Commodity Futures – USD Crude Palm Oil Futures (FUPO) Reading Material...Additional Reading Material USD Crude Palm Oil Futures (FUPO) Commodity Futures – USD Crude Palm

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  • Module 14 Futures and Options

    Additional Reading Materials on USD Crude Palm Oil Futures (FUPO)

    Copyright 2009

    Securities Industry Development Corporation

    3, Persiaran Bukit Kiara

    Bukit Kiara, 50490 Kuala Lumpur

    (This document consists of 22 pages including the cover page)

  • Additional Reading Material USD Crude Palm Oil Futures (FUPO)

    Commodity Futures USD Crude Palm Oil Futures (FUPO)

    Contents Page Topic Objectives 1 Outlines: 1.0 Introduction 2 2.0 The futures contracts 4 2.1 Contract specifications for FUPO 2.2 Trading with palm oil futures 2.3 Users and uses of commodity futures 3.0 Trading Strategies with FUPO 8

    3.1 Hedging with palm oil futures 3.1.1 Position hedge 3.1.2 Anticipatory hedge

    3.2 Speculating with palm oil futures 3.2.1 Outright position 3.2.2 Spread trading strategies 3.3 Arbitraging with palm oil futures 3.3.1 No arbitrage pricing model 3.3.2 Cash-and-carry arbitrage 3.3.3 Reverse cash-and-carry arbitrage 4.0 Risks involved in trading FUPO contracts 17 4.1 Commodity Price Risk 4.2 Trading Risk 4.3 Foreign Currency Risk 4.4 Liquidity Risk 5.0 Comparative analysis between FUPO and Ringgit (MYR)denominated

    palm oil futures contracts(FCPO) 18

    6.0 Summary 19 6.1 Key Terms 6.2 Review Questions & Answers

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  • Additional Reading Material USD Crude Palm Oil Futures (FUPO)

    Topic Objectives

    At the end of this topic, you should be able to:

    Describe the features of the underlying instrument of the US Dollar denominated crude palm oil futures (FUPO) contract

    State the contract specifications for crude palm oil futures contract Describe the trading mechanism and strategies for trading FUPO contracts Construct a buying and selling hedge using crude palm oil futures

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  • Additional Reading Material USD Crude Palm Oil Futures (FUPO)

    1.0 Introduction

    FUPO is a USD denominated palm oil futures contract, launched by Bursa Malaysia Derivatives Bhd. in September 2008. It is considered as a commodity derivatives instrument complementing the Ringgit denominated Crude Palm Oil Futures contract (FCPO), which has been trading since 1980.

    The underlying instrument for this commodity futures contract is Crude Palm Oil (CPO). As an edible oil, its worldwide demand is only second to soybean oil and it is also the most widely traded edible oil in the world. It has a balanced ratio of unsaturated and saturated fatty acids, making it an edible oil that is suitable for use in a variety of food application.

    Malaysia currently accounts for 41 % of world palm oil production in 2007 and 46% of world exports, which is equivalent to 11.5% and 26% of the world's total production and exports of oils and fats respectively (source: Malaysian Palm Oil Board). Therefore, as the major producer and exporter of palm oil and palm oil products, Malaysia has an important role to play in fulfilling the growing need for oils and fats.

    Palm Oil Exports To Major Countries

    Country Jan-08 Jan-09 Change (Volume) Change

    (%) Jan - Dec

    2008 China 257,914 154,267 -103,647 -40.2 3,794,494 European Union 108,444 142,246 33,802 31.2 2,052,769 Pakistan 121,428 223,935 102,507 84.4 1,257,396 India 37,738 203,049 165,311 438 970,734 Japan 44,183 52,924 8,741 19.8 547,468 USA 73,158 88,705 15,547 21.3 1,047,668

    TOTAL 642,865 865,126 222,261 34.6 9,670,529

    Source: Malaysian Palm Oil Board

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  • Additional Reading Material USD Crude Palm Oil Futures (FUPO)

    The existing Ringgit denominated Crude Palm Oil Future contract (FCPO) has been very successful since its introduction to the market and it has become the global pricing benchmark for palm oil. With the launching of FUPO, together, both products will help to consolidate Malaysias position as the leading price discovery centre for palm oil.

    The main driving factor for introducing FUPO is to offer an avenue for funds that were previously unwilling to trade in the FCPO due to currency risk exposure. Being the first US dollar-denominated crude palm oil futures contract in the region, it also enables foreign buyers and importers to hedge their exposure to CPO price fluctuations in USD instead of Ringgit. With FUPO and FCPO trading side by side, it provides arbitrage opportunities to traders as a result of currency movement in between the Ringgit and USD contracts.

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  • Additional Reading Material USD Crude Palm Oil Futures (FUPO)

    2.0 The Futures Contracts

    FUPO is a USD-denominated futures contract listed on Bursa Malaysia Derivatives Berhad. Each contract is equivalent to 25 metric tons of crude palm oil which will be cash settled upon maturity, against a final settlement price that is based on FCPO price, that is the globally accepted benchmark price for CPO. The exchange rate of USD/MYR will be taken from Bank Negara Malayisa as the conversion rate for the calculation of the final settlement value. Stated in section 2.1 are the detailed contract specifications for FUPO.

    2.1 Contract specifications for FUPO

    Contract Code FUPO Underlying Instrument Crude Palm Oil Contract Size 25 metric tons Minimum Price Fluctuation

    USD0.25 per metric ton

    Settlement Methodology

    Cash Settled

    Daily Price Limits A +/- 10% limit from the Settlement Prices of the preceding trading day will apply for all contract months, except for the spot month. When at least 3 non-spot month contracts are trading at the 10% limit, a 10 minute Cooling Off period will apply for all quoted months (except spot month as there are no price limits for spot month contract) during which trading shall only take place within the 10% Limit. Following the Cooling Off period, all quoted months shall be interrupted for 5 minutes, after which the price limit will be expanded to +/-15%. The 10% price limit will apply for the rest of the 1st trading session if the price limit is triggered less than 30 minutes before the end of session, and the price limit will be expanded to 15% for the 2nd trading session. If the 10% limit is triggered less than 30 minutes before the end of the 2nd trading session, the 10% limit will apply for the rest of the trading day.

    Contract Months Spot month and the next 5 succeeding months, and thereafter, alternate months up to 24 months ahead

    Trading Hours First trading session : Malaysian Time: 10:30 a.m. to 12:30 p.m. Second trading session : Malaysian Time: 3:00 p.m. to 6:00 p.m.

    Speculative Position Limits

    500 contracts net long or net short for the spot month

    5,000 contracts for any single contract month except for the spot month

    8,000 contracts for all contract months combined

    Final Trading Day and Contract expires at noon on the 15th day of the spot

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  • Additional Reading Material USD Crude Palm Oil Futures (FUPO)

    Maturity Date month, or if the 15th is a nonmarket day, the preceding Business Day.

    Final Settlement Cash settlement based on the Final Settlement Value. Final Settlement Price The average price of the Daily Spot Month Settlement Price

    of the FCPO on the last 5 Business Days prior to the expiration including the Final Trading Day. The mid exchange rate of USD/MYR as at 6.00pm on each of the 4 Business Days prior to the Final Trading Day taken from Bank Negara Malaysia shall be used as the conversion price for the calculation of FCPO Daily Spot Month Settlement Value (Mid price USD/MYR multiplied by the Daily Spot Month Settlement Price of FCPO). The mid Exchange rate of USD/MYR as at noon will be used for calculation of Daily Spot Month Settlement Price for the Final Trading Day. The FUPO Final Settlement Value shall be the average of the converted FCPO Daily Spot Month Settlement Prices rounded to the nearest 25 cents.

    2.2 Trading with palm oil futures

    To start trading with FUPO, an investor will first need to open a futures trading account with a futures broker and deposit cash or collateral with the broker. However, a USD bank account is not required for trading. The futures broker will be able to act as an agent to licensed onshore banks, to quote exchange rates for the conversion of the MYR deposit to USD to facilitate the settlement in USD.

    For Malaysian resident without domestic MYR credit facilities (borrowings in MYR), there will be no restrictions on funds flow. However, for those with domestic MYR credit facilities, conversion of MYR to USD is capped at MYR1 million per year for individuals and MYR50 million for corporate group if the investor choose to convert MYR to trade in USD. There will be no restrictions if trading is done with existing foreign currency funds. Those who carry out the transactions in MYR will be excluded from the above mentioned restrictions (Figure 1 is a flow chart of the exchange control for resident). As for foreigners, there will be no exchange controls applicable for the trading of FUPO.

    The trading of FUPO will take place on Bursa Malaysia Derivatives Berhad and prices are disseminated real-time through Bursa Malaysia and a number of price reporting agencies

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  • Additional Reading Material USD Crude Palm Oil Futures (FUPO)

    2.3 Users and uses of commodity futures

    The main feature of FUPO that differentiates it from FCPO and other regional commodity futures contracts is that it is denominated in USD. Therefore, all parties that are subject to USD currency risk can u