Reading Futures Options - CME Australian Dollar

CME Australian Dollar

A. Reading Futures Options

Exhibit 67 shows the Chicago Mercantile Exchange (IMM) options on a futures contract.

FUTURES OPTIONS

143

To interpret the numbers in this column, consider the call options. These are rights to buy the June DM futures contract at specified prices—the strike prices. For example, the call option with a strike price of 5800 means that you can purchase an option to buy a June DM futures contract, up to the June settlement date, for $0.5800 per mark. This option will cost

$0.0134 per Deutsche mark, or $1,675, plus brokerage commission, for a DM 125,000 contract.

The price is high because the option is in-the-money. In contrast, the June futures option with a strike price of 6000, which is out-of-the-money, costs only $0.0044 per mark, or $550 for one contract. These option prices indicate that the market expects the dollar price of the Deutsche mark to exceed $0.5800 but not to go up much above $0.6000 by June. Note: A futures call option allows you to buy the relevant futures contract, which is settled at maturity.

In contrast, a call options contract is an option to buy foreign exchange spot, which is settled when the call option is exercised; the buyer receives foreign currency immediately.

See CURRENCY OPTION; FOREIGN CURRENCY FUTURES; MARKED-TO-MARKET.

EXHIBIT 67 Futures Options

DEUTSCHE MARK (CME)—125,000 marks; cents per mark Calls—Settle³ Puts—Settle⁴

Strike Price¹ Feb² Mar Apr Feb Mar Apr

5650 1.20 1.37 1.44 0.06 0.24 0.63

5700 0.75 1.04 1.15 0.11 0.40 0.83

5750 0.41 0.75 0.90 0.27 0.61 1.08

5800 0.20 0.52 0.69 0.56 0.88 ....

5850 0.09 0.34 0.52 0.95 1.19 ....

5900 0.02 0.22 0.39 1.38 1.57 ....

5. Est. vol. 12,585; Wed. vol. 7,875 calls; 9,754 puts 6. Open interest Wed. 111,163 calls; 74,498 puts Explanations:

1. Most active strike prices 2. Expiration months

3. Closing prices for call options 4. Closing prices for put options

5. Volume of options transacted in the previous two trading sessions, each unit representing both the buyer and the seller

6. The number of options in still open positions at the end of the previous day’s trading session FUTURES OPTIONS

144

G

GAMMA

Gamma is a measure of the sensitivity of an option’s delta to small changes in the price of the underlying security (or foreign exchange).

See also CURRENCY OPTION PRICING SENSITIVITY; DELTA.

GATT

See GENERAL AGREEMENT ON TARIFFS AND TRADE.

GENERAL AGREEMENT ON TARIFFS AND TRADE (GATT)

An agreement signed at the Geneva Conference in 1947 which became effective on January 1, 1948. It set a framework of policies and guidelines for international trade, including a negotiation of lower international trade barriers, and settling trade disputes. GATT also acts as international arbitrator with respect to trade agreement abrogation. More specifically, GATT has four basic long-run objectives: (1) reduction of tariffs by negotiation, (2) elimination of import quotas (with some exceptions), (3) nondiscrimination in trade through adherence to unconditional most- favored-nation treatment, and (4) resolution of differences through arbitration and consultation.

GENERIC

See PLAIN-VANILLA.

GEOMETRIC AVERAGE RETURN

See ARITHEMATIC AVERAGE RETURN VS. COMPOUND (GEOMETRIC) AVERAGE RETURN; RETURN RELATIVE.

GILT (OR GILT-EDGED) A U.K. government bond.

GLOBAL BOND INDEXES

Today, investors do not have to settle for only the U.S. bond market to get fixed-income results.

The J.P. Morgan Government Bond Index is considered the most widely-used benchmark for measuring performance and quantifying risk across international fixed income bond markets.

The index and its underlying subindexes measure the total, principal, and interest returns in each of 13 countries and can be reported in 19 different currencies. The index limits inclusion to markets and issues that are available to international investors, to provide a more realistic measure of market performance.

Other global bond indexes include:

• J.P. Morgan Emerging Markets Bond Index Plus: Total return index of U.S. dollar and other external currency denominated Brady bonds, loans, Eurobonds, and local market debt instruments traded in emerging markets.

• Salomon Smith Barney World Government Bond Index: Tracks debt issues traded in 14 world government bond markets. Issues included in the Index have fixed- rate coupons and maturities of at least one year.

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While finding bond yields is relatively easy, locating bond index results can be trickier.

The Wall Street Journal and Barron’s have extensive bond index coverage. And business news cable TV channels such as CNBC and CNNfn also track these indexes. Internet users can check Web sites such as www.bloomberg.com or www.bondsonline.com for bond index results.

GLOBAL FUND

A global fund is a mutual fund that invests globally—in both U.S. and foreign securities.

Unlike an international fund, it invests anywhere in the world, including the United States.

However, most global funds keep the majority of their assets in foreign markets.

GLOBAL REGISTERED SHARES

Global registered shares are equity shares that are registered and traded in many foreign equity markets. They contrast with American Depository Receipts (ADRs), which are foreign company shares placed in trust with a U.S. bank, which in turn issues depository receipts to U.S. investors. For quotations on global shares, log on to www.adr.com by J.P. Morgan.

See also AMERICAN DEPOSITORY RECEIPTS; AMERICAN SHARES.

GOLD EXCHANGE STANDARD

The Gold Exchange Standard emerged as a result of negotiations at the Bretton Woods Confer- ence in 1944. Under the Agreement, all countries were to fix the value of their currencies in terms of gold but were not required to exchange their currencies for gold. Only the U.S. dollar remained convertible into gold at $35 per ounce. All participating countries agreed to maintain the value of their currencies within 1% of par by buying or selling foreign exchange or gold as needed. But if a currency became weak, a devaluation of up to 10% would be allowed. Larger devaluations required the IMF’s approval.

GOLD STANDARD

The Gold Standard is the setting by most major countries of fixed values for their currencies in relation to gold. A country’s currency is expressed on its equivalent value to gold such as one U.S. dollar equating to 23.22 grains of fine gold. It displays how much of the units of a currency are exchangeable into a certain amount of gold. If a significant outflow of gold occurs, a deficit in the balance of payments may arise. A gold standard may aid stability in exchange rates. It is a system in which currencies are defined in terms of their gold content and payment imbalances between countries are settled in gold.

GUILDER

Monetary unit of the Netherlands, Antilles, and Surinam.

GULF RIYAL

Monetary unit of Dubai and Qatar.

GULF RIYAL

146

H

HARD CURRENCY

Often referred to as convertible currency, hard currency is the currency of a country that is widely accepted in the world and may be exchanged for that of another nation without restric- tion. Hard currency nations typically have sizeable surpluses in their balance of payments and foreign exchange reserves. The U.S. dollar and British pound are good examples.

I

IBRD

See INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT.

IMF

See INTERNATIONAL MONETARY FUND.

IMM

See INTERNATIONAL MONETARY MARKET; INTERNATIONAL MONEY MANAGE- MENT.

IMPORT AND EXPORT PRICE INDEXES

The import and export price indexes measure price changes in agricultural, mineral, and manufactured products for goods bought from and sold to foreigners. They represent increases and decreases in prices of internationally traded goods due to changes in the value of the dollar and changes in the markets for the items. Import and export price indexes are provided monthly by the Bureau of Labor Statistics in the U.S. Department of Labor. The data are published in a press release and in the BLS monthly journal, Monthly Labor Review. The import and export price indexes cover most foreign traded goods. The broad product categories of the indexes are food, beverages and tobacco, crude materials, fuels, intermediate manufactured products, machinery and transportation equipment, and miscellaneous manufactured products. The monthly figures cover approximately 10,000 products. Additional product detail is provided quarterly. Military equipment, works of art, commercial aircraft, and ships are excluded. Prices represent the actual transaction value including premiums and discounts from list prices and changes in credit terms and packaging. Prices usually are based on the time the item is delivered, not the time the order is placed. The indexes reflect movements for the same or similar items exclusive of enhancement or reduction in the quality or quantity of the item. The import and export price indexes are not seasonally adjusted.

INDIRECT QUOTE

The price of a unit of home currency, expressed in terms of a foreign currency. For example, in the Unites States, a quotation of 110 yens per dollar is an indirect quote for the Japanese yen. Indirect and direct quotations are reciprocals.

An indirect quote is the general method used in the over-the-counter market. Exceptions to this rule include British pounds, Irish punts, Australian dollars, and New Zealand dollars, which are quoted via direct quote for historical reasons. (e.g., 1 pound sterling = $1.68). In their foreign exchange activities, U.S. banks follow the European method of direct quote. See also AMERICAN TERMS; DIRECT QUOTE; EUROPEAN TERMS.

Indirect quote 1 Direct quote

--- 1

$0.00909

--- 110 yens

= = =

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INFLATION

Inflation is the general rise in prices of consumer goods and services. The federal government measures inflation with four key indices: Consumer Price Index (CPI), Producer Price Index (PPI), Gross Domestic Product (GDP) Deflator, and Employment Cost Index (ECI).

Price indexes are designed to measure the rate of inflation of the economy. Various price indexes are used to measure living costs, price level changes, and inflation.

• Consumer Price Index: The Consumer Price Index, the most well-known inflation gauge, is used as the cost-of-living index, to which labor contracts and social security are tied. The CPI measures the cost of buying a fixed bundle of goods (some 400 consumer goods and services), representative of the purchase of a typical working-class urban family. The fixed basket is divided into the following categories: food and beverages, housing, apparel, transportation, medical care, enter- tainment, and other. Generally referred to as a cost-of-living index, it is published by the Bureau of Labor Statistics of the U.S. Department of Labor. The CPI is widely used for escalation clauses. The base year for the CPI index was 1982–84 at which time it was assigned 100.

• Producer Price Index: Like the CPI, the PPI is a measure of the cost of a given basket of goods priced in wholesale markets, including raw materials, semifin- ished goods, and finished goods at the early stage of the distribution system. The PPI is published monthly by the Bureau of Labor Statistics of the Department of Commerce. The PPI signals changes in the general price level, or the CPI, some time before they actually materialize. (Because the PPI does not include services, caution should be exercised when the principal cause of inflation is service prices.) For this reason, the PPI and especially some of its subindexes, such as the index of sensitive materials, serve as one of the leading indicators that are closely watched by policy makers.

• GDP Deflator: This index of inflation is used to separate price changes in GDP calculations from real changes in economic activity. The Deflator is a weighted average of the price indexes used to deflate GDP so true economic growth can be separated from inflationary growth. Thus, it reflects price changes for goods and services bought by consumers, businesses, and governments. Because it covers a broader group of goods and services than the CPI and PPI, the GDP Deflator is a very widely used price index that is frequently used to measure inflation. The GDP deflator, unlike the CPI and PPI, is available only quarterly—not monthly. It is also published by the U.S. Department of Commerce.

• Employment Cost Index: This index is the most comprehensive and refined measure of underlying trends in employee compensation as a cost of production. It measures the cost of labor and includes changes in wages, salaries, and employer costs for employee benefits. ECI tracks wages and bonuses, sick and vacation pay plus benefits such as insurance, pension and Social Security, and unemployment taxes from a survey of 18,300 occupations at 4,500 sample establishments in private industry and 4,200 occupations within about 800 state and local governments.

• CRB Bridge Spot Price Index and the CRB Bridge Futures Price Index: These are two widely watched benchmarks for commodity prices by Bridge/CRB, formerly Commodity Research Bureau. The CRB Spot Price Index is based on prices of 23 different commodities, representing livestock and products, fats and oils, metals, and textiles and fibers, and it serves as an indicator of inflation.

Higher commodity prices, for example, can signal inflation, which in turn can lead to higher interest rates and yields. The CRB Bridge Futures Price Index is

INFLATION

150

the composite index of futures prices that tracks the volatile behavior of commodity prices. As the best known commodity index, the CRB Futures Index, produced by Bridge Information Systems, was designed to monitor broad changes in the commodity markets. The CRB Futures Index consists of 21 commodities. In addition to the CRB Futures Index, nine subindexes are main- tained for baskets of commodities representing currencies, energy, interest rates, imported commodities, industrial commodities, grains, oil, seeds, livestock and meats, and precious metals. All indexes have a base level of 100 as of 1967, except the currencies, energy, and interest rates indexes, which were set at 100 in 1977.

• The Economist Commodities Index: This is the gauge of commodity spot prices and their movements. The index is a geometric weighted-average based on the significance in international trade of spot prices of major commodities. The index is design to measure inflation pressure in the world’s industrial powers.

It includes only commodities that freely trade in open markets, excluding items such as iron and rice. Also, this index does not track precious metal or oil prices.

The commodities tracked are weighted by their export volume to developed economies. The index information may be obtained from Reuters News Services or in The Economist magazine. The index may be used as a reflection of worldwide commodities prices, enabling the investor to determine the attractiveness of specific commodities. The MNC may enter into futures contracts. The indicators also may serve as barometers of global inflation and global interest rates.

Price indexes get major coverage, appearing in daily newspapers and business dailies, on business TV cable networks such CNNfn and CNBC and on Internet financial news services. Government Internet Web sites www.stats.bls.gov and www.census.gov/econ/

also provide this data.

A Word of Caution: Inflation results in an increase in all prices, but relative price changes indicate that not all prices move together. Some prices increase more rapidly than others, and some go up while others go down. Inflation is like an elevator carrying a load of tennis balls, which represent the prices of individual goods. As the inflation continues, the balls are carried higher by the elevator, which means that all prices are increasing. But as the inflation continues and the elevator rises, the balls, or individual prices, are bouncing up and down. So while the elevator lifts all the balls inside, the balls do not bounce up and down together. The balls bouncing up have their prices rising relative to the balls going down.

See also PURCHASING POWER PARITY; PURCHASING POWER RISK.

INFLATION RISK

See PURCHASING POWER RISK.

INITIAL MARGIN

The minimum amount of money (or equity) that must be provided by a margin investor at the time of purchase. It is used to prevent overtrading and excessive speculation. Margin requirements for stock have been 50% for some time. Margin requirements for foreign currency futures are determined and periodically revised by the International Money Market (IMM), a division of the Chicago Mercantile Exchange, in line with changing currency volatilities using a computerized risk management program called SPAN (Standard Portfolio Analysis of Risk). See also MAINTENANCE MARGIN; MARGIN TRADING.

INFLATION RISK

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