Safex

BACKGROUND

 

The South African Futures Exchange (SAFEX) is the futures exchange subsidiary of JSE Limited, the Johannesburg based exchange. It consists of two divisions; a financial markets division for trading of equity derivatives and an agricultural markets division (AMD) for trading of agricultural derivatives.

Safex was formed in 1990 as an independent exchange and experienced steady growth over the following decade. In 1995 a separate agricultural markets division was formed for trading of agricultural derivatives. The exchange continued to make steady progress despite intensifying competition from international derivative exchanges and over-the counter (OTC) alternatives. By 1997 Safex reserves had grown sufficiently to allow a significant reduction in fees it levies per future or options contract. Consequently all fees were reduced by 50 per cent that year and in the changes on allocated trades were removed.

In 1988 the Equity Derivatives Market was established to provide a secure environment to trade derivatives in South Africa. It was formally known as SAFEX or South African Features Exchange. In a transparent environment, a platform is provided for professional traders and private investors to trade Futures, exchange traded CFD’s and sophisticated Derivatives.

In 2001 the exchange was acquired by the JSE Securities Exchange, with the JSE agreeing to keep the Safex branding.

The exchange is a Self-Regulatory Authority and exercises its regulatory functions in terms of the Financial Markets Control Act of 1989 and its rules. The Exchange in turn is supervised by the Financial Services Board. (FSB)

The JSE clearing house clears al contracts to reduce credit risk from over-the-counter transactions.

The profit or loss on JSE Equity Derivatives are paid on a daily basis once the instrument is sold which is known as a variation margin and is equal to the day-to-day difference in the value of the Derivative.

Closeout dates exist on all JSE Equity Derivatives with the expiry of contracts. This occurs quarterly at 12h00 on the third Thursday in March, June, September and December.

An auction process determines the closeout prices of JSE listed Equities between 12h00 and 12h15.

JSE Clear clears all transactions in line with international requirements in order to reduce counterparty credit risk.

For the purpose of this paper the focus will be more on the Commodity Derivative market.

 

DERIVATIVES

 

Definition: A Derivative is a financial security with a value that is reliant upon or derived from an underlying asset or group of assets – a benchmark. A derivative itself is a contract between two or more parties, and the derivative derives its price from fluctuations in the underlying asset.

Example:  A Derivative is an instrument whose value is derived from the value of one or more underlying, which can be commodities, precious metals, currency, bonds, stocks, stock indices etc.

The most common examples of derivatives instruments are Forwards, Futures, Options and Swaps.

Key Purpose:  The Key Purpose of a Derivative is the management and especially the mitigation of risk.

When a derivative contract is entered, one party to the deal typically wants to free itself of a specific risk linked to its commercial activities, such as currency or interest rate risk over a given period.

Use: Derivatives are used to hedge a position (protecting against the risk of an adverse move in an asset) or to speculate on future moves in the underlying instrument.

Risk: Counterparty credit risk arises if one of the parties involved in a derivatives trade, such as a buyer, seller or dealer, defaults on the contract. The risk is higher in over-the-counter or OTC markets, which are much less regulated than ordinary trading exchanges.

Derivatives can be used to mitigate the risk of economic loss arising from changes in the value of the underlying. This activity is known as Hedging.

Alternatively, derivatives can be used by investors to increase the profit arising if the value of the underlying moves in the direction they expect.

Trading Derivatives: Derivatives can be bought or sold in two ways: over-the-counter (OTC) or on exchange. OTC derivatives are contracts that are made privately between parties, such as swap agreements, in an unregulated venue while derivatives that trade on exchange are standardized contracts.

Derivative Options: Options are a type of derivative security. An option is a derivative because its price is intrinsically linked to the price of something else. If you buy an options contract, it grants you the right, but not the obligation to buy or sell an underlying asset at a set price on or before a specific date.

Futures: are Derivative financial contracts that obligate the parties to transact an asset at a predetermined date and price.

Valuation: Derivative valuations are based on three components: future cash flows, the present value of future cash flows and the valuation model used.

Margins: In Finance, margin is collateral that the holder of a financial instrument has to deposit with a counterparty (most often a broker or an exchange) to cover some or all of the credit risk the holder poses for the counterparty.

Derivative Clearing Houses: A clearinghouse acts as an intermediary between a buyer and seller and seeks to ensure that the process from trade inception to settlement is smooth. Its main role is to make certain that the buyer and seller honor their contractual obligations. Responsibilities include settling trading accounts, clearing trades, collecting and maintaining margin monies, regulating delivery of the bought/sold instrument, and reporting trading data. Clearinghouses act as third parties to all futures and options contracts, as buyers to every clearing member seller, and as sellers to every clearing member buyer.

 

AGRICULTURAL DERIVATIVES

 

Definition: Producers and other users of Agricultural Derivatives often use them to Hedge price risk.

They are used for Hedging or to diversify a portfolio, both of which are ways of managing risk. They are also often used to speculate on price, which is a way of profiting from price movements in the grains market.

 

This instrument was developed for the grains market in South Africa as a platform for efficient price risk management.

Future expiry date of Future Contracts ensures that both parties honour their position on the traded date.

Option Contracts determine a floor or ceiling price and a premium cost is agreed upon.

A variety of Grain Futures include:

White maize (Only exchange in the world where White “Corn” is listed)

Yellow maize (South African)

Soya beans  (South African)

Wheat (South African)

Corn (Corn Futures and Options are derivatives contracts that give investors exposure to the international price of corn. The underlying contract is the corn derivative contract as traded on the Chicago Board of Trade (CBOT).The product gives local investors an innovative tool to hedge international price risk and the opportunity to better assess patterns in the global corn market. Contracts are cash-settled in Rand and easily accessed via JSE commodity derivatives members.)

 Soy Complex Futures and Options (Beans, Meal, Oil) Soy Bean, Meal and Oil Futures and Options derivatives contracts reference the Soy Bean, Meal and Oil contract traded on the Chicago Board of trade (CBOT). The product gives local investors an innovative tool to hedge international price risk and the opportunity to better assess patterns in the global soy market. Contracts are cash-settled in Rand and easily accessed via JSE commodity derivatives members.

Hard Red Winter Wheat (These derivatives contracts give local investors exposure to the international wheat market. as determined by the Kansas City Board of Trade (KCBT) now owned by CME Group)

Soft Red Wheat  (The underlying instrument meeting specifications as listed and traded on the Chicago Board of Trade (CBOT), a division of the CME Group.)

 

ENERGY DERIVATIVES

 

Crude Oil Futures and Options

These Options give exposure to the international crude oil price.

It is a product that can be used to hedge against diesel price risk of local users and contracts are settled in Rand.

The most important feature is that it provides investors with hedge and exposure factors purely of the fact that oil is highly sensitive to political and socio-economic influences making an investment in oil extremely risky.

There are no limits to apply for corporate entities, individuals or foreigners.

 

Quanto Futures and Options

These are Derivatives that are cash-settled.

The underlying traded product is denominated in a foreign currency and settled in a domestic currency at a fixed exchange rate.

There are three categories of Quanto Futures and Options:

• Soft Commodities
• Energy Commodities
• Metal Commodities

 

Examples of Soft Commodities: Sugar, Corn, Coffee, Cotton, Cocoa, Soya Beans, Fruit and Livestock.

Soft Commodity refers to future contracts where the actuals are grown rather than extracted or mined. Soft Commodities represent some of the oldest types of Futures known to have been actively traded. They are often referred to as tropical commodities or food and fibre commodities.

Soft Commodities play a major role in futures market. They are used by farmers wishing to lock-in the future prices of their crops, and by speculative investors seeking a profit. Due to the uncertainties of weather and other risks of farming, soft commodity futures tend to be more volatile than other futures. For example, weather and seeding/harvesting reports can cause the prices of the grains and oilseeds to fluctuate significantly, impacting the values of contracts differently depending on the delivery dates.

Whether a contract is classified as a soft commodity or not, is less important to a futures trader than the understanding of the underlying commodity and its historical trends. Because of their volatile nature and differing supply and demand cycles, soft commodities can be more challenging to trade than hard commodities. As with any derivatives trade, investors should understand the market they are entering as well as the implications of the contract they are using to enter well in advance of putting real money on the line.

 

Examples of Energy Commodities: Brent Crude Oil, Natural Gas, Gasoline and Heating Oil.

Energy Derivatives are financial instruments in which the underlying asset is based on energy products including oil, natural gas, and electricity. They trade either on an exchange or over the counter (OTC). Energy derivatives can be options, futures or swap agreements among others. The value of a derivative will vary based on the changes in the price of the underlying energy product.

Energy Derivatives can be used for both speculation and hedging purposes. Companies, whether they sell or just use energy, can buy or sell energy derivatives to hedge against fluctuations in the movement of underlying energy prices. Speculators can use derivatives to profit from the changes in the underlying price and can amplify those profits through the use of leverage.

Energy Derivatives trade both over-the-counter (OTC) and on commodity exchanges. OTC trading occurs directly between two counter-parties outside the framework of an established commodity exchange.

Energy Derivative traders are a type of commodity trader. A commodity trader focuses on trading futures or option contracts in physical substances like oil and gold. Most often these traders are dealing in raw materials used at the beginning of the production value chain, such as copper for construction or grains for animal feeds. Energy products such as oil, natural gas and electricity are part of this commodity complex.

In addition to commodity price risks, energy companies can also use derivatives to hedge against foreign exchange risks and interest rate risks. Derivatives serve a vital purpose in the energy market to reduce risk, providing all parties with the price certainty needed to plan business operations.

 

 Examples of Metal Commodities:  Gold, Silver, Platinum, Copper and Palladium.

Base Metals are common metals that tarnish, oxidize, or corrode relatively quickly when exposed to air or moisture. They are widely used in commercial and industrial applications, such as construction and manufacturing.  Base metals include lead, nickel, zinc and copper.  Precious Metals include Gold, Silver and Platinum.

Several exchanges around the world offer contracts to trade in base metals. But the hub of international trading remains the London Metal exchange.

Risks and Return:  These commodities are settled in Rand and produce the same payoff as an investment which is dollar-denominated.

Immunity of USD/ZAR exchange rate fluctuations are a given to investors deriving a payoff from the dollar performance of the underlying commodity.

 

 

Frequently Asked Questions

 

When was Safex established?

1990

 

What is Safex?

Go here for a comprehensive explanation of Safex

 

What is the purpose of derivates?

The main purpose is the management and mitigation of risk.

 

What is the use of agricultural derivates?

It is often used to hedge the price risk.

 

What are energy commodities?

Examples are: natural gas, brent crude oil, gasoline & heating oil.