Introdução aos Derivativos
Much has changed in option markets over the last 20 years [1995-2014]. Twenty years ago, organized option markets existed only in the major industrialized nations.
But as the importance of derivatives as both an investment vehicle and a risk-management tool has become widely recognized, new option markets have opened in countries around the world. Options are now traded not only on traditional products—stocks, interest rates, commodities, and foreign currencies—but also on a bewildering array of new products—real estate, pollution, weather, inflation, and insurance. Many exchanges have also added variations on traditional products—short-term and midcurve options, flex options, options on spreads, and implied and realized volatility contracts.
Not only has there been a dramatic increase in the number of option markets, but the traders in those markets have become increasingly sophisticated. When this text was first published [1995], knowledgeable traders could only be found at firms that traded derivatives professionally—market-making firms, hedge funds, investment banks, and other proprietary trading firms.
Now, many retail customers have a level of knowledge equal to that of a professional trader. At the same time, universities are adding or expanding programs in financial engineering. In many cases, those who choose a career in derivatives trading have already had in-depth exposure to the mathematics of option pricing.
Sheldon Natenberg, "Option Volatility and Pricing: Advanced Trading Strategies and Techniques", McGraw-Hill Education, 2nd Edition, November, 2014
The good news is that the more complex structures are constructed from some simple building blocks – forwards and futures; swaps; and options – which are defined below.
Forwards. A forward contract is a contractual agreement made directly between two parties. One party agrees to buy a commodity or a financial asset on a date in the future at a fixed price. The other side agrees to deliver that commodity or asset at the predetermined price. There is no element of optionality about the deal. Both sides are obliged to go through with the contract, which is a legal and binding commitment, irrespective of the value of the commodity or asset at the point of delivery. Since forwards are negotiated directly between two parties, the terms and conditions of a contract can be customized. However, there is a risk that one side might default on its obligations.
Futures. A futures contract is essentially the same as a forward, except that the deal is made through an organized and regulated exchange rather than being negotiated directly between two parties. One side agrees to deliver a commodity or asset on a future date (or within a range of dates) at a fixed price, and the other party agrees to take delivery. The contract is a legal and binding commitment. There are three key differences between forwards and futures. Firstly, a futures contract is guaranteed against default. Secondly, futures are standardized, in order to promote active trading. Thirdly, they are settled on a daily basis. The settlement process is explained in detail in later chapters.
Swaps. A swap is an agreement made between two parties to exchange payments on regular future dates, where the payment legs are calculated on a different basis. As swaps are OTC deals, there is a risk that one side or the other might default on its obligations. Swaps are used to manage or hedge the risks associated with volatile interest rates, currency exchange rates, commodity prices and share prices. A typical example occurs when a company has borrowed money from a bank at a variable rate and is exposed to an increase in interest rates; by entering into a swap the company can fix its cost of funding. (Although it is often considered as one of the most basic types of derivative product, a swap is actually composed of a series of forward contracts.)
Options. A “call option” gives the holder the right to buy an underlying asset by a certain date at a fixed price. A “put option” conveys the right to sell an underlying asset by a certain date at a fixed price. The purchaser of an option has to pay an initial sum of money called the premium to the seller or writer of the contract. This is because the option provides flexibility; it need never be exercised (taken up). Options are either negotiated between two parties in the OTC market, one of which is normally a specialist dealer, or freely traded on organized “exchanges”. Traded options are generally standardized products, though some “exchanges” have introduced contracts with some features that can be customized.
Andrew M. Chisholm, "Derivatives Demystified - A Step-by-Step Guide to Forwards, Futures, Swaps and Options",
2004, John Wiley and Sons.
John C. Hull, “Options, Futures, and Other Derivatives”, 10th Edition, Publisher: Pearson, 2018.
Forward Prices and Spot Prices
We shall be discussing in some detail the relationship between spot and forward prices in Chapter 5. For a quick preview of why the two are related, consider a stock that pays no dividend and is worth $60. You can borrow or lend money for 1 year at 5%. What should the 1-year forward price of the stock be?
The answer is $60 grossed up at 5% for 1 year, or $63. If the forward price is more than this, say $67, you could borrow $60, buy one share of the stock, and sell it forward for $67. After paying off the loan, you would net a profit of $4 in 1 year. If the forward price is less than $63, say $58, an investor owning the stock as part of a portfolio would sell the stock for $60 and enter into a forward contract to buy it back for $58 in 1 year. The proceeds of investment would be invested at 5% to earn $3. The investor would end up $5 better off than if the stock were kept in the portfolio for the year.
John C. Hull, “Options, Futures, and Other Derivatives”, 10th Edition, Publisher: Pearson, 2018.
Types of Traders
Derivatives markets have been outstandingly successful. The main reason is that they have attracted many different types of traders and have a great deal of liquidity. When a trader wants to take one side of a contract, there is usually no problem in finding someone who is prepared to take the other side.
Three broad categories of traders can be identified: hedgers, speculators, and arbitrageurs. Hedgers use derivatives to reduce the risk that they face from potential future movements in a market variable. Speculators use them to bet on the future direction of a market variable. Arbitrageurs take offsetting positions in two or more instruments to lock in a profit. As described in Business Snapshot 1.3, hedge funds have become big users of derivatives for all three purposes.
John C. Hull, “Options, Futures, and Other Derivatives”, 10th Edition, Publisher: Pearson, 2018.
In 1994, a few of these apparently sound, sane, rational, and efficient risk-management arrangements suddenly blew up, causing enormous losses among the customers that the risk-management dealers were supposedly sheltering from disaster. The surprise was not just in the events themselves; the real shocker was in the prestige and high reputation of the victims, which included such giants as Procter & Gamble, Gibson Greetings, and the German Metallgesellschaft AG.
There is no inherent reason why a hedging instrument should wreak havoc on its owner. On the contrary, significant losses on a hedge should mean that the company's primary bet is simultaneously providing a big payoff. If an oil company loses on a hedge against a decline in the price of oil, it must be making a large profit on the higher price that caused the loss in the hedging contract; if an airline loses on a hedge against a rise in the price of oil, it must be because the price has fallen and lowered its operating costs.
These disasters in derivative deals among big-name companies occurred for the simple reason that corporate executives ended up adding to their exposure to volatility rather than limiting it. They turned the company's treasury into a profit center. They treated low probability events as being impossible. When given a choice between a certain loss and a gamble, they chose the gamble.
They ignored the most fundamental principle
of investment theory:
you cannot expect to make large profits
without taking the risk of large losses.
Chapter 18 - The Fantastic System of Side Bets, page 323, from book “Against The Gods: The Remarkable Story of Risk”, by Peter Bernstein, published by John Wiley & Sons, September 1996.
The Lehman Bankruptcy
On September 15, 2008, Lehman Brothers filed for bankruptcy. This was the largest bankruptcy in U.S. history and its ramifications were felt throughout derivatives markets. Almost until the end, it seemed as though there was a good chance that Lehman would survive. A number of companies (e.g., the Korean Development Bank, Barclays Bank in the United Kingdom, and Bank of America) expressed interest in buying it, but none of these was able to close a deal. Many people thought that Lehman was ‘‘too big to fail’’ and that the U.S. government would have to bail it out if no purchaser could be found. This proved not to be the case.
How did this happen? It was a combination of high leverage, risky investments, and liquidity problems. Commercial banks that take deposits are subject to regulations on the amount of capital they must keep. Lehman was an investment bank and not subject to these regulations. By 2007, its leverage ratio had increased to 31:1, which means that a 3–4% decline in the value of its assets would wipe out its capital. Dick Fuld, Lehman’s Chairman and Chief Executive Officer, encouraged an aggressive deal-making, risk-taking culture. He is reported to have told his executives: ‘‘Every day is a battle. You have to kill the enemy.’’ The Chief Risk Officer at Lehman was competent, but did not have much influence and was even removed from the executive committee in 2007. The risks taken by Lehman included large positions in the instruments created from subprime mortgages, which will be described in Chapter 8. Lehman funded much of its operations with short-term debt. When there was a loss of confidence in the company, lenders refused to renew this funding, forcing it into bankruptcy.
Lehman was very active in the over-the-counter derivatives markets. It had over a million transactions outstanding with about 8,000 different counterparties. Lehman’s counterparties were often required to post collateral and this collateral had in many cases been used by Lehman for various purposes. Litigation aimed at determining who owes what to whom continued for many years after the bankruptcy filing.
John C. Hull, “Options, Futures, and Other Derivatives”, 10th Edition, Publisher: Pearson, 2018.
obs: caso clássico de falha da Governança Corporativa da Gestão de Risco. Mesmo o Lehman tendo uma estrutura funcional de risco, com medições diárias das métricas de risco e relatórios sendo enviados para o "Board" de forma sistemática, não houve uma tomada de decisão eficiente. Os shareholders pagaram o pato !!!
Company’s Board of Directors was successfully sued for failing to use Derivatives to hedge the price risk of grain
…derivative securities can be used effectively for risk management. In fact, such risk management is becoming accepted as part of the fiduciary responsibility of financial managers. Indeed, in one often-cited court case, Brane v. Roth, a company’s board of directors was successfully sued for failing to use derivatives to hedge the price risk of grain held in storage. Such hedging might have been accomplished using protective puts.
The claim that derivatives are best viewed as risk management tools may seem surprising in light of the credit crisis of the last few years. The crisis was immediately precipitated when the highly risky positions that many financial institutions had established in credit derivatives blew up 2007–2008, resulting in large losses and government bailouts. Still, the same characteristics that make derivatives potent tools to increase risk also make them highly effective in managing risk, at least when used properly. Derivatives have aptly been compared to power tools: very useful in skilled hands, but also very dangerous when not handled with care.
Zvi Bodie, Alex Kane and Alan Marcus, "Investments", 11th Edition, McGraw-Hill, 2017.
Since Co-op [rural grain elevator cooperative] had economic difficulties, the directors [Board of Directors] decided to implement a new strategy.[5] Under the new strategy, Co-op would hedge its grain position to protect itself from the volatility of the grain market. Although Co-op’s directors authorized the manager to hedge, only a minimal amount was effectively hedged (US$20,500 out US$7,300,000 of Co-op’s total grain sales) [6]. Shareholders brought a suit alleging that director’s failure to adequately hedge in the grain market had caused the losses to Co-op. [7]
The lower court found in favor of the shareholders and stated that Co-op’s directors had breached their fiduciary duty by retaining an inexperienced manager, by failing to maintain reasonable supervision over him, and by failing to attain knowledge of the fundamentals of hedging to be able to direct the hedging activities and supervise the manager. [8]
The Court of Appeals reaffirmed the lower court’s decision stating that Co-op’s losses resulted from the failure to hedge.[9] The position taken by the court was corroborated by both a witness and an outside expert in the grain market who testified that grain elevators cooperatives should engage in hedging activities to protect themselves from the fluctuations of the gain industry. [10]
THE MECHANICS OF SHAREHOLDER RIGHTS
Shareholders have limited liability and therefore they have limited rights to affect the direction of the company. Essentially, the mechanics of those rights fall into three categories. They have the right to “elect” the board of directors. As we note elsewhere in detail, this right is limited by the managers’ ability to control the selection of candidates, power that may be lessened if the “proxy access” provision of the Dodd–Frank legislation, giving shareholders a limited right to put their own candidates on the company’s proxy, survives a court challenge. In a very small fraction of the director elections each year, usually well under 1 percent, dissident shareholders mount a very expensive full-scale challenge, nominating an entire slate of opposing candidates. Shareholders also have the right to vote on management-sponsored proxy issues like the approval of the auditors and certain compensation arrangements.
Second, shareholders have the right to submit shareholder proposals to a vote. If they want their proposals to be circulated on the company’s proxy card, it must be limited in subject matter (see the SEC’s rule 14a-8). It may not pertain to “ordinary business” or to any specific individual matter. It is limited in length to 500 words. In one case, a proposal was excluded because it was one word over. Most important, in virtually all cases it must be nonbinding, so even a 100 percent vote would not require the company to comply. Finally, shareholders have the right to bring a lawsuit against the company or the board for failure to meet their obligations. An entire category of litigation in the US called “derivative” suits are unique because they involve shareholders suing on behalf of the corporation and usually against its own executives, for actions they believe the corporation should have pursued. These lawsuits are frequent in the US but rarely go to trial as nearly all are settled by the company’s insurer. In the past, they have been very lucrative for the lawyers but have not provided much benefit to shareholders as the insurance payouts often return to the corporate treasury. More recently, settlements have required specific governance improvements as well as penalties. Derivative suits are far more rare in the UK due to the 1843 decision in Foss v. Harbottle, which establishes a higher standard for injury to support a claim, usually fraud or acting beyond the scope of granted authority.
Robert A. G. Monks and Nell Minow, “Corporate Governance”, Wiley, 5th edition,August 15, 2011.
John C. Hull, “Options, Futures, and Other Derivatives”, 10th Edition, Publisher: Pearson, 2018.
obs: muito cuidado com os "Profit Diagrams" !!! Eles ignoram a primeira e mais importante lição da Matemática Financeira. Os "Profit Diagrams" somam quantidades de dinheiro em instantes diferentes de tempo !!!
A segunda mais importante lição é RISCO !!! Com que taxa mínima de atratividade você quer ser compensado por causa do risco que você está "tomando" ???
The fact that you have made a profit on your position is not necessarily a cause for rejoicing. The profit needs to compensate you for the time value of money and the risk that you took.
Brealey, Myers and Allen,"Principles of Corporate Finance", 12th Ed., McGraw-Hill Education, 2017.
The are two markets for trading financial instruments.
The Exchange-Traded Market and
The Over-The-Counter Market (or OTC Market)
1. Exchange-Traded Markets
Exchanges have been used to trade financial products for many years. Some exchanges such as the New York Stock Exchange (NYSE; www.nyse.com) focus on the trading of stocks. Others such as the Chicago Board Options Exchange (CBOE; www.cboe.com) and CME Group (CME; www.cmegroup.com) are concerned with the trading of derivatives such as futures and options. The role of the exchange is to define the contracts that trade and organize trading so that market participants can be sure that the trades they agree to will be honored.
The exchange-traded market is a market where products developed by an exchange are bought and sold on a trading platform developed by the exchange. A market participant’s trade must be cleared by a member of the exchange clearing house. The exchange clearing house requires margin (i.e., collateral) from its members, and the members require margin from the brokers whose trades they are clearing. The brokers in turn require margin from their clients.
2. Over-the-Counter Markets
The OTC market is a huge network of traders who work for financial institutions, large corporations, or fund managers. It is used for trading many different products including bonds, foreign currencies, and derivatives. Banks are very active participants in the market and often act as market makers for the more commonly traded instruments. For example, most banks are prepared to provide bid and offer quotes on a range of different exchange rates.
The OTC market is a market where financial institutions, fund managers, and corporate treasurers deal directly with each other. An exchange is not involved. Before the 2007–2008 credit crisis, the OTC market was largely unregulated. Two market participants could enter into any trade they liked. They could agree to post collateral or not post collateral. They could agree to clear the trade directly with each other or use a third party. Also, they were under no obligation to disclose details of the trade to anyone else.
Some OTC trades have been cleared through clearing houses, known as central counterparties (CCPs), for many years. A CCP plays a similar role to an exchange clearing house. It stands between the two sides in a transaction so that they do not have credit exposure to each other. Like an exchange clearing house, a CCP has members who contribute to a guaranty fund, and provide margin to guarantee their performance. Regulations now require standardized derivatives between financial institutions to be cleared through CCPs.
Since the crisis (2008 crisis), the OTC market has been subject to a great deal of regulation. …[] that regulatory pressure is leading to the OTC market becoming more like the exchange-traded market.
Clearing in OTC Markets
We start by describing how transactions are cleared in the OTC market. There are two main approaches: central clearing and bilateral clearing. In bilateral clearing, market participants clear transactions with each other. In central clearing, a third party, known as a central counterparty (CCP), clears the transactions.
John C. Hull, “Risk Management and Financial Institutions”, 5th Edition, Wiley Finance Series, 2018.
John C. Hull, “Options, Futures, and Other Derivatives”, 10th Edition, Publisher: Pearson, 2018.
Jon Gregory,"The xVA Challenge: Counterparty Credit Risk, Funding, Collateral and Capital", 3rd Edition, Wiley, 2015.
Clearing Houses
Exchange-traded derivatives contracts are administered by a clearing house (obs: aqui deve-se chamar a atenção para o detalhe de que o autor está falando dos derivativos que são negociados numa Exchange. Existe uma definição bem restrita do quê é uma Exchange). The clearing house has a number of members, and trades by non-members have to be channeled through members for clearing. The members of the clearing house contribute to a guaranty fund that is managed by the clearing house.
Suppose that, in a particular exchange-traded market, Trader X agrees to sell one futures contract to Trader Y. The clearing house in effect stands between the two traders so that Trader X is selling the contract to the clearing house and Trader Y is buying the contract from the clearing house. The advantage of this is that Trader X does not need to worry about the creditworthiness of Trader Y, and vice versa. Both traders deal only with the clearing house. If a trader is a clearing house member, the trader deals directly with the clearing house. Otherwise, the trader deals with the clearing house through a clearing house member.
When a trader has potential future liabilities from a trade (e.g., when the trader is entering into a futures contract or selling an option), the clearing house requires the trader to provide cash or marketable securities as collateral. The word used by clearing houses to describe collateral is margin. Without margin, the clearing house is taking the risk that the market will move against the trader and the trader will not fulfill his or her obligations. The clearing house aims to set margin requirements sufficiently high that it is over 99% certain that this will not happen. On those few occasions where it does happen, the guaranty fund is used. As a result, failures by clearing houses are extremely rare.
John C. Hull, “Risk Management and Financial Institutions”, 5th Edition, Wiley Finance Series, 2018.
Daily Settlement or Marking to Market
To illustrate how margin accounts work, we consider a trader who contacts his or her broker to buy two December gold futures contracts. We suppose that the current futures price is $1,250 per ounce. Because the contract size is 100 ounces, the trader has contracted to buy a total of 200 ounces at this price. The broker will require the trader to deposit funds in a margin account. The amount that must be deposited at the time the contract is entered into is known as the initial margin. We suppose this is $6,000 per contract, or $12,000 in total. At the end of each trading day, the margin account is adjusted to reflect the trader’s gain or loss. This practice is referred to as daily settlement or marking to market.
John C. Hull, “Options, Futures, and Other Derivatives”, 10th Edition, Publisher: Pearson, 2018.
DAILY SETTLEMENT EXAMPLE
(obs)
(obs) - Each day thereafter, you must maintain $4,400 in the account so that on any given day when the balance is greater than $4,400, the excess over the initial margin can be withdrawn. We shall assume, however, that you do not withdraw the excess. If the balance falls below the $4,400 maintenance margin requirement, you receive a margin call and must deposit enough funds to bring the balance back up to the initial margin requirement.
Don M. Chance and Roberts Brooks, "An Introduction to Derivatives and Risk Management", 10th Edition, 2015.
BLOCKCHAIN TECHNOLOGY and CCPs
Blockchain technology, which is described as an incorruptible digital ledger of economic transactions that can be programmed to record financial transactions, arguably represents a new frontier for CCPs. In November 2015, clearinghouses from several nations joined forces to create a think tank known as the Post Trade Distributed Ledger Group, which studies how blockchain technology can affect the way in which security trades are cleared, settled, and recorded. The Group, which in 2018 began collaborating with the Global Blockchain Business Council, now includes around 40 financial institutions all around the world.
The PTDL Group believes new technology can reduce risk and margin requirements, save on operational costs, increase settlement cycle efficiency, and facilitate greater regulatory oversight—both before and after trading. And because this group’s members represent various parts of the securities settlement process, they comprehensively understand how the blockchain technology can aid the settlement, clearing, and reporting processes.