THINKING OUTSIDE OF THE INDEX
EQUITY INDEX FUTURES & SWAPS
Tutorial and Case Studies
Tim McCourt
Executive Director, Equity Products
tim.mccourt@cmegroup.com
+1 (212) 299 2415
March 27, 2014
EDUCATIONAL MATERIALS
Prepared by CME Group | © 2014 CME Group. All rights reserved
Equity Index Futures & Swaps
•
•
What is an Equity Index Future?
•
How is a Equity Index Future Theoretically Priced?
•
Mechanics of a Future
•
Rolling of the Futures
•
Fair Value and Arbitrage – Banks, Props, Hedge Funds
What is an Equity Swap?
•
Common Definitions
•
Types of Equity Swaps
•
Examples of Swap Transactions and Cash Flows
Prepared by CME Group | © 2014 CME Group. All rights reserved
What is an Equity Index Future?
An Equity Index Future is a cash-settled contract on the value of a specific equity market index.
•
No physical delivery obligation
•
Cash Settlement is tied to initial transaction price and the index final settlement price
•
Special Opening Quotation (SOQ)
•
Expiration Calendar – Quarterly for major US Indices and Sectors, Bi-Monthly for USD-Bovespa ,
N225 and Nifty have Quarterly but add the first two monthly serials
•
Access points for trading – Open Out Cry, Globex, Ex-Pit (mostly EFP, small blocks - ClearPort or
Front End Clearing (FEC))
Prepared by CME Group | © 2014 CME Group. All rights reserved
Overview of U.S. Index Futures Market
Index Futures are one of the most important trading tools in the equity market
•
In terms of daily notional trading volume activity, index futures dwarf the cash market in the U.S.
• Currently, almost 90% of all CME Group Equity Index Futures Volume is electronic traded on the Globex platform,
which has seen a dramatic increases in Average Daily Volume (ADV) over the past 12 years
Market Size for ES Contract
Prepared by CME Group | © 2014 CME Group. All rights reserved
CFTC Commitment of Traders Report (Futures)
The Commitments of Traders (COT) reports provide a breakdown of each Tuesday’s open interest for
markets in which 20 or more traders hold positions equal to or above the reporting levels established by the
CFTC. This is publicly available information, and valuable for observing market participation shifts.
Link to Website  http://www.cftc.gov/MarketReports/CommitmentsOfTraders/Index.htm
* CFTC COT Data is as of March 18, 2014, raw .csv data transcribed to chart by CME Group
Prepared by CME Group | © 2014 CME Group. All rights reserved
Equity Index Futures & Swaps
•
•
What is an Equity Index Future?
•
How is a Equity Index Future Theoretically Priced?
•
Mechanics of a Future
•
Rolling of the Futures
•
Fair Value and Arbitrage – Banks, Props, Hedge Funds
What is an Equity Swap?
•
Common Definitions
•
Types of Equity Swaps
•
Examples of Swap Transactions and Cash Flows
Prepared by CME Group | © 2014 CME Group. All rights reserved
How is a Future Priced?
It is important to understand the variables that are used in pricing futures,
as different clients, and users of futures, have varying sensitivities to the
variables.
FV = Se(r-b)*t – D *
FV
S
(r-b)
t
D
Future Value of the Index
Current Spot Level of the Index
r = Risk Free Rate, b = Rebate; (r-b) = “All In” financing rate
Time to maturity in years
Dividends
* Please note that the variable D here is representative only, and is meant to show Discreet
Dividend points as they occur on Ex date, and would need to be formulaically adjusted to represent
the ex-dividend on the exact date.
Prepared by CME Group | © 2014 CME Group. All rights reserved
How is a Future Priced?
197
Future Value
187
177
167
INDEX PRICE
157
S
147
(1+r)^t
Se(r*t)
Se(r-b)*t
137
Se(r-b)*t-D
Se(r-b-D%)*t
127
117
107
97
T
0.08
0.16
0.25
0.33
0.41
0.50
0.58
TIME in Years
Prepared by CME Group | © 2014 CME Group. All rights reserved
0.66
0.75
0.83
0.91
0.997
How is a Future Priced?
CASH DEPOSIT
$100
Prepared by CME Group | © 2014 CME Group. All rights reserved
How is a Future Priced?
FV = S(1+r)t
TIME VALUE of MONEY, FUTURE VALUE
106
Future Value
$105
r = 5%, t = 1.0
105
104
INDEX PRICE
103
102
S
(1+r)^t
Se(r*t)
101
Se(r-b)*t
Se(r-b)*t-D
100
Se(r-b-D%)*t
S=100
99
98
97
T
0.08
0.16
0.25
0.33
0.41
0.50
0.58
TIME in Years
Prepared by CME Group | © 2014 CME Group. All rights reserved
0.66
0.75
0.83
0.91
0.997
How is a Future Priced?
FV = Se(rt)
CONTINUOUS COMPOUNDING
106
Future Value
$105.13
r = 5%, t = 1.0
105
104
INDEX PRICE
103
102
S
(1+r)^t
Se(r*t)
101
Se(r-b)*t
Se(r-b)*t-D
100
Se(r-b-D%)*t
S=100
99
98
97
T
0.08
0.16
0.25
0.33
0.41
0.50
0.58
TIME in Years
Prepared by CME Group | © 2014 CME Group. All rights reserved
0.66
0.75
0.83
0.91
0.997
How is a Future Priced?
FV = Se(rt)
CONTINUOUS COMPOUNDING
122
Future Value
$116.18
r = 15%, t = 1.0, Sert
117
$115.00
r = 15%, t = 1.0, S*(1+r) t
INDEX PRICE
112
S
(1+r)^t
Se(r*t)
Se(r-b)*t
107
Se(r-b)*t-D
Se(r-b-D%)*t
102
S=100
97
T
0.08
0.16
0.25
0.33
0.41
0.50
0.58
TIME in Years
Prepared by CME Group | © 2014 CME Group. All rights reserved
0.66
0.75
0.83
0.91
0.997
How is a Future Priced?
FV = Se(rt)
FUTURE VALUE (Continous)
106
Future Value
FV = $105.13
r = 5%, t = 1.0
105
104
INDEX PRICE
103
102
S
(1+r)^t
Se(r*t)
101
Se(r-b)*t
Se(r-b)*t-D
100
Se(r-b-D%)*t
S=100
99
98
97
T
0.08
0.16
0.25
0.33
0.41
0.50
0.58
TIME in Years
Prepared by CME Group | © 2014 CME Group. All rights reserved
0.66
0.75
0.83
0.91
0.997
How is a Future Priced?
FV = Se(r-b)*t
INTRODUCTION OF REBATE
106
Future Value
105
FV = $104.81
r=5%, b=0.30%, t=1.0
104
INDEX PRICE
103
102
S
(1+r)^t
Se(r*t)
101
Se(r-b)*t
Se(r-b)*t-D
100
Se(r-b-D%)*t
S=100
99
98
97
T
0.08
0.16
0.25
0.33
0.41
0.50
0.58
TIME in Years
Prepared by CME Group | © 2014 CME Group. All rights reserved
0.66
0.75
0.83
0.91
0.997
How is a Future Priced?
FV = Se(r-b)*t
INTRODUCTION OF REBATE
106
FV = $105.44
r=5%, b=(0.30%), t=1.0
Future Value
105
104
INDEX PRICE
103
102
S
(1+r)^t
Se(r*t)
101
Se(r-b)*t
Se(r-b)*t-D
100
Se(r-b-D%)*t
S=100
99
98
97
T
0.08
0.16
0.25
0.33
0.41
0.50
0.58
TIME in Years
Prepared by CME Group | © 2014 CME Group. All rights reserved
0.66
0.75
0.83
0.91
0.997
How is a Future Priced?
FV = Se(r-b)*t
INTRODUCTION OF REBATE
106
Future Value
105
FV = $104.81
r=5%, b=0.30%, t=1.0
104
INDEX PRICE
103
102
S
(1+r)^t
Se(r*t)
101
Se(r-b)*t
Se(r-b)*t-D
100
Se(r-b-D%)*t
S=100
99
98
97
T
0.08
0.16
0.25
0.33
0.41
0.50
0.58
TIME in Years
Prepared by CME Group | © 2014 CME Group. All rights reserved
0.66
0.75
0.83
0.91
0.997
How is a Future Priced?
FV = Se(r-b)*t
FUTURE VALUE INCLUSIVE OF REBATE
106
Future Value
105
FV = $104.81
r=5%, b=0.30%, t=1.0
104
INDEX PRICE
103
102
S
(1+r)^t
Se(r*t)
101
Se(r-b)*t
Se(r-b)*t-D
100
Se(r-b-D%)*t
S=100
99
98
97
T
0.08
0.16
0.25
0.33
0.41
0.50
0.58
TIME in Years
Prepared by CME Group | © 2014 CME Group. All rights reserved
0.66
0.75
0.83
0.91
0.997
How is a Future Priced?
FV = Se(r-b-D%)*t
FUTURE VALUE INCLUSIVE OF REBATE
with Linear Dividend Yield
106
Future Value
105
104
103
INDEX PRICE
FV = $102.25
r=5%, b=0.30%, D=2.5% t=1.0
102
S
(1+r)^t
Se(r*t)
101
Se(r-b)*t
Se(r-b)*t-D
100
Se(r-b-D%)*t
S=100
99
98
97
T
0.08
0.16
0.25
0.33
0.41
0.50
0.58
TIME in Years
Prepared by CME Group | © 2014 CME Group. All rights reserved
0.66
0.75
0.83
0.91
0.997
How is a Future Priced?
FV = Se(r-b)*t – D *
FUTURE VALUE INCLUSIVE OF REBATE
with Month End Dividends
106
Future Value
105
104
103
INDEX PRICE
FV = $102.26
r=5%, b=0.30%, D=2.5% t=1.0
102
S
(1+r)^t
Se(r*t)
101
Se(r-b)*t
Se(r-b)*t-D
100
Se(r-b-D%)*t
S=100
99
98
97
T
0.08
0.16
0.25
0.33
0.41
0.50
0.58
TIME in Years
* Please note that the variable D here is representative only, and is meant to show Discreet Month
End Dividend points, and would need to be formulaically adjusted to represent the ex-dividend on
the exact date.
Prepared by CME Group | © 2014 CME Group. All rights reserved
0.66
0.75
0.83
0.91
0.997
How is a Future Priced?
FV = Se(r-b)*t – D *
FUTURE VALUE INCLUSIVE OF REBATE
with Actual Dividend Ex Dates
106
Future Value
105
104
103
INDEX PRICE
FV = $102.26
r=5%, b=0.30%, D=2.5% t=1.0
102
S
(1+r)^t
Se(r*t)
101
Se(r-b)*t
Se(r-b)*t-D
100
Se(r-b-D%)*t
S=100
99
98
97
T
0.08
0.16
0.25
0.33
0.41
0.50
0.58
TIME in Years
* Please note that the variable D here is representative only, and is meant to show Discreet
Dividend points as they occur on Ex date, and would need to be formulaically adjusted to represent
the ex-dividend on the exact date.
Prepared by CME Group | © 2014 CME Group. All rights reserved
0.66
0.75
0.83
0.91
0.997
How is a Future Priced?
FV = Se(r-b)*t – D *
ALL INCLUSIVE THEO FUTURE VALUE
with Actual Dividend Ex Dates
103
Future Value
FV = $102.26
r=5%, b=0.30%, D=2.5% t=1.0
102
INDEX PRICE
101
S
100
(1+r)^t
S=100
Se(r*t)
Se(r-b)*t
Se(r-b)*t-D
99
Se(r-b-D%)*t
98
97
T
0.08
0.16
0.25
0.33
0.41
0.50
0.58
TIME in Years
* Please note that the variable D here is representative only, and is meant to show Discreet
Dividend points as they occur on Ex date, and would need to be formulaically adjusted to represent
the ex-dividend on the exact date.
Prepared by CME Group | © 2014 CME Group. All rights reserved
0.66
0.75
0.83
0.91
0.997
How is a Future Priced?
ALL INCLUSIVE THEO FUTURE VALUE
with Dividend Comparison
103
Future Value
FV = $102.26
r=5%, b=0.30%, D=2.5% t=1.0
Linear Dividend Yield UNDER values index for
these time periods
102
101
INDEX PRICE
Linear Dividend Yield Over values index for
these time periods
S
100
(1+r)^t
S=100
Se(r*t)
Se(r-b)*t
Se(r-b)*t-D
99
Se(r-b-D%)*t
98
97
T
0.08
0.16
0.25
0.33
0.41
0.50
0.58
TIME in Years
Prepared by CME Group | © 2014 CME Group. All rights reserved
0.66
0.75
0.83
0.91
0.997
How is a Future Priced?
ALL INCLUSIVE THEO FUTURE VALUE
with Dividend Comparison
103
Future Value
FV = $102.26
r=5%, b=0.30%, D=2.5% t=1.0
102
INDEX PRICE
101
S
100
(1+r)^t
S=100
Se(r*t)
Se(r-b)*t
Se(r-b)*t-D
99
Se(r-b-D%)*t
98
97
T
0.08
0.16
0.25
0.33
0.41
0.50
0.58
TIME in Years
Prepared by CME Group | © 2014 CME Group. All rights reserved
0.66
0.75
0.83
0.91
0.997
How is a Future Priced?
It is important to understand the variables that are used in pricing futures,
as different clients, and users of futures, have varying sensitivities to the
variables.
FV = Se(r-b)*t – D *
FV
S
(r-b)
t
D
Future Value of the Index
Current Spot Level of the Index
r = Risk Free Rate, b = Rebate; (r-b) = “All In” financing rate
Time to maturity in years
Dividends
Heuristically, the future value price formula can be expressed as:
Future Value = Spot Index Value + Finance Charges - Dividends
Additionally, future value can be expressed in basis terms to the underlying index:
Future Basis = Future Value of the Index - Spot Index Level
* Please note that the variable D here is representative only, and is meant to show Discreet
Dividend points as they occur on Ex date, and would need to be formulaically adjusted to represent
the ex-dividend on the exact date.
Prepared by CME Group | © 2014 CME Group. All rights reserved
Changes in Interest Rate – variable ‘r’
FV = $102.26
Base Case
FV = $104.96
r increase s to 10%, Day 180
FV = $103.85
FV = $100.15
r decrease s to 1%, Day 180
Prepared by CME Group | © 2014 CME Group. All rights reserved
r with sporadic increases and decreases
Changes in Discreet Dividends – variable ‘D’
FV = $102.26
Base Case
FV = $101.74
Unexpected Dividend Increase, .50 Index Points on Day 113
FV = $100.19
FV = $102.67
Several Companies stop dividend, .10 Index Points per Quarter reduction
Prepared by CME Group | © 2014 CME Group. All rights reserved
Sporadic Increases and Decreases, net Increase of Dividends of 2.0 Index Points
Equity Index Futures & Swaps
•
•
What is an Equity Index Future?
•
How is a Equity Index Future Theoretically Priced?
•
Mechanics of a Future
•
Rolling of the Futures
•
Fair Value and Arbitrage – Banks, Props, Hedge Funds
What is an Equity Swap?
•
Common Definitions
•
Types of Equity Swaps
•
Examples of Swap Transactions and Cash Flows
Prepared by CME Group | © 2014 CME Group. All rights reserved
Mechanics of Stock Index Futures
Value of Equity Index Future Contracts
Future Contract Value
=
Contract Quoted Value
E-Mini S&P June ‘14
=
1,857.00
E-Mini S&P June ‘13
=
$92,850.00
x
Contract Multiplier
x
$50.00
Popular e-Mini stock index futures:
E-mini S&P 500
E-mini Nasdaq-100
E-mini S&P
MidCap 400
E-mini DJIA ($5)
Contact Multiplier
$50 x S&P 500 Index
$20 x Nasdaq-100 Index
$100 x S&P MidCap
400
$5 x Dow Jones
Industrial Avg
Minimum Price
Fluctuation (Tick)
Price Limits
0.25 index points
($12.50)
0.50 index points
($10.00)
0.10 index points
($10.00)
1.00 index points
($5.00)
Contract Months
Trading Hours (CT)
Limits at 7%, 13%, 20% moves; 5% up/down
First 5 Months in March Quarterly Cycle – (Mar, Jun, Sep, Dec)
Mon - Thu: 5:00 p.m. previous day to 4:15 p.m., with a trading halt between 3:15 p.m. and 3:30 p.m.
Trading Ends at
8:30 am on 3rd Friday of month
Cash Settlement
Vs. Special Opening Quote (SOQ)
Position Limits
Ticker
First 4 months in
March quarterly cycle
28,000 standard S&P
contracts
10,000 standard Nasdaq
contracts
5,000 standard MidCap
contracts
50,000 contracts
ES
NQ
ME
YM
Prepared by CME Group | © 2014 CME Group. All rights reserved
29
Mechanics of Stock Index Futures
Cash Settlement Mechanism
• Equity Index Futures are Marked-to- Market (MTM) on a daily basis, which in the
aggregate, is the difference between the contract traded price at inception of position
and the daily settlement price of the contract.
Futures Trade:
Buy 100 ESM14 Contracts @ 1850.75
Settlement Price:
1857.00 (as per S&P Daily Settlement Mechanism)
MTM / P&L =
+ Index Points * Contract Multiplier $
MTM / P&L =
+ 6.25 * $50.00 = +$312.50
• Cash Settlement of Contract at Expiry is against the underlying cash index’s Final
Settlement Price as defined by the contract specifications
• Special Opening Quotation (SOQ)
• VWAP over contract specified time period on Expiration Date (Ibovespa)
• Cash Index Official Close (Nifty)
Prepared by CME Group | © 2014 CME Group. All rights reserved
30
Mechanics of Stock Index Futures
Future Contract Expiration and Convergence to Cash Index Value
As futures get closer to expiry, the contract price will naturally converge to the cash index.
This is because the future’s contract price is effectively the future price of the cash index
on a given date when accounting for cost of carry and dividends. When you reach that
date and there is no more cost of carry, or dividends, only the spot value of the index
remains.
FV = Se(r-b)*t – D
If D = 0, we can rewrite the formula as:
FV = Se(r-b)*t – 0
FV = Se(r-b)*t
At Expiration, t = 0, which makes the entire exponential term equal to 0.
FV = Se(r-b)* 0
FVExpiry = Se(0)
For any f(x) = e(x), where x = 0, f(x) = e(0) = 1 so, for maturity t = 0 where all dividends have
gone “Ex” future value is:
FVExpiry = S * 1
FVExpiry = Spot Value of Index
Prepared by CME Group | © 2014 CME Group. All rights reserved
31
Mechanics of Stock Index Futures
Cost of Carry … not the same as “Rich” or “Cheap”
• If dividend stream < all-in finance costs  negative carry
• If dividend stream > finance costs  positive carry
• RICH or CHEAP?
ALL IN FINANCING RATE ? < = > ? RISK FREE RATE
Prepared by CME Group | © 2014 CME Group. All rights reserved
Equity Index Futures & Swaps
•
•
What is an Equity Index Future?
•
How is a Equity Index Future Theoretically Priced?
•
Mechanics of a Future
•
Rolling of the Futures
•
Fair Value and Arbitrage – Banks, Props, Hedge Funds
What is an Equity Swap?
•
Common Definitions
•
Types of Equity Swaps
•
Examples of Swap Transactions and Cash Flows
Prepared by CME Group | © 2014 CME Group. All rights reserved
Futures Expiry and Rolling Futures
The standard convention for Index Futures Expiry is quarterly on the third Friday
of March, June, September and December against the Special Opening
Quotation (SOQ).
After a contract expires, it is no longer tradable, it is worthless and devoid of any
exposure to the underlying index.
Scenario 1:
Futures do not exist into perpetuity like cash equities
Wednesday Close
Thursday Session
Position
Exposure Value
+1,000 SPM13
406,125,000.00
Thursday Close
Position
NO TRADES
+1,000 SPM13
Friday SOQ
Exposure Value
406,125,000
Friday Session
Position
1626.5
+1,000 SPM13 EXPIRED
Change in Exposure
Exposure Value
0.00
No MOO Trade
406,125,000.00
Scenario 2:
406,125,000
-
(406,125,000)
Since futures expire against the cash index level, you can seamlessly replace delta with the cash index
Wednesday Close
Thursday Session
Position
Exposure Value
+1,000 SPM13
406,125,000.00
Thursday Close
Position
NO TRADES
+1,000 SPM13
406,125,000.00
Prepared by CME Group | © 2014 CME Group. All rights reserved
Friday SOQ
Exposure Value
406,125,000
406,125,000
Friday Session
Position
1626.5
+1,000 SPM13 EXPIRED
BUY SPX MOO
+ SPX STOCK BASKET
Change in Exposure
Exposure Value
0.00
406,125,000
-
0.00
Futures Expiry and Rolling Futures
ROLLING FUTURES is a calendar spread transaction where you simultaneously
trade out of the expiring near contract and trade into the deferred (far) contract.
If you are a Buyer of the Near Future and a Seller of the Far Future, you are a
SELLER of the Roll.
If you are a Seller of the Near Future and a Buyer of the Far Future, you are a
BUYER of the Roll.
Scenario 3:
Wednesday Close
Thursday Session
Position
Exposure Value
+1,000 SPM13
406,125,000.00
Thursday Close
Position
-1,000 SPM13
0 SPM13
+1,000 SPU13
+1,000 SPU13
Friday SOQ
Exposure Value
-
406,125,000.00
Prepared by CME Group | © 2014 CME Group. All rights reserved
Position
1626.5
406,125,000.00
BUYS ROLL
Change in Exposure
Exposure Value
-
+1,000 SPU13
No MOO Trade
406,125,000.00
Friday Session
406,125,000.00
-
406,125,000.00
0.00
Futures Expiry and Rolling Futures
Roll Level = Far Contract Future Value – Near Contract Future Value
June Roll
= Sep 2013 e-Mini S&P Contract – June 2013 e-Mini S&P Contract
= 1619.00 – 1624.50
= - 5.50 Index Points
•
“Richness” or “Cheapness” of the Roll is an expression of the implied financing
• Implied “All-In” (r-b) Financing Rate < Benchmark Interest Rate = CHEAP
• Implied “All-In” (r-b) Financing Rate = Benchmark Interest Rate = FAIR
• Implied “All-In” (r-b) Financing Rate > Benchmark Interest Rate = RICH
USD Libor
Prepared by CME Group | © 2014 CME Group. All rights reserved
Futures Expiry and Rolling Futures
Solving For the Implied Roll Rate – what (r-b)% is used to the Far Expiry?
Roll Level
- 5.50
- 5.50 + 1624.50
- 5.50 +1624.50 + DFC
1619.00 + 11.62
1630.62
S
1630.62
S
LN 1630.62
1626.67
LN
= Far Contract Future (FC) – Near Contract Future (NC)
= (Se(r-b)tFC – DFC) – 1624.50
= Se(r-b)tFC – DFC
= Se(r-b)tFC
= Se(r-b)tFC
= e(r-b)tFC
= e(r-b)tFC
e(r-b)tFC
=
LN
1.002428274
=
(r-b)tFC
0.00242533
tFC
=
(r-b)
=
(r-b)
0.00242533
.369444
.6565% = (r-b)
Prepared by CME Group | © 2014 CME Group. All rights reserved
Futures Expiry and Rolling Futures
(r-b) = 0.6565%
Interpolated USD Libor Rate to Far Contract Expiry = 0.33553%
The Jun13:Sep13 Roll, at -5.50 is trading RICH (0.6565% > 0.33553%) by 32bps
(r-b) = 0.6565%
r = 0.33553%, therefore “- b” = 0.32097%, b = - 0.32097%
This is the negative rebate scenario mentioned earlier.
So in terms of the future formula variables, the rebate variable b can be used to
determine if the future is trading at a premium or discount.
If b is negative, and therefore additive, to the risk free rate the future is trading at a
premium or RICH to the risk free rate. The opposite holds true if b is a positive
number and is decremental to the risk free rate. If b was zero, then the future
would be trading at Fair Value.
Prepared by CME Group | © 2014 CME Group. All rights reserved
Equity Index Futures & Swaps
•
•
What is an Equity Index Future?
•
How is a Equity Index Future Theoretically Priced?
•
Mechanics of a Future
•
Rolling of the Futures
•
Fair Value and Arbitrage – Banks, Props, Hedge Funds
What is an Equity Swap?
•
Common Definitions
•
Types of Equity Swaps
•
Examples of Swap Transactions and Cash Flows
Prepared by CME Group | © 2014 CME Group. All rights reserved
Fair Value and Passive Index Arbitrage
What if your All-in financing rate,
(r-b) differs than the implied future’s financing rate?
Passive Index Arbitrage:
June 2013 S&P 500 Contract, 133 Days to Expiry
Sell Futures and Buy Stock if your cost of cash is less than future financing
Futures Market Price: 1619.00
Implied All-in Financing Rate: 0.6565%
Spot Cash Index Level: 1626.67
Dividend Assumption: 11.62
Your Theoretical Futures Price: 1617.46
Implied All-in Financing Rate: 0.40%
Spot Cash Index Level: 1626.67
Dividend Assumption: 11.62
Prepared by CME Group | © 2014 CME Group. All rights reserved
Fair Value and Passive Index Arbitrage
If you can access your cheaper .40% financing you can sell the future, hedge
yourself with the cash basket and collect +1.544 per contract.
Buy Stocks in perfect replication
Incur Finance Charges @ .40% for 133 Days
Receive Dividend Cash Flows from Long Stock
- 1,626.67
2.41
+ 11.62
Total Cash Outlay/Future Break Even Price
Sell Futures at Market (Cash Inflow at Maturity)
- 1,617.46
+1,619.00
Net Arbitrage Difference
+ 1.54 PROFIT
Prepared by CME Group | © 2014 CME Group. All rights reserved
Fair Value and Passive Index Arbitrage
What if your All-in financing rate,
(r-b) differs than the implied future’s financing rate?
Passive Index Arbitrage:
June 2013 S&P 500 Contract, 133 Days to Expiry
Buy Futures and Sell Stock if your cost of cash is more than future financing
Futures Market Price: 1619.00
Implied All-in Financing Rate: 0.6565%
Spot Cash Index Level: 1626.67
Dividend Assumption: 11.62
Your Theoretical Futures Price: 1620.17
Implied All-in Financing Rate: 0.85%
Spot Cash Index Level: 1626.67
Dividend Assumption: 11.62
Prepared by CME Group | © 2014 CME Group. All rights reserved
Fair Value and Passive Index Arbitrage
If your financing costs are higher, and you can deposit cash and earn the
0.85% financing you can BUY the future, hedge yourself with the short
cash basket and collect +1.17 per contract.
Short Stocks in perfect replication
Deposit Sale Proceeds @ 0.85%* for 133 Days
Pay Dividend Cash Flows from Long Stock
+ 1,626.67
+
5.12
11.62
Total Cash Inflow/Future Break Even Price
+ 1,620.17
Buy Futures at Market (Cash Outflow at Maturity) - 1,619.00
Net Arbitrage Difference
* assumes 0.85% earned net of borrow cost
Prepared by CME Group | © 2014 CME Group. All rights reserved
+1.17 PROFIT
Fair Value and Active Index Arbitrage
What if your traded Cash Index Spot Level,
‘S’ differs than the derived future’s Cash Index Spot Level?
Active Index Arbitrage:
June 2013 S&P 500 Contract, 133 Days to Expiry
Market Futures Basis is -7.67 (1619.00 – 1626.67)
Sell Futures and Buy Stock if you can execute cash index at a lower level
Futures Market Price: 1619.00
Implied All-in Financing Rate: 0.6565%
(market assumption)
Spot Cash Index Level: 1626.67
(derived observation)
Dividend Assumption: 11.62
(market assumption)
Your Theoretical Futures Price: 1617.33
Implied All-in Financing Rate: 0.6565%
Spot Cash Index Level: 1625.00
Dividend Assumption: 11.62
Prepared by CME Group | © 2014 CME Group. All rights reserved
(market assumption)
(competitive edge)
(market assumption)
Fair Value and Active Index Arbitrage
If you can execute the cash index in perfect replication at a lower price level,
you BUY the Stock Basket and Sell the Futures to collect +1.67 per
contract
Buy Stocks cheaper, in perfect replication
Incur Finance Charges @ .40% for 133 Days
Receive Dividend Cash Flows from Long Stock
- 1,625.00
3.95
+
11.62
Total Cash Outflow/Future Break Even Price
Sell Futures at Market (Cash Inflow at Maturity)
- 1,617.33
+ 1,619.00
Net Arbitrage Difference
+1.67 PROFIT
* assumes 0.85% earned net of borrow cost
Prepared by CME Group | © 2014 CME Group. All rights reserved
Fair Value and Active Index Arbitrage
Active Arbitrage traders, look to lock in the profit as soon as possible.
Recall, the market basis is -7.67 (1619.00 – 1626.67)
Buy Stocks cheaper, in perfect replication
Sell Futures at Market (Cash Inflow at Maturity)
Traded Basis (Futures – Cash Index)
- 1,625.00
+ 1,619.00
6.00
EXIT STRATEGY – TRADE EFP:
Buy Futures @ 1619.00
Sell Physical Equivalent @ 1626.67
Buy SPX June EFP, delta neutral @ Basis
- 1,619.00
+ 1,626.67
+
7.67
Net Arbitrage Difference, No Exposure
- Futures at Market, + Futures EFP
+ Index Cash Basket, - EFP Physical
+1.67 PROFIT
$0 Delta
$0 Delta
Prepared by CME Group | © 2014 CME Group. All rights reserved
Why is the Market not clearing; why is it not efficient?
What is different the last few US Future rolls; why has it gotten so expensive and
behaving differently each roll?
Why are the Passive Index Arbitragers with access to better funding, not trading
the Richness of the roll away?
Are clients concerned with new regulations around arbitrage and proprietary
trading?
Are the banks, the supply side of the roll, being charged higher internal funding
rates to post Initial and Variation margin for futures; has this eroded the
profitability of the trade?
Are there other non-economic factors to consider – what is the current risk-reward
profile for the arbitragers on the Street? Is this causing a contagion effect?
Is the Return on Assets (ROA), or Return on Equity (ROE), required by clients’
increasing such that there are more attractive asset classes than Equities
available to arbitrage or invest in?
Prepared by CME Group | © 2014 CME Group. All rights reserved
Equity Index Futures & Swaps
•
•
What is an Equity Index Future?
•
How is a Equity Index Future Theoretically Priced?
•
Mechanics of a Future
•
Rolling of the Futures
•
Fair Value and Arbitrage – Banks, Props, Hedge Funds
What is an Equity Swap?
•
Common Definitions
•
Types of Equity Swaps
•
Examples of Swap Transactions and Cash Flows
Prepared by CME Group | © 2014 CME Group. All rights reserved
What is an Equity Swap
Prepared by CME Group | © 2014 CME Group. All rights reserved
Equity Index Futures & Swaps
•
•
What is an Equity Index Future?
•
How is a Equity Index Future Theoretically Priced?
•
Mechanics of a Future
•
Rolling of the Futures
•
Fair Value and Arbitrage – Banks, Props, Hedge Funds
What is an Equity Swap?
•
Common Definitions
•
Types of Equity Swaps
•
Examples of Swap Transactions and Cash Flows
Prepared by CME Group | © 2014 CME Group. All rights reserved
What is an Equity Swap – Common Definitions
SWAP SELLER
The Counterparty that PAYS the Positive Equity Performance and Dividends (if applicable), and RECEIVES the Negative Equity
Performance and Financing. The swap seller is Short the Equity Swap Exposure.
SWAP BUYER
The Counterparty that RECEIVES the Positive Equity Performance and Dividends (if applicable), and PAYS the Negative Equity
Performance and Financing. The Swap Buyer is Long the Equity Swap Exposure.
UNDERLYING
The identified asset of the swap on which the performance payment will be calculated. For Equity Swaps this will either be a Single
Share (Common or Preferred), a Basket of Shares, a Mutual Fund, an ETF, or an Index.
NOTIONAL
The total exposure to the underlying of the swap, for the given period. Equal to 𝑁𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝑆𝑤𝑎𝑝 𝑈𝑛𝑖𝑡𝑠 × 𝑃𝑟𝑖𝑐𝑒𝐼𝑛𝑖𝑡𝑖𝑎𝑙 and can
either be a swap that RESETS where a new Initial Price is observed at an agreed upon schedule with performance payments
exchanged on reset, or a BULLET Swap where it is fixed at inception with one performance payment made at maturity.
REFERENCE RATE
The identified base benchmark used to calculate the interest liability for the period for the given notional, e.g. USD 3-month LIBOR
SPREAD
The premium, or discount, applied to the observed Reference Rate used to calculate the interest liability, or coupon, to be
exchanged for the period. This is usually stated, or agreed to, in basis points (bps, where 1bps = 0.01%)
Prepared by CME Group | © 2014 CME Group. All rights reserved
Equity Index Futures & Swaps
•
•
What is an Equity Index Future?
•
How is a Equity Index Future Theoretically Priced?
•
Mechanics of a Future
•
Rolling of the Futures
•
Fair Value and Arbitrage – Banks, Props, Hedge Funds
What is an Equity Swap?
•
Common Definitions
•
Types of Equity Swaps
•
Examples of Swap Transactions and Cash Flows
Prepared by CME Group | © 2014 CME Group. All rights reserved
What is an Equity Swap – Types of Equity Swaps
Price Return Swap (PRS)
An Equity Swap that only exchanges the Equity (Stock or Index) Price Performance and Financing. The per period Swap Leg
Payments applicable in a PRS are:
• 𝐸𝑞𝑢𝑖𝑡𝑦 𝐿𝑒𝑔 𝑃𝑎𝑦𝑚𝑒𝑛𝑡 = 𝑁𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝑆𝑤𝑎𝑝 𝑈𝑛𝑖𝑡𝑠 × 𝑃𝑟𝑖𝑐𝑒𝑓𝑖𝑛𝑎𝑙 − 𝑃𝑟𝑖𝑐𝑒𝐼𝑛𝑖𝑡𝑖𝑎𝑙
• 𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝐿𝑒𝑔 𝑃𝑎𝑦𝑚𝑒𝑛𝑡 = 𝑁𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝑆𝑤𝑎𝑝 𝑈𝑛𝑖𝑡𝑠 × 𝑃𝑟𝑖𝑐𝑒𝐼𝑛𝑖𝑡𝑖𝑎𝑙 × 𝑅𝑒𝑓𝑒𝑟𝑒𝑛𝑐𝑒 𝑅𝑎𝑡𝑒 ± 𝑆𝑝𝑟𝑒𝑎𝑑 ×
𝐷𝑎𝑦𝑠
360
Total Return Swap (TRS)
An Equity Swap that not only exchanges the Equity (Stock or Index) Price Performance and Financing, but also passes through the
associated Dividends. The per period Swap Leg Payments applicable in a TRS are:
• 𝐸𝑞𝑢𝑖𝑡𝑦 𝐿𝑒𝑔 𝑃𝑎𝑦𝑚𝑒𝑛𝑡 = 𝑁𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝑆𝑤𝑎𝑝 𝑈𝑛𝑖𝑡𝑠 × 𝑃𝑟𝑖𝑐𝑒𝐹𝑖𝑛𝑎𝑙 − 𝑃𝑟𝑖𝑐𝑒𝐼𝑛𝑖𝑡𝑖𝑎𝑙
• 𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑 𝐿𝑒𝑔 𝑃𝑎𝑦𝑚𝑒𝑛𝑡 = 𝑁𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝑆𝑤𝑎𝑝 𝑈𝑛𝑖𝑡𝑠 × 𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑 𝑂𝑏𝑠𝑒𝑟𝑣𝑎𝑡𝑖𝑜𝑛
• 𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝐿𝑒𝑔 𝑃𝑎𝑦𝑚𝑒𝑛𝑡 =
𝑁𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝑆𝑤𝑎𝑝 𝑈𝑛𝑖𝑡𝑠 × 𝑃𝑟𝑖𝑐𝑒𝐼𝑛𝑖𝑡𝑖𝑎𝑙 × 𝑅𝑒𝑓𝑒𝑟𝑒𝑛𝑐𝑒 𝑅𝑎𝑡𝑒 ± 𝑆𝑝𝑟𝑒𝑎𝑑 ×
𝐷𝑎𝑦𝑠
360
*Please note that most “Total Return Index Swaps”, e.g. swaps on the SPTR, XNDX, DJITR Indices, are Price Return Swaps on a Total Return Index with no
dividend leg (dividends are reinvested in the underlying index price) and are not Total Return Swaps
Dividend Swaps
A swap that exchanges a series of net cash payments at defined intervals, with one variable amount based on the total “Ex”
dividends of the underlying equity for the period (performance) and one agreed upon fixed “Ex” dividend amount per period (fee)..
• 𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑 𝑆𝑤𝑎𝑝 𝑃𝑎𝑦𝑚𝑒𝑛𝑡 = 𝑆𝑤𝑎𝑝 𝑈𝑛𝑖𝑡𝑠 × 𝑁𝑜𝑡𝑖𝑜𝑛𝑎𝑙 𝑝𝑒𝑟 𝑈𝑛𝑖𝑡 × "𝐸𝑥" 𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑𝑠𝐴𝑐𝑡𝑢𝑎𝑙 − "𝐸𝑥" 𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑𝐹𝑖𝑥𝑒𝑑
Variance Swap (Equity Index)
A swap that exchanges one net cash payment at maturity with one variable amount based on the realized variance at maturity
(performance) and one agreed upon fixed amount that acts as the strike (fee)..
• 𝑉𝑎𝑟𝑖𝑎𝑛𝑐𝑒 𝑃𝑎𝑦𝑚𝑒𝑛𝑡 = 𝑁𝑣𝑎𝑟 𝜎 2 𝑟𝑒𝑎𝑙𝑖𝑧𝑒𝑑 − 𝜎 2 𝑠𝑡𝑟𝑖𝑘𝑒
• Where, 𝑁𝑣𝑎𝑟 = 𝑉𝑎𝑟𝑖𝑎𝑛𝑐𝑒 𝑁𝑜𝑡𝑖𝑜𝑛𝑎𝑙 𝑜𝑟 𝑈𝑛𝑖𝑡𝑠, 𝜎 2 𝑟𝑒𝑎𝑙𝑖𝑧𝑒𝑑 = 𝑎𝑛𝑛𝑢𝑎𝑙𝑖𝑧𝑒𝑑 𝑟𝑒𝑎𝑙𝑖𝑧𝑒𝑑 𝑣𝑎𝑟𝑖𝑎𝑛𝑐𝑒, 𝑎𝑛𝑑 𝜎 2 𝑠𝑡𝑟𝑖𝑘𝑒 = 𝑣𝑎𝑟𝑎𝑖𝑎𝑛𝑐𝑒 𝑠𝑡𝑟𝑖𝑘𝑒
Prepared by CME Group | © 2014 CME Group. All rights reserved
Equity Index Futures & Swaps
•
•
What is an Equity Index Future?
•
How is a Equity Index Future Theoretically Priced?
•
Mechanics of a Future
•
Rolling of the Futures
•
Fair Value and Arbitrage – Banks, Props, Hedge Funds
What is an Equity Swap?
•
Common Definitions
•
Types of Equity Swaps
•
Examples of Swap Transactions and Cash Flows
Prepared by CME Group | © 2014 CME Group. All rights reserved
What is an Equity Swap? Client Goes Long Swap
EQUITY PERFORMANCE
FINANCING + SPREAD
Prepared by CME Group | © 2014 CME Group. All rights reserved
What is an Equity Swap? Client Goes Short Swap
COLLATERAL
AGENT LENDERS
INTERNAL STOCK
BORROW LOAN
(SBL) DESK
PROCEEDS
REBATE
STOCK
(COLLATERAL)
%
EQUITY PERFORMANCE
FINANCING + SPREAD
STOCK
$$$
SHORT SALE
PROCEEDS
MARKET
(Stock Basket,
ETF, Swaps)
Prepared by CME Group | © 2014 CME Group. All rights reserved
SPTR SWAP – 1Y vs. 3mL + 35bps, LOCKED – NO EARLY TERMINATION RIGHTS
Price Return Swap on the S&P 500 Total Return Index, 1 Year Maturity, Equity and Interest Reset and Pay Quarterly, No Right to Early Termination
·
·
·
·
·
·
·
·
·
·
·
·
Prepared by CME Group | © 2014 CME Group. All rights reserved
35,000 units traded on swap on 28-May-2013 for One Year against 3m
USD Libor, with both Equity and Interest Resetting and Paying quarterly.
Initial SPTR Price is 2921.88.
Swap Notional = Units x SPTR Price
SPTR Observation Price is the Official Close as published by S&P.
Settlement Period is T+3
Interest Reference is 3-Month USD Libor (US0003M)
Interest Resets Effective Date – 2 Business Days
Equity and Libor Payments are Netted on Payment Date
Modified Following Business Day Convention
Client has No Rights to Increase/Early Terminate
Swap provider will not alternatively quote modifications.
Swap will remain on the books “locked” as is for the one year period
and will only change as a function of Interest and Equity Resets and
payments.
CASHFLOWS (Dealer Perspective)
·
·
·
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·
Prepared by CME Group | © 2014 CME Group. All rights reserved
-35,000 units fully unwound in the third period on 07-Jan-14, at the
SPTR price of 3147.74.
The unwind trade establishes the Final Price for the Equity
Performance, and the Final Accrual Date for the interest calculated
on the swap.
The unwind trade does not change the current swap notional, and
the swap ceases to exist post accelerated Termination/Payment
Date.
Early Termination was allowed with a quoted unwind spread for an
offsetting swap with the exact units and reset/maturity dates at a +
25bps spread.
No new swap is booked, rather a break fee is paid equal to the
difference between the original L+35bps cash flow and the “new”
L+25bps unwind cash flow out to the original maturity.
The Full Early Termination generates a Payment due on T+3 (EQ + FL
+ Break).
·
·
CASHFLOWS (Dealer Perspective)
·
·
·
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·
Prepared by CME Group | © 2014 CME Group. All rights reserved
-17,500 units partially unwound during the third period on 07-Jan14, at the SPTR price of 3147.74.
The unwind trade establishes the Final Price for the Equity
Performance, and the Final Accrual Date for the interest calculated
on the 17.5K units unwound.
The unwind trade does not change the notional amount of the units
being unwound, or the notional outstanding for the units remaining;
it is not a reset.
Early Termination was allowed with a quoted unwind spread for
17,500 units of an offsetting swap, with the exact reset/maturity
dates at a + 25bps spread.
No new swap is booked, rather a break fee is paid equal to the
difference between the original L+35bps cash flow and the “new”
L+25bps unwind cash flow out to the original maturity for the units
unwound.
The Partial Early Termination generates a Payment due on T+3 (EQ +
FL + Break).
The remaining units function as per the original swap for the
remainder of Period 3 and all of Period 4, terminating on 28-May-14
with a Final Payment on 02-Jun-2014.
SPTR SWAP – 1Y vs. 3mL + 35bps – MID-PERIOD POSITION INCREASE @ +45bps to MATURITY
Price Return Swap on the S&P 500 Total Return Index, 1 Year Maturity, Equity and Interest Reset and Pay Quarterly, No Right to Early Termination
Swap Provider agrees to Client Request to add 10,000 units at the close of 14-Jan14 at a spread of +45bps with normal 3mL Fixing, and average spread going forward
·
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CASHFLOWS (Dealer Perspective)
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Prepared by CME Group | © 2014 CME Group. All rights reserved
+10,000 Units added to swap during the third period on 14Jan-14, at the SPTR price of 3125.67.
The Increase does not impact Period 3's prior reset or notional
values, it will serve as an independent stub. The Increase not
only establishes a unique Initial Price for Equity Performance,
but also a unique Increase Notional and Initial Accrual Date for
the interest to be calculated on the 10,000 units added.
The Increase Notional has a traded spread of +45bps and Libor
Reset Rate of 0.52% based on the Increase Effective Date.
The Increase adds an Equity and Interest Payment to the
payment schedule with the final observation being consistent
with the third period’s Feb 28th Final Equity Date and March 5th
settlement/payment date.
On the following reset (start of Period 4) the units are
combined to express a total number and the total resetting
swap notional is subjected to the Libor Reset at a weighted
average spread.
The swap will fully terminate against the Final Equity Valuation
level of 2,758.02 on 28-May-14 with a Final Payment on 02Jun-2014.
SPTR SWAP – 1Y vs. 3mL + 35bps – COMPLETE EARLY TERMINATION on RESET @ 25bps to MATURITY
Price Return Swap on the S&P 500 Total Return Index, 1 Year Maturity, Equity and Interest Reset and Pay Quarterly, Early Termination with Break Fee allowed
CASHFLOWS (Dealer Perspective)
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Prepared by CME Group | © 2014 CME Group. All rights reserved
-35,000 Units are completely unwound from the swap on the Reset Date
at the end of the third period/beginning of fourth period on 28-Feb-14, at
the SPTR Close Price of 3447.53
The Unwind Trade happens seamlessly at the would be reset level, and
does not impact Period 3's prior reset, notional values, and Interest
Payments; it only serves as the Final Price Observation for Period 3.
The Early Termination was traded at an unwind spread of +25bps for
17,500 units of an offsetting swap with the start date being equal to the
Period 3/4 Interim Reset date.
No other swap is booked , rather a break fee is paid equal to the
difference between the original L+35bps cash flow and the L+25bps
unwind cash flow for the 35,000 units unwound for Period 4 only.
The break fee is paid on the existing Reset Payment Date, 05-Mar-14 and
is netted with the Equity and Interest Payments.
The Unwind Accelerates the Termination Date of the Swap to 05-Mar-14
and the swap ceases to exist after that date, there is no Period 4.
SPTR SWAP – 1Y vs. 3mL + 35bps – PARTIAL EARLY TERMINATION on RESET @ 25bps to MATURITY
Price Return Swap on the S&P 500 Total Return Index, 1 Year Maturity, Equity and Interest Reset and Pay Quarterly, Early Termination with Break Fee allowed
·
CASHFLOWS (Dealer Perspective)
·
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Prepared by CME Group | © 2014 CME Group. All rights reserved
-17,500 Units are partially unwound from the swap on the Reset Date at the end of
the third period/beginning of fourth period on 28-Feb-14, at the SPTR Close Price
of 3447.53
The Unwind Trade happens seamlessly at the reset level, and does not impact
Period 3's prior reset, notional values, or Equity and Interest Payments; it only
affects Period 4 swap units going forward and a break fee will be added to Period
3's payments.
The unwind trade in of itself does not change the notional amount of the units
being unwound, or the notional outstanding for the units remaining; the remaining
17,500 units are subject to Period 4's reset.
The Early Termination was traded at an unwind spread of +25bps for 17,500 units
of an offsetting swap with the start date being equal to the Period 3/4 Interim
Reset date.
No new swap is booked , rather a break fee is paid equal to the difference between
the original L+35bps cash flow and the “new” L+25bps unwind cash flow of the
remaining Period 4 for the 17,500 units unwound.
The break fee is paid on the existing Reset Payment Date, 05-Mar-14 and is netted
with the Equity and Interest Payments.
The remaining units function as per the original swap trade for Period 4, fully
terminating on 28-May-14 with a Final Payment on 02-Jun-2014.
SPTR SWAP – 1Y vs. 3mL + 35bps – POSITION INCREASE on RESET @ +45bps to MATURITY
Price Return Swap on the S&P 500 Total Return Index, 1 Year Maturity, Equity and Interest Reset and Pay Quarterly, No Right to Early Termination
CASHFLOWS (Dealer Perspective)
·
·
·
·
·
Prepared by CME Group | © 2014 CME Group. All rights reserved
+10,000 Units are added to the swap on the Reset Date at the
end of the third period/beginning of fourth period on 28-Feb14, at the SPTR Close Price of 3447.53
The Increase Trade happens seamlessly at the reset level, and
does not impact Period 3's prior reset, notional values, or
payments; it only increases Period 4 swap units going forward.
The Increase Notional has a unique traded spread of +45bps,
which creates an average weighted spread of 0.3722% for the
post-increase 45,000 swap units for Period 4 only.
The new increased swap notional for Period 4 is subjected to
the original Libor Reset Date and will reset at the rate of
0.55% as per the original terms of the swap, there is no
Financing stub created for this seamless reset.
The swap will fully terminate against the Final Equity
Valuation level of 2,758.02 on 28-May-14 with a Final
Payment on 02-Jun-2014.
CME EQUITY INDEX
FUTURES QUIZ
Prepared by CME Group | © 2014 CME Group. All rights reserved
CME Equity Index Futures Quiz
1)
The Average Daily dollar Volume of the E-mini S&P500 future is approximately:
a) $200 million
b) $200 billion
c) $50 billion
d)
$1 billion
2)
The average daily dollar volume of all 5025 ETFs around the globe is
approximately:
a)
b)
c)
d)
300 billion
150 billion
100 million
70 billion
BONUS:
What is the approximate average daily dollar volume of ETFs traded in the US?
3)
Back in the early 1980s, Bill Gross and Myron Scholes had a discussion at a PIMCO board
meeting on the topic of collateralizing S&P 500 futures with a portfolio of liquid Fixed
income instruments that gave birth to the strategy known as:
a) Strategic Asset Allocation
b) Tactical Asset Allocation
c) Global Tactical Asset Allocation
d) none of the above
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65
CME Equity Index Futures Quiz
4)
Assuming the S&P 500 advanced 10%, which of the following would have the best gain in
percentage terms?
a) S&P 500 SPDR ETF - SPY
b) S&P 500 Futures
c) Vanguard 500 Index fund
5)
Which of the following would require the largest upfront capital outlay:
if you wanted a $1,000,000 exposure
a) S&P 500 SPDR ETF - SPY
b) S&P 500 Futures
c) Vanguard 500 Index fund
6)
In discreet, index point terms, does the S&P 500 future currently trade at a discount or a
premium to the cash index?
BONUS:
7)
WHY?
In financing terms, does the S&P 500 future currently trade rich, cheap or fair? (circle one)
Prepared by CME Group | © 2014 CME Group. All rights reserved
66
CME Equity Index Futures Quiz
8)
What are some of the differences between securities margining and futures margining ?
9)
One of the primary differences between an OTC Equity Swap and an Equity Index future is
the existence of ____________________?
10)
True or False: Equity Swaps are required to be cleared according to Dodd Frank?
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67
CASE STUDIES
Prepared by CME Group | © 2014 CME Group. All rights reserved
Case Study I – Cash Equitization and Beta
You are the Portfolio Manager of a major S&P 500 Index fund.
The following data is available on your Bloomberg terminal:
June 2014 S&P 500 futures (ESM4)
1857.44
S&P 500 Cash Index (SPX Index)
1849.90
LIBOR Rate:
Time to Expiration:
0.23236 %
90 days
Approximately $10,000,000 in funds needs to be invested….
What will you do ???
Prepared by CME Group | © 2014 CME Group. All rights reserved
Case Study I – Cash Equitization and Beta
You are the Portfolio Manager of a major S&P 500 Index fund.
The following data is available on your Bloomberg terminal and are your
firm’s working assumptions:
June 2014 S&P 500 futures (ESM4)
1849.90
S&P 500 Cash Index (SPX Index)
1857.44
S&P 500 Cash Index Fair Value
LIBOR Rate:
0.23236 %
Time to Expiration:
Forecasted Dividends
S&P 500 Rebate (Borrow/Loan Value)
90 days
9.52
(0.25)%
Approximately $10,000,000 in funds needs to be invested….
What will you do ???
(please do not look ahead)
Prepared by CME Group | © 2014 CME Group. All rights reserved
Case Study I – Cash Equitization and Beta
Theoretical Value of a Future – Fair Value
The fair value of an Equity Index Future is the calculated value of the future
when all variables are known, and is the equilibrium point where one is
indifferent between trading the future or the underlying Spot Index.
FV = Se(r-b)*t – D *
FV
S
(r-b)
t
D
Future Value of the Index
Current Spot Level of the Index
r = Risk Free Rate, b = Rebate; (r-b) = “All In” financing rate
Time to maturity in years
Dividends
1849.90 = 𝑺𝑒
0.0023236 −−.0025 ∗(90 360)
𝑺𝐹𝑎𝑖𝑟 𝑉𝑎𝑙𝑢𝑒
1859.42
= .001206
𝑒
𝑺𝐹𝑎𝑖𝑟 𝑉𝑎𝑙𝑢𝑒 = 𝟏𝟖𝟓𝟕. 𝟏𝟕𝟗
* Please note that the variable D here is representative only, and is meant to show Discreet
Dividend points as they occur on Ex date, and would need to be formulaically adjusted to represent
the ex-dividend on the exact date.
Prepared by CME Group | © 2014 CME Group. All rights reserved
− 9.52
Case Study I – Cash Equitization and Beta
You are the Portfolio Manager of a S&P 500 Index fund, with $10,000,000 of
new funds to invest. Where do you put those funds to work? Will you fully
invest the new investment? Can you minimally satisfy your Beta while
exploring opportunities to generate alpha?
𝑺𝑆𝑃𝑋 𝑀𝑎𝑟𝑘𝑒𝑡 = 𝟏𝟖𝟓𝟕. 𝟒𝟒
<
𝑺𝐹𝑎𝑖𝑟 𝑉𝑎𝑙𝑢𝑒 = 𝟏𝟖𝟓𝟕. 𝟏𝟕𝟗
Which is the better investment?
Prepared by CME Group | © 2014 CME Group. All rights reserved
Case Study I – Cash Equitization and Beta
E-mini S&P 500 futures vs. S&P 500 SPDRs (SPY)
E-mini S&P 500
SPY ETF
Where Traded:
CME Group
Various exchanges
Ticker symbol:
ES
SPY
Underlying
SPX Index
SPX Index Creation Unit
Minimum tick
0.25 ($12.50)
.01
Notional or Dollar value
$ 92,500
$186.19
Average Daily Volume$
$ 200.896 Billion
$ 21.904 Billion
Average Daily Volume
2,171,969
118,081,128 (30-Day, Bloomberg)
Margin
5.1% ($4,758)
50% Reg T margin FRBNY
Transaction costs*
22.8 bps
29.5 bps
Management fee
n/a
.0945% annually
24 hour trading
nearly 24 hours
9:30 – 16:00 ET with various ETH
Options
Yes
Yes
Tax Treatment
(60/40)
no 60/40, LTCG (or STCG) applies
Number of ETFs to
---
~500 shares
Equal 1 futures contract
* $100 million USD trade held one year.
Source: CME, Products and Services as of 24-Mar-2014
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73
Case Study I – Cash Equitization and Beta
Various ways to buy the S&P 500 (aka acquiring beta)
Buy SPY
ETF
Buy cash
S&P 500
Buy S&P
500 futures
• ETF purchases typically require cash outlay of 100% of
investment (can do Reg T margin in some cases)
• Receive Dividends
• Holding costs/year: 28.5 - 29.5 bps*
• Physical stock purchases typically require a cash outlay of
100% of investment. (can do Reg T-margin in some cases)
• Receive Dividends
• Holding costs/year 28.5 - 29.5 bps*
•
•
•
•
CME initial minimum margin = 5%
No dividends, receive interest on balance of funds
Holding costs/year 19.8 - 22.8 bps*
Combination of cheap/efficient beta and reasonable leverage
allows the process of portable alpha
* Source: Bank of America Merrill Lynch Delta One Futures/ETFs report
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74
Case Study II – Constructing a Portable Alpha Portfolio
Buy SPY
ETF
Buy cash
S&P 500
Buy S&P
500 futures
• Pay $4,500,000 to buy 25,000 shares of SPY
Exchange Traded fund
• Pay $4,500,000 to buy each component of the S&P
500 in the exact proportion of the index
• Buy 10 S&P 500 futures contracts ($450k notional/contract X 10
contracts = $4.500,000)
• CME initial minimum performance bond margin = ~$24k per contract
• No dividends on futures but majority of cash balance available to be
invested in high quality, liquid collateral portfolio. ($4,276,000) and
this is where portable alpha gets interesting…
* Source: Bank of America Merrill Lynch Delta One Futures/ETFs report
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75
Case Study II – Constructing a Portable Alpha Portfolio
What if you combined the
incredibly liquid, efficient
and cheap source of beta
like S&P 500 futures
with….
…an immense fixed
income expertise…across
the entire spectrum of
Treasuries, agencies,
mortgages, corporates,
high yield debt, etc.?
Many asset managers have done this, but
PIMCO has been doing it the longest and with impressive
results. Case II provides a close up of the StocksPlus portfolio..
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76
Case Study II – Constructing a Portable Alpha Portfolio
The Beta and Alpha Components
The Beta Side
• Futures provide same exposures as
owning underlying index (S&P 500, S&P
MidCap 400, etc.)
The Alpha Component aka collateral (can
be fixed income)
•
Excess return over LIBOR across time
(e.g. BAGG outperforms LIBOR)
• No worries about rebalance, corporate
actions, additions/deletions when
trading Equity Index futures.
•
Long Term Capital Preservation
•
Liquidity for margin calls
• Exceedingly cheap and efficient to trade
index futures.
•
Structural sources of excess return for
longer term outperformance
• In fact, the ADV (in USD) of S&P 500
futures far exceeds the average daily
dollar amount of all 5300 ETFs that trade
around the world—it is the most liquid
stock index futures contract in the
world.
For the alpha component, shorter
duration, fixed income securities
frequently used. But true alpha can be
“ported” from many sources…
Hedge funds
Commodity portfolios
Active Management (Factor Modeling)
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77
Portable Alpha didn’t
originate with Stocks
Early 1980’s saw portable alpha
with treasuries and treasury futures
1982 CME launched stock index
futures on S&P 500 index
Bill Gross and Myron Scholes
(then PIMCO board member)
wondered if S&P 500 futures would
work collateralized with portfolio of
Fixed Income instruments
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78
Case Study III – The Evolution of Global Tactical Asset Allocation
Traditional Asset
Allocation
Brinson, Beebower and
Hood 1986 Study
“Determinants of Portfolio
Performance”
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Strategic Asset
Allocation--SAA
Allows for ranges i.e.
instead of 60% equities, a
range of 57%- 63% equity
allocation might be
allowed per investment
guidelines
Newer asset classes
Commodities, Private
Equity, Timber,
Infrastructure
Tactical Asset Allocation.
SAA has merits but can
be inflexible—even with
ranges.
TAA allows for overlay of
views onto existing
portfolio
Global/Dynamic TAA
uses ALL asset classes
TAA frequently executed
using derivatives.
Usually Stock index
futures, Treasuries and
others depending on
desired exposures
79
Case Study III – The Evolution of Global Tactical Asset Allocation
The Futures Imperative:
•
Stock index futures make GTAA implementation easier
•
Stock index futures are generally extremely cheap regarding execution costs
•
Futures offer unmatched liquidity
•
Futures offer depth of order book
•
Futures make shorting an asset class simple
•
Futures offer near perfect audit trail via Globex matching engine
•
Futures trade on regulated exchanges
•
Futures trade virtually around the clock
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80
Case Study III – The Evolution of Global Tactical Asset Allocation
Lets say you run Franklin Templeton’s Mutual Quest Mutual fund.
You see that European equities are cheap and put several billion into them.
But what if you think British Pounds and Yen are expensive?
What would you do?
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81
Case Study III – The Evolution of Global Tactical Asset Allocation
Not just theory, but actively practiced
Over recent 3 year period TAA overlays have added:
$590 million of alpha (.59 bps annualized) at Texas Teachers
$231 million of alpha (158 bps) at SBCERA
Notable plans:
Verizon
Exelon
Boeing
Texas Teachers Retirement System
San Bernardino County Retirement System
Ontario Teachers Pension Plan
This approach can be executed with futures or other derivatives, its an unfunded
proposition which leaves cash to be kept aside for liquidity purposes.
Using derivatives avoids any disruption to underlying portfolio of equities, bonds
or any asset class has a liquid derivative counterpart.
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82
Case Study IV – Solving the Dilemma of Illiquid Futures
Replicating the Russell 1000 Index
There are many pension plans sponsors, endowments and foundations
that utilize stock index futures and futures in general.
What if your benchmark, your required Beta, has no futures contract or
only has an illiquid futures counterpart?
This is not only the dilemma of a large Sacramento based pension fund
and a large Michigan based Indexed Asset Manager but also and
hundreds of other money managers.
Some assets benchmarked to the Russell 1000, which is a good
benchmark, but the associate futures contract suffers poor liquidity with
average daily volumes less than 2500 contracts a day.
What could you do as an alternative?
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83
Case Study IV – Solving the Dilemma of Illiquid Futures
•
•
•
•
Russell 1000 (RIY) benchmarks the top 1,000 US listed companies by market cap
S&P 500 (SPX) benchmarks the top 500 US listed companies also by market cap
S&P 400 (MID) benchmarks the subsequent 400 US listed companies by market cao.
When combined, the SPX + MID components are the top 900 US listed companies.
Can one trade the S&P 500 and S&P 400 together as a proxy for the Russell 1000?
January 2010 – December 2013
SPX Only
Vol Adj SPX
1.00
1.014
SPX + MID
S&P 500: 0.892
S&P 400: 0.106
Russell 1000
Replication
S&P 500 futures
only
S&P 500 futures
(vol adj)
SPX + MID
Combo
Average Tracking
Error
-0.025%
-2.5 bps
-0.008%
-0.8 bps
-0.01%
-1.0 bps
Std Deviation
19.2 bps
17.6 bps
8.2 bps
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84