The curent status of spread betting
Spread Betting Present
1st January 2007
The
simple idea behind futures contracts is so useful that they are now
used in a spectacular number of areas. For example, the growth in
global trade has increased the volatility in the shipping markets.
Units of freight space on the ships are traded, allowing manufacturers
and shipping firms to manage risks from fluctuations in the market.
Futures contracts are also traded on the right to buy or sell the ships
themselves at a future date. The industrialisation that fuels this
trade also drives pollution fears and international regulation of
emissions from companies. Now companies can trade their emissions
quotas. The increasingly volatile weather of recent years has become an
increased risk to companies. As a consequence those companies are
increasingly turning to futures contracts on rainfall, snowfall, frost
and the temperature. Weather risks are important to any companies for
whom rapid seasonal turnaround is crucial to margins such as
re-insurers, soft drinks companies, energy companies and even fashion
retailers. The CME saw a 170% surge in the number of opened weather
derivatives last year.3 Even rubbish has value and there are now
growing futures exchanges dedicated to trading recyclables such as
paper and plastics.
The nineteenth century grain
farmers would be amazed at how accepted derivatives have become. The
number of markets and asset classes they now cover are impressive and
their commercial usage is commonplace. Everyday corporations use them
to manage the risks affecting their businesses, such as foreign
exchange or interest rate risks. 92% of the 500 largest corporations
use derivatives to manage their risks according to the International
Swaps and Derivatives Association.4 Of these 500, the 35 British
companies all make use of derivatives. The usage of derivatives is
increasing by 22% per annum and by July 2005 the value of the assets
underlying these derivatives amounted to $201.4 trillion,5 around four
times the value of global GDP.
Innovation is, of
course, never-ending and did not stop when applying futures contracts
to new markets and assets. The banks have developed more complicated
“exotic” derivatives from plain vanilla derivatives such as futures
contracts. These non-standard contracts serve the specific needs of a
bank or large company to shift risk and plan for the future. The banks
employ quantitative analysts to design and price these products – the
“rocket scientists” of the finance world. The value of an exotic
derivative could be based on any number of conditions and often using
more than one underlying asset, perhaps a mix or basket of stocks or
commodities.
An example of an exotic contract might
be a security that pays interest, similar to a bond; however, this
interest payment is instead determined by returns on an index of traded
commodities; this interest payment will continue until the expiry of
the contract unless one of five specified stocks rises 10% above its
price at the start of the contact. It is perhaps clear (or unclear)
from this example why these are described as exotic contracts.
Banks
have had easy access to all these markets for so long and moved on so
far from the farmer’s humble starting point. However, as financial
products have become more and more complex and more and more derivative
in a recursive, Russian-doll type relationship, it is only a matter of
time before there are derivatives of credit derivatives, a sort of
`derivatives cubed’. As a consequence such products become ever more
distanced from individual investors who have ended up without easy
access to even the simplest derivatives. Even plain vanilla futures
contracts are not as easily available to the individual investor as
other financial products due to the additional requirements when
opening a futures account. Wealthier investors might have enough
capital to open their own futures trading accounts but even they would
still face several restrictions. Restricted to their domestic market
only, they would still be isolated from trading or managing the risks
from international stock markets. Commodities not traded at home or
trading foreign currencies to hedge risks or speculate would still be a
problem. To get around this they could open accounts with foreign
brokers or pay exorbitant fees. Notwithstanding this, however they
manage to trade foreign markets, their overseas investments would still
be vulnerable to a plunge in value of the foreign currency of their
investment. And these are the problems that just the wealthier
investors faced – everyone else simply never got a look in. They could
only miss out on opportunities and watch quietly, at the mercy of
international shifts in wealth. Individual investors had been left
behind. What was needed was a single trading account that allowed
exposure to many different types of assets, in many countries and with
the ability to manage currency risks from any foreign investments.