Summary
The derivatives market according to what has been learned in classes is the one through which the parties enter into contracts with instruments whose value depends or is contingent on the value of another asset, called the underlying asset. One of the main functions of the derivatives market is to provide hedging or investment financial instruments that promote adequate risk management.
Derivatives are financial products (specifically contracts) whose value (price) is based on the price of an underlying asset. For example, the price of an oil derivative will fluctuate depending on the price of oil, in this case the underlying asset is oil.
One of the characteristics of the derivatives market is that it operates in installments, that is, a period of time must elapse between the signing of the contract and the settlement and that period must be sufficient to make possible a negotiation in the secondary market.
Abstract
The derivatives market according to what is learned in classes one through which the parties contract with instruments whose value depends upon or is contingent on the value of another asset, called the underlying asset. One of the main functions of the derivatives market is to provide financial instruments for hedging and investment to encourage proper risk management.
Derivatives are financial products (specifically contracts) whose value (price) is based on the price of an underlying asset. For example, the price of a derivative on oil will fluctuate depending on the price of oil, in this case the underlying asset is oil.
One of the characteristics of the derivatives market is that it operates in installments, ie should spend time between signing the contract and the settlement and that period should be sufficient to enable a secondary market trading.
The derivatives market is divided into the stock market is one in which the transaction is carried out on a stock exchange currently known in Mexico known as Mercado Mexicano de Derivados (MexDer) and this institution operates futures and option contracts on financial assets such as They are the dollar, the euro, bonds, stocks, and interest rates.. This gives the possibility to plan, hedge and manage financial risks and portfolios.
And the over-the-counter market is one in which operations are agreed directly between buyers and sellers, without there being a central counterpart that reduces credit risk.
Now is the time to address the elements that make up the derivatives market, whether they are options or futures, and the main uses that can be given to these financial tools.
In this sense, all derivatives operations have some common features that also mark the different strategies that an investor can follow in this market and the use that can be made to complete their investment portfolio.
A future contract is a contract or agreement that obliges the contracting parties to buy or sell a certain number of goods or securities (underlying asset) at a certain future date and with a price established in advance.
There are two reasons why someone may be interested in hiring a future:
- Hedging operations: The person has or will have the underlying asset in the future (oil, gas, oranges, wheat, etc.) and will sell it in the future. With the operation she wants to secure a fixed price today for the operation tomorrow. Speculative operations: The person who contracts the future only seeks to speculate with the evolution of its price from the date of the contract until the expiration of the same.
Regardless of the fact that a futures contract can be purchased with the intention of maintaining the commitment until its expiration date, it can also be used as a hedging instrument in speculative-type operations, since it is not necessary to keep the position open until the expiration date. due date; At any time the position can be closed with an operation of the opposite sign to the one initially carried out: when you have a buying position, it can be closed without waiting for the expiration date simply by selling the number of buyer contracts that you have; conversely, someone with a short position can close it early by going to the market and buying the number of futures contracts required to offset their position.
Futures contracts on raw materials, precious metals, agricultural products and various merchandise have been traded for more than two centuries. For financial products they have been traded for more than two decades, existing futures on short, medium and long-term interest rates, futures on currencies and futures on stocks and stock indices.
The first indications about futures contracts date back to 2000 BC in the time of the Egyptians. Farmers, not knowing the quantity or quality of their crops in the future, agreed with a buyer a price for the entire crop regardless of the result. The futures contract as a financial instrument has been traded for more than two decades, with futures on short, medium and long-term interest rates, futures on currencies and futures on stocks and stock indices.
In agriculture, futures contracts are used so that both the farmer and the buyer of the product (asset) secure a price for the day of harvest (expiration). In order to guarantee the contract a margin is given. In the event that the price of the product (for example cotton) in the market is more expensive than the agreed price for the expiration date of the futures contract, the buyer will benefit since due to the futures contract, he will be able to buy the asset at a price lower than the market.
The prices in the market of futures contracts are established through the supply and demand of the market, if there is a lot of demand for a certain product its price will increase and if the demand is very low the price will be low.
A forward, as a derivative financial instrument, is a long-term contract between two parties to buy or sell an asset at a fixed price and on a specified date.
The most common forwards traded in treasuries are on currencies, metals and fixed income instruments.
There are two ways to resolve foreign currency forward contracts:
- By compensation (non delivery forward): upon expiration of the contract, the spot exchange rate is compared against the forward exchange rate, and the differential against is paid by the corresponding party By physical delivery (delivery forward): at expiration by the buyer and the seller exchange the currencies according to the agreed exchange rate.
In simple words, we must understand a Forward contract as the agreement between two parties who agree to exchange assets specified in quantity, on a previously fixed future date and at a price agreed in the market. Allowing in this way to eliminate the risk due to the exchange rate in addition to not affecting the debt capacity of the company, since it is not a credit, nor its liquidity, since it does not require money to sign the contracts The Forward It is the instrument that could be profitable for exporters and importers, since it is aimed at eliminating the risk of t / c or acting as an exchange insurance. The great advantage is that very large amounts can be traded with a small guarantee, depending on the term.
The option contract in a promise of sale whose object is titles of credit, that is to say; it is a preparatory contract for a future sale contract. Like any promise, the option must meet three requirements:
In the first place, it must contain the elements of the future contract to be concluded. In the case of a promise of sale, of titles such elements are: the titles of the operation and the price. It must be limited to a certain time and must be in writing. The option, as a promise that it is, gives rise to obligations to do, consisting of the commitment to enter into the future contract.
Financial options are contracts in which the buyer has the right (not the obligation) to exercise the purchase or sale of the underlying asset at a predetermined price in exchange for a premium to be paid to the seller of the contract.
The options can be unilateral or bilateral, depending on the obligations of entering into the future contract, there is a position of only one of the parties or a position of both. When the obliged one in an option is the future seller, it is called a purchase option, and when the future buyer is, it is called a put option.
On the other hand, according to what has been studied, there are two types of options: the call option which tells us that this option gives the buyer the right to buy the underlying value at the agreed price in exchange for a premium, therefore the seller of the call option will have the obligation to sell the underlying asset if the buyer exercises the right to purchase. Obviously the buyer will exercise his right to purchase if the market price is previously established.
And the second option is the put option, the put options give the right to the buyer of the same to sell the underlying asset at a previously agreed price in exchange for a premium, therefore, the buyer of the put option will have the obligation to buy the underlying asset if the buyer exercises the right of sale. In this case, the buyer will exercise his right if the market price is lower than previously agreed.
The option is a right for the buyer of the same, who is the one who makes the decision to exercise it or not, while for the seller it constitutes an obligation to buy or sell the asset and in return receives a premium. Options can be traded on a wide range of assets, including transferable securities, futures, stock indices, gold and currencies.
Here is an example of the call option:
One person owns shares in a company and another wants to buy them in the future. The opinion of the second (buyer of the call option) is that the price of the company's shares will rise to levels of 4 euros in three months (the current price is 3 euros) and therefore wants to set a price of 3.5 euros for, when the expiration date (within three months), be able to buy at 3.5 euros when the shares are at 4 euros. For this he pays a premium of 0.5 euros. Upon maturity, the share is trading at 4.5 euros. The buyer exercises the call and buys his share at 3.5 euros. He then sells his share at the market price, that is, at 4.5 euros. The buyer has paid 0.5 euros for the premium and, in return, has earned 1 euro (4'5-3'5 = 1; 1-0'5 = 0.5). The seller, for his part,He has lost the same 0.5 euros (he received a 0.5 premium and today he lost 1 when he stopped winning because he could not sell the share).
Suppose the stock is trading at € 3.25 on the option's expiration date. The buyer of the call is not going to exercise his option, since the share is cheaper in the market. However, you will have lost 0.5 euros that you paid as a premium. In conclusion, with the call option, the buyer limits his loss to the premium, but the profit is theoretically unlimited.
Put option example:
A person has shares of a company and sees that its price has entered a downward channel. He wants to ensure a sale price when a maturity (three months) has come. For this, he buys a put, guaranteeing the sale price at 3.5 euros within three months. To do this, pay 0.5 euros of premium. Upon maturity, the shares are trading at 2.5 euros. The buyer exercises the put and sells his shares at 3.5 euros, when they are listed on the market at 2.5 euros. He has earned 1 euro minus the 0.5 euros that he paid as a premium. Let's suppose that the shares instead of going down have risen to 4.5 euros. In this case, the buyer of the put option will not exercise the option, since he can sell the shares on the market at a higher price. In this case you would only lose the premium.
Futures and options contracts are instruments that present a high degree of standardization. This incorporates notable advantages, since it simplifies processes and integrates users, increasing trading volumes and market liquidity. The standardization of contracts is evident in the following aspects:
- Low number of maturities with specific dates. As a general rule in terms of interest rates, there are usually four annual maturities, which coincide with a certain date in the months of March, June, September and December. In equities, maturities are usually established by monthly periods, with the nearest three months and a fourth month relatively distant in time being quoted simultaneously. Amounts normalized by contract. When an operator quotes a certain number of contracts, those who receive the offer or observe it on the screen already know what the individual amount is, and consequently they also know the total value of the possible operation to be carried out. The minimum value of price fluctuation is also known, which in the operating jargon of derivatives markets is called a "tick".Operations must be crossed by whole numbers, and fractions of contracts cannot be negotiated. Market hours and negotiation rules. The futures and options markets have specific trading hours and specific clauses of the contracts that attempt to meet conditions of maximum interest to all the members who can operate in the market. Possibility of closing the position before expiration. Any user of the futures and options market who wishes to close their position early, without having to wait for the expiration of the contracts, can go to the market and carry out an operation of the opposite sign to the position they have, in such a way that if they have a position The seller must buy contracts and if the buyer has it, she must sell contracts.The possibility of not having to maintain operations until the expiration date allows hedging operations that begin or end on "broken dates", which is the name given to those days other than expiration. Existence of guarantee deposits and profit and loss settlements. The clearinghouse is responsible for setting amounts that market users must deliver as collateral for the operations they carry out and at the same time sets rules for the settlement of gains and losses.Existence of guarantee deposits and profit and loss settlements. The clearinghouse is responsible for setting amounts that market users must deliver as collateral for the operations they carry out and at the same time sets rules for the settlement of gains and losses.Existence of guarantee deposits and profit and loss settlements. The clearinghouse is responsible for setting amounts that market users must deliver as collateral for the operations they carry out and at the same time sets rules for the settlement of gains and losses.
Another derivative market instrument is swap, or financial swap, which is a contract by which two parties agree to exchange a series of amounts of money at future dates. Normally, future money exchanges are referenced to interest rates, being called IRS (Interest Rate Swap), although in a more generic way any future exchange of goods or services (including money) referenced to any observable variable can be considered a swap.
A normal interest rate swap is a contract by which one party to the transaction agrees to pay the other party an interest rate fixed in advance on a nominal also fixed in advance, and the second party agrees to pay at the first at a variable interest rate on the same nominal.
A swap is not a loan, since it is exclusively an exchange of interest rate flows and no one lends the nominal to anyone, that is, the amounts of principal are not exchanged.
On the other hand, there is also a future contract on interest rates, this simply refers to a hedging contract on an asset whose price depends only on the level of interest rates. The importance of this type of contract is that at present, the total volume of operation of futures contracts on financial instruments represents more than half the volume of this entire industry.
The purpose of this market is for participants to have a mechanism that allows them to set real interest rates in advance and hedge against their volatility due to inflation. Future contracts of Cetes and TIIE.-These contracts are instruments of short term and are operated in Mexico. The Cetes (Certificates of the Treasury of the United Mexican States), with issuance terms of 28, 91, 181 and 360 days, which are auctioned weekly. The TIIE is the Equilibrium Interbank Interest Rate.
With a future interest rate, the seller of the same, agrees to deliver a certain amount of debt securities that have a validity period, at a price agreed upon entering the future, at a future date (at the expiration of the contract); the buyer agrees to receive the titles and pay the agreed price. The gains of both at maturity, arise because there is a difference in interest rates between the agreed and the one that exists in the market when the contract expires.
conclusion
There is no doubt that derivatives market instruments have been very will continue to be great alternatives for investors seeking to protect themselves from financial risks.
The Mexican Derivatives Market is a long-term purchase option that is subject to involuntary and perhaps improvised volatility of currencies, product value, interest rates and long-term assets, therefore, actions carried out in this The market should not be taken as a long-term investment but as a futures contract with obligations to fulfill, in addition to taking a preventive strategy against risks and in a more rational way, think about whether we can risk what we want and if, even with the variations that the risks may bring; what you get is enough to start a speculative activity.
As the functions of this market are subject to the trading partners and the buyers, it is important to get from them those who have a strong currency (as a partner) and a currency of at least equal or lesser appreciation than our own (as buyers), as well as the elaboration of futures contracts that benefit the interactive ones.
In the case of Mexico, a speculative market may be insecure at first glance, but getting partnerships that can sustain investment risks can be beneficial for the dynamics of the country's economy.
In conclusion, like all speculative activity, risk plans must be in place, a broad study of competitors and a strong association that receives special benefit from our company to motivate support between partners and make buyers interested in our services, demonstrating a commercial certificate.
It is important to point out that the derivatives market in our country has been operating for a short time, however, thanks to the efforts of many parties, it has been possible to achieve a degree of reliability with investors, which, thanks to the transparency and dedication of the Authorities in charge of MexDer have found in this market an option to be able to invest and hedge against risks at the same time and this has undoubtedly been reflected in the volume of contracts traded in this market since its inception until now, and the recent opening of financial options market, which is an indication that the derivatives market is in a period of development and strength, which is undoubtedly something positive for our country in general.
Key aspects
Market: in economics, it is any set of transactions or agreements for the exchange of goods or services between individuals or associations of individuals.
Stock Market: Relating to the Stock Market, and its operations and values.
Contracts: The contract is an agreement of wills, verbal or written, manifested in common between two, or more, people with capacity (parties to the contract), who are bound by it, regulating their relationships related to a certain purpose or thing, and whose fulfillment they may be reciprocally compelled, if the contract is bilateral, or one party compelled the other, if the contract is unilateral.
