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CME OPTIONS ON NIKKEI 225 FUTURES – ENHANCING THE STOCK INDEX RISK MANAGEMENT REPERTOIRE

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JOHN NYHOFF

Nikkei 225 futures, and in particular CME’s Nikkei 225 futures, have experienced significant growth during 2013, motivated by optimism for the Japanese economic outlook. To help equity market participants take advantage of this changing Japanese economic landscape CME Group will introduce both quarterly and serial options on Yen Denominated Nikkei Stock Average futures on CME Globex beginning at 5PM on January 12, 2014 for trade date January 13, 2014.

CME Group

CME Group

“Abenomics” has been the recent catalyst for increased activity in Japanese cash equity market and Japanese equity derivative market activity. Abenomics refers to the economic policies implemented in Japan under the direction of Prime Minister Shinzo Abe. The three pronged approach of Abenomics includes – monetary stimulus; fiscal stimulus; and, structural reforms. The intent of Abenomics is to jumpstart Japanese economic growth, which has been quite lackluster since the late 1980s.

It is an understatement to indicate that the Japanese equity market has reacted very favorably to Abenomics. The Nikkei 225 index, Japan’s premier equity market index, rallied more than 50% from December 28 2012 through the closing level posted on May 22, 2013. Subsequently, the Nikkei 225 declined more than 20% from late May 2013 through mid-June 2013, before recovering substantively. As of November 8, 2013, the Nikkei 225 index has appreciated slightly more than 35.5%. This price pattern is illustrated in the Nikkei 225 Index chart below:

nikkei225

nikkei225

An alternative way of viewing the recent heightened Japanese equity market price volatility is through the lens of Nikkei 225 Index 20-day historical volatility (20-day HV). During late 2012, the range for Nikkei 225 20-day HV lingered in the 12% to 16% range. The strong early 2013 Japanese equity market rally propelled 20-day HV into the 20% to 30% range. Historical volatility exploded along with the Nikkei 225’s strong price declines in late May/early June 2013, peaking near 52%, before reverting back towards the recent 20% level. The historical volatility pattern is shown in the Nikkei 225 Index 20-day Historical Volatility chart below:

nikkei225

nikkei225

A significant increase in Nikkei 225 futures trading activity has coincided with the recovery in the Japanese equity market and the increase in realized volatility. Trading volume in CME’s Yen Denominated Nikkei 225 futures has increased more than 100% to nearly 47,000 contracts per day during the first ten months of 2013, while Nikkei 225 futures volume at the Osaka Securities Exchange has increased more than 77% during the same time period.

This substantial Nikkei 225 futures volume trend has created demand for options on Nikkei 225 futures, a contract that CME has introduced which can be cleared at CME. Japanese equity market participants have been seeking an alternative method of gaining exposure to the equity market price shifts. The introduction of CME options on Nikkei 225 futures gives traders an enhanced set of tools by which they can establish market exposures than can’t be accomplished with futures contracts alone.

The potential options on futures strategies that may be used include, but are not limited to: limited risk price directional positions associated with long option exposure and/or debit vertical spread exposure; long or short volatility trading positions via traditional straddle or strangle positions; income enhancement positions via covered option writing programs;, time value capture related positions via butterfly, condor or horizontal spreads; as well as dynamic portfolio reweighting programs via strangle writing strategies.

CME will introduce options on Yen Denominated Nikkei Stock Average futures on CME Globex beginning at 5PM on January 12, 2014 for trade date January 13, 2014.

CME options on Yen Denominated Nikkei futures will be listed on 2 quarterly cycle months (March/June/September/December) and 2 serial months (January/February/April/May/July/August/ October/November) listed at any time. The cycle month options will feature American-style exercise, whereas the serial month options will feature European-style exercise.

Serial month options will be automatically exercised into CME Yen Denominated Nikkei futures based on a fixing price determined by trading activity in the mini Nikkei futures at the Osaka Securities Exchange (OSE) during the last thirty seconds of cash equity market trading on the serial option expiration day. Contrarian instructions are not permitted for serial options on CME’s Yen Denominated Nikkei Stock Average futures.

Quarterly CME Yen Denominated Nikkei Stock Average futures will settle to a Special Opening Quotation (SOQ) of the Nikkei 225 index on the second Friday of the expiration month. In-the-money options on CME’s Yen Denominated Nikkei Stock Average futures are automatically exercised on expiration day into the underlying futures contract, which is then marked to market against the Nikkei 225 Stock Average SOQ.

Futures and options trading is not suitable for all investors, and involves the risk of loss. Futures and options are a leveraged investment, and because only a percentage of a contract’s value is required to trade, it is possible to lose more than the amount of money deposited for a futures position. Therefore, traders should only use funds that they can afford to lose without affecting their lifestyles. And only a portion of those funds should be devoted to any one trade because they cannot expect to profit on every trade.

Any research views expressed are those of the individual author and do not necessarily represent the views of the CME Group or its affiliates.

All examples are hypothetical situations, used for explanation purposes only, and should not be considered investment advice or the results of actual market experience.

All matters pertaining to rules and specifications herein are made subject to and are superseded by official CME, CBOT, NYMEX and KCBT rules. Current rules should be consulted in all cases concerning contract specifications.

JOHN NYHOFF

JOHN NYHOFF

About the Author:
JOHN NYHOFF
Executive Director, Financial Research and Product Development
John Nyhoff serves as Executive Director, Financial Research and Product Development of CME Group. He is responsible for developing interest rate and credit-related products. Previously, Nyhoff served as Director, Research and Product Development of CME since March 2006.

Before joining CME, Nyhoff most recently served as Executive Vice President and Co-Chief Operating Officer for Tokyo-Mitsubishi Futures, Inc., the futures subsidiary of Japan’s largest bank.  He worked for Tokyo-Mitsubishi since 1988, holding a variety of roles responsible for strategic planning, economic analysis, marketing and electronic trading including Senior Vice President, Trading & Research and Vice President & Chief Economist.  He also worked as an Options Specialist for SECTREND, a futures commission merchant that became part of Tokyo-Mitsubishi.  Nyhoff also served as Vice President for Refco, Inc. where he was responsible for recruiting new customers to derivatives trading.  He began his career as Senior Financial Economist for The Chicago Board of Trade.

Nyhoff earned a bachelor’s degree in economics from DePaul University, a master’s degree in economics from Northern Illinois University and a master’s degree in financial economics from Simon Graduate School of Business at the University of Rochester.  He has worked as a business statistics instructor at Northern Illinois University and has co-authored a number of publications, including Trading Options on Futures: Markets, Methods, Strategies & Tactics (John Wiley & Sons, 1988) and Trading Financial Futures: Markets, Methods, Strategies & Tactics (John Wiley & Sons, 1988).

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China, New Zealand ink trade deal as Beijing calls for reduced global barriers

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China, New Zealand ink trade deal as Beijing calls for reduced global barriers 1

By Praveen Menon and Gabriel Crossley

WELLINGTON/BEIJING (Reuters) – China and New Zealand signed a deal on Tuesday upgrading a free trade pact to give exports from the Pacific nation greater access to the world’s second-largest economy.

The pact comes as Beijing seeks to establish itself as a strong advocate of multilateralism after a bruising trade war with the United States, at a time when the coronavirus has forced the closure of many international borders.

New Zealand Prime Minister Jacinda Ardern confirmed the signing of the expanded deal.

“China remains one of our most important trade partners…For this to take place during the global economic crisis bought about by COVID-19 makes it particularly important,” she told a news conference.

The pact widens an existing trade deal with China to ensure it remains fit for purpose for another decade, Trade Minister Damien O’Connor said in a statement.

It provides for tariffs to be either removed or cut on many of New Zealand’s mostly commodities-based exports, ranging from dairy to timber and seafood, while compliance costs will also be reduced.

For a factbox on key deal points, please click on the square brackets:

CHINA’S MULTILATERAL PUSH

“The upgrade shows the two sides’ firm determination to support multilateralism and free trade,” Zhao Lijian, a spokesman of China’s foreign ministry, told a news briefing in Beijing on Tuesday.

The previous day, speaking at a virtual meeting of the World Economic Forum, President Xi Jinping had criticised isolationism and “Cold War” thinking and called for barriers to trade, investment and technological exchange to be removed.

In recent months, Beijing has signed an investment pact with the European Union and joined the world’s largest free trade bloc in the 15-country Regional Comprehensive Economic Partnership (RCEP), which includes New Zealand.

China has also expressed interest in joining the Comprehensive and Progressive Trans-Pacific Partnership (CPTPP) Agreement, the successor to a pact from which Washington withdrew.

China’s new deal with Wellington also opens up sectors such as aviation, education and finance. In exchange, New Zealand will increase visa quotas for Chinese language teachers and tour guides, the official Xinhua news agency said.

New Zealand was the first developed nation to sign a free trade pact with China in 2008, and has long been touted by Beijing as an exemplar of Western engagement.

China is now New Zealand’s largest trading partner, with annual two-way trade of more than NZ$32 billion ($21.58 billion).

But ties have been tested under Ardern’s government as New Zealand criticised China’s influence on small Pacific islands and raised human rights concerns about Muslim Uighurs.

Ardern also backed Taiwan’s participation at the World Health Organization (WHO) despite a warning from Beijing.

The wider trade pact also comes as Beijing’s ties with neighbouring Australia worsened after Canberra called for an independent investigation into the origins of the coronavirus pandemic, which was first reported in central China.

Australia has appealed to the World Trade Organization to review China’s decision to impose hefty tariffs on imports of its barley.

New Zealand, which will host the regional Asia Pacific Economic Cooperation summit this year, has said it would be willing to help negotiate a truce between China and Australia.

($1=1.3914 New Zealand dollars)

(Reporting by Praveen Menon; Editing by Aurora Ellis and Sam Holmes)

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Cryptocurrencies: the new gold?

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Cryptocurrencies: the new gold? 2

By Gerald Moser, Chief Market Strategist, Barclays Private Bank

Time to add to a portfolio?

There has been a lot of talk about bitcoin, and cryptocurrencies in general, being a “digital” gold. Similar to gold, there is a finite amount, it is not backed by any sovereign and no single-entity controls its production. But for bitcoin to be considered in a portfolio and to become an investable asset, similar to gold, the asset would need to improve the risk/return profile of that portfolio. This seems a tall order.

While it is nigh on impossible to forecast an expected return for bitcoin, its volatility makes the asset almost “uninvestable” from a portfolio perspective. With spikes in volatility that are multiples of that typically experienced by risk assets such as equities or oil, many would probably throw the cryptocurrency out of any portfolio in a typical mean-variance optimisation.

Cryptocurrencies: the new gold? 3

Poor diversifier

And while bitcoin’s correlation measures are relatively supportive, it seems to falter when diversification is most needed, such as during sharp downturns in financial markets. Looking at weekly return correlations since 2016 shows that bitcoin is not strongly correlated with any assets (see below). It is however only second to US high yield in its correlation with equities. US Treasuries, gold and US investment grade were better diversifiers than bitcoin when it comes to equities.

Source: Bloomberg, Barclays Private Bank

Source: Bloomberg, Barclays Private Bank

Furthermore, looking at global equity corrections since 2015 (see below), it is noticeable that bitcoin has performed even worse than equities over the last three corrections. And while gold and fixed income provided some relief during those corrections, bitcoin compounded the loss that investors would have incurred from equities exposure.

Source: Bloomberg, Barclays Private Bank

Source: Bloomberg, Barclays Private Bank

The fact that cryptocurrencies also fluctuate alongside equities suggests that investment in bitcoin is more akin to a bubble phenomenon rather than a rational, long-term investment decision. The performance of the cryptocurrency has been mostly driven by retail investors joining a seemingly unsustainable rally rather than institutional money investing on a long-term basis.

Several studies around market structure have shown that emerging markets with high retail/low institutional participation are more unstable and more likely subject to financial bubbles than mature markets with institutional participation. And while more leading financial houses seem to be taking an interest in cryptocurrencies, the market’s behaviour suggests that the level of institutional involvement is still limited. Another issue is around its concentration: about 2% of bitcoin accounts control 95% of all bitcoins.

In summary, difficulty to forecast return, lack of diversification and high volatility makes it hard to consider bitcoin as a standalone asset in a diversified portfolio for long-term investors.

An inflation hedge?

Another point widely quoted in favour of cryptocurrencies is that they provide an inflation hedge. This might be a valid point, if inflation stems from fiat currency debasement. As mentioned above, a currency’s worth comes from the trust economic agents have in it. If unsustainable amounts of debt and large money creation shatter belief in sovereign-backed currencies through spiralling inflation, cryptocurrencies could be seen as an alternative.

Regardless of its price, bitcoin’s production is set on a precise schedule and cannot be changed. If oil or copper prices go up, there is an incentive to produce more. This is not the case for cryptocurrencies. In a very specific and highly hypothetical scenario of all fiat currency collapsing, this could be positive. But other real assets such as precious metals, inflation-linked bonds or real estate usually provide a hedge against inflation.

Other considerations

Bitcoin’s technology should theoretically make it extremely secure. As there is no intermediary, each transaction is reviewed by a large number of participants which can all certify the transaction. However, there have been frauds and thefts from exchanges. Another point to consider is the risk of “losing” bitcoins. According to the cryptocurrency data firm Chainanalysis, around 20% of the existing 18.5m bitcoins are lost or stranded in wallets, with no mean of being recovered. As there is no intermediary, there is no backup for a lost bitcoin.

From a sustainability point of view, adding cryptocurrencies to a portfolio will make it less green. Mining and exchanging them is highly energy intensive. According to estimates published by Alex de Vries, data scientist at the Dutch Central Bank, the bitcoin mining network possibly consumed as much in 2018 as the electricity consumed by a country like Switzerland. This translates to an average carbon footprint per transaction in the range of 230-360kg of CO2. In comparison, the average carbon footprint of a VISA transaction is 0.4g of CO2.

Beyond energy use, the mining process generates a large amount of electronic waste (e-waste). As mining requires a growing amount of computational power, the study estimates that mining equipment becomes obsolete every 18 months. The study suggests that the bitcoin industry generates an annual amount of e-waste similar to a country like Luxembourg.

Cryptocurrencies are here to stay

Innovation in digital assets continues rapidly and will likely drive increased participation, both from retail and institutional investors. The underlying blockchain technology behind bitcoin was meant to disrupt a few different industries. While results have not lived up to the initial hype, more sectors are investigating the use of the technology.

And with Facebook announcing a stablecoin, or a cryptocurrency pegged to a basket of different fiat currencies, central banks have accelerated the movement towards central bank digital currencies. Those could improve payment systems resilience and facilitate cross-border payments.

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Energy stocks drag down FTSE 100, IG Group slides

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Energy stocks drag down FTSE 100, IG Group slides 4

By Shivani Kumaresan

(Reuters) – London’s FTSE 100 slipped on Thursday, weighed down by falls in energy stocks as oil prices slid after a surprise increase in U.S. crude inventories, while IG Group tumbled on plans to buy U.S. trading platform tastytrade for $1 billion.

The blue-chip FTSE 100 index lost 0.4%, while the domestically focussed mid-cap FTSE 250 index also slid 0.4%.

Energy majors BP and Royal Dutch Shell fell 3.2% and 2.5%, respectively, and were the biggest drags on the FTSE-100 index. [O/R]

“What is holding back the UK is a lack of tech stocks to capture the ‘rotation’ back into tech seen since Netflix results,” said Chris Beauchamp, chief market analyst at IG.

“Stock markets overall are much quieter today, looking so far in vain for a new catalyst for further upside.”

The FTSE 100 shed 14.3% in value last year, its worst performance since a 31% plunge in 2008 and underperforming its European peers by a wide margin, as pandemic-driven lockdowns battered the economy and led to mass layoffs.

British Prime Minister Boris Johnson said it was too early to say when the national coronavirus lockdown in England would end, as daily deaths from COVID-19 reach new highs and hospitals become increasingly stretched.

IG Group tumbled 8.5% after announcing plans to buy tastytrade, venturing into North America after a stellar year for the new breed of retail investment brokerages.

Ibstock jumped 7.3% to the top of the FTSE 250 after the company said fourth-quarter activity benefited from better-than-expected demand for new houses and repairs.

Pets at Home Group Plc rose 2.2% after reporting an 18% jump in third-quarter revenue, boosted by higher demand for its accessories and veterinary services as more people adopted pets during lockdowns.

(Reporting by Shivani Kumaresan in Bengaluru; editing by Uttaresh.V and Mark Potter)

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