FINC6010 Derivative Securities Assignment
2024 S2
Overview:
CME Group is the world’s leading derivatives marketplace. The group has four exchanges, CME (Chicago Mercantile Exchange), CBOT (Chicago Board of Trade), NYMEX (New York Mercantile Exchange) and COMEX (The Commodity Exchange). These four exchanges offer a wide range of trading benchmarks for all major asset classes. CME Group’s website (https://www.cmegroup.com/) provides comprehensive information on derivatives trading and can be used as the major information source of this assignment.
Student teams from University of Sydney’s FINC6010 course are going to investigate derivative securities trading using the trading simulator provided by CME. The simulator can be accessed after registration (free) and login (see the following link). Initially, each trading team will have $100,000 to trade but you do not need use all the amount.
https://www.cmegroup.com/trading_tools/simulator.html
This assignment is designed to help students study and analyze real-life derivative trading. It aims to develop a deeper understanding of various types of derivatives, and to gain practical experience in analyzing derivative contracts. By completing this assignment, students will enhance their ability to apply theoretical knowledge to real-world scenarios and improve their readiness for job interviews and careers in the financial industry.
Submission Guidelines
o Deadline: The assignment is due by 14 Oct 2024 at 23:59.
o Late submission is not accepted. For special consideration request, please contact the student center for formal approval.
o Submission Method: Submit your report online via Canvas (“Assignments” tab on Canvas).
o File Format: Submit the report as a PDF (.pdf) or Word (.docx) document.
Group Formation:
o You can form. a group with students in different tutorial classes.
o Possible student number of your team ∈ [4, 5, 6].
o NO need to send group formation confirmation by emails or canvas.
Format:
o The report should be well-structured with clear headings.
o Please present the report in a Questions/Answers format.
o Please answer the questions listed below in sequence.
o Please use charts, tables, calculations, screenshots, or references (cite sources) for explanation purpose.
Page Limit:
o The submitted report (main body) should not be more than 10 pages, excluding cover page, references, and appendices.
o There is no font size or line spacing constraints, if others can read your report.
o Please provide the necessary screenshots to show your actual trading practice.
o Please note that marking will be based on your answers provided in the body of the report, appendices is used as double check the details, rather than answering questions.
o No need to provide executive summary and introduction, etc.
o Cover page is needed for providing the group name, student ID, and student names.
o For each team, only submit one document and once. Please put “(submitter)” after the submitter’s name.
o An example for cover page:
Group name: Big Shot
Group members: Green Soros (submitter), SID 123456;
Walsh Buffett, SID 234567;
Jack Rogers, SID 345678;
William Specter, SID 456789.
o Make sure your SID is correct in your report. Incorrect SID will significantly delay your mark release.
We will hold a special workshop in Week 7 to provide detailed instructions for the assignment. You are encouraged to ask questions to clarify any unclear points during this session.
Please note that emails or inquiries from group members regarding whether a specific item is included in the report are highly likely to incur mark deductions on the group report.
Question 1 (3 marks) Part (A)
After several rate hikes in the post-pandemic period, the U.S. Federal Reserve (Fed) holds varying opinions on the long-term outlook for U.S. policy interest rates. In the near term, most Fed officials anticipate a decrease in interest rates starting in December 2024. However, one Fed official holds a different view, expecting a significant increase in rates from December onward. This divergence in expectations creates substantial risk management needs for participants in the CME Group. Based on the futures contracts available in the trading simulator, you find that the 3-month SOFR contracts are the most relevant for hedging short-term interest rate risk.
1) Please explain the price quotation method for the 3-month SOFR contracts.
2) Describe the appropriate position and mechanism for using this contract to hedge against the risk of falling interest rates in the near future.
Part (B)
Suppose you are the manager for a major gold mine in the United States, responsible for risk management for the firm. Today is September 1, 2024, and you anticipate having 24,580 ounces of gold to sell on November 30, 2024. All of your gold is sold locally in the United States. Currently, the spot price of gold is quoted at USD 2,426 per ounce.
1) Identify the risk your company faces with selling gold?
2) Should you enter long or short futures contract to eliminate this risk? Among the future contracts available in the trading simulator, please specify which contracts you will trade and how many contracts you will trade.
Question 2 (1 mark)
The Japanese stock market has recently experienced volatile price changes. As a mutual fund manager planning to purchase a Japanese stock portfolio in November 2024, you need to manage the associated market risks. Using your trading simulator, navigate to the “Equity Index” tab to explore the available equity index derivatives.
1) Which futures contract position would be most appropriate if you expect the Japanese stock market to increase?
2) Explain how this position would help you achieve your objective.
Question 3 (2 marks)
Suppose your colleague Lucy is a portfolio manager currently managing the December futures contract for the CAD/USD currency pair, as shown in the CME trading simulator (6CZ4). The current bid and ask prices are 0.72710 and 0.72720, respectively. The last executed trade was at 0.72715, and her current net position shows a loss of 0.00065. Based on this information, please answer the following:
1) The trading desk manager suggests selling the CAD/USD December futures contract if the price falls to or below 0.72650. Lucy wants to use an market-if-touched (MIT) order to achieve this. Is an MIT order appropriate for this purpose? If yes, please specify the reason. If not, please suggest which type of order should be used, and why?
2) The senior manager requests selling the CAD/USD December futures contract when the price falls to or below 0.72650 but no lower than 0.72630. Which type of order can achieve this objective? Any disadvantage using this type of order? Please explain.
Question 4 (2 marks)
The trading desk manager directs you to purchase (long) two RTYZ4 futures contracts via a market order but does not provide details. Moreover, the manager emphasizes the importance of minimizing potential losses in a volatile market environment. To fulfill this task, you need to do the following:
1) Please specify the underlying asset and the asset class (eg, agriculture, interest rates, equity index, etc.) for the RTYZ4 contract.
2) Capture screenshots illustrating the process of initiating the long position and explain the order process. Keep this position open for a minimum of one trading day.
3) Monitor the price of RTYZ4 contract to identify an opportune time to sell, try to close (liquidate) your position without incurring any losses. Include screenshots to describe your steps. If the screenshots are too large, resize them using your computer skills to ensure they fit properly in your report.
Question 5 (2 marks)
You can manage risk in the foreign exchange markets with CME Group futures and options. Navigate to the Foreign Exchange Market section and focus on FX derivatives. Use the trading simulator to generate a chart comparing the futures prices of the British Pound (GBP), Canadian Dollar (CAD), and Australian Dollar (AUD), all with December 2024 maturity.
1) Present your comparison in a single chart. You may select a 3-month or 6-month time window for your analysis.
2) Summarize the price fluctuations for the British Pound, Canadian Dollar, and Australian Dollar. Identify and communicate the key findings from your comparison, considering aspects for example correlations between the currencies, and other relevant insights.
Question 6 (4 marks)
Suppose you work for a Canadian foreign trade company. You need to sell wheat overseas every year. On the CME platform, agriculture derivatives (futures and options) are quoted in US dollars (dollars and cents/bushel). Therefore, foreign exchange exposure is also a focus of your company. Click the "FX" tab, these are foreign exchange derivatives. Go to the " Canadian Dollar FX" panel and look at the quotes. How is the Canadian Dollar quoted? If the quote is 0.7304, what does it represent?
Now check the option series (Select “OPTIONS” at the upper right corner) on contract 6CZ4. Suppose that put options on Canadian Dollar with strike prices 0.74 and 0.76 cost 0.01380 and 0.02980 , respectively. How can the options be used to create a bull spread. Construct a table that shows the profit and payoff for the spreads.
Question 7 (4 marks)
You recently met John, the CFO of the largest local corn company. Given the low volatility in the company's business, you recommended using options for risk management, specifically using a butterfly spread. This involves purchasing one put option at a lower strike price, writing two put options at a higher strike price, and purchasing another put option at an even higher strike price, all on the ZCZ4 contracts.
It is essential that all options have the same expiration date and equidistant strike prices. You should open and close the long and short put positions simultaneously within 10 trading days, allowing for a brief time lag if necessary.
Required:
- Construct the butterfly spread using ZCZ4 contracts. Clearly identify the underlying asset, strike prices, expiration date, and both the opening and closing transaction times of the option contracts.
- Capture screenshots of the daily trading profit. Specify the conditions under which this strategy yields a profit, and provide a detailed explanation of the underlying reasons.
- Calculate breakeven points. Analyze whether the breakeven points and profit/loss at maturity from your estimation align with the CME P&L. Discuss any discrepancies and explain why they may occur.
Question 8 (4 marks)
The post-Ukraine-Russia war price trajectory of Ether (ETH) has demonstrated notable resilience and growth. Despite initial volatility spurred by geopolitical tensions, Ethereum has sustained an upward trend. As of July 1, 2024, ETH was trading at approximately $3,068.67, suggesting its stature as the second-largest cryptocurrency by market capitalization.
The growing adoption of decentralized finance (DeFi) and non-fungible tokens (NFTs) has significantly driven demand forEthereum. Analysts maintain an optimistic outlook on its long- term potential, with projections suggesting that ETH could reach new all-time highs. For instance, some forecasts predict that Ether's price may climb to approximately $4,100 by the end of 2024.
You decide to use a derivative strategy with two call options on contract ETHZ4 (have the same maturity date but different strike prices) to capitalize on this bullish view. Try to minimize the upfront payment. Explain the construction process of your strategy with screenshots. Calculate the breakeven price(s) for ETH at expiration. Determine the maximum profit and maximum loss for this strategy. Then, try to liquidate your position without making any loss. It may take some time. Provide screenshot(s) to show how you did it. If your screenshots are too large, then use your computer skills to modify them to fit in your report.
Question 9 (3 marks)
The natural gas markets experienced significant volatility in the aftermath of the COVID-19 pandemic. Initial lockdowns and reduced industrial activity led to a sharp decline in demand and prices. However, as economies began to reopen, demand for natural gas rebounded strongly, driving up prices and highlighting the market's sensitivity to economic activity.
The natural gas market saw substantial growth during this period as countries sought to diversify their energy supplies and enhance energy security. The United States emerged as a significant natural gas exporter, reshaping global natural gas supply dynamics. Geopolitical tensions, particularly the Ukraine-Russia conflict, further impacted the market by creating supply uncertainties in Europe and increasing the demand for natural gas from alternative sources.
Required:
Your manager asks you to construct an option straddle strategy to benefit from the high volatility of energy prices. The manager tells you the underlying asset is a natural gas futures contract with delivery in December 2024, but he does not provide the contract code. What is the contract code for the underlying asset? Please go to the “Energy” tab, and these are the energy derivatives available to trade on the CME platform. Explain the construction process of your strategy with screenshots. Construct a table that shows the profit from a straddle. For what range of stock prices would the straddle lead to a loss?