2002 ISDA Equity Derivatives Definitions
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Article 8 Cash Settlement
Section 8.1. Cash Settlement of Option Transactions. In respect of each Exercise Date under an Option Transaction for which “Cash Settlement” is applicable, Seller shall pay to Buyer the Option Cash Settlement Amount, if any, on the relevant Cash Settlement Payment Date for all Options exercised or deemed exercised on that Exercise Date.
Section 8.2. Option Cash Settlement Amount. “Option Cash Settlement Amount” means, unless otherwise provided in the related Confirmation, in respect of each Valuation Date:
- (a) under an Index Option Transaction or Index Basket Option Transaction, an amount equal to the number of Options exercised or deemed exercised on the relevant Exercise Date multiplied by the Strike Price Differential multiplied by one unit of the Settlement Currency multiplied by the Multiplier, if any; and
- (b) under a Share Option Transaction or Share Basket Option Transaction, an amount equal to the number of Options exercised or deemed exercised on the relevant Exercise Date multiplied by the Option Entitlement multiplied by the Strike Price Differential.
Section 8.3. Strike Price Differential. “Strike Price Differential” means, unless otherwise provided in the related Confirmation, in respect of each Valuation Date, an amount equal to the greater of (a) the excess of (i) in the case of a Call, the relevant Settlement Price over the Strike Price or (ii) in the case of a Put, the Strike Price over the relevant Settlement Price, and (b) zero.
Section 8.4. Cash Settlement of Forward Transactions. In respect of each Cash Settlement Payment Date under a Forward Transaction for which “Cash Settlement” is applicable:
- (a) if “Prepayment” is not applicable:
- (i) if the Forward Cash Settlement Amount is a positive number, then Seller shall pay to Buyer the Forward Cash Settlement Amount on the relevant Cash Settlement Payment Date; and
- (ii) if the Forward Cash Settlement Amount is a negative number, then Buyer shall pay to Seller the absolute value of the Forward Cash Settlement Amount on the relevant Cash Settlement Payment Date; and
- (b) if “Prepayment” is applicable, then Seller will pay to Buyer on the relevant Cash Settlement Payment Date the sum of the Forward Cash Settlement Amount and the Excess Dividend Amount, if any.
Section 8.5. Forward Cash Settlement Amount. “Forward Cash Settlement Amount” means, unless otherwise provided in the related Confirmation, in respect of each Valuation Date:
- (a) under an Index Forward Transaction or Index Basket Forward Transaction to which “Prepayment” is not applicable, an amount equal to the Settlement Price minus the Forward Price multiplied by one unit of the Settlement Currency multiplied by the Multiplier, if any;
- (b) under an Index Forward Transaction or Index Basket Forward Transaction to which “Prepayment” is applicable, an amount equal to the Settlement Price multiplied by one unit of the Settlement Currency multiplied by the Multiplier, if any;
- (c) under a Share Forward Transaction or Share Basket Forward Transaction to which “Prepayment” is not applicable and “Variable Obligation” is not applicable, an amount equal to the Number of Shares or the Number of Baskets, as the case may be, multiplied by an amount equal to the Settlement Price minus the Forward Price;
- (d) under a Share Forward Transaction or Share Basket Forward Transaction to which “Prepayment” is applicable and “Variable Obligation” is not applicable, an amount equal to the Number of Shares or the Number of Baskets, as the case may be, multiplied by the Settlement Price;
- (e) under a Share Forward Transaction or Share Basket Forward Transaction to which “Prepayment” is not applicable and “Variable Obligation” is applicable, an amount equal to the Number of Shares or the Number of Baskets, as the case may be, multiplied by:
- (i) if the Settlement Price is less than or equal to the Forward Floor Price, an amount equal to the Settlement Price minus the Forward Floor Price;
- (ii) if the Settlement Price is greater than the Forward Floor Price but less than or equal to the Forward Cap Price, zero; and
- (iii) if the Settlement Price is greater than the Forward Cap Price, an amount equal to the Settlement Price minus the Forward Cap Price; and
- (f) under a Share Forward Transaction or Share Basket Forward Transaction to which both “Prepayment” and “Variable Obligation” are applicable, an amount equal to the Number of Shares to be Delivered or the Number of Baskets to be Delivered, as the case may be and in either case determined without regard to rounding, multiplied by the Settlement Price.
Section 8.6. Cash Settlement of Equity Swap Transactions. In respect of each Cash Settlement Payment Date for an Equity Amount Payer under an Equity Swap Transaction for which "Cash Settlement” is applicable:
- 8.6(a) if the Type of Return specified in the related Confirmation is “Price Return”, then:
- (i) if the Equity Amount determined by the Calculation Agent in relation to that Equity Amount Payer is a positive number, then that Equity Amount Payer will pay (in addition to any other amounts payable by that Equity Amount Payer) to the Equity Amount Receiver the Equity Amount on the relevant Cash Settlement Payment Date; and
- (ii) if the Equity Amount determined by the Calculation Agent in relation to that Equity Amount Payer is a negative number, then the Equity Amount Receiver will pay (in addition to any other amounts payable by that Equity Amount Receiver) to the Equity Amount Payer the absolute value of the Equity Amount on the relevant Cash Settlement Payment Date;
- 8.6(b) if the Type of Return specified in the related Confirmation is “Total Return” and “Re-investment of Dividends” is not applicable, then Section 8.6(a) will apply as though Price Return were the applicable Type of Return and, in addition, on each Dividend Payment Date, the relevant Equity Amount Payer will pay to the Equity Amount Receiver the relevant Dividend Amount (if any) owed by such Equity Amount Payer on that Dividend Payment Date; and
- 8.6(c) if the Type of Return specified in the related Confirmation is “Total Return” and “Re-investment of Dividends” is applicable, then Section 8.6(a) will apply as though Price Return were the applicable Type of Return, provided that for purposes of determining the relevant Equity Amount for each subsequent Cash Settlement Payment Date the Calculation Agent shall make the adjustment provided for in Section 10.4.
Section 8.7. Equity Amount. “Equity Amount” means, in respect of each Cash Settlement Payment Date and an Equity Amount Payer, an amount, determined by the Calculation Agent as of the Valuation Time on the Valuation Date to which the Cash Settlement Payment Date relates, equal to the product of the Equity Notional Amount and the Rate of Return.
Section 8.8. Cash Settlement Payment Date. “Cash Settlement Payment Date” means any date specified or otherwise determined as provided in the related Confirmation or, if any such date is not a Currency Business Day, the next following Currency Business Day. If no such date is specified in the related Confirmation, the Cash Settlement Payment Date will fall on the date that is one Settlement Cycle following the Valuation Date, or if such date is not a Currency Business Day, the next following Currency Business Day. In the case of an Index Basket Transaction or Share Basket Transaction, if as a result of the occurrence of a Disrupted Day there is more than one Valuation Date with respect to Indices or Shares comprised in the Basket, then the relevant Cash Settlement Payment Date shall be determined by reference to the Valuation Date which is the last to occur.
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Resources and Navigation
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Comparisons
8 Cash Settlement
Section 8.1 Cash Settlement of Option Transactions
Section 8.2 Option Cash Settlement Amount
Section 8.3 Strike Price Differential
Section 8.4 Cash Settlement of Forward Transactions
Section 8.5 Forward Cash Settlement Amount
Section 8.6 Cash Settlement of Equity Swap Transactions
- 8.6(a). Price Return
- 8.6(b). “Total Return” and “Re-investment of Dividends” is not applicable
- 8.6(c). “Total Return” and “Re-investment of Dividends” is applicable
Section 8.7 Equity Amount
Section 8.8 Cash Settlement Payment Date
Compare Section 8.6 with Physical Settlement of Equity Swap Transactions under Section 9.3, which I am bound to say is a lot less fraught.
Basics
On the difference between Final Price and Relevant Price
Final Price is defined in Article 5 of the 2002 ISDA Equity Derivatives Definitions and is germane therefore to Equity Swap Transactions only and not, say, Forward Transactions (which, circuitously, rely instead on Relevant Price, albeit defined in a similar way).
The Final Price also has separately broken-out scenarios for Basket Transactions (being just the weighted sums of the individual components in the basket). Relevant Price doesn’t bother to break these out — whether that is because Share Basket Forwards behave differently to Basket Swaps, or just because ISDA’s crack drafting squad™ was losing the will to live, is a question to which we have yet to get to the bottom.
Don’t hold your breath.
Section 8.6: Cash Settlement of Equity Swap Transactions
Equity Swap Transactions can be settled either by reference to Price Return or Total Return.
Under Section 8.6 (Cash Settlement of Equity Swap Transactions) where “Cash Settlement” applies, a payment is made on each Cash Settlement Payment Date depending on the Type of Return specified as follows:
Price Return
Price Return is simply a function of the price at the beginning and end, and takes no account of declared dividends or other income or distributions received off the underlier in the meantime. It is simply
Equity Notional Amount * Rate of Return
Where “Rate of Return” is
((Final Price - Initial Price)/Initial Price) * any Multiplier
The Equity Amount is paid one way or the other depending on whether it is positive or negative.
Total Return
Total Return is the Price Return, but adjusted for income.
Where Re-investment of Dividends does not apply, the Equity Amount Payer must pay Dividend Amounts along with the Equity Amount, whichever way it might be paid, as per Price Return.
Where Re-investment of Dividends does apply, then Equity Amounts will be adjusted as per the “Re-investment of Dividends” provision.
Section 8.7: Equity Amount
Equity Amounts, then. Straightforward enough: Take your Equity Notional Amount — helpfully filled out in the Confirmation — multiply it by the Rate of Return, being the performance of the underlying share over the period in question — and there’s your number.
Let’s put some numbers on this, because, as with many of the finer creations of ISDA’s crack drafting squad™, there is quite a lot of buried technology in there to unpack.
The first component is the Rate of Return. This is a calculation of the performance of the Share over the period, times a Multiplier which might apply if you are doing some kind of kooky leveraged trade, but more likely will account for capital gains or stamp duty payable by the broker on the underlying hedge — so you might expect something like 85%. But that makes the mathematics too complicated for this old fellow, so let’s call the Multiplier 100%, so you can ignore it, and say the Initial Price is 100. And let’s do two scenarios: where the stock has gone up — here say the Final Price is 105, and where the stock has gone down — here, say the Final Price is 95.
The Rate of Return formula is (Final Price - Initial Price)/Initial Price) * Multiplier, which works out as:
- Where the stock went up: (105-100)/100 * 100% = 5/100 = +5%.
- Where the stock went down: (95-100)/100 * 100% = -5/100 = -5%.
Now to calculate your Equity Amount, we take the Equity Notional Amount (for ease of calculation, say USD1,000,000?) and times it by the Rate of Return:
- Where the stock went up: USD1,000,000 * +5% = USD+50,000.
- Where the stock went down: USD1,000,000 * -5% = USD-50,000.
Section 8.8: Cash Settlement Payment Date
A provision that does very little to help an inquiring mind with the question “What is the Cash Settlement Payment Date actually, like, for?”
For that, you would be advised to consult Section 8.6, Cash Settlement of Equity Swap Transactions, which differentiates between “Price Return”, which concerns itself purely with the prevailing equity price of the underlier, and “Total Return” which also factors in dividends paid on the relevant stock, and “slight return”, which is a Jimi Hendrix song.[1]
Note: Dividend Amounts are typically payable on the Cash Settlement Payment Date — though the Cash Settlement Payment Date following what — that is the question, whose answer, it turns out, is a little bit odd, as you will see if you investigate further.
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References
- ↑ It doesn’t really relate to slight return, though that is a Jimi Hendrix song.