Futures Price Valuation - Equity Derivatives Provision
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2002 ISDA Equity Derivatives Definitions Paragraph 6.8 in a Nutshell™ Use at your own risk, campers!
Full text of Paragraph 6.8
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Content and comparisons
Article 6. Valuation
Section 6.1. Valuation Time
Section 6.2. Valuation Date
Section 6.3. General Terms Relating to Market Disruption Events
- 6.3(a) Market Disruption Event
- 6.3(b) Trading Disruption
- 6.3(c) Exchange Disruption
- 6.3(d) Early Closure
Section 6.4. Disrupted Day
Section 6.5. Scheduled Valuation Date
Section 6.6. Consequences of Disrupted Days
Section 6.7. Averaging
- 6.7(a). Averaging Date
- 6.7(b). Settlement Price and Final Price
- 6.7(c). Averaging Date Disruption
- 6.7(d). Adjustments of the Exchange-traded Contract
- 6.7(e). Adjustments to Indices (Averaging)
Section 6.8. Futures Price Valuation
- 6.8(a) Valuation Date (Futures Price Valuation)
- 6.8(b) Additional definitions (Futures Price Valuation)
- 6.8(c) Settlement Price and Final Price (Futures Price Valuation)
- 6.8(d) Adjustments of the Exchange-traded Contract (Futures Price Valuation)
- 6.8(e) Non-Commencement or Discontinuance of the Exchange-traded Contract
- 6.8(f) Corrections of the Official Settlement Price
Paragraph 6.8(d) is identical to the text of 6.7(d), except that that relates to Averaging.
Summary
Where you price an Index Swap or Index Basket Swap by reference to an futures contract rather than the published price of the Index itself. This requires you to designate not just the Index to which the futures contract relates (which needless to say you’d be specifying anyway), but also the delivery month of the relevant futures contract and the exchange on which the futures contract is traded.
Note that valuation keys off the Official Settlement Price published by the Exchange on the Valuation Date, so you don’t need the Valuation Time concept.
Section 6.8(e) Non-Commencement or Discontinuance of the Exchange-traded Contract
Part of the greater flow of what you should do if you have a Index swap which you are hedging by reference to an Exchange-traded Contract. This part: what to do if the Exchange-traded Contract you are hedging with goes away, or — more ontologically challengingly, you would think — never existed in the first place.
General discussion
A trick for young players. For all this talk of Futures Price Valuation, section 6.8 is all about Index Transactions and Index Basket Transactions, where (since you can’t by an Index directly, it not being a corporeal thing, but merely an interesting[1] disembodied intellectual concept), so the cleanest way of getting actual exposure to an index is to buy futures on the Index. It’s that, or buying the actual shares underlying the index — which is quite the operational pain in the posterior, if there are a hundred shares: all that balancing whenever the index constituents change. Gah. You get the idea.
Now, what say you want to write an Equity Swap Transaction on a share future directly?
Question one you’ll have (I know, because I had it) is why would you write an OTC derivative on an exchange-traded derivative of an exchange-traded security? At least with an Index, if you want to hedge unmessily, the only option is a future. Hence all this Futures Price Valuation malarkey.
But if it is just a single share, why not just reference that single Share and make it a standard Share Transaction?
As is so often the case, the answer can be laid at the door of our American friends. The CFTC doesn’t allow one to write swaps on certain Shares, so if you want synthetic exposure to them, the, ahhh, future is your only hope.[2]
You may want to borrow some of the concepts from this Futures Price Valuation — what’s not to like about ISDA standard drafting, after all — but you’ll need to do some ninja mutatis mutandis moves, taking our references to “Index” throughougt and replacing them with references to “the assets underling the Exchange-traded Contract”.