PSX DERIVATIVE

SEGMENT
DEVELOPMENT

Presentation by:

Mr. Sani-e-Mehmood Khan

General Manager - Pakistan Stock
Exchange (PSX)

Date: November 29, 2016

DERIVATIVE SEGMENT DEVELOPMENT—PRE REQUISITES

A
Properties of

Fair, Vibrant and Inclusive Capital Markets

Fair, Vibrant and Inclusive
Capital Market is the basic pre-requisite for an efficient
DERIVATIVE SEGMENT

environment and
Deep and Liquid

Product Suite
Ready Market

Participation
Institutional
Inclusion
Financial

Enabling
Roadmap for Market Development 2

Pakistan Stock Exchange Limited 2

FINANCIAL INCLUSION
FINANCIAL INCLUSION

Indicator Pakistan Turkey Bangladesh Thailand

Population 197,000,000 73,722,988 158,570,000 66,870,000
# of Investors 216,996 4,132,704 (5.6%) 2,804,629 3,050,000
(.13%) (1.77%) (4.6%)
Insurance 0.7% 1.28% 0.94% 4.1%
Penetration
# of CIS Unit 140,000 (.075%) 3,626,017 (4.9%) N/A 1,550,000
Holders (2.3%)
Participants of 2,000 2,638,310 (3.6%) N/A 3,400,000
Pension Funds (.001%) (5.1%)
Savings Rate 13.8% 12.7% 19% 30.7%
Literacy Rate 56% 90.8% 48.8% 93.5%

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DEEP AND LIQUID MARKET
DEEP AND LIQUID READY MARKET

MARKET HAVING OVER 1 BN $s AVG DAILY VALUE TRADED

US, India, Thailand, Turkey, France, Hong Kong, Germany, Korea, UK, Russia, and Japan
are amongst the Markets which observe an average daily value traded which is over and
above US $ one billion per day.
MARKET HAVING 500-999 MLN $s AVG DAILY VALUE TRADED
Mexico, Malaysia and Singapore are the nations which observe an average daily value
traded between 500-999 Millions of US $s per day

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DERIVATIVE PRODUCTS, ACROSS ASIA AND ACROSS GLOBE

Types of Derivative Products

Market
Region Country Futures Options Forward
Classification
SSF SIF SSO IO DFM
Hong Kong Developed     ×
Japan Developed ×    ×
Singapore Developed ×  ×  ×
China Emerging ×   × ×
India Emerging     ×
Indonesia Emerging ×   × ×
Korea Emerging     ×
Asia
Malaysia Emerging   ×  ×
Philippines Emerging × × × × ×
Thailand Emerging   ×  ×
Bangladesh Frontier × × × × ×
Pakistan Frontier   × × 
Sri Lanka Frontier × × × × ×
Vietnam Frontier × × × × ×

Pakistan Stock Exchange Limited 7

DERIVATIVE PRODUCTS, ACROSS ASIA AND ACROSS GLOBE

Types of Derivative Products

Market
Region Country Futures Options Forward
Classification
SSF SIF SSO IO DFM
United States Developed     ×
Canada Developed ×    ×
Americas Mexico Emerging     ×
Brazil Emerging ×    ×
Colombia Emerging   × × ×
Saudi Arabia Emerging × × × × ×
Middle East & Jordan Frontier × × × × ×
Africa Qatar Emerging × × × × ×
South Africa Emerging     ×
United Kingdom Developed     ×
France Developed     ×
Germany Developed     ×
Europe
Israel Developed ×    ×
Russia Emerging     ×
Turkey Emerging     ×

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PRODUCT POSITIONING: INDIA’S GLOBAL RANKING

Index Options

Single Stock Futures

Index Futures
2
Equities
3
3
4

Equity derivatives turnover 12.6 times of cash market in FY13

Pakistan Stock Exchange Limited 9

PSX—Present Dynamics, Derivative Product Suite

Stock
Index
Futures

Ready
Market
Cash
Deliverable
Settled
Futures
Futures

DFM turnover accounts for 0.17% of cash market in FY15-16

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 PRODUCT SUITE

*FOCUSES only on the inactive derivatives

CASH SETTLED FUTURES, PRODUCT OVERVIEW

What are Cash Settled Futures?

• Standardized 90 Days Contracts to buy/sell single stock futures to be settled in cash
• M2M is settled in cash on daily basis using Daily Settlement Price
• Attracts VaR Margin on open positions
• Contract are concluded on basis of underlined instrument’s price on Cash Counter
• The result of the trade is the cash difference between the bought and sold price.

Pros
• No requirement to settle principle amount
• No requirement to square-off the open position
• Provides 6-7 times leverage for retail audience
• There shall be no obligation to deliver shares at the end of contract

Cons
• Small investors may become the victim of smart institutional hedging
• Does not contain risk of delivery pressures at the end of contract as observed in March 2005

Pakistan Stock Exchange Limited 12

PRODUCT OVERVIEW, CONTRACT SPECIFICATION

Period Contract
90 or 30 days

Opening of Contract
First Trading day of the next week following the close of the contract.

Overlapping Period
None.

Expiration Date/ Last Trading day

Last Friday of the calendar month, if last Friday is not a trading day, then
immediate preceding trading day.

Final Settlement
Cash settlement on T+1 basis on the expiration date.

Contract Value
The Contract Value shall be the product of Futures price and the Contract Multiplier

Pakistan Stock Exchange Limited 13

CSF TRANSACTION LIFE CYCLE, DAILY SETTLEMENT PRICE

Sr# Volume Rate Value

1 500.00 10.00 5,000.00
2 1,500.00 10.05 15,075.00
India, Brazil,
3 6,000.00 10.10 60,600.00 Philippines
4 500.00 10.05 5,025.00 Athens, and
5 3,000.00 10.10 30,300.00 Mexico use
6 21,000.00 10.15 213,150.00 similar CSF
7 1,000.00 10.15 10,150.00 closing price as
8 9,000.00 10.20 91,800.00 DAILY
9 500.00 10.20 5,100.00 SETTLEMENT
10 5,500.00 10.20 56,100.00 PRICE.
11 2,000.00 10.20 20,400.00 i.e. Volume
12 26,000.00 10.20 265,200.00 weighted price of
13 1,000.00 10.15 10,150.00 last 30 minutes
77,500.00 788,050.00
for each stock.
Total Volume of Last 1/2 Hours 77,500.00
Total Value of Last 1/2 Hours 788,050.00
Daily Settlement Price 10.17

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CSF TRANSACTION LIFE CYCLE, DAILY SETTLEMENT PRICE

Suppose a buy transaction takes place at RS 41/=

Open Daily PLS/M2M Close MGN

Prevailing
Days Scrip Trade Type Trade Qty Contract Settlement Settlement Contract Requirement
Trade Rate
Value Price On T+1 Value at EOD

1 LUCK-CJUN BUY 41.00 1,000.00 41,000.00 42.50 1,500.00 42,500.00 7,437.50

2 42.50 1,000.00 42,500.00 44.00 1,500.00 44,000.00 7,700.00

.. 44.00 1,000.00 44,000.00 46.90 2,900.00 46,900.00 8,207.50

.. 46.90 1,000.00 46,900.00 48.50 1,600.00 48,500.00 8,487.50

.. 48.50 1,000.00 48,500.00 49.80 1,300.00 49,800.00 8,715.00

.. 49.80 1,000.00 49,800.00 48.10 (1,700.00) 48,100.00 8,417.50

.. 48.10 1,000.00 48,100.00 48.30 200.00 48,300.00 8,452.50

Profit/Loss till 2nd last day of the contract======== 7,300.00

Pakistan Stock Exchange Limited 15

CSF TRANSACTION LIFE CYCLE, DAILY SETTLEMENT PRICE

Daily
Prevailing Gain/Loss on
Days Scrip Trade Type Trade Qty Contract Settlement
Trade Rate T+1
Value Price

1 LUCK-CJUN BUY 41.00 1,000.00 41,000.00 42.50 1,500.00

2 42.50 1,000.00 42,500.00 44.00 1,500.00
.. 44.00 1,000.00 44,000.00 46.90 2,900.00
.. 46.90 1,000.00 46,900.00 48.50 1,600.00
.. 48.50 1,000.00 48,500.00 49.80 1,300.00
.. 49.80 1,000.00 49,800.00 48.10 (1,700.00)
.. 48.10 1,000.00 48,100.00 48.30 200.00
Profit/Loss till 2nd last day of the contract======> 7,300.00
• What happens when you take a position on CSF and continue to hold?
– 5% pre-trade Margin is required for the placement of order
– Subsequent to order execution 1-Day VaR is payable immediately after trade-generation by KATS
– M2M/Gain-or-loss is settled in cash on daily basis using Daily Settlement Price
– The next day open position is set at last day’s daily settlement price prevailing at CSF
– Contract are concluded on the last day using the FINAL SETTLEMENT PRICE of underlined
instrument’s price on Cash Counter

• What happens when you offset your open position?

– The result of the trade is the cash difference between the bought and sold price.
– The difference is credited/debited to your account on T+1 basis
– Open position is not carried forward anymore
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CSF TRANSACTION LIFE CYCLE, FINAL SETTLEMENT PRICE

One Minute BID ASK Sum

Sr#
Interval X Y X+Y
1 12.15 47.2 47.25 94.45
2 12.16 47.2 47.25 94.45
The average bid / ask quote of the 3 12.17 47.15 47.2 94.35
47.15 47.2 94.35
scrip in the Ready Market which 47.1 47.15 94.25
would be calculated as a ratio of 47 47.15 94.15
A/B where “A” equals the sum of 47.4 47.45 94.85
108 14.12 47.35 47.4 94.75
market bid and ask prices taking 109 14.13 47.4 47.45 94.85
the best bid and best ask prices 110 14.14 47.35 47.4 94.75
of the scrip during each one Total 104.14
Total Bid
minute interval for last two hour Count 110
trading. Total Ask
Count 110

Final Settlement Price (FSP)

FSP = 10414.5/220
FSP = 47.35068

India, Brazil Athens and Malaysia use underlined assets closing price as Final
Settlement Price
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CSF TRANSACTION LIFE CYCLE, FINAL SETTLEMENT PRICE

Daily
Prevailing Gain/Loss on
Days Scrip Trade Type Trade Qty Contract Settlement
Trade Rate T+1
Value Price

1 LUCK-CJUN BUY 41.00 1,000.00 41,000.00 42.50 1,500.00

2 42.50 1,000.00 42,500.00 44.00 1,500.00
.. 44.00 1,000.00 44,000.00 46.90 2,900.00
.. 46.90 1,000.00 46,900.00 48.50 1,600.00
.. 48.50 1,000.00 48,500.00 49.80 1,300.00
.. 49.80 1,000.00 49,800.00 48.10 (1,700.00)
.. 48.10 1,000.00 48,100.00 48.30 200.00
Profit/Loss till 2nd last day of the contract------> 7,300.00
• What happens to the open positions at the end of CSF Contract?
– Contract are concluded on the last day using the FINAL SETTLEMENT PRICE of underlined
instrument’s price on Cash Counter
– 120 readings of bids and offers of last 2 hours are taken
– The open positions does not require an square-off, gain-or-loss is collected on the basis of final
settlement price and the contract is concluded

• What happens when you offset your open position?

– The result of the trade is the cash difference between the bought and sold price.
– The difference is credited/debited to your account on T+1 basis
– Open position is not carried forward anymore
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CSF TRANSACTION LIFE CYCLE — NETTING REGIME, RMS, & LIMITS

• Netting Regime?
– Netting SHALL NOT be allowed between buy and sell position in same scrip for different clients
– Netting SHALL NOT be allowed between buy and sell position in different scrip for same client
– Netting SHALL NOT be allowed across different contracts(30, 60, 90) for same client in same scrip
– Spread Discounts shall soon be available as the volumes pick-up

• Risk Management?
– Open positions to attract Ready Market VaR Margins applicable at client level
– Margin are payable 100% in securities and will soon be in Cash
– Normal haircuts are applied on the collaterals
– KSE has resisted and not imposed special margins and profit retention, however, concentration
margins shall be introduced subsequent detailed presentation to member community

• Capital Adequacy Limit?

– CAL shall continue to be in the multiple of NCB times 25 of a member
– With the conclusion of CFS and DFM, a member can utilize 10 times of its NCB in CSF

• Position Limits?
– Market wide limit per scrip is 40% of the free float
– Member-wide limit per scrip is 10% of the free float
– Client-wide limit per scrip is 1% of the free float

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CSF TRANSACTION LIFE CYCLE—CORPORATE ACTIONS

• Adjustments in case of RIGHT ISSUE?

– The contract multiplier will be adjusted against RIGHT issue in the underlying scrip
– When there is 1-for-2 right issue, the contract multiplier will be adjusted to
– 750 from 500 in the following manner
– 750 (500 X 3/2)
– On the ex-right date
– The buyer or seller can square-off their open positions in the multiple of lot-sizes
– KSE shall soon be revising lot-size to 1 and CSF contract multiplier

• Cash Dividend?

– In case where cash dividend is declared in a scrip, no adjustment would be made by the exchange
– The market to re-adjust in consideration of cash dividend.

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 CSF TRANSACTION LIFE CYCLE—CORPORATE ACTIONS

Existing Contract
• Adjustment of Bonus
Issue? Contract Vol Futures Price Contract Value
– Open positions to attract 500.00 540.00 270,000.00
Ready Market VaR Margins
applicable at client level
– When there is a 1-for-2 bonus Conpany Announces 1.222 Shares for each share
shares issue i.e. for every 2
existing shares,
– the holder gets one additional Revised Contract
shares
– The “Exchange: shall adjust
the prices in the following Contract Vol Bonus Multiple Bonus Shares
manner 500.00 1,222.00 611.00
Original Volume 500.00
Revised Contract Volume =======> 1,111.00

New Contract Price is determined by dividing

Old Contract Value by Revised Contract Size

Old Contract Value 270,000.00

Revised Volume 1,111.00
Revised Price 243.02

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PRODUCT REVIEW, STOCK INDEX FUTURES

Stock Index Futures is simply buying or selling a specified number of

contracts, whose mark-to-market difference is settled in cash on daily basis.
Contract Duration Standardized 90 days Contracts

Contract Start Date first day following the last Friday of Each Month

Contract End Date Last Friday of respective Month

Daily PLS Settlement Volume weighted average value of last half hour of trading in relevant stock
index futures contract multiplied by contract multiplier.
Final Settlement Same as of CSF, except that SIFC uses underlined index values

Contract Multiplier RS 5/=, Minimum Fluctuation one index point of KSE-30

Contract Unit Numerical Value of underlined Index i.e. KSE-30

Exposure Margin and VaR marginsof exposure

Deposits

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PRODUCT REVIEW, STOCK INDEX FUTURES

OPERATING PARAMETER OPERATING VALUE

Contract Unit Value of Underlying Index

Contract Multiplier RS 5
Margin Requirement VaR values around 6%

CURRENT KSE-30 INDEX = 6000

TRANSACTING VOLUME = 5
---------------------------------------------------------------
CONTRACT VALUE = 30,000
============================================

*3750—exposure margin, and RS 5 per index point movement is the gain or loss

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TRADING SCENARIO, READY/DFM TRADING

Delivery Based Products

Cash Management

 DVP  DVP
Bank/  T+2 Settlement  30 days contract
Personal Traded at PSX  Traded at PSX
Borrowing Settled by NCC  Settled at NCC
(K+4) Features
 Bull Run
 Ready Future Arbitrage  Go long in DFM
 pay at the end of DFM
 Borrow Cash

Settle Ready  Go long in Ready  Bearish Run

 Go short in DFM
on T+2
Sell in DFM (K+4+n)  Buy/lift delivery at the end of
contract

Past Experiences
 March 2005 Crises was triggered due to delivery pressures in the 4th week of March 2005

 SECP advised to introduce non-deliverable-CSF to avert delivery requirement on the end of long position holders.

 2008 syndrome appear to be a mere re-occurrences, PSX introduced CSF in 2007.

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TRADING SCENARIO, READY/CFS TRADING

Delivery Based Products

Cash Management

CFS  DVP  DVP

Financier  T+2 Settlement  22 days contract
offer Traded at PSX  Traded at PSX
Financing@ Settled by NCC  Settled at NCC
(K+4) Features

 Buy in Ready Market

 Get CFS on a agreed premium rate  Always for Bull Run
 Release CFS Trade with Cost of Carry  Doesn't Support Bearish
 Sell in Ready Market Trend
Settle Ready
on T+2

Past Experiences
 Carrying one transaction forward involves 3 additional transaction.

 Exorbitantly high cost of transaction, brokers lending risk is on the clearinghouse.

 Carries huge incentive to default.

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TRADING SCENARIO, READY/CFS TRADING

Cash Settled/Non-Deliverable Products

Cash Management

 DVP  CSF
Use of  T+2 Settlement  90 days contract
Futures and Traded at PSX  Traded at PSX
Financing Settled by NCC  Settled at NCC
tool. Lender
should go
Features
short in
CSF and go  Hedging
long in Buy in Ready Market  Supports Bull Run
ready to Go short in CSF  Support Bearish Trend
earn return No need to square the trade in CSF
at KIBOR+n  Lend in Ready and earn money
 Loss is hedged against down-trend

Past Experiences
Investors tend to use CSF. The fear factor prevalent at Brokers is impeding the volumes in this product.

 Presence of Circuit Breakers is yet another impediment in the growth of this product.

 Institutions are allowed to do financing in CFS. However, they Mutual Fund cannot trade on CSF.

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TRADING SCENARIO, READY/SIFC TRADING

Cash Settled/Non-Deliverable Products

Trading Strategy

The SIFC price  DVP  CSF

will follow the  T+2 Settlement  90 days contract
level of a Traded at PSX  Traded at PSX
hypothetical Settled by NCC  Settled at NCC
portfolio of Features
stocks (KSE-
30) to increase
 Choices
or decrease
Buy KSE30 Basket  Supports Bull Run
their exposure
Sell the Index (SIFC)  Support Bearish Trend
to Country’s
 Do Not buy KSE-30 Basket
only Capital
 Just Go Short in SIFC
Market

Past Experiences
International consultants have regarded this as an excellent arbitrage and hedging tool.

 Yet the fear factor and Presence of Circuit Breakers remains a key impediment in the growth of this product.

 Institutions are allowed to do financing in CFS. However, Mutual Fund cannot trade on CSF.

Pakistan Stock Exchange Limited 27

 THANK YOU
For any further information or queries please contact:
helpdesk@psx.com.pk or sani.khan@psx.com.pk

Serving Investors & Industry

Stock Exchange Building, Stock Exchange Road, Karachi-74000, Pakistan.
Tel: (+92)111-001-122, Website: www.psx.com.pk