buy the asset at the prevailing price. He can also give the buyer another derivative contract that offsets the value of the first. This makes derivatives much easier to trade than the asset itself. According to the Securities Contract Regulation Act, 1956 the term ‘Derivative’ includes: i. a security derived from a debt instrument, share, loan, whether secured or unsecured, risk instrument or contract for differences or any other form of security. ii. a contract which derives its value from the prices or index of prices, of underlying securities. CLASSIFICATION OF DERIVATIVES Derivatives can be classified into broad categories depending upon the type of underlying asset, the nature of derivative contract or the trading of derivative contract. 1. Commodity derivative and Financial derivative In commodity derivatives, the underlying asset is a commodity, such as cotton, gold, copper, wheat, or spices. Commodity derivatives were originally designed to protect farmers from the risk of under- or overproduction of crops. Commodity derivatives are investment tools that allow investors to profit from certain commodities without possessing them. -
Morningstar Global Fixed Income Classification Methodology
? Morningstar Global Fixed Income Classification Morningstar Research Introduction Effective Oct. 31, 2016 Fixed-Income Sectors Contents The fixed-income securities and fixed-income derivative exposures within a portfolio are mapped into 1 Introduction Secondary Sectors that represent the most granular level of classification. Each item can also be 2 Super Sectors 10 Sectors grouped into one of several higher-level Primary Sectors, which ultimately roll up to five fixed-income Super Sectors. Important Disclosure The conduct of Morningstar’s analysts is governed Cash Sectors by Code of Ethics/Code of Conduct Policy, Personal Cash securities and cash-derivative exposures within a portfolio are mapped into Secondary Sectors that Security Trading Policy (or an equivalent of), and Investment Research Policy. For information represent the most granular level of classification. Each item can also be grouped into cash & regarding conflicts of interest, please visit: http://global.morningstar.com/equitydisclosures equivalents Primary Sector and into cash & equivalents Super Sector (cash & equivalents Primary Sector = cash & equivalents Super Sector ). Morningstar includes cash within fixed-income sectors. Cash is not a bond, but it is a type of fixed- income. When bond-fund managers are feeling nervous about interest rates rising, they might increase their cash stake to shorten the portfolio’s duration. Moving assets into cash is a defensive strategy for interest-rate risk. In addition, Morningstar includes securities that mature in less than 92 days in the definition of cash. The cash & equivalents Secondary Sectors allow for more-detailed identification of cash, allowing clients to see, for example, if the cash holdings are in currency or short-term government bonds. -
Derivatives Primer Analyst: Michele Wong
The NAIC’s Capital Markets Bureau monitors developments in the capital markets globally and analyzes their potential impact on the investment portfolios of U.S. insurance companies. A list of archived Capital Markets Bureau Primers is available via the INDEX. Derivatives Primer Analyst: Michele Wong Executive Summary • Derivatives are contracts whose value is based on an observable underlying value—a security’s or commodity’s price, an interest rate, an exchange rate, an index, or an event. • U.S. insurers primarily use derivatives to hedge risks (such as interest rate risk, credit risk, currency risk and equity risk) and, to a lesser extent, replicate assets and generate additional income. • The primary risks associated with derivatives use include market risk, liquidity risk and counterparty risks. • Derivatives use laws, NAIC model regulations, derivatives use plans and statutory accounting requirements are important components in the oversight of derivatives use by U.S. insurers. What Are Derivatives? Derivatives are contracts whose value, at one or more future points in time, is based on an observable underlying value—a security’s or commodity’s price, an interest rate, exchange rate, index, or event, such as a credit default. The derivatives contract is between two parties and specifies terms under which payments are to be made, depending on fluctuations in the value of the underlying. Specified terms typically include notional amount, price, premium, maturity date, delivery date, and reference entity or underlying asset. Statement of Statutory Accounting Principles (SSAP) No. 86 – Derivatives defines a “derivative instrument” as “an agreement, option, instrument or a series or combination thereof: a. -
Lecture 09: Multi-Period Model Fixed Income, Futures, Swaps
Fin 501:Asset Pricing I Lecture 09: Multi-period Model Fixed Income, Futures, Swaps Prof. Markus K. Brunnermeier Slide 09-1 Fin 501:Asset Pricing I Overview 1. Bond basics 2. Duration 3. Term structure of the real interest rate 4. Forwards and futures 1. Forwards versus futures prices 2. Currency futures 3. Commodity futures: backwardation and contango 5. Repos 6. Swaps Slide 09-2 Fin 501:Asset Pricing I Bond basics • Example: U.S. Treasury (Table 7.1) Bills (<1 year), no coupons, sell at discount Notes (1-10 years), Bonds (10-30 years), coupons, sell at par STRIPS: claim to a single coupon or principal, zero-coupon • Notation: rt (t1,t2): Interest rate from time t1 to t2 prevailing at time t. Pto(t1,t2): Price of a bond quoted at t= t0 to be purchased at t=t1 maturing at t= t2 Yield to maturity: Percentage increase in $s earned from the bond Slide 09-3 Fin 501:Asset Pricing I Bond basics (cont.) • Zero-coupon bonds make a single payment at maturity One year zero-coupon bond: P(0,1)=0.943396 • Pay $0.943396 today to receive $1 at t=1 • Yield to maturity (YTM) = 1/0.943396 - 1 = 0.06 = 6% = r (0,1) Two year zero-coupon bond: P(0,2)=0.881659 • YTM=1/0.881659 - 1=0.134225=(1+r(0,2))2=>r(0,2)=0.065=6.5% Slide 09-4 Fin 501:Asset Pricing I Bond basics (cont.) • Zero-coupon bond price that pays Ct at t: • Yield curve: Graph of annualized bond yields C against time P(0,t) t [1 r(0,t)]t • Implied forward rates Suppose current one-year rate r(0,1) and two-year rate r(0,2) Current forward rate from year 1 to year 2, r0(1,2), must satisfy: -
The Volatility Structure Implied by Options on the SPI Futures Contract by Christine A
2 The Volatility Structure Implied by Options on the SPI Futures Contract by Christine A. Brown † Abstract: The Asay (1982) option pricing model prices options on futures contracts where the premia are margined. The model assumes that the volatility of the underlying futures contract is constant over the life of the option. However it is an empirical observation in many markets that options on the same underlying futures contract with the same maturity, but at different strikes, trade at different implied volatilities. Since the 1987 crash, it has been documented that in many markets the volatility implied by out-of-the-money put options is higher than that implied by out-of-the-money call options. This phenomenon has become known as the ‘volatility skew’. This paper examines the volatility structure for options on the SPI futures contract over the period June 1993 to June 1994, and provides theoretical explanations consistent with its shape. Keywords: ASAY MODEL; VOLATILITY SMILE; VOLATILITY SKEW. † Department of Accounting and Finance, University of Melbourne, Parkville, Victoria 3052. Email: [email protected] I am grateful to Rob Brown, Kevin Davis and James Pickles for helpful comments, and to Raymond Liu for research assistance. Australian Journal of Management, Vol. 24, No. 2, December 1999, © The Australian Graduate School of Management – 115– AUSTRALIAN JOURNAL OF MANAGEMENT December 1999 1. Introduction he Sydney Futures Exchange (SFE) is one of the few futures exchanges to trade Toptions on futures where the options are subject to futures style margining.1 An initial margin2 is deposited and the option contract is marked to market at the end of each day, where the loss on a long option position is limited to the size of the initial premium. -
Finance B40.3333 Debt Instruments and Markets
Professor Hessel Fin B40.3333 Fall 2007 Debt Instruments and Markets Office 9-150 FINANCE B40.3333 DEBT INSTRUMENTS AND MARKETS Required Text: Bond Markets, Analysis and Strategies, 2006 Edition, by Frank J. Fabozzi, Prentice Hall Required Calculator: Texas Instrument Business Calculator TI BAII Plus or HP 12C or HP17B Grade is determined by 2 non cumulative exams and assignments COURSE DESCRIPTION The course introduces students to the characteristics of bonds, floating rate notes and money market security and calculations of price and yield. Term structure of interest rates, bootstrapping the zero curve and calculating the forward curve are examined in light of strategy building. Credit spreads and OAS are covered. Analysis of interest rate exposure is shown by estimating bond duration, convexity and DV01. Risk management techniques presented include immunization, hedging and swapping. Credit risk is discussed along with the role of credit default products to control credit risk and enhance return. Attention then turns to mortgage back securities and collateralized debt obligations. OUTLINE OF COURSE DETAILS TOPIC 1 INTRODUCTION TO FIXED RATE BONDS AND MONEY MARKET SECURITIES (Read Chapters 6,7,8) • Fixed rate bonds versus Floating rate bonds • Interest Added versus Discounted securities • Role of Federal Funds market and Federal Reserve Policy • Leverage using Repos TOPIC 2 PRICING DEBT SECURITIES (Read Chapters 2 and 4) • Pricing a fixed rate bond • Pricing a floating rate note • Macaulay Duration and Modified Duration • Duration and Convexity Measures Concept and Calculations • PV01 – Concept and Calculations TOPIC 3 YIELD TO MATURITY AND VARIATIONS ON THE THEME (Read Chapter 3) • Concept and Calculation of Yield to Maturity • Yield to Maturity on a Fixed rate Bond • Yield to call and yield to worst TOPIC 4 TERM STRUCTURE OF INSTEREST RATES (Read Chapter 5) • Yield curve • Bootstrapping the zero curve from the yield curve • Par curve • Calculation of the forward curve • Strategies based on the forward curve.