*** The Last Trading Day of all UK equity options will change from the current
third Wednesday of the expiry month to the third Friday of the expiry month.
All maturities from the Jan 04 contract month onwards (with the exception of the
Jan 04, Apr 04 and Oct 04 expiry months in VOD) will have the new third Friday
Last Trading Day.
Trading Platform
• LIFFE CONNECT™ Trading Host for Equity Options.
• Algorithm: Central order book applies a price-time trading algo-
rithm with priority given to the first order at the best price.
• Wholesale Services: Block Trading.
Contract Standard
Delivery will be 1,000 shares (or other such number of shares as
determined by the terms of the contract).
Exercise Price Intervals
The interval between the exercise prices is set according to a fixed
scale determined by the Exchange.
Introduction of new exercise prices
Additional exercise prices will be introduced after the underlying
index level has exceeded the second highest, or fallen below the
second lowest, available exercise price.
Option Premium
is payable in full by the buyer on the business day following a
transaction.
Economic and Monetary Union/Euro
Please refer to the full contract specification on the LIFFE web site
at www.liffe.com.
Unless otherwise indicated, all times are London times.
In the United States these products may only be offered and sold
to prescribed entities under specified conditions.
Source: Euronext.liffe.
It is important to note that the expiry cycle of the Euronext.liffe indi-
vidual equity options have been standardised to the March, June,
September and December cycle. From the clearing and settlement
point of view, there is a concentration of both activity, as the options
series approaches maturity and closing transactions take place, in the
exercise and assignment of positions.
Derivative products 25
A full list of the individual equity options and their tick size can be
found at www.liffe.com.
From a settlement point of view it is also important to note the
comment in the specification that relates to how the terms of
the specification might change due to a corporate action event on
the underlying. This is covered in more detail later in the book.
One very important aspect of the derivatives products available today
is the demand by market participants. In the exchange-traded environ-
ment this is reflected by the liquidity in the products. Liquidity must
be there for the users to have confidence that the obligations they have
entered into can be terminated by ‘closing out’ the position by entering
into an equal and opposite trade. For example, the seller of a future
who creates a short position has an obligation to go to delivery and can
remove that obligation only by purchasing a futures contract and then
closing out the two offsetting positions. The details, with the exception
of the price, must be the same, i.e. the maturity or delivery month.
It is vitally important that all closeouts are done correctly and
immediately if unwanted delivery is to be avoided.
Example
15th Jan. Sell 10 Mar. Position: Short 10 contracts
Widget futures @ $200
20th Feb. Buy 5 Mar. Position: Long of 5 contracts, short of
Widget futures @ $180 10 contracts
Close out 5 contracts Position: Short 5 contracts
3rd Mar. Buy 5 Mar. Position: Long of 5 contracts, short of
Widget futures @ $150 5 contracts
Close out 5 contracts Position: Flat (i.e. no obligations
remain)
One way that an investor can ascertain the liquidity in an exchange-
traded contract is to look at the data published by the exchange that
shows the volumes traded and also the ‘open interest’. The latter is the
number of contracts held open and which therefore will either be
traded out before maturity or will, in the case of futures, go to delivery.
High daily volume but a very low open interest might indicate that
there is little institutional client activity in that particular contract,
i.e. fund managers hedging portfolios and therefore holding open posi-
tions. Most of the trading is speculative and is termed as ‘day trading’.
If volatility falls, so too will the volume being traded.
26 Clearing and settlement of derivatives
There are also some marked differences between financial and
commodity derivatives. Producers and users of the relevant com-
modity, to enable a reduction in risk and forward planning on supply
and demand, have traditionally used commodity derivatives. To some
degree they are perhaps a more technical market place with a very
specific user base. Today, given the demand to generate returns on
investment and poorly performing equity markets and fairly stable
interest rates, commodities are an asset class that fund managers
have to look at and so the user base is widening.
Later in the book we will look at commodity derivatives in more detail
but by comparing the following contract specification of an oil future
with that of the index and bond future earlier in the chapter we will see
how some characteristics of the contract are similar to a financial
derivative whilst others are somewhat different.
IPE BRENT CRUDE FUTURES CONTRACT
BACKGROUND
The IPE Brent Crude futures contract provides a highly flexible
hedging instrument and trading mechanism. It is tailored specif-
ically to meet the oil industry’s need for an international crude oil
futures contract and is an integral part of the Brent pricing
complex, which also includes spot and forward markets.
The Brent pricing complex is used to price over 65 per cent of the
world’s traded crude oil. The IPE Brent Crude futures contract is
a deliverable contract based on EFP delivery with an option to
cash settle.
FEATURES OF THE CONTRACT
Increased flexibility
By providing a contract parallel to the physical market, the oil
industry has the opportunity to separate its pricing from supply
arrangements by means of EFPs and basis trading, giving greater
control and flexibility with regard to the timing of purchases and
sales.
Price transparency
Real-time prices are available through the major data vendors. As
a result, the price at which a particular contract is trading can be
known instantly by all participants.
Derivative products 27
IPE Brent Weighted Average (BWAVE)
The IPE Brent Weighted Average is produced on a daily basis. It
represents the average price of all trades executed on the market
floor for each contract each business day. Following its introduc-
tion in November 1999, the BWAVE has itself become a benchmark
price in its own right.
As well as being the basis for EFP, EFS and OTC transactions, it
is used directly by several major oil producing nations as the
basis for crude exports into Europe.
The BWAVE is published each day after the close of business for
that day. It was first published on 16 November 1999. An average
for each traded month is published in the prices section of this
site. The average is calculated for each traded month using trades
executed during IPE opening hours. All trade types are included in
the calculation except EFPs, EFSs, settlement and contra trades
which are excluded.
The calculation for each contract month is:
Sum (Trade Volume * Trade Price) Divided by Total Daily volume
(less EFP, EFS, Settlement & Contra Volume)
Due to the nature of the above calculation, the IPE does not pub-
lish a real-time BWAVE. The IPE does not support any unofficially
generated BWAVE Index. The official Brent Weighted Average is
updated once each business day.
Small parcel trading
The contract provides the opportunity to trade in small parcels
(multiples of 1,000 barrels) of less than the standard cargo size
necessary on the physical market.
Contract security
The London Clearing House Ltd (LCH) acts as the central counter-
party for trades conducted on the London exchanges. This enables
it to guarantee the financial performance of every contract registered
with it by its members (the clearing members of the exchanges) up
to and including delivery, exercise and/or settlement. LCH has no
obligation or contractual relationship with its members’ clients who
are non-member users of the exchange markets, or non-clearing
members of the exchanges.
28 Clearing and settlement of derivatives
CONTRACT SPECIFICATION
Date of launch
23 June 1988.
Trading hours
Open 02:00 Close 22:00(20:30 Fridays) – local time, electronic
Open 10:02 Close 19:30 – local time, open outcry.
Unit of trading
One or more lots of 1,000 net barrels (42,000 US gallons) of Brent
crude oil.
Specification
Current pipeline export quality Brent blend as supplied at Sullom
Voe.
Quotation
The contract price is in US dollars and cents per barrel.
Minimum price fluctuation
One cent per barrel, equivalent to a tick value of $10.
Maximum daily price fluctuation
There are no limits.
Daily margin
All open contracts are marked-to-market daily.
Trading period
Twelve consecutive months then quarterly out to a maximum
twenty-four months and then half yearly out to a maximum thirty-
six months.
Position limits
There are no limits to the size of position.
DELIVERY MECHANISM
Cessation of trading
Trading shall cease at the close of business on the business day
immediately preceding the 15th day prior to the first day of the
delivery month, if such 15th day is a banking day in London. If the
15th day is a non-banking day in London (including Saturday),
Derivative products 29
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