FINC3012 Derivative Securities Assignment

2024 S2

This assignment is designed to help students study and analyze real-life derivative trading and prepare for their future trading-based job interviews and careers in the financial industry. Students with a strong motive to self-study a wide range of derivatives contracts will benefit from working on the assignment and its related materials.

The due date for submitting the assignment report is 14 Oct 2024 at 23:59.

The deadline cannot be deferred further. If you or your team want to ask for special consideration, please contact the student center for formal approval.

Upload  your  assignment  work  in  Word  format  (.docx)  or  pdf  format  (.pdf)  from “Assignments” tag on Canvas.

CME Group is the world’s leading derivatives marketplace. The group has four exchanges, CME (Chicago Mercantile Exchange, established in 1848), 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  the  University  of  Sydney’s  FINC3012  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 to use all the amount.

Please access the CME Group Trading Simulator here:

https://www.cmegroup.com/trading_tools/simulator.html

The investigation report should be in a Questions/Answers format (you don’t need a cover page, executive summary, introduction etc.), answering the questions listed below in sequence.

The 10-page report should include everything the student team wants to report. The submitted report should not be more than 10 pages.

“Everything” means student traders should not send anenquiry email, asking whether certain items are included in the 10-page limit. The answer is always - yes included.

Please provide some screenshots at the end of your report to show your actual trading practice.

Reports without any trading evidence will incur 5 marks penalty.

You or your team do not need to send group formation information via email or register group information on Canvas. You can form a group with students from different tutorial classes. Groups should consist of 4-6 members.

Student(s) sending in emails, asking whether they can form. groups across tutorial classes, will incur 3 marks penalty.

The report does not need a separate cover page.

Put student IDs and student names of your team on the first page of the report.

For  each  team,  only  submit  one  document  and  once.  Please  put  “(submitter)”  after  the submitter’s name.

For example: Green Soros (submitter), SID 123456; Walsh Buffett, SID 234567; Jack Rogers, SID 345678.

Example for one-person team: Joe Soros (submitter), SID 987764.

Make sure your SID is correct in your report. Incorrect SID will significantly delay your mark release.

The  report  can  use  charts,  tables,  calculations,  screenshots,  or  references  (cite  sources)  for explanation purpose. There is no font size or line spacing constraints if others can read your report. Try to summarize the information and write the report within the 10-page limit.

Login and open the CME simulator using your practice account. The questions are as follows.

Question 1 (2 marks)

After several rate hikes in the post-pandemic period, looking ahead to 2025, the U.S. Federal Reserve (Fed) and the market both expect that the US policy interest rate will gradually peak and then fall. In June 2024, most Fed officials expect the policy rate to be 5.6% in 2024 and 4.1% in 2025, suggesting the rate continue decreasing in 2024. However, one expects the 2-year interest rate (i.e., the expected interest rate for 2026) to rise back to 5.8%. This creates significant risk management needs for participants in the CME Group. In your trading simulator, click on the “Interest Rate” tag and select interest rate derivatives. Investigate and report the price quotation method of the 3-month SOFR contracts. How can the 3-month SOFR contracts be used to hedge against a prospective decrease in interest rates? Additionally, provide hedging strategies using the T-note for the anticipated interest rate rise in 2 years.

Question 2 (1 marks)

Look at the main chart of your trading simulator. Click on “Equity Index” tag and these are equity index derivatives. As a U.S. mutual fund manager, you are going to sell a Japanese stock portfolio in November 2024, which futures contract position is best for hedging purposes, how and why?

Question 3 (2 marks)

You are managing a portfolio that includes positions in the December 2024 futures contract for the AUD/USD currency pair, as shown in the CME trading simulator (6JZ4). Assume the current bid and ask prices are 0.65060 and 0.65065, respectively. Your last executed trade was at 0.65065, and your current net position shows a loss of 0.00400. Given this scenario, you need to develop a trading strategy and risk management plan to optimize your position (i.e., try to reduce losses). Determine the most appropriate order type (such as Market, Limit, or Stop-Limit) for managing both entry and exit points in the market. (a) How would you utilize these order types given the current market conditions and the specific characteristics of the AUD/USD futures contract? (b) When managing your trades, you can choose between DAY orders and GTC (Good 'Til Canceled) orders. Explain the differences between these two types of orders. In what situations would you prefer  one  over  the  other?  Consider  factors  like  market  volatility,  timing  of  economic announcements, and specific trading goals in your response. You may conduct research to support your answer.

Question 4 (2 marks)

The trading desk manager instructs you to buy (long) two RTYZ4 futures contracts using a market order but does not specify the underlying asset. Identify the underlying asset for the RTYZ4 contract. Take screenshots showing the steps you took to execute the long position. Maintain this position for at least two trading days. Then, attempt to sell (liquidate) your position without incurring any losses. This process might require some time. Include screenshots to document how you achieved this. If the  screenshots  are too large, use your computer  skills to resize them appropriately for your report.

Question 5 (2 marks)

You can manage risk in the precious metals markets with CME Group Metals futures and options, getting more liquidity, access, and price transparency for trading Gold, Silver, Copper, Platinum, and Palladium on CME platform. Click on “Metal” tag and these are metal derivatives. Use trading simulator chart to compare futures prices of Copper, Silver and Palladium, all with December 2024 delivery. Present your comparison in one chart. You may use 3-month (3m) or 6-month (6m) time windows. Summarize the price performance of Copper, Silver and Palladium in your chart and communicate the key findings from the comparison to your trading desk manager. You need to figure out the “key findings” by yourself. Please consider the change, correlations etc.

Question 6 (2 marks)

As an employee of an Australian foreign trade company, your task is to import copper, which is traded in US dollars (USD) on the CME platform. To manage both the commodity price and foreign exchange exposure, you must understand and potentially utilize derivatives like futures and options. The AUD/USD exchange rate and copper futures prices are critical in your decision- making process.

Required:

(a) Assume the AUD/USD quote on the CME platform. is 0.6752. Explain what this quote means in terms of AUD's value relative to USD and how this affects the cost of importing copper.

(b) Evaluate the available monthly options for the 6AZ4 futures contract. If the current AUD/USD exchange rate is close to 0.6752. Identify the strike price nearest to this rate for the options. If your goal is to hedge against the possibility of the AUD weakening, would you purchase a call or put option (assume the strike price is the one you identified, quantity is 1)? Explain your choice and discuss the potential outcomes, including how this strategy could reduce risk. Consider the cost of the option, potential savings if the AUD weakens, and the financial implications for your company. Provide a brief explanation of the payoff structure and how it contributes to reducing risk. Please provide screenshots to show your buy/sell strategies.

Question 7 (3 marks)

You have a bullish outlook on the price of Wheat till December. You decide to use a derivative strategy with two call options on future contract ZWZ4 (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 Wheat price(s) 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 8 (3 marks)

To execute this trading strategy and construct a butterfly spread, one should purchase one put option at a lower strike price, write two put options at a higher strike price, and purchase another put option at an even higher strike price, all on the ESZ4 future contracts.

Ensure that all options have the same expiration date, with equidistant strike prices. Then liquidate your position (i.e., open and close the long and short put positions simultaneously within 10 trading days, allowing for a brief time lag if necessary).

Required:

•   Consistently  monitor  and  record  the  daily  profit  and  loss  from  this  strategy,  capturing screenshots of the positions' profit and loss.

•   Clearly identify the underlying asset, strike prices, expiration date, and transaction times (both opening and closing) of the option contracts.

•    Specify  the  conditions  under  which  this  strategy  yields  a  profit  and  provide  a  detailed explanation of the reasons.

Question 9 (3 marks)

The 2-year T-note yield continued to exhibit volatility in the post-pandemic period. While the Fed continued to raise rates in the first half of 2023, it signaled a more data-dependent approach in the latter half, leading to fluctuations in yields. Yields became highly sensitive to economic data releases, particularly those related to inflation and employment. Strong economic data often led to higher yields, while weaker data resulted in lower yields as market participants adjusted their expectations for future Fed actions.

Required:

Since the 2-year T-note yield is exhibiting significant volatility and sensitivity to economic data, a straddle spread would be the most appropriate strategy. Based on the underlying asset of ZTZ4 future contracts, please construct a straddle spread to benefit from high volatility. Explain the construction process of your strategy with screenshots. Calculate the breakevens at expiration. Are the results of your calculation of P&L consistent with P&L on CME? why or why not? Then, try to liquidate your position without making any loss. 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.