The Cyprus Stock Exchange (CSE) has already implemented the tools of the Market Maker and the Over the Counter Trades, just as most of the other derivatives exchanges that were established in the US in the 1980s and ’90s and rapidly expanded to Europe. The CSE has also prepared the framework for the operation of the Short Selling and Securities Lending facility.

CSE officials say that in times of crisis and falling revenues the derivatives market will generate higher earnings for the CSE with growing interest for companies to list their instruments or invest in them, due to the protection provided through hedging and dealing with futures.

Ideally, once the corporatisation of public services such as telco Cyta, power utility EAC and the Ports Authority goes ahead, as well as at the Coop banks, these will become attractive to new investors, while the most popular traded derivatives are those of commodities, such as the instruments that will come out of the development of the oil and gas industry of Cyprus. “Derivatives products are expected to flourish in the future and the role of the CSE will be important in the mid- to long-term. New listings on the CSE coming out of tourism infrastructure, privatisations, etc., will relate to companies of big capitalisation and sufficient liquidity, and it is expectedthat derivatives products related to them, will be introduced and supported in the market,” a CSE official said.

What are the financial derivatives?

Financial derivatives are any type of transaction whose value depend on the value of another product. A derivative trade is an agreement to buy or sell a specific quantity of the underlying product at a predetermined price, at a certain point in the future. The subject product (underlying) can be shares, stock indices, interest rates, currencies, rates, commodities, etc. Internationally these are two categories of products, in liquid equities or indices and more specifically, Futures and Options.

A futures contract concerns the purchase or sell of a specific pre-arranged quantity of an underlying security at an agreed future time (expiry date) and price (futures price), in the regulated market. An options contract gives the holder the right to buy (Call Options) or sell (Put Options) an agreed quantity of a given asset, at an agreed price and future time or time leading up to it. A call option gives the holder the right to buy an asset by a certain date for a certain price. A put option gives the holder the right to sell an asset by a certain date for a certain price.

Hedging - Speculation

The purpose of the creation of derivatives is none other than the guarantee or compensation for risk (hedging), from any kind of financial transaction. Trading in derivatives is intended to offset some risk. Apart from the hedge, one can take place in the derivatives market based on estimates / projections / expectations for future market development. The speculation is an essential ingredient in all markets and facilitates the transfer of risk.

Derivatives can be a valuable tool for investors (professional or otherwise), when used properly and are among the most complex forms of investment and the use of financial derivatives requires full knowledge of the functioning and the reasoning for which they are created; otherwise there is always a constant threat of substantial capital losses. After the mushrooming of the foreign exchange (FX) traders and employment opportunities that were created, the derivatives market should also create new job opportunities with training firms joining the bandwagon of grooming candidates for certification and licensing to deal in these instruments.

Source: Financial Mirror