What are Futures and Options?
Futures and options are types of derivatives. A derivative is a financial instrument derived from an underlying asset or share.
Futures and options allow investors to establish, ahead of time, the price or rate they will pay or receive for the underlying asset or share. They allow investors to manage price risk in their investments by taking on more risk in the expectation of higher profits, or by hedging against risk if the expectation is lower profits.
What distinguishes futures and options from an underlying asset or share is the ability to take a comparatively large position for a very small initial capital outlay. This is known as leverage.
However like all investments, futures and options do carry risk and are suited to experienced investors who are aware of the differences compared to buying and selling shares. Investors should understand the potential benefits as well as potential risks and should make an informed decision based on their risk tolerance and their portfolio objectives.
When used correctly, futures and options provide investors with a cost effective mechanism for hedging their positions, minimising investment risk or gaining exposure to price movement for potential profit.
What are NZFOX products?
NZFOX products are New Zealand futures and options contracts listed and traded on the Sydney Futures Exchange. NZFOX products are based on shares listed on NZX's markets. New Zealand investors can buy and sell them through accredited NZX Futures and Options Participants or any other entity authorised by the Securities Commission. NZFOX products are created and marketed in New Zealand by NZX.
Background to futures and options markets
Futures and options markets developed in response to the economic risk inherent in dealing with commodities and financial instruments. Financial markets in New Zealand have largely been deregulated since the early 1980s; interest rates, exchange rates, commodities and share prices have since fluctuated rapidly and widely, causing uncertainty. Fund managers, corporates, financial institutions, primary producers and individual investors have become increasingly reliant on derivatives (futures and options) in the management of their portfolios, protecting them against adverse changes in share prices, commodity prices, interest rates and exchange rates.
The role of futures and options
Futures and options play an important role in the management of sharemarket risk. People often have different perceptions of risk. Some may want to avoid risk while others want to deliberately take on more risk in order to profit by correctly forecasting market movements. With NZFOX products you can transfer undesired risk to anyone else who wants it.
In effect, you can establish the price or rate you will pay or receive for an underlying financial instrument ahead of time. It is important to note that price risks are not created by the futures and options market, but are inherent in the underlying market.
Trading futures and options is not, per se, an alternative means for acquiring financial instruments such as shares. Rather, futures and options can be used to create positions in the market which hedge against risk to protect the value of your investments, or can be used speculatively to increase your risk profile in the expectation of profit.
