NZX Derivatives Adviser cheat sheet

NZX Derivatives is a licensed market under the Financial Markets Conduct Act 2013 (FMC Act); its market operator is NZX Limited, and conduct rules sit in the NZX Derivatives Market Rules plus the FMC Act fair dealing provisions.

A derivatives issuer (DI) offering derivatives to retail clients must hold a market services licence with the derivatives issuer licence class, or rely on an exemption; a licensed DI must also be a member of a licensed market or approved clearing house system.

Financial Markets Authority (FMA) is the conduct regulator; it licenses market services, issues standard conditions, and can order stop orders, censure, or refer for prosecution.

The FMC Act fair dealing provisions prohibit misleading or deceptive conduct, false or misleading representations, unsubstantiated representations, and conduct that misleads about the nature or risk of a financial product.

Under the Financial Service Providers (Registration and Dispute Resolution) Act 2008, advisers and DIs must be registered on the FSPR and belong to an approved dispute resolution scheme.

Disclosure uses the Product Disclosure Statement (PDS) regime: a PDS must be worded clearly, be no more than a prescribed length, and be updated for material changes; a supplementary disclosure can be used for changes before a new PDS.

Anti-money laundering obligations arise under the AML/CFT Act 2009: customer due diligence, beneficial ownership identification, enhanced due diligence for PEPs and higher-risk jurisdictions, and suspicious activity reports to the FIU.

Breach reporting: licensees must report material breaches to the FMA, and the FMC Act imposes duties to notify the regulator of serious contraventions, alongside internal complaints and dispute resolution processes.

A derivative is a contract whose value derives from an underlying (equity, index, FX rate, interest rate, commodity); no upfront full payment of the underlying is required, which creates leverage.

Futures are standardised, exchange-traded, cleared and margined contracts with daily mark-to-market; forwards are OTC, bespoke, and carry counterparty credit risk.

Options give the buyer a right, not an obligation: calls convey the right to buy, puts the right to sell, at a strike price on or before expiry; the buyer pays a premium.

Swaps exchange cash flows: an interest rate swap exchanges fixed for floating payments on a notional; a currency swap exchanges principal and interest in two currencies.

Contracts for difference (CFDs) are cash-settled derivatives on price movements of an underlying; NZX-regulated CFDs are margined and do not involve delivery of the underlying.

Payoff at expiry for a long call is max(S−K, 0) less premium; long put is max(K−S, 0) less premium; a short position mirrors this and has limited gain but potentially large loss.

Intrinsic value is the positive difference between underlying price and strike; time value is option premium minus intrinsic value and decays toward zero at expiry.

NZX derivatives include equity options, index futures/options, and dairy (whole milk powder) and other commodity derivatives; contract specifications define multiplier, tick size, expiry and settlement.

Futures positions are opened by buying (long) or selling (short); each contract has a specified contract unit/multiplier, so notional value = price × multiplier × number of contracts.

Daily mark-to-market: gains are credited and losses debited to the margin account each settlement day; unrealised profit can be withdrawn only after variation margin is credited.

Initial margin is required to open a position; maintenance margin is the floor below which the account must be restored to the initial level via a margin call.

A margin call must be met within the time specified by the clearing participant; failure can lead to a forced close-out of positions at the client's cost.

Rollover closes a near-expiry contract and opens the next expiry; the cost/benefit is the price spread between expiries (contango or backwardation).

Option moneyness: in-the-money, at-the-money, out-of-the-money; exercise style may be American (any time before expiry) or European (at expiry only).

NZX equity options are typically physically settled into the underlying shares, while index and cash-settled derivatives settle in cash against the final settlement price.

Close-out: an offsetting trade in the same contract and expiry extinguishes the position; unmatched positions at expiry go to settlement or exercise/assignment.

Central counterparty (CCP) clearing interposes the clearing house between buyer and seller, replacing bilateral counterparty risk with CCP risk; NZX clearing is performed through its clearing house arrangements.

Initial margin covers potential future exposure over the close-out period; variation margin settles actual daily mark-to-market gains and losses.

Margin is calculated on a portfolio basis by clearing participants, often using SPAN-type scenario analysis that stresses price, volatility and time.

Clearing participants (general and individual) guarantee client obligations to the clearing house; clients face their clearing participant, not the CCP, for margin calls.

Segregation: client money and client positions must be kept separate from the participant's own assets, so a participant insolvency does not automatically expose client collateral.

Settlement risk is managed by delivery-versus-payment for securities and by cash settlement against final settlement price for cash-settled derivatives.

Default waterfall: a defaulting participant's margin, then its default fund contribution, then the CCP's own capital, are applied in a defined order.

Margin is collateral, not a fee: it is returned when the position is closed, less any realised losses and costs.

Cost-of-carry model for a futures price: F = S × e^((r − q + c − y)T), where r is the risk-free rate, q the dividend or convenience yield, c storage and y any income; for no income assets F = S × e^(rT).

Fair value basis = futures price − spot price; a positive basis (contango) is normal when carry costs exceed income; backwardation arises when convenience yield exceeds carry.

At expiry, futures price converges to the spot price; arbitrage enforces this convergence.

Put-call parity for European options: C − P = S − K × e^(−rT); a violation implies an arbitrage using a synthetic forward.

Black-Scholes inputs are spot price, strike, time to expiry, volatility, risk-free rate and dividend yield; the only unobservable input is volatility, so the model outputs implied volatility.

The Greeks: delta measures change in option value per unit change in underlying; gamma is the change in delta; theta is time decay; vega is sensitivity to volatility; rho is sensitivity to interest rates.

Implied volatility is the market's forward-looking volatility estimate backed out of the traded premium; higher implied volatility raises both call and put premiums.

Basis risk: a hedge using a futures contract on a related but non-identical underlying leaves residual price risk equal to the difference between the two prices.

Hedge ratio in contracts = (value of exposure × beta or price sensitivity) ÷ (futures price × contract multiplier); round to whole contracts and accept residual basis risk.

A short futures hedge protects a long underlying position against price falls; a long futures hedge protects a planned purchase or short exposure against price rises.

Protective put: buy a put to floor downside while retaining upside; cost is the premium, which reduces net return. Covered call: sell a call for income but cap upside above the strike.

Collar = long put plus short call; it reduces or eliminates net premium but caps both downside protection and upside participation.

Delta hedging an option book requires trading the underlying in proportion to delta; delta changes as the underlying moves, so the hedge must be rebalanced (dynamic hedging).

Stress testing and scenario analysis should cover adverse price moves, volatility spikes, gap risk and liquidity of the underlying, not just historical volatility.

Stop-loss and position limits are controls, not hedges: they cap loss size but can be gapped through in fast markets, so they do not replace margin planning.

Netting and correlation: offsetting positions only reduce risk to the extent their prices are correlated; correlation can break down in stress, so gross exposure must also be monitored.

Suitability assessment must consider the client's financial situation, investment experience, objectives, risk tolerance, and understanding of derivatives; leveraged products are unsuitable for clients who cannot bear losses exceeding deposits.

The advice process: gather client information, assess suitability, identify and disclose conflicts of interest, explain the product's risks and costs, and record the advice and client instructions.

A PDS must be given before, or at the time of, the offer being made; the adviser should confirm the client has received and understood the key risks, fees and margin obligations.

Disclose all fees and costs: spreads, commissions, financing/overnight funding charges, inactivity fees, and the cost of rolling positions.

Warn clients that a margin call may require additional funds at short notice and that positions may be closed out without further consent if margin is not met.

Record-keeping: retain client suitability assessments, advice records, order instructions and communications for the period required by the licence conditions and FMC Act.

Complaints must go through the licensee's internal complaints process and then the approved dispute resolution scheme; the client must be told of this pathway.

Personalised advice must be distinguished from general product information; generic education does not substitute for a suitability assessment when advice is given.

Market manipulation includes wash trades, pre-arranged trading that creates a false appearance of activity, and marking the close; all are prohibited under the FMC Act and market rules.

Insider trading: trading on material non-public information, or tipping another person, breaches the insider trading prohibitions; information is material if a reasonable person would expect it to affect price.

Client order priority: handle client orders before own-account orders, do not front-run client orders, and do not trade ahead of known client flow.

Best execution: take reasonable steps to obtain the best available outcome for clients considering price, cost, speed and likelihood of execution, and document the execution policy.

Conflicts of interest must be identified, disclosed and managed; personal account dealing by staff is typically restricted and requires pre-clearance.

Record and report suspicious trading or conduct to compliance; licensees must cooperate with FMA and NZX market supervision enquiries.

Ethical conduct: act with integrity, skill and care, do not mislead clients about risk or returns, and do not recommend products primarily to generate commission.

Market manipulation includes wash trades, pre-arranged trading that creates a false appearance of activity, and marking the close; all are prohibited under the FMC Act and market rules.

Insider trading: trading on material non-public information, or tipping another person, breaches the insider trading prohibitions; information is material if a reasonable person would expect it to affect price.

Client order priority: handle client orders before own-account orders, do not front-run client orders, and do not trade ahead of known client flow.

Best execution: take reasonable steps to obtain the best available outcome for clients considering price, cost, speed and likelihood of execution, and document the execution policy.

Conflicts of interest must be identified, disclosed and managed; personal account dealing by staff is typically restricted and requires pre-clearance.

Record and report suspicious trading or conduct to compliance; licensees must cooperate with FMA and NZX market supervision enquiries.

Ethical conduct: act with integrity, skill and care, do not mislead clients about risk or returns, and do not recommend products primarily to generate commission.