trading handbook

8/12/2019 Trading Handbook

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Trading Handbook

Table of Contents

Trading Handbook


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1. What is Trading............................................................................................32. How does a trade start..................................................................................33. Who are the Players in Trading.......................................................................54. Where Trading will be done............................................................................65. Different Trade Types....................................................................................6

5.1. Physi al Trade........................................................................................65.2. Paper Trade............................................................................................!6. Deri"ate Trade Types....................................................................................!

6.1. Deri"ati"e..............................................................................................!6.2. #$t$res..................................................................................................%6.3. #orwards................................................................................................%6.4. &ptions................................................................................................1'6.5. (waps.................................................................................................15

!. )eneral Trade Ter*s...................................................................................1+

Trading Handbook 2


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1. What is Trading

The word trade *eans ,-n e hange of one thing for another.,

Trade is "ol$ntary e hange of goods and/or ser"i es.

0 hanges *ay take pla e between two parties bilateral trade or a*ongst*ore than two parties *$ltilateral trade .

Trading is si*ply the b$ying and/or selling of a o**odity for risk*anage*ent or re"en$e generation p$rposes. f a o*pany only b$ys a

o**odity it is a pro $rer or b$yer if it only sells it is a retailer or seller. -norgani ation that does both is a trader

$yers sellers and traders intera ting in the *arket reate traded "ol$*e

(ophisti ated trading strategies are needed and parti ipants with predi tableb$ying or selling patterns are losing o$t.

t is lear that organi ations will trade to a hie"e different ob7e ti"es fore a*ple opti*i ation of internal long/short positions or spe $lati"ely forprofit generation reasons.

The pro ess of b$ying and selling se $rities8 an be ond$ ted for a fir*9sa o$nt or for its $sto*ers8 either ond$ ted on an e hange or o"er the

o$nter

2. How does a trade start

- trade starts o$t with one person offering so*ething to another person ine hange for an ite* that he /she wants.

- person *akes an offer and the other person either a epts de lines orproposes a different offer.

f the offer has been a epted by the other party the ne t step is to de idehow both the parties will send the*. This is the end of the trade.

Trading Handbook 3


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The 0ntire Trading :ife ;y le has "ario$s a ti"ities of whi h Trade ;apt$refor*s a "ery r$ ial *ilestone as the s$bse ;ost

P>: =eports ?anage*ent=eports

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*. Who are the $la(ers in Trading

?ost of those who parti ipate in the f$t$res or options *arkets an beategori ed broadly into one of two gro$ps

Hedgers

(pe $lators

+rokers

rokers are si*ply inter*ediaries who arry o$t b$ying and sellinginstr$ tions fro* hedgers or spe $lators.

Hedgers

Hedgers are *arket parti ipants who want to transfer risk. They an beprod$ ers or ons$*ers. - prod$ er hedger wants to transfer the risk that

pri es will de line by the ti*e a sale is *ade. - ons$*er hedger wants totransfer the risk that pri es will in rease before a p$r hase is *ade.

'peculators

- spe $lator takes a position in the f$t$res or options *arket in the hope ofgenerating profit. f a spe $lator takes a long position and the *arket pri egoes $p the position is profitable. :ikewise profits a r$e on a short positionas *arket pri es drop.

%ocals

-n indi"id$al spe $lator who physi ally trades on the 0 hange floor is knownas a lo al. Typi ally this indi"id$al pro"ides *arket li


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,. Where Trading will be done

- change/

- entral *arketpla e with established r$les and reg$lations where b$yersand sellers *eet to trade f$t$res and options ontra ts or se $rities.

0 hanges in l$de board of trade or e hange designated by the ;o**odity#$t$res Trading ;o**ission ;#T; or Deri"ati"es Transa tion 0 e $tion#a ility DT0# .

- *arketpla e or any organi ation or gro$p that pro"ides or *aintains a*arketpla e for trading se $rities options f$t$res or o**odities.

The deals traded on e hanges are referred to as 90 hange@traded deals9.

O er The Counter 0OTC /

The trading of o**odities ontra ts or other instr$*ents not listed on anye hange .

&T; transa tions an o $r ele troni ally or o"er the telephone.

=efers to sto ks not traded on registered e hanges.

-lso referred to as 9&ff@0 hange9.

The deals traded on &T; are referred to as 9&T;@traded deals9.

Counter $art(/

The party on the other side of the deal. .e. if one is the b$yer the o$nter@party is the seller and "i e@"ersa.

. 3ifferent Trade T(pes

.1. $h(sical Trade

- ontra t to a b$y/sell of real o**odity .

t in"ol"es physi al transport/*o"e*ent of o**odity fro* seller to theb$yer.

?ode of transport is an essential part of this trade. ;o$ld be ships pipes ortr$ ks.

Physi al Trades are so*e ti*es referred to as Wet Trades also.

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.2. $aper Trade

- ontra t to b$y/sell oil whi h does not in"ol"e *o"e*ent of o**odity .

;ontra ts where deli"ery is settled in ash rather than by deli"ery of thephysi al prod$ t on whi h the ontra t is based.

Deri"ati"es like options > swaps plays a *a7or role in this trade.

4. 3eri ate Trade T(pes

4.1. 3eri ati e

Deri"ati"es are instr$*ents that ha"e no intrinsi "al$e b$t deri"e their "al$efro* so*ething else.

They hedge the risk of owning things that are s$b7e t to $ne pe ted pri efl$ t$ations e.g. foreign $rren ies b$shels of wheat sto ks and go"ern*entbonds.

Trading Handbook

Physi al Trade Paper Trade

Trade Types

Physi al

#orward

#$t$res

Deri"ati"es

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There are two types of Deri"ati"esA

#$t$res or ontra ts for f$t$re deli"ery at a spe ified pri e.

&ptions that gi"e one party the opport$nity to b$y fro* or sell to the otherside at a prearranged pri e.

4.2. )utures

#$t$res are deri"ati"e ontra ts that gi"e the holder the opport$nity to b$y orsell the $nderlying at a pre@spe ified pri e so*e ti*e in the f$t$re.

They o*e in standardi ed for* with fi ed e piry ti*e ontra t si e andpri e.

-n agree*ent that a b$yer will p$r hase a spe ifi


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$t it is *ore risky lea"ing the dealer "$lnerable in ase the pri es go higherthan the pre@arranged pri e at the arri"al of the f$t$re date as e hange isnot there to absorb the risk.

#orwards are si*ilar ontra ts b$t $sto*i able in ter*s of ontra t si ee piry date and pri e as per the needs of the $ser.

)ull )orwards/

They are forward deals with spe ifi standardi ed


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-n 0#P o $rs d$ring the f$t$res ontra t trading period.

($ h deals are $s$ally done between energy *a7ors.

4.,. Options

- syste* of trading $nder whi h the writer of the option gi"es so*eone theright b$t not the obligation to b$y or sell an $nderlying o**odity.

-n agree*ent between two parties that gi"es one party the option holderthe option b$t not the obligation to b$yor sell an asset.

&ptions ontra ts do not i*ply a sale. nstead they i*ply a possible sale bygranting the potential b$yer the option to hoose whether or not they wish top$r hase the o**odity .

The pri e of the option whi h is alled the strike pri e and the *at$rity dateare fi ed and the option iss$er the o$nterparty does not ha"e the sa*efle ibility that the option holder en7oys.#or this reason the option holder *ay e pe t to pay a pre*i$* to the optioniss$er.

f the option holder an p$r hase the a t$al o**odity at that pri e on orbefore the asso iated date at a pri e whi h is fa"orable to the* they willprobably e er ise the option and *ake the p$r hase. f the pri e is too highat that ti*e they an hoose not to e er ise the option and the ontra te pires and they lose only the pre*i$*.

&ptions are lassified into "ario$s ategories and are below

Trading Handbook

Physi al Trade Paper Trade

Trade Types

&ptions

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Call Option A ;all &ption is the right to b$y a parti $lar asset at a pre@deter*ined fi ed pri e strike pri e at a ti*e $p to the *at$rity date.

$ut Option A P$t &ption is the right to sell a parti $lar asset at the strike pri e$p to *at$rity.

American Option A -n option that *ay be e er ised on any day ahead ofe piry. These trade on the f$t$res e hanges.

-uropean Option A &ption that an only be e er ised on the date of e piry.

Asian Option A -n option that is e er ised against an a"erage o"er a period.

At the &one( A -n option with an e er ise pri e at the $rrent *arket le"el ofthe $nderlying.

In the &one( A -n option with an e er ise pri e higher than the $rrent "al$e

of the $nderlying o**odity Out of &one( A -n option with an e er ise pri es lower than the $rrent

*arket le"el of the $nderlying instr$*ent

Options/ +u( Call

Trading Handbook

Strike Price

Breakeven Price

Profit

Loss

Share Price

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'trateg( 5iew/ n"estor thinks that the *arket will rise signifi antly in theshort@ter*.

'trateg( Implementation A ;all options are bo$ght with a strike pri e of a.The *ore b$llish the in"estor is the higher the strike pri e sho$ld be.

6pside $otential A Profit potential is $nli*ited and rises as the *arket rises.

+reake en $oint at - pir( A (trike pri e pl$s pre*i$*.

3ownside #isk A :i*ited to the pre*i$* paid @ in $rred if the *arket ate piry is at or below the strike a

Options/ 'ell $ut

'trateg( 5iew A n"estor is ertain that the *arket will not go down b$t$ns$re/$n on erned abo$t whether it will rise.

'trateg( Implementation A P$t options are sold with a strike pri e a. f anin"estor is "ery b$llish then in@the@*oney p$ts wo$ld be sold.

6pside $otential A Profit potential is li*ited to the pre*i$* re ei"ed. The*ore the option is in@the@*oney the greater the pre*i$* re ei"ed.

+reake en $oint at - pir( A (trike pri e less pre*i$*

3ownside #isk A :oss is al*ost $nli*ited ,al*ost, as the $nderlying pri ean not fall below eroG . High risk strategy. Potential h$ge losses in $rred if

the *arket rashes

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Options/ +u( $ut

'trateg( 5iew A n"estor thinks that the *arket will fall signifi antly in theshort@ter*.

'trateg( Implementation A P$t option is bo$ght with a strike pri e of a. The*ore bearish the in"estor is the lower the strike pri e sho$ld be.

6pside $otential A Profit potential is $nli*ited well not really $nli*ited ofo$rse as the *arket an not fall below ero .

+reake en $oint at - pir( A (trike pri e *in$s pre*i$* paid.

3ownside #isk A :i*ited to the pre*i$* paid @ in $rred if at e piry the*arket is at or abo"e the strike a.

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Options/ 'ell Call

'trateg( 5iew A n"estor is ertain that the *arket will not rise and is $ns$rewhether it will fall.

'trateg( Implementation A ;all option is sold with a strike pri e of a . f thein"estor is "ery ertain of his "iew then at@the@*oney options sho$ld be sold

if less ertain then o$t@of@the@*oney ones sho$ld be sold. 6pside $otential A :i*ited to the pre*i$* re ei"ed @ re ei"ed if the *arket

at e piry is at or below the option strike.

3ownside #isk A nli*ited. :osses on the position will worsen as the *arketrises.

Trading Handbook 14


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Options/ +ull 'pread

'trateg( 5iew A n"estor thinks that the *arket will not fall b$t wants to apthe risk.

'trateg( Implementation A ;all option is bo$ght with a strike pri e of a andanother all option sold with a strike of b prod$ ing a net initial debit

&=P$t option is bo$ght with a strike of a and another p$t sold with a strike of bprod$ ing a net initial redit.

6pside $otential/ :i*ited in both ases @ ;allsA differen e between strikes*in$s initial debit.P$tsA Bet initial redit.?a i*$* profit if *arket at e piry is abo"e the higher strike.

3ownside #isk A :i*ited in both ases @ ;allsA net initial debitP$tsA differen e between strikes *in$s initial redit?a i*$* loss if at e piry *arket is below the lower strike.

4. . 'waps

(wap is a deri"ati"e where two o$nterparties e hange one strea* of ashflows against another strea*. These strea*s are alled the legs of the swap.

#irst &il (wap was traded in 1+%6 % years after #$t$res trading started inBy*e . 1 billion arrel *ark for swap trading a hie"ed in 1+%+

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(i*ple (wap is an agree*ent where by a floating pri e is e hanged for afi ed pri e o"er a spe ified period.

n *arket appro i*ately !5I of all &T; transa tions are (waps.

(waps are now $sed by e"ery kind of $ser of the finan ial *arkets @ banksins$ran e o*panies non@finan ial orporations and instit$tional in"estors.

7eneral characteristics of 'waps/

The ter* of the swap is a whole n$*ber o**only one two three fi"e andse"en and o$ld be till 1' years.

The fi ed or floating pay*ents take pla e at reg$lar inter"als for e a*plee"ery *onth si or 12 *onths.

The prin ipal of the swap re*ains onstant for the ter* of the swap.

The fi ed rate re*ains onstant for the ter* of the swap.

The floating rate is set at the beginning of ea h interest period and paid inarrears at the end of the interest period.

$urpose/ Prod$ ers sell swap to lo k their sales pri e

- ample/Prod$ er and the nter*ediary agree a fi ed pri e for e a*ple J1% a barrelfor an agreed oil spe ifi ation and a floating pri e often a referen e pri ederi"ed fro* Platt s or one of the f$t$res *arket.

Case A/ When )loating $rice is %owerProd$ er re ei"ed fro* the inter*ediary the differen e between fi ed andfloating

Case +/ When )loating $rice is HigherProd$ er pays the differen e between the floating pri e and fi ed pri e to theinter*ediary.

)ormulae/

Pri e Differen eA ;ontra ted ?onthly Kol$*e L #i ed Pri e C #loating Pri e

Therefore if the prod$ er bo$ght an J1% (wap for 5' ''' bbl per *onth

f the floating pri e is J1!.2 for the *onth of De e*ber

Prod$ er wo$ld re ei"eA 5' ''' bbl L J1% @ J1!.2 F J4' '''

3ifferential 'wap

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Differential swap is based on the differen e between a fi ed differential fortwo prod$ ts and the a t$al or floating differential o"er ti*e.

$urpose/

Differential (waps are typi ally $sed by refiners to hedge hanging *argins

between refined prod$ ts.

=efiners $s$ally re ei"e the fi ed@ pri e side of the swap ens$ring a knownforward relationship for the pri e of their "ario$s prod$ ts.

f they sell the diff and the diff narrows then the refiner re ei"es thedifferen e if it e pands the refiner pays o$t.

Diff (waps *ay also be $sed by o*panies as a way of *anaging basis riskass$*ed d$ring their nor*al hedging a ti"ity.

&argin or Crack 'wap

=efining *argin is lo ked at a ertain base le"el with the help of ?argin or;ra k (wap.

#i ed differential between prod$ t - and is e hanged for #loating differential

between prod$ t - and .

$urpose/

=efiners who prefer to fi a known refining *argin an enter into a refining*argin swap whereby the prod$ t o$tp$t of the refinery and the r$de

feedsto k inp$t are si*$ltaneo$sly hedged i.e. the prod$ ts are sold andthe r$de is bo$ght for forward periods.

The refiner either pays or re ei"es the differen e between *argins thereforeg$aranteeing the profit of the refiner.

$articipation 'wap

Parti ipation (wap is si*ilar to a reg$lar (wap in that the fi ed pri e payer is1''I prote ted when the pri es rise abo"e the agreed pri e b$t $nlike anordinary swap the lient Mparti ipatesN in the downside.

- ample/

Trading Handbook

PRODUCTA

REFINERY PRODUCTB

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- parti ipation (wap was agreed at a le"el of J%' per tonne for a high s$lph$rf$el oil H(#& with a 5'I parti ipation the b$yer wo$ld be f$lly prote tedagainst pri es abo"e J%' per tonne b$t wo$ld also retain 5'I of the sa"ingsgenerated when pri es fell below J%' per tonne. f pri es fell to J!' pertonne the lient wo$ld only pay o$t J5 per tonne rather than the J1' pertonne d$e $nder the reg$lar swap.

3ouble 8 6p 'wap

y $sing this instr$*ent swap $sers an a hie"e a swap pri e whi h is betterthan the a t$al *arket pri e b$t the swap pro"ider will retain the option todo$ble the swap "ol$*e before the pri ing period starts. (wap o*bined withan &ption.

- tendable 'wap

(i*ilar to Do$ble@ p (wap e ept that the pro"ider has right to e tend theswap at the end of the agreed period for a predeter*ined period.

$re9$aid 'wap

#i ed pay*ent ash flow an be dis o$nted ba k to its net present "al$e andpaid to the $sed.

+arter 'waps

n a barter swap one o**odity is swapped for another.

)i ed9)loat 'waps

- swap where for an agreed f$t$re date a fi ed pri e is se $red for yo$ro**odity whose *arket pri e floating pri e fl$ t$ates with $n ertainty.

y re ei"ing a fi ed o**odity *arket pri e trader an b$dget and plan with*ore ertainty.

- pri e settled at the ti*e of the deal where a per entage of the pri e is fi ed

agreed and the re*aining per entage is floating "ariable and dependanton the f$t$re *arket.

+enefits of )i ed")loat 'waps/

Pri e prote tion @ =e ei"e a g$aranteed fi ed pri e for an agreed


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Negative side of Fixed/Float Swaps

The transa tion does not o"er the basis risk whi h is the risk arising fro*entering into the transa tion not being identi al to the risk being o"ered.

Oo$ annot benefit fro* fa"orable o**odity pri e *o"e*ents.

)loat9)loat 'waps

The swapping of one type of float rate inde for another. :ike if the e pe tedpri e of r$de is referen ed to the pri e at one lo ation e hanging that pri efor the pri e at another lo ation onstit$tes a float@float swap.

t is *ore pop$larly referred as 9basis@swaps9 as it helps in hedging the basisrisks .

;an also in"ol"e swapping the base $rren y s$ h as swapping the basepri e of a o**odity in ( dollars for the base pri e in apanese yen.

s $sed in the energy ind$stry as a te hni


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Cur es A

t is the ontin$o$s i*age of $nit inter"al.

When it o*es to pri e $r"eA t is the pri e


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=isk that o$nterparty does not deli"er se $rity or its "al$e in ash as peragree*ent.

Commodit( A

- transportable arti le of trade or o**er e that an be traded or sold

-ny goods or ser"i es whi h are e hanged for *oney

(o*ething of "al$e that an be bo$ght or sold $s$ally a prod$ t or raw*aterial

- posure A

The potential redit/loss d$e to the *arket "al$e of a ontra t witho$nterparty

The finan ial i*pli ation of *arket pri e *o"es.

The a*o$nt of f$nds in"ested in a parti $lar type of se $rity and/or *arketse tor or ind$stry and $s$ally e pressed as a per entage of totalportfolio holdings th$s it is the a*o$nt an in"estor has at risk or thea*o$nt the in"estor an lose.

Hedging/

s to offset ta kle the potential risks and ret$rns of one position by takingo$t an opposing position to reate an o$t o*e of greater ertainty

s a risk *anage*ent te hni


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Hedging/

Trader who strikes the deal a ts as an agent for another Trader who iso*pleting the deal .

?ediating for a deal between another trader and the o$nter@party.

&aster Trade Agreement/

This agree*ent defines the r$les/g$idelines for the deal ontra ts betweenthe trader and the o$nter parties.

This agree*ent is o**only $sed for ontra ts in "ario$s energy deri"ati"e*arkets.

These standard *aster agree*ents are defined by "ario$s trade bodies andtrading o*panies abide to the* for their deals in trade *arket.

7eneral Terms ! Conditions/

These are the ter*inologies and the onditions whi h two parties the traderand the o$nter@party agree for a deal when in"ol"ed in a deal ontra t.

%i

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