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Introduction
Agricultural markets across the world have moved away from government price intervention towards economic based markets. This has been mainly due to the pressure of a globalising world economy as well as failure of costly agricultural subsidy regimes and state controlled agricultural marketing boards. It is now common for smaller commodity markets to form exchanges, either cash or futures, which are playing an integral role in facilitating marketing and ensuring price transparency. Bulgaria, Poland, Romania and Hungary are examples of countries experiencing the same dynamic growth in their commodity markets as South Africa. The demise of agricultural marketing control boards in South Africa during the early 1990's and extensive liberalisation was the background that stimulated the formation of Safex's Agricultural Markets Division to trade agricultural derivatives.
The growth in the market has resulted from an increased number of participants, greater understanding of the market and the development of a broader base of marketing strategies based on the derivative products. In 2010, the division reinvented itself by introducing other commodity products and so rebranded to become the Safex Commodity Derivatives Division.
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sunflower seeds. Soybean contracts are quoted at their Rand value per ton, and comprise 25 tons per contract. The soybean contract trades at the same basis price in a number of registered silos with no location differentials. Daily price limits, limiting the daily movement of prices, add security to the market. If the limit is reached on two like contracts on two consecutive days the price limits are increased to 150% of the original limit and the extended limits will remain in place until the daily movement on all like contracts is less then the original limits. Extended price limits also result in increased initial margin requirements for those periods when the extended limits apply. Futures are quoted on the trading system as: Month of expiry, year of expiry, four letter code of commodity JUL10 WMAZ White maize contract DEC10 YMAZ Yellow maize contract SEP10 WEAT Wheat contract MAR10 SUNS Sunflower seeds contract MAY10 SOYA Soybean contract
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The following methodology is used when determining the mtm volatility: Options traded over the last hour of the trading session will be considered for the mtm process. Three strike prices (50 points) either side of the option at the money will be considered eg if at the money strike is 600, then 560, 580 and 620, 640 strikes will be considered in the process. If 60 or more contracts have traded for the entire day, the contract will be considered liquid. The opposite applies to illiquid contracts, if less than 60 contracts have traded for the entire day then the contract is classified illiquid. If classified as liquid, then a volume weighted average of 40 or more contracts will be required in the last hour of trade as the mtm volatility, if this quantity does not trade then the volatility will remain unchanged. If classified as illiquid, then a volume weighted average of 20 or more contracts will be required in the last hour of trade for the m-t-m volatility, if this quantity does not trade then the volatility will remain unchanged. As an exception, where the future contracts trade limit up or down for most of the option mtm period, only options traded on the delta option window will be considered for mtm volatility purposes. No options traded on price through the naked option window will be considered. If the number of delta options traded do not meet the liquid or illiquid criteria as described above, the bids and offers on the delta window will be considered as a last resort and at the exchanges discretion. The exchange reserves the right to make the final decision regarding the mtm volatility and may exercise its discretion as need be. As an exception, where the future contracts trade limit up or down for most of the option m-t-m period, only options traded on the delta option window will be considered for m-t-m volatility purposes. No options traded on price through the naked option window will be considered. If the number of delta options traded do not meet the liquid or illiquid criteria as described above, the bids and offers on the delta window will be considered as a last resort and at the exchanges discretion.
The exchange reserves the right to make the final decision regarding the m-t-m volatility and may exercise its discretion as need be. This implied volatility is then used to value all option positions.
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For example a short position holder could give notice on the September futures contract on the 31 August for delivery on the 1 September or his last notice day would be the 29 September for delivery on the 30 September. (For all delivery dates see Agricultural Markets Contract specifications on the web page). The deliveries are randomly allocated by computer programme to existing long position holders. A long position holder allocated stock will be notified through the clearing member of the allocation (the detailed allocation algorithm is available on the web page under the physical delivery subsection). Any long position holder (buyer of the commodity) could be allocated product at any time during the delivery month with one day's notice but is assured that he will receive such stock by the last day of the delivery month. Buyers are guaranteed that it will be at a registered silo and free along side rail. The best case scenario is being allocated maize in a silo convenient to the buyer however the worse case scenario is Randfontein. Therefore the location differential will always ensure that the basis Randfontein price is traded. The closing price (Mark-to-Market) on the notice day is the price at which contracts are closed. The location differentials and any outstanding storage is deducted from the amount payable by a long position holder (in the case of wheat a grade discount is also applicable). The exchange does not take any prepaid storage into account and the seller forfeits any storage costs that have been prepaid. Long position holders are charged a standard daily storage rate fixed for each marketing season and are responsible for storage from the delivery day onwards. Silo receipts have to be delivered to a broker who will in turn ensure that they reach the exchange no later than 12h45 on the notice day. The receipt will then be used to confirm the notice of delivery via the trading system. The trading system has being enhanced and is used to facilitate the entire delivery process onto the exchange.
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Delivery day Payments for products take place by 12h00 on the delivery day. Long position holders are able to collect silo receipts from the exchange from 14h00 onwards. Positions can still be opened or closed during the delivery month until the last trading day. The last trading day is the eighth last business day of each delivery month. Once the contract has closed for trading any position still open will have to be honored by payment or delivery (short position holders have until the last business day of the delivery month to make delivery). Margin Requirements during the Delivery Month Margin requirements used as a guarantee by the exchange change during the delivery month. Current margin requirements can be obtained from the exchange. On the first position day the daily price limits are removed to allow the alignment of the futures value to the value of the underlying product and initial margin is increased to cover the increased risk. After the last trading day initial margin is increased again. In the same way, all long position holders have to take delivery once they are assigned. All futures positions are converted to physical positions which are not Marked-to-Market on a daily basis. Since the risk increases, the initial margin requirement is increased accordingly in the same fashion as the short position holder.
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Producer is concerned that Maize will be sold in July at a low price. Maize price falls. If the producers sells maize in the market he will realise R1700/ton.
Results
The producer receives the discounted spot price (R1700/ton) for the whole crop.
The Long (Buying) Hedge This would be an appropriate strategy for a user of maize (e.g. miller). In August a miller decides to take advantage of a historically low maize price by hedging his planned November purchases. Physical Market
August November Miller needs to purchase Maize in November and wishes to be protected against rising prices. Maize price has risen by R100/ton. The miller buys maize at R700/ton resulting in a R100 notional loss. The miller pays R700/ton for the physical stock in November due to the price increase.
Futures Market
Miller buys November Maize futures contract at R600/ton. November futures have risen in line with the spot market to R700/ton. The miller sells back the futures contracts at the higher price. The R100/ton gain from the sale of the futures position offsets the increased price of the physical product and the miller effectively pays R600/t for the maize.
Results
Please Note: All examples used are only meant to help you understand the fundamentals of futures and options trading. They are not meant as investment advice, and as you can see, there is risk of loss. Also, commissions and fees were left out for simplicity's sake. Furthermore, the option prices quoted in the above examples may or may not be executable at the levels cited depending on market conditions prevailing at the specific time of execution.
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he purchased and there is a possibility that the price may decrease in the future. When an option is exercised, both the buyer and seller are assigned opposite futures positions on a random basis. Expiration: If the option is out-the-money the option holder could let it expire worthless by simply doing nothing. Example: Buy 100 July 800 WM1 calls for 15 R/ton (R1500 per contract or R150,000 total). The seller of the July 800 call is obliged to sell July White Maize futures at 800 R/ton at any time during the life of the option no matter how high the price is actually trading in the futures market. In return for this obligation the seller of the option will receive a premium which he keeps no matter what happens in the underlying futures market.
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Settlement method
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Settlement Method
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Settlement method
1700 contracts within 10 days of the 1st delivery day of the month except during the harvest period from March to May where the maximum limit allowed for will be 2500 contracts for all position holders.
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Settlement method
R3750/contract up to first notice day. At extended price limits, requirements increased to R5 000/contract R5000/contract up to expiry day. R10 000/contract up to last delivery day. R1 200/contract for calendar spreads. Closing futures price as determined by the Clearing House. Futures: R3.00/contract (incl VAT). Options: R1.50/contract (incl VAT). Physical delivery: R50.00/contract (incl VAT) 1600 contracts within 10 days of the 1st delivery day of the month except during the harvest period from March to May where the maximum limit allowed for will be 2400 contracts for all position holders. American style option contracts are available on all the above futures contracts for trading months March, May, July, September and December.
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Glossary of terms
Arbitrage Trading strategies designed to profit from price differences for the same or similar goods in different markets. Ask price (see Offer price) At-the-money An option is at-the-money if the strike price of the option is equal to the market price of the underlying asset. Bid price The quoted price at which a particular market dealer is willing to buy. Call Option An option contract that gives the holder the right, but not the obligation, to buy the underlying asset at a specified price (strike price) for a certain fixed period of time. The seller of a call option is obliged to deliver the underlying asset at the strike price. Clearing The settlement of a transaction, often involving exchange of payments and/or documentation. Clearing House An organisation, legally separate from the Exchange, which clears transactions and guarantees all trades (see novation). Delta A measure of how much an option premium changes given a unit change in the price of the underlying. Derivative A financial security whose value is determined, in part, from the value and characteristics of an underlying asset e.g. futures, options (both exchange traded and OTC). Exercise Implementation of the right under which the holder of an option is entitled to buy (in the case of a call) or sell (in the case of a put) the underlying asset. Exercise price (see Strike price)
Expiry, expiration date, maturity date Date and time upon which an option or future, and the right to exercise them, ceases to exist. Most commonly used to describe when the buyer / holder of an option ceases to have any rights under the contract, or when a futures contract month ceases trading. Hedge A conservative strategy used to limit price losses by effecting a transaction that protects an existing position. Dealing in such a manner as to reduce risk by taking a position that offsets an existing or anticipated exposure to a change in market prices. In-the-money A call option is in-the-money if the strike price is less than the market price of the underlying asset. A put option is in-the-money if the strike price is greater than the market price of the underlying asset. Initial margin A good faith deposit which both buyer and seller must lodge with the clearinghouse as security. Intrinsic value The amount by which an option is in-the-money (see above definition). Location Differential This is the indicative cost of transporting stock from any Safex registered silo to Randfontein. The traded price is always referred to as a Randfontein price while the price the buyer pays will be reduced by the cost differential to Randfontein of the silo he was allocated. Long position An investor has a long position when contracts are purchased. Margin (or Variation Margin) The cash payment that is required to maintain an initial margin position. This is determined daily by the Exchange via a process of Mark-to-Market. Margin requirement (for options) The amount an uncovered option writer (seller) is required to deposit and maintain to cover a position. The margin requirement is calculated daily.
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Mark-to-Market (M-t-M) The revaluation of a futures or options position at its current market price. All positions are marked-to-market by the clearinghouse, once a day. The profit/loss that is revealed by the re-valuation is received by or paid to the clearinghouse (known as variation margin). Novation The guaranteeing responsibility of a clearing house upon successful matching of a trade. The clearinghouse is substituted as the seller to every buyer and buyer to every seller on a principal to principal basis. Offer price (or Ask price) The quoted price at which a particular market trader is willing to sell. Out-of-the-money A call option is out-of-themoney if the strike price is greater than the market price of the underlying asset. A put option is out-of-the-money if the strike price is less than the market price of the underlying asset. Over the counter (OTC) Term used to describe trading in financial instruments off organised exchanges with the risk that performance by the counter parties is not guaranteed by an exchange. Physical (spot/cash) market The current market in the underlying asset for immediate delivery. Premium The fair value of an option contract, determined in the competitive marketplace, which the buyer of the option pays to the option writer for the rights conveyed by the option contract. Put option An option contract that gives the holder the right, but not the obligation, to sell the underlying asset at a specified price for a certain fixed period of time. The seller of a put option is obliged to take delivery of the underlying security at the put strike price. Physical delivery Safex makes use of a Safex silo receipt for physical delivery in completion of a futures contract. The silo receipt represents the specific
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quantity of stock in a registered Safex silo. The silo owner who stores the product guarantees the quality and quantity of the stock. Risk management The science of assessing and controlling risks with the aim of keeping them within acceptable bounds. Short position Selling a derivative when one does not own the physical security but intends supplying the physical security upon expiry of the contract. Silo receipt A transferable, but not negotiable document that represents title to a specific quantity, of a specified quality free alongside rail at a registered Safex silo. Spot market (See physical market ) Strike price The agreed price per share for which the underlying security may be purchased (in the case of a call) or sold (in the case of a put) by the option holder upon exercise of the option contract. Tick The smallest change in price movement of a contract permitted by the Exchange. (See contract specifications for each contracts tick). Time value The portion of the option premium that is attributable to the amount of time remaining until the expiration of the option contract. Time value is whatever value the option is worth in addition to its intrinsic value. Type The classification of an option contract as either a put or a call. Underlying asset The physical asset upon which a derivative contract is based (see also Physical). Variation Margin (See marking-to-market) Volatility A measure of the fluctuation in the market price of the underlying security. Mathematically, volatility is the annualised standard deviation of returns. Writer The seller of an option contract.
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Notes
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Disclaimer: This document is intended to provide general information regarding the JSE Limited and its affiliates and subsidiaries (JSE) and its products and services, and is not intended to, nor does it, constitute investment or other professional advice. It is prudent to consult professional advisers before making any investment decision or taking any action which might affect your personal finances or business. All information as set out in this document is provided for information purposes only and no responsibility or liability of any kind or nature, howsoever arising (including in negligence), will be accepted by the JSE, its officers, employees and agents for any errors contained in, or for any loss arising from use of, or reliance on this document. All rights, including copyright, in this document shall vest in the JSE. JSE is a trade mark of the JSE. No part of this document may be reproduced or amended without the prior written consent of the JSE. Compiled: November 2011.
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