MALAYSIAN PALM OIL TRADE FAIR & SEMINAR 2012 (POTS 2012)

“PRICE UNCERTAINTY: BMD’S ROLE

COMES INTO FOCUS” Jeffrey Tan, CFA

General Manager Product & Market Development

Bursa Malaysia Derivatives Berhad

16 October 2012 Shangri-La Hotel, Kuala Lumpur

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RM/MT FCPO 3rd Month Daily Settlement Price

Palm Oil Prices in the New Millennium (Jan 2000 – 5 Oct 2012)

Palm Oil Prices (Jan 2011 – 5 Oct 2012)

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RM/MT FCPO 3rd Month Daily Settlement Price

CPO Futures Volatility (Jan 2000 – 5 Oct 2012)

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% FCPO 3rd Month Daily 10D Volatility

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% FCPO 3rd Month Daily 10D Volatility

CPO Futures Volatility (Jan 2012 – 5 Oct 2012)

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2006 2007 2008 2009 2010 2011 2012

OI '000 ADV '000 Jan 2006 - 5 Oct 2012

ADV Open Interest

Palm Oil Average Daily Volume & Open Interest (Jan 2006 – 5 Oct 2012)

Palm Oil Average Daily Volume & Open Interest (Jan 2012 – 5 Oct 2012)

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OI '000 ADV '000 Jan 2012 - 5 Oct 2012

ADV Open Interest

Rank Volume Date Open Interest Date 1 63,019 16/05/2012 148,121 12/10/2012 2 57,092 18/09/2012 143,338 13/10/2011 3 56,235 23/05/2012 143,285 12/10/2011 4 52,583 11/09/2012 142,442 11/10/2011 5 52,473 20/06/2012 142,297 10/10/2011 6 50,577 03/10/2012 141,918 17/10/2011 7 50,057 12/10/2012 141,841 11/10/2012 8 49,867 02/10/2012 141,333 14/09/2011 9 48,741 17/11/2011 139,670 07/10/2011

10 48,704 24/02/2011 139,665 14/10/2011

Top 10 CPO Futures Volume & Open Interest

Commodity Derivatives Traded (Selected) Commodity Exchange Largest

Producing Countries

Ratio of Derivatives to

Production Natural Rubber SHFE (China)

Thai/Indonesia/M’sia 111.72x

Crude Palm Oil RBD Palm Olein

BMD (M’sia) DCE (China)

Indonesia/M’sia M’sia

2.64x 24.36x

Soybean

Soybean Oil

Soybean Meal

CME (US) DCE (China) DCE (China)

CME (US) DCE (China)

CME (US)

US

US

US

24.74x

38.27x

17.48x

Corn ( Maize)

Sugar

CME (US) DCE (China) ZCE (China)

ICE (US)

US

Brazil

10.63x

18.55x

Source : World Federation of Exchanges

Market Demography of FCPO

14 Source : BMD

§  Increasing market usage of futures. Level of sophistication increasing and market users ask for options.

§  Launched on 16 July 2012 and complements the futures contract.

§  Provides a wider array of risk management tools for palm market – different risk/reward profiles

Crude Palm Oil Options

OCPO Contract Specs Contract Code Calls: C OCPO

Puts: P OCPO Type European Options

Underlying Crude Palm Oil futures contract (FCPO)

Contract Size

One Crude Palm Oil futures contract (of a specified month) of 25 metric tons (MT)

Tick Size RM0.50 per MT (RM12.50 per contract)

Strike Price Intervals

Trading shall be conducted for put and call options with striking prices in integral multiples of RM50 per MT. There will be at least 11 strike prices (five are in-the-money, one is at-the-money and five are out-of-the-money).

Contract Months

Monthly (list the third, fourth, fifth and sixth forward months) then alternate months going out 24 months of the FCPO contract. The first spot option contract month will be trading the 3rd month FCPO contract.

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OCPO Contract Specs (2) Contract Code Calls: C OCPO

Puts: P OCPO Daily Price Limit There will be no daily price limits.

Last Trading Day The spot options will cease trading at 6pm on the 10th day of every month, or the preceding business day if the 10th day is a non-business day. The futures position will be delivered at end-of-day process and will be available for trading on the next business day.

Exercise In the absence of contrary instructions delivered to the Clearing House, an option that is in-the money at expiration shall be automatically exercised. Exercise results in a long 3rd month FCPO position, which corresponds with the option’s contract month for a call buyer or a put seller, and a short 3rd month FCPO position for a put buyer or a call seller.

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OCPO Contract Specs (3) Contract Code Calls: C OCPO

Puts: P OCPO Trading Hours

First trading session: Malaysian time: 10.30 a.m. to 12.30 p.m. Second trading session: Malaysian time: 3.00 p.m. to 6.00 p.m. *same as FCPO trading hours

Speculative Position Limit

10,000 futures equivalent contracts net long or net short for any single month. 15,000 futures equivalent contracts for all contract months combined. Speculative Position Limits are combined together with the FCPO contract.

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Example of OCPO Contract Months

FCPO Nov 12 Dec 12 Jan 13 Feb 13 Mar 13 Apr 13 May 13 Jul 13 Sep 13

OCPO - - Jan 13* Feb13 Mar 13 Apr 13 May 13 Jul 13 Sep 13

Example: Available months to trade as at 16 October 2012

FCPO Nov 13 Jan14 Mar 14 May 14 Jul 14 Sep 14

OCPO Nov13 Jan14 Mar 14 May 14 Jul 14 Sep 14

* Jan 13 OCPO contract expires on 10 Nov 2012 * New OCPO contract month will be listed on 16 Nov 2012 together with the FCPO new contract month.

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What happens when January 2013 OCPO contract expires?

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At 6 p.m. Trading ends

At 7.30 p.m. BMD clearing house clears all the trades. If OCPO is in the money it will be converted to FCPO. If out of the money the options will

be worthless.

Jan 2013 FCPO contract will be ready to trade

9 Nov 2012 12 Nov 2012

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Year to Date Market Demography for OCPO (2012)

Source : BMD

§  Market risk includes 2 components: price and basis. Prices are discovered with BMD futures market. Basis is the relationship between physical market price and BMD futures price (physical price – futures price = basis)

§  2 common producer strategies using BMD futures and options: short futures hedge and long put option hedge. For consumers, the reverse applies, i.e., long futures hedge and long call option hedge

Managing Price Risk with CPO Futures and Options

§  Basic risk management strategy for producers. A short position is initiated as a temporary substitute for the eventual sale of the palm oil to a local mill or trader

§  Placed well in advance of harvest and will provide price protection until crop is sold. Immediately upon the sale of the crop, short position should be closed out

§  Since prices in cash and futures generally move up or down together over time, a loss in either of these markets will be offset by a gain in the other – thus allowing producers to lock in a price level in advance of the cash sale

Short Futures Hedge

Sell January CPO futures: RM2,500/MT Expected Basis for December: -RM10/MT Expected selling price: RM2,490/MT January Scenario 1: Falling Prices Buy (offset) January futures: RM2,300/MT Basis: -RM10/MT Physical Price: RM2,290 Futures profit: RM200/MT Actual selling price: RM2,490/MT

Short Futures Hedge Example: Assumptions

Source: CME

Sell January CPO futures: RM2,500/MT Expected Basis for January: -RM10/MT Expected selling price: RM2,490/MT January Scenario 2: Rising Prices Buy (offset) January futures: RM2,700/MT Basis: -RM10/MT Physical price: RM2,690 Futures loss: RM200/MT Actual selling price: RM2,490/MT

Short Futures Hedge Example: Assumptions

Source: CME

§  Eliminates risk of lower price levels §  Establishes selling price in advance of physical sale §  Strengthening basis improves selling price §  Futures position guaranteed by BMD Clearing House Disadvantages §  Weakening basis lowers selling price §  No benefit from higher price levels §  Transaction costs

Advantages

§  Long put option gives the producer the right (but not the obligation) to sell BMD futures/CPO at a specific price level (strike price)

§  If prices < this level, the producer/option buyer has the right to sell the futures at the strike price. Should prices > this level, the producer not obliged to the put strike price. Hence, producer can sell physical production at the higher market

§  Eliminates downside risk while allowing the producer to sell at a better price level if the markets move higher

Long Put Option Hedge

Buy 2500 January Put Option: RM85/MT Expected Basis for January: -RM10/MT Expected minimum selling price: RM2,405/MT January Scenario 1: Falling Prices January futures: RM2,300/MT Basis: -RM10/MT Physical price: RM2,290/MT Put option profit: RM115/MT Actual selling price: RM2,405/MT

Long Put Option Hedge Example: Assumptions

Source: CME

Buy 2500 January Put Option: RM85/MT Expected Basis for January: -RM10/MT Expected minimum selling price: RM2,405/MT January Scenario 2: Rising Prices January futures: RM2,700/MT Basis: -RM10/MT Physical price: RM2,690/MT Put option loss: RM85/MT Actual selling price: RM2,605/MT

Long Put Option Hedge Example: Assumptions

Source: CME

§  Eliminates risk of lower price level §  Buying insurance and establishes a minimum selling

price level §  Benefits from a higher price level §  No margin requirements (option buyers do not post

margin) §  Option position guaranteed by BMD Clearing House

(option sellers post margins) Disadvantages §  Premium is paid in full at time of option purchase §  Transaction costs

Advantages

§  Short futures and long put option are 2 common risk management alternatives, eliminates risk of lower price level while long futures and long call option eliminates risk of higher prices

§  Establishes a minimum selling price level and vice versa for long futures and long call

§  Depending on needs and costs, combination of futures and options could be utilized

Summary

§  Worst US drought in half a century decimates the global corn crop. Benchmark corn futures up 50%, record high of $8.28/bushel

§  Options market - explosion of trades on yet higher prices §  Call options on right to buy corn at between $9 and $10

in December risen 13 times (CME) §  Trading houses protecting themselves against non-

delivery and consumers accelerate hedging programmes

“Trading houses and consumers bet corn prices to soar…Financial Times (2nd August 2012)

Source: Financial Times

§  If you buy options you can look like a loser for a while, perhaps a long while, but you can suddenly become a big winner (if the market moves drastically in your favour)

§  If you sell options you can be a winner fast (collect upfront premiums) but you can lose big suddenly (if the market moves drastically against you)

§  Famed investment guru like Warren Buffett is an options seller while veteran trader and renowned intellectual Nassim Taleb is a buyer of options

Some Observations on Options

§  BMD’s CPO futures provide a viable and liquid risk management market for hedgers and traders.

§  The CPO options contract added a new dimension for our users, with the ability to buy “insurance”

§  BMD is the marketplace for all your palm oil hedging and trading needs

Conclusion

List of Futures Brokers (www.bursamalaysia.com) 1.  AmFutures Sdn Bhd 2.  CIMB Futures Sdn Bhd 3.  ECM Libra Investment Bank Bhd 4.  HDM Futures Sdn Bhd 5.  HLG Futures Sdn Bhd 6.  Interactive Futures Sdn Bhd 7.  Inter-Pacific Securities Sdn Bhd 8.  JF Apex Securities Bhd 9.  JPMorgan Securities (Malaysia) Sdn Bhd 10. Kenanga Deutsche Futures Sdn Bhd 11.  LT International Futures (M) Sdn Bhd 12. Okachi (M) Sdn Bhd 13. Oriental Pacific Futures Sdn Bhd 14. OSK Investment Bank Bhd 15. Phillip Futures Sdn Bhd 16. RHB Investment Bank Bhd 17. Sunny Futures Sdn Bhd 18. TA Futures Sdn Bhd 19.  UOB-Kay Hian Futures Sdn Bhd

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Jeffrey Tan - jefftan@bursamalaysia.com +6019 261 5332 Moriazi Mohamad - MoriaziMohamad@bursamalaysia.com +6017 200 1117 Elmery Yap - elmeryyap@bursamalaysia.com +603 2034 7578