Exchange-traded contracts

All market participants in exchange-traded contracts trade with a central counterparty, the exchange s clearing house. This eliminates counterparty risk. The clearing house is able to guarantee each deal, because all participants are required to contribute to its clearing fund... 

An equilibrium model of the term structure, of which we reviewed three in the previous section, is a model that is derived from (or consistent with) a general equilibrium model of the economy. They use generally constant parameters, including most crucially a constant volatility, and the actual parameters used are often calculated from historical time series data. Banks commonly also use parameters that are calculated from actual data and implied volatilities, which are obtained from the prices of exchange-traded option contracts. 

The New York Coffee, Sugar and Cocoa Exchange traded a futures contract on the United States consumer prices index (CPI) in the 1980s. 

In this section we will explore exchange-traded interest rate options— contracts traded on organised exchanges. In contrast, OTC options offered by banks will be examined in the next section. 

Eurex offers three principal bond option contracts, all of these being options on the futures contracts traded on the same exchange. The contracts available are ... 

Options are traded both on recognized exchanges and over the counter (OTC). Exchange-traded options are standardized plain vanilla contracts OTC options can take on virtually any form. Options traded on an exchange are often written on futures contracts. For example, a gilt option... 

Futures. Most exchanges trade options on the futures contracts that they trade. These options expire one or two days before the underlying futures do. Some, such as those traded on the Philadelphia Currency Options Exchange, allow cash settlement. This means that when the holders of a futures call exercise it, they are assigned both a long position in the future and the cash value of the difference between the strike price and the futures price. 

Bonds. Exchange-traded options on bonds are invariably written on the bonds futures contracts. One of the most popular exchange-traded options contracts, for example, is the Treasury bond option, which is written on the Treasury futures contract and traded on the Chict o Board of Trade Options Exchange. Options written on actual bonds must be traded in the OTC market. 

The London-based International Petroleum Exchange (IPE) is the second largest energy futures exchange in the world, listing futures contracts that represent the pricing benchmarks for two-thirds of the world s crude oil and the majority of middle distillate traded in Europe. IPE natural gas futures may also develop into an international benchmark as the European market develops larger sales volume. 

Futures Prices Natural gas futures contracts began trading on April 3, 1990, on the New York Mercantile Exchange (NYMEX). Sabine Pipe Line Company s Heniy Hub near Erath,... 

NYMEX New York Mercantile Exchange, Inc. (NYMEX Exchange). The company is a major provider of financial services to the energy and metals industries including the trading of energy futures and options contracts. 

The Bund future was launched on 29 September 1988. With the introduction of the German government bond futures contract LIFFE was now trading bond contracts in the US Treasury bond, the Japanese government bond, the Italian government bond and UK gilts. It was the first financial futures exchange to have achieved this position. The contract specifications on the UK and European bond futures offered at that time appear in Exhibit 16.1. 

Of course, these contracts have evolved to reflect new political and economic regimes. Today the Bund has become the Euro-Bund, denominated in euros, and traded on Eurex and LIFFE CONNECT platform. The UK gilt has been decimalised and the open outcry system of trading has been replaced by LIFFE CONNECT. While the Italian bond, now also quoted in euros, is traded solely on the Italian Exchange. 

As with bond options, each of these options contracts are exercisable into one contract in the underlying futures, also traded on the same exchange. The detailed specifications for EURIBOR STIR options are given in Exhibit 17.11, with those for the other currencies being very similar. However, as the EURIBOR contracts are the most liquid, we will concentrate on these for the remainder of this section. 

Euronext-LIFFE s 3-month EURIBOR futures option, traded on the Chicago Mercantile Exchange, is an actively traded short-term interest rate option that enjoys high trading volume. If these options are exercised, the buyer and the seller of the option take positions in an underlying 3-month EURIBOR futures contract. The futures contract is cash-settled and the final price at delivery is equal to 100 minus the 3-month LIBOR. 

---