DERIVATIVES NUMBER 4 JUNE 2018 04

Celebrating One Year page 2 A view from Dear Readers, Oslo Børs I would like to welcome you to the 1st anniversary edition of the LSEG Derivatives Newsletter. When we set out last year with the publication of the first edition we had some clear objective in mind: increase the knowledge of our markets and products, keep our clients abreast of the latest developments, be a voice page 3 of expertise in derivatives and give our members and users a forum to talk about their expertise. Looking back at the first four issues we can confidently LSEDM say that we have met all these goals while establishing a strong readership & Oslo Børs: that now stands at about 3,000 regular viewers. For that and for your continuous a model support we give thanks to you all. in co-operation In this issue we focus on one of our key markets at LSEDM; the partnership with Oslo Børs now in its tenth year. CEO Bente Landsnes talks about the partnership and the reasons of the success of this unique market structure, as well the Norwegian economy in general. The Oslo equity derivatives team page 7 provides a deep dive on clearing and market characteristics. From Milan, we host a contribution from the Intermonte trading desk on how Hedging to use ratio spreads to take advantage of the skew in FTSE MIB Index options. the known As usual, this time of the year is particularly intense as we prepare for the main unknown derivatives event of the year in London. The FIA INTERNATIONAL DERIVATIVES EXPO- IDX 2018 is taking place from 4-6 June and the program looks great. LSEG Derivatives is hosting a sponsored session at 13:45 on Wednesday the 6th on innovation in smaller derivatives markets. I will be joined by a panel page 9 of distinguished colleagues from B3, MEFF and Oslo Børs, as well as Conor McTiernan, Head of Options Market Structure, Susquehanna for what I am Statistics sure will be a lively discussion. You are all cordially invited. Events and initiatives Yours, Contacts Nicolas Bertrand Global Head of Derivatives and Commodities

London Stock Exchange Group Derivatives Newsletter Photographer: Stian Lysberg Solum A view from Oslo Børs

Bente Landsnes has been at the helm of Oslo Børs since 2006 and is one of the driving forces behind the partnership between the Norwegian Market and LSEG. We ask Bente to share with us her thoughts on the joint derivatives order book and on the Norwegian market in general.

What are the main benefits of this partnership What do you think are the driver for the between the two exchanges? development and growth of derivatives For a relatively small market like , the partnership products in Norway? has been beneficial for Oslo Børs and its members to get a wide The nominal NOK exchange rate sank by 18% from 2012 distribution. We have found a model that allows members of both to 2017, while at the same time the oil crisis hit the country. exchanges to trade in the same orderbook. For LSE we believe This has left the currency cheaper although the economy has it’s beneficial to have a wider selection of products on offer. not lost as much momentum as it was initially feared. The slide in the currency has had the effect to make Norwegian In addition, for Oslo Børs it is important to have a robust technical investments more attractive to international investors. delivery partner. Our derivatives members have been enjoying The oil and off shore industry could be at the verge of a new a stable and efficient platform since the introduction of SOLA upswing supported by firmer oil prices. Other industries such in 2009. With two interoperable clearinghouses, our members can as seafood have gained a larger footprint in the economy. combine their choice of execution partner with their preferred This picture is clearly conducive to derivatives activity. choice of CCP in the two locations. This adds the benefits of being Single stock derivatives are driven by volatility in the underlying able to move positions across the border in a frictionless manner market. The prices of many companies listed on Oslo Børs are between SIX-X Clear and LCH clearing members. influenced by the fluctuations of commodity prices. This is a factor that can become a source of additional volatility When people think about the Norwegian market, and makes sectors fall in and out of favour with investors. they mostly think of its large exposure to the This behaviour also effects the underlying listing and delisting Energy sector. However, Consumer Goods and activity, which in Norway has a faster pace than in neighbouring Financials represent 23% and 18% of the OBX countries in the region. index respectively. Can you tell us about the success of the non-energy sector over the years? Oslo has been pioneering derivatives on alternative asset classes with the launch of the In 2008 the OBX index consisted of 53% oil related companies, Fish Pool market and derivatives based on Salmon. at the end of 2017 that figure was 29%. Today there are Are there any other asset in the Nordic region 5 seafood companies in the OBX, representing 13% of the Index. that would lend themselves to be traded in new The salmon rush has been an important driver of the diversity and innovative formats? in the OBX. The financial sector has always been important, and it denotes Norwegian household economy is to a large extent tied up the presence of one of the leading banks in the Nordic region in real estate and the tax regime is a clear trigger. Products and strong insurance companies. Lately we have witnessed that can allow a risk management of that exposure would be increased activity in listing of new types of financials, such a long sought for product, but not easily achievable. Products as consumer lending, with Norwegian Finans Holding of being that facilitate price discovery and inventory management of included in the index at the end of 2017. Statoil, who recently natural resources are clearly interesting and when you look changed its name to , remains the largest company at our country’s specialities, contracts on electricity, timber of the OBX, followed by DnB and . and shipping come to mind.

02 London Stock Exchange Group Derivatives Newsletter LSEDM & Oslo Børs: a model in co-operation

Thomas LSEDM and Oslo Børs have a long history of cooperation Jacobsen, in the derivatives market and operate a linked order book Oslo Børs for Norwegian derivatives. This gives members of the respective exchanges access to the same instruments, prices and liquidity.

Besides a linked order book, LSEDM and Oslo Børs’ oil and gas, but also a diverse base of supporting cooperation model offers an interoperable clearing industries. There are 7 companies which are link between LCH Ltd and Six X-Clear. With market OBX-index constituents with derivatives listings participants growing more diverse and industry from these industries. The rebound in oil prices changes demanding more flexibility, the and renewed company activity and awarded interoperability of CCPs offered by LSEDM and Oslo contracts means several producers and oil services Børs has been important in bridging international have seen strong gains (Fig. 1). flow and localized liquidity in a specialised market. In addition, Norway’s long and diverse coast has In continuing to harmonize the Norwegian always supported a large fishing community, and derivatives market to comparable markets, and later, its industry. From being a means of survival, instruments, the expiry date for OBX and equity this industry has grown to become an industry derivatives changed as of the January expiry 2018 leader with exports around the globe. So much to the 3rd Friday of the month. so, that Oslo Børs has attracted several foreign companies for listing. One of these companies One of the distinctive features of the Oslo is , which alongside Marine Harvest, derivatives market is the availability of the Market the largest salmon producer in the world, have Place Service Desk. This service is operated as an individual derivatives listings. These companies exchange broking desk for derivatives products. have been amongst the biggest winners so far Given the local nature of the market, the exchange in 2018 (Fig. 2). broking desk has become a focal point for market interaction and a very effective way for members Having shaken off the market slump in the to source liquidity. Recently, this service has also beginning of the year, the OBX-index rose to a new been made available for LSEDM members, who now all-time high in April, with The Oslo Børs Seafood also can benefit from the price discovery service Index (OBSFX) gaining more than 30% by mid-April. for block trades. For more information about Five of the 25 companies in the OBX-index, with gaining access to this service, please contact a combined weight of 13%, are also constituents [email protected]. of the OBSFX.

The Norwegian stock market, and subsequently its The market gyrations in February this year have derivatives offering, is in several ways impacted by contributed to a pick up in the spread between geography. A mature, continental shelf rich in implied and historical volatility in the OBX Index hydrocarbons means Norway has a well-developed presenting a new set of opportunities to benefit industry of not only exploration and production of of elevated relative levels of option volatility (Fig. 3).

03 London Stock Exchange Group Derivatives Newsletter Fig.1 - OBX vs. Oil and Oil Services OBX Index Equinor* AKERBP TGS Geophisycal * Formerly Statoil ASA

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70.00 02/01/2018 17/01/2018 01/02/2018 16/02/2018 03/03/2018 18/03/2018 02/04/2018 17/04/2018

Fig.2 - OBX Index vs. OBSFX Index (Seafood) OBX OBSFX (Seafood)

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90.00

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70.00 02/01/2018 17/01/2018 01/02/2018 16/02/2018 03/03/2018 18/03/2018 02/04/2018 17/04/2018

04 LSEDM & Oslo Børs: a model in co-operations Fig.3 - OBX Index Implied vs. Historical Volatility 3 mths 3 mths Volatility Risk ATM Implied volatility realized volatility Premium (RH)

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5

0 16/01/2017 16/02/2017 16/03/2017 16/04/2017 16/05/2017 16/06/2017 16/07/2017 16/08/2017 16/09/2017 16/10/2017 16/11/2017 16/12/2017 16/01/2018 16/02/2018 16/03/2018 16/04/2018

Offering in Norwegian Derivatives “The market Ticker Company Name GICS Description OBX OBX-Index gyrations in AKERBP Aker BP Oil & Gas Exploration & Production AKSO Oil & Gas Equipment & Services

February have BAKKA Bakkafrost Packaged Foods & Meats contributed to DNB DNB Diversified Banks DNO DNO Oil & Gas Exploration & Production a pick up in the FRO Frontline Oil & Gas Storage & Transportation spread between GJF Forsikring Multi-line Insurance MHG Marine Harvest Packaged Foods & Meats implied and NAS Airlines NHY Aluminium

historical NOD Nordic Semiconductor Semiconductors volatility in ORK Orkla Packaged Foods & Meats PGS Petroleum Geo-Services Oil & Gas Equipment & Services the OBX Index REC REC Silicon Semiconductor Equipment offering new STB Life & Health Insurance EQNR* Equinor Integrated Oil & Gas opportunities SUBC Subsea 7 Oil & Gas Equipment & Services TEL Telenor Integrated Telecom. Services

to benefit option TGS TGS Nopec Geophysical Oil & Gas Equipment & Services volatility.” YAR Fertilizers & Agricultural Chemicals * Formerly STL, Statoil ASA

05 LSEDM & Oslo Børs: a model in co-operations Fig.4 - OBX Index Breakdown by sector Key features and benefits

—— Shared order book: customers of LSEDM and Oslo Børs have access to one central pool of liquidity, making all trades fully fungible —— On screen liquidity: dedicated market makers from both LSEDM and Oslo Børs provide a transparent on screen price picture Materials 12% —— Trade reporting facility: LSEDM and Oslo Børs will accept bilaterally negotiated trades from members and brokers.

Industrials London Stock Exchange Membership = 0 cost 1% Derivatives Market (LSEDM) Market Data = 0 cost

LSEDM Oslo Børs Member Member (LSEM) (OBM)

Matching Engine Consumer, incl. Seafood 2% Shared Order Book Consumer Staples 21% Energy 33% BID ASK Financials 18% LSEM LSEM Industrials 1% LSEM OBM Materials 12% OBM LSEM Telecoms 13% OBM OBM

Executed Trades LSEG and Oslo Børs have been operating a linked order book market since 2009. The two markets have LCH SIX Clear combined their liquidity pool into a shared order Interoperable CCPs = book which enables international customers on both Fungible contracts markets to trade Norwegian equity derivatives with Give up Agreements each others without the need of additional membership or clearing arrangements. Membership Trades match on SOLA Technology of either one of the two markets grants automatic access to this market segment at no additional cost.

The interoperability of CCPs offered by LSEDM and Oslo Børs has been important in bridging international flow and localized liquidity.

06 LSEDM & Oslo Børs: a model in co-operations Hedging the known unknown

Intermonte SIM In the last few years the market has experienced a series of events Market Making with uncertain outcomes and unpredictable impact, with the only sure Desk thing being the date they were due to take place. First off the blocks was the UK’s Brexit referendum, followed by the US Presidential election, the Italian constitutional referendum and, most recently, the Italian general election.

As these events approached, the front bucket of the volatility surfaces of the major equity indexes presented a characteristic “umbrella” pattern (see fig. below).

Fig.1 - FTSE MIB example

Volatility Normal “Umbrella” pattern

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0.4 0.6 0.8 1.0 1.2 1.4 1.6 Moneyness (%)

The smile for these maturities tends to take this buy put options At the money and sell double shape because operators expect the event itself the amount of Out of the money. If traded with the to spark significant initial movement around the right timing this strategy will significantly reduce At the money, with a subsequent return to less the negative impact of any market downturn, drastic market fluctuations and a more normalized while also allowing the portfolio to benefit from the volatility skew. movements in volatility surfaces described above.

In this kind of situation, a long only portfolio The decision to use this 1:2 ratio is dependent seeking to implement a hedging strategy could on the desired delta exposure.

07 London Stock Exchange Group Derivatives Newsletter Given the ongoing political deadlock in Italy and the date of the event. FTSE MIB monthly options the serious possibility that further elections will provide the ideal way of implementing this portfolio be called, it is legitimate to expect volatility hedging strategy. surfaces once again to take the shape of the “umbrella” pattern, thus making this hedging An example of this hedge prior to March 4th Italian strategy appealing. general elections is described in the table below.

As this effect is most notable for options with short Since 2011, Intermonte SIM is a leading Primary term maturities, these patterns are best exploited Market Maker on FTSE MIB options and on the most by trading the first option expiration that includes liquid Italian stock options listed on the IDEM market.

Opening position

Current Maturity Contract Money Trade date Index Strike Lots Side Price Multiplier spot of option kind amount

22 Feb 18 - 3.55 PM 22.375 FTSE MIB 16 mar 18 Put 22.500 1 Buy 600 2,5 -1.500

22 Feb 18 - 3.55 PM 22.375 FTSE MIB 16 mar 18 Put 21.000 1 Sell 166 2,5 830

22 Feb 18 - 3.55 PM 22.375 FTSE MIB 16 mar 18 Put Ratio 22.500 / 21.000 1-2 Buy 268 2,5 -670

Closing position

Current Maturity Contract Money Trade date Index Strike Lots Side Price Multiplier spot of option kind amount

5 Mar 18 - 10.25 PM 21.600 FTSE MIB 16 mar 18 Put 22.500 1 Sell 1.000 2,5 2.500

5 Mar 18 - 10.25 PM 21.600 FTSE MIB 16 mar 18 Put 21.000 1 Buy 192 2,5 -960

5 Mar 18 - 10.25 PM 21.600 FTSE MIB 16 mar 18 Put Ratio 22.500 / 21.000 1-2 Sell 616 2,5 1.540

Recap of the structure

Current Maturity Contract Money Trade date Index Strike Lots Side Price Multiplier spot of option kind amount

22 Feb 18 - 3.55 PM 22.375 FTSE MIB 16 mar 18 Put Ratio 22.500 / 21.000 +1 -2 Buy 268 2,5 -670

5 Mar 18 - 10.25 PM 21.600 FTSE MIB 16 mar 18 Put Ratio 22.500 / 21.000 +1 -2 Sell 616 2,5 1.540

Profit and Loss: 870

Comparison Index spot Start day Start price End day End price Movement %

Market FTSE MIB 22 Feb 18 22.375 5 Mar 18 21.600 -3.46%

FTSE MIB Put Ratio Price of derivatives structure 22 Feb 18 268 5 Mar 18 616 130% 22.500/21.000 mar 18

08 Hedging the known unknown Statistics — IDEM Equity — LSEDM

Events and initiatives The group derivatives markets will attend/organize the following events: — Introduction to retail trading. FinecoBank in partnership with Academy LSEG 04 June 2018 — 11 th Annual FIA International Derivatives Expo 2018 04 - 06 June 2018 — Investment Trading Forum Rimini 14 - 15 June 2018 — Commodities Exchange Milan (CEMI) 22 June 2018 Contacts — LSEDM [email protected] — IDEM [email protected]

The materials presented by the London Stock Exchange Group plc and its group undertakings (to be construed in accordance with s.1161 of the Companies Act 2006) (“LSEG”) to illustrate its products or services do not constitute, nor purport to effect an offering or sale of securities, the provision of investment or trading advice or an intermediation in activities pertaining to the marketing of securities, futures contracts, options on futures, swaps or other commodities. The prospective use of products and services offered by LSEG, including but not limited to the use of any materials made available by LSEG in connection with the presentation of any products and services to audiences in the US, is subject to all applicable US Federal securities and commodities laws and regulations. This document is not to be considered complete and it is meant for information and personal purposes only. LSEG accepts no liability raising, without limitation to the generality of the foregoing, from inaccuracies and/or mistakes, for decisions and/or actions taken by any party based on this document. “London Stock Exchange” and the coat of arms device and “FTSE” are registered trade marks of London Stock Exchange plc. The trademarks “Borsa Italiana” and “IDEM” are owned by Borsa Italiana S.p.A. The above trademarks and any other trademark owned by LSEG cannot be used without express written consent by the company having the ownership of the same.

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