NZX Derivatives Adviser flashcards

32 cards. Read the term and the definition here. The deck at the top of this page is optional.

Derivative definition

A contract whose value derives from an underlying asset, rate or index. Performance is settled in future cash flows rather than by paying the full underlying price upfront, which creates leverage.

Futures versus forwards

Futures are standardised, exchange-traded, cleared and marked to market daily. Forwards are bespoke over-the-counter contracts that carry bilateral counterparty credit risk and settle at maturity.

Long call payoff

At expiry the long call holder receives max(spot minus strike, 0), less the premium paid. Maximum loss is the premium; gain is theoretically unlimited as the underlying rises.

Put-call parity

For European options on the same strike and expiry, call minus put equals spot minus the present value of the strike. Violations allow arbitrage via a synthetic forward position.

Cost of carry formula

Fair futures price equals spot multiplied by the exponential of the net carry rate times time to expiry. Net carry combines interest, storage costs and income or convenience yield.

Implied volatility

The volatility input that makes an option pricing model reproduce the observed market premium. It reflects forward-looking market expectations and rises in both call and put prices.

Option delta

Delta measures the change in option value for a one-unit change in the underlying price. Calls have positive delta, puts negative, and delta shifts as the underlying moves.

Initial versus maintenance margin

Initial margin is posted to open a position. Maintenance margin is the minimum balance; falling below it triggers a call to restore the account to the initial level.

Variation margin

Daily cash settlement of mark-to-market gains and losses on open futures positions. Profits are credited and losses debited, so unrealised gains become available only after settlement.

Central counterparty role

The clearing house interposes itself between buyer and seller, becoming counterparty to each. This replaces bilateral credit risk with central counterparty risk backed by margin and a default fund.

Client money segregation

Client funds and positions must be held separately from the clearing participant's own assets. This protects clients if the participant becomes insolvent, subject to the applicable rules.

Hedge ratio calculation

Number of contracts equals the exposure value times its beta or price sensitivity, divided by futures price times contract multiplier. Round to whole contracts and accept residual basis risk.

Protective put strategy

Buying a put against a held long position sets a floor sale price while retaining upside. The premium paid is the cost of that insurance and reduces net return.

Covered call strategy

Selling a call against an owned underlying generates premium income but caps gains above the strike. The position still bears full downside risk on the underlying.

Basis risk

Residual risk when a hedge uses a contract on a related but non-identical underlying. The hedge is imperfect because the two prices do not move exactly together.

Contango and backwardation

Contango is when futures trade above spot, typically reflecting carry costs. Backwardation is when futures trade below spot, often due to high convenience yield or tight supply.

Futures notional value

Contract price multiplied by the contract unit or multiplier, then by number of contracts. This determines the economic exposure and drives margin requirements.

Option moneyness

In-the-money means exercise would yield positive intrinsic value now. At-the-money means strike equals spot; out-of-the-money means no intrinsic value and premium is all time value.

Exercise versus assignment

The option buyer exercises the right; the clearing house then assigns the obligation to a writer. Exercise style may be American, any time, or European, at expiry only.

Rollover of a futures position

Closing the near-expiry contract and opening the next expiry to maintain exposure. The economic cost or gain is the price spread between the two expiries.

Market services licence

FMA-issued licence under the Financial Markets Conduct Act permitting defined market services, such as derivatives issuance or advice, subject to standard and specific conditions.

Product Disclosure Statement

A short, clearly worded disclosure document for a financial product. It must describe key terms, risks, fees and how to complain, and be given before the offer is accepted.

Fair dealing provisions

FMC Act prohibitions on misleading or deceptive conduct, false representations, unsubstantiated claims and misleading statements about financial products. They apply broadly to advisers and issuers.

Anti-money laundering duties

Under the AML/CFT Act, reporting entities must conduct customer due diligence, identify beneficial owners, apply enhanced checks for higher-risk clients, and report suspicious activity.

Suitability assessment

Gathering and evaluating a client's financial position, objectives, experience and risk tolerance to judge whether a leveraged derivative is appropriate before recommending or accepting an order.

Disclosure of costs

Clients must be told of spreads, commissions, overnight financing, inactivity and rollover costs. Total cost affects net return and must be presented clearly, not buried.

Margin call warning

Clients must be told that additional funds may be required at short notice and that positions can be closed without consent if margin is not met.

Complaints pathway

Clients must be informed of the internal complaints process and the approved dispute resolution scheme membership. Records of complaints and outcomes must be retained.

Wash trading prohibition

Entering offsetting trades that create false appearance of trading volume or price movement. It is a form of market manipulation prohibited by market rules and the FMC Act.

Insider trading

Trading or tipping on material non-public information. Information is material if a reasonable person would expect it to affect price or value of the product.

Best execution duty

Taking reasonable steps to achieve the best available outcome for client orders, considering price, cost, speed and likelihood of execution, and documenting the execution policy.

Client order priority

Handling client orders before own-account orders and not trading ahead of known client flow. Front-running client orders breaches conduct and fair dealing obligations.