The Hindu Business Line : Contract based on proposed merger of CBOT launched

Contract rules
Event is established prior to listing by exchange rules.
Buyer/seller takes yes or no position on whether event will happen by specified date.
Contract is quoted in probability points.

Mumbai April 10 In what may seem an unusual "underlying" for a futures contract, the US Futures Exchange (USFE) has launched its first-ever set of Binary Futures Contract with the underlying being a specific `event' to occur in the near future.

And the "event" for the newly launched contract is the proposed merger of Chicago Board of Trade (CBOT) with either Chicago Mercantile Exchange (CME) or with the Intercontinental Exchange (ICE). The two possible events are reflected through two contracts.

Hedging risks

One contract denotes that CBOT will merge with CME, while the other contract denotes that CBOT will merge with ICE.

"We saw an opportunity in the event for the people to hedge the risks associated with either merger possibility," Mr Satish Nandapurkar, CEO of USFE, told Business Line. He is travelling through Asia exploring new product ventures.

Though the contract may cater to a small community of those associated with the futures industry, the event has huge economic implications for the US economy and financial consequences for the industry associates, according to Mr Nandapurkar.

This type of contract requires certification from the Commodity Futures Trading Commission, said Mr Nandapurkar adding that this can be achieved within a day, though informal discussions with the CFTC usually begin days or weeks in advance.

Taking position

Unlike the general futures contracts, a buyer/seller of the Binary Event Futures (BEF) takes a "yes" or a "no" position respectively on whether an event will take place on or by a specified date. The event is well established prior to listing by exchange rules, which operate to dictate the settlement of the contract before expiry.

The contract is quoted in probability points from 0 to 100 with each point reflecting $10 of contract value. The tick increment is 0.5 probability points or $5.

The contract is cash settled and the settlement price is a pre-specified value of $1,000 if the event occurs, otherwise expires to $0 (zero).

The daily settlement price of the BEF contract will be based on trading conditions.

Thus, if the defined event occurs, BEF contract buyer is entitled to a pre-specified cash payout from the contract seller.

Say one purchases a CBOT-CME merger contract, and CBOT does in fact merge with the CME on or before December 31, the purchaser is entitled to the full contract value being $1,000 in this case.

If the probability points/contract price reflect that the probability of either event taking place on or before December 31 is low, the exchange plans to launch another set of contracts with the same event as the underlying with June 2008 as the new deadline, said Mr Nandapurkar.

The BEF will begin trading on April 20. UFSE is mainly owned by MAN Group plc, the world's largest futures broker.