Equity Derivatives

[NMD]

Hello everyone,

I hope you are all well and staying safe given the current climate.

I was wondering whether anyone had a good knowledge of equity derivatives and could explain it in a simple way. I am keen to learn more about the area of law, the types of clients operate in this field, and how they are being impacted by today's economic climate?

Insight into this field would be really appreciated and incredibly helpful! Good luck in all your schemes and make sure to enjoy some of the summer!

 

[D]

I do not profess to be an expert in this topic, however, I did go down a bit of a rabbit-hole with options recently. I started with Investopedia, and it really went from there. You'll be surprised at what you pick up. What I did, was every time there was a word or phrase I didn't understand, I then "forked" my research on to that aspect to clear it up before I moved on.

 

[NMD]

Thank you, thats really helpful! Did you find out anything interesting?

I do not profess to be an expert in this topic, however, I did go down a bit of a rabbit-hole with options recently. I started with Investopedia, and it really went from there. You'll be surprised at what you pick up. What I did, was every time there was a word or phrase I didn't understand, I then "forked" my research on to that aspect to clear it up before I moved on.

 

[D]

Thank you, thats really helpful! Did you find out anything interesting?

I started researching it because of the reports I heard of people seeing insane gains on their portfolio's with SPY Puts. I saw $5k -> $1m in the aftermath of CoViD. This got me intrigued.

Derivatives in general, you can't go wrong with watching films like The Big Short. They will summarise some fairly complex concepts very simply. It's also very entertaining

 

[SportsThoughts]

Hello everyone,

I hope you are all well and staying safe given the current climate.

I was wondering whether anyone had a good knowledge of equity derivatives and could explain it in a simple way. I am keen to learn more about the area of law, the types of clients operate in this field, and how they are being impacted by today's economic climate?

Insight into this field would be really appreciated and incredibly helpful! Good luck in all your schemes and make sure to enjoy some of the summer!

Hey!

My recommendation would be to learn more about derivatives as a sole financial products and what they do first (forwards, futures, options and swaps). So all of these products are essentially contracts which operate in different ways but their price and behaviour in the market are derived from the price of an underlying asset.

Once you have a sound understanding of the definitions and their operation, you can consider corporates that would want to buy/sell these contracts. A good way to understand is through applying it to physical commodities and the same principles apply to equities. If you look at Norton Rose Fulbright's yearly accounts on companies house, I know they have invested in foreign exchange products which protects them from violent swings in currency valuation when holding money in escrow accounts, given their global footprint.

A good examples would be that if a farmer (also applies to oil, metals, foreign exchange, equities) produces 100 hay bales a year and need to sell 50 at £10 each to break even, he could enter into a futures contract with a purchaser of a hay bales for 50 hay bales at £8 each to sell when the harvest comes in.

Now, at that point in time that the market price for a hay bale might only be £8 and entering into the contract guarantees the farmer the sale of 50 bales at £8 upon harvest (in reality, there would be all sorts of data produced to predict the value of hay at the time of harvest, in order to accurately price the future). This brings the farmer pretty close to a guaranteed break even for that year so he is happy. Now, the farmer is still left with 50 bales to sell upon harvest.

Lets say the market price rockets for hay bales, and they're now worth £15 per bale. Great news for the farmer, he can now sell the remaining 50 at £15 and make a nice little profit for the harvest (assuming he is in the sole business of farming hay). All great news? Not quite, remember the farmer entered into a futures contract for £8 - he still has to sell the first 50 to the holder of the futures contract which means he has under priced 50 of his bales by £7 (15-8).

We can also consider the other party in the futures contract, the person who purchased the future. There's upside potential and downside potential.

Upside - lets say we're operating under the same market conditions, the price for hay is £15 per bale. The person holding the contract is laughing their socks off, they've agreed to pay £8 per bale when they're worth £15. They could keep the contract if the purchaser themselves wanted to take delivery of the bales, or they could choose to sell it at £13 per bale, £2 below market price but also making £5 per bale profit, these guys are called speculators (which makes it an attractive purchase for someone who would actually want the bales, like stables).

Let's now say that upon harvest there was a load of supply for bales and little demand, which plummets the price to £4 per bale.

Luckily for the farmer, the futures agreement stands and he's guaranteed to sell 50 bales at £8, bringing him close to break even. However, he now has to sell the remaining 50 in a deflated market meaning very little profits for him that year.

The purchaser of the futures contract is not so lucky, they will be left with 50 bales having paid double the market price for them, meaning they will either have to take delivery of the 50 bales, OR sell the contract at below market price £3, to dilute some of their losses.

I hope that helps and hasn't regurgitated the info you've found online, as that'll be embarrassing for me lol. Given that my example only relates to futures and you're interested in Structured Products/Derivatives then it's worth checking out American Depository Receipts, Contingent Value Rights and the other three Derivatives I mentioned above. They're all super interesting ways of diversifying risk and/or making money.

 

[NMD]

Hey!

My recommendation would be to learn more about derivatives as a sole financial products and what they do first (forwards, futures, options and swaps). So all of these products are essentially contracts which operate in different ways but their price and behaviour in the market are derived from the price of an underlying asset.

Once you have a sound understanding of the definitions and their operation, you can consider corporates that would want to buy/sell these contracts. A good way to understand is through applying it to physical commodities and the same principles apply to equities. If you look at Norton Rose Fulbright's yearly accounts on companies house, I know they have invested in foreign exchange products which protects them from violent swings in currency valuation when holding money in escrow accounts, given their global footprint.

A good examples would be that if a farmer (also applies to oil, metals, foreign exchange, equities) produces 100 hay bales a year and need to sell 50 at £10 each to break even, he could enter into a futures contract with a purchaser of a hay bales for 50 hay bales at £8 each to sell when the harvest comes in.

Now, at that point in time that the market price for a hay bale might only be £8 and entering into the contract guarantees the farmer the sale of 50 bales at £8 upon harvest (in reality, there would be all sorts of data produced to predict the value of hay at the time of harvest, in order to accurately price the future). This brings the farmer pretty close to a guaranteed break even for that year so he is happy. Now, the farmer is still left with 50 bales to sell upon harvest.

Lets say the market price rockets for hay bales, and they're now worth £15 per bale. Great news for the farmer, he can now sell the remaining 50 at £15 and make a nice little profit for the harvest (assuming he is in the sole business of farming hay). All great news? Not quite, remember the farmer entered into a futures contract for £8 - he still has to sell the first 50 to the holder of the futures contract which means he has under priced 50 of his bales by £7 (15-8).

We can also consider the other party in the futures contract, the person who purchased the future. There's upside potential and downside potential.

Upside - lets say we're operating under the same market conditions, the price for hay is £15 per bale. The person holding the contract is laughing their socks off, they've agreed to pay £8 per bale when they're worth £15. They could keep the contract if the purchaser themselves wanted to take delivery of the bales, or they could choose to sell it at £13 per bale, £2 below market price but also making £5 per bale profit, these guys are called speculators (which makes it an attractive purchase for someone who would actually want the bales, like stables).

Let's now say that upon harvest there was a load of supply for bales and little demand, which plummets the price to £4 per bale.

Luckily for the farmer, the futures agreement stands and he's guaranteed to sell 50 bales at £8, bringing him close to break even. However, he now has to sell the remaining 50 in a deflated market meaning very little profits for him that year.

The purchaser of the futures contract is not so lucky, they will be left with 50 bales having paid double the market price for them, meaning they will either have to take delivery of the 50 bales, OR sell the contract at below market price £3, to dilute some of their losses.

I hope that helps and hasn't regurgitated the info you've found online, as that'll be embarrassing for me lol. Given that my example only relates to futures and you're interested in Structured Products/Derivatives then it's worth checking out American Depository Receipts, Contingent Value Rights and the other three Derivatives I mentioned above. They're all super interesting ways of diversifying risk and/or making money.

Hey, it would never be embarrassing! This is amazing, thank you for taking time out of your day to write all this up. It has really helped! Wishing you all the best in your endeavours

 

[Romiras]

Hello everyone,

I hope you are all well and staying safe given the current climate.

I was wondering whether anyone had a good knowledge of equity derivatives and could explain it in a simple way. I am keen to learn more about the area of law, the types of clients operate in this field, and how they are being impacted by today's economic climate?

Insight into this field would be really appreciated and incredibly helpful! Good luck in all your schemes and make sure to enjoy some of the summer!

One thing to note is to query why you're interested in specifically equity derivatives. Most law firms deal with both and group 'both' into a single group.

Law - The type of work involves considering and dealing with hedging agreements like loans, structuring, capital markets work, loan financing, debt restructuring, Islamic structured products, mortality swaps, repos, repackagings, synthetic securitisations, etc.

Clients - Clients are varied. It is often financial institutions (i.e. banks), corporates and sovereigns.

Impact - They're always busy - and things don't change now. As you can imagine, almost every transaction needs to be 'hedged' in some way, especially financing arrangements. Therefore, clients will be looking at how to deal with the fallout of COVID19, or finding ways to hedge against it and its related risks, etc.

 

[Alice G]

Hey!

My recommendation would be to learn more about derivatives as a sole financial products and what they do first (forwards, futures, options and swaps). So all of these products are essentially contracts which operate in different ways but their price and behaviour in the market are derived from the price of an underlying asset.

Once you have a sound understanding of the definitions and their operation, you can consider corporates that would want to buy/sell these contracts. A good way to understand is through applying it to physical commodities and the same principles apply to equities. If you look at Norton Rose Fulbright's yearly accounts on companies house, I know they have invested in foreign exchange products which protects them from violent swings in currency valuation when holding money in escrow accounts, given their global footprint.

A good examples would be that if a farmer (also applies to oil, metals, foreign exchange, equities) produces 100 hay bales a year and need to sell 50 at £10 each to break even, he could enter into a futures contract with a purchaser of a hay bales for 50 hay bales at £8 each to sell when the harvest comes in.

Now, at that point in time that the market price for a hay bale might only be £8 and entering into the contract guarantees the farmer the sale of 50 bales at £8 upon harvest (in reality, there would be all sorts of data produced to predict the value of hay at the time of harvest, in order to accurately price the future). This brings the farmer pretty close to a guaranteed break even for that year so he is happy. Now, the farmer is still left with 50 bales to sell upon harvest.

Lets say the market price rockets for hay bales, and they're now worth £15 per bale. Great news for the farmer, he can now sell the remaining 50 at £15 and make a nice little profit for the harvest (assuming he is in the sole business of farming hay). All great news? Not quite, remember the farmer entered into a futures contract for £8 - he still has to sell the first 50 to the holder of the futures contract which means he has under priced 50 of his bales by £7 (15-8).

We can also consider the other party in the futures contract, the person who purchased the future. There's upside potential and downside potential.

Upside - lets say we're operating under the same market conditions, the price for hay is £15 per bale. The person holding the contract is laughing their socks off, they've agreed to pay £8 per bale when they're worth £15. They could keep the contract if the purchaser themselves wanted to take delivery of the bales, or they could choose to sell it at £13 per bale, £2 below market price but also making £5 per bale profit, these guys are called speculators (which makes it an attractive purchase for someone who would actually want the bales, like stables).

Let's now say that upon harvest there was a load of supply for bales and little demand, which plummets the price to £4 per bale.

Luckily for the farmer, the futures agreement stands and he's guaranteed to sell 50 bales at £8, bringing him close to break even. However, he now has to sell the remaining 50 in a deflated market meaning very little profits for him that year.

The purchaser of the futures contract is not so lucky, they will be left with 50 bales having paid double the market price for them, meaning they will either have to take delivery of the 50 bales, OR sell the contract at below market price £3, to dilute some of their losses.

I hope that helps and hasn't regurgitated the info you've found online, as that'll be embarrassing for me lol. Given that my example only relates to futures and you're interested in Structured Products/Derivatives then it's worth checking out American Depository Receipts, Contingent Value Rights and the other three Derivatives I mentioned above. They're all super interesting ways of diversifying risk and/or making money.

This is amazing, thank you @SportsThoughts