Exchange Traded Funds (ETFs) are certainly one of the most innovative and successful exchange-traded c Exchange Traded Funds (ETFs) are certainly one of the most innovative and successful exchange-traded cash products to emerge over the last few years. They have proven popular for many reasons, including the fact that they allow investors to easily initiate exposure to an equity or bond index or discrete sector. ETFs are priced in real time, which means that the market can be entered or exited quickly and, they can be relatively easily shorted or borrowed. Given the successful development of cash ETFs, it was a natural step for Eurex to launch futures and options on ETFs in November 2002. Cash and derivatives products have several differences which make one or the other product more suitable depending on the investor’s current situation. Cash ETFs have no maturity dates, whereas the futures are listed with three-month cycles. This means that for longer-term buy and hold strategies, the cash products are likely to be better suited as they will not have to be ‘rolled over’. Derivatives are traded on margin, which means that they are often less cash intensive and may be more suited for short-term strategies. Lower transaction costs make them cheaper to trade. However, derivatives normally attract a different accounting and taxation regime, which investors will need to consider. Derivative Contract Specifications A marked difference in contrast to Eurex’s equity index futures is that ETF futures are physically settled, which suits many investors, particularly active hedgers. Physical settlement can provide for greater hedge efficiency. At expiration, the investor can take or make delivery of the underlying ETF. Also, ETF derivatives have a far smaller contract size than the established equity index contracts. This allows more precise hedging and makes them extremely useful for managing short-term flows in and out of funds. Both the futures and options contracts are comprised of an underlying basket of 100 shares and have a tick size of just EUR 0.01. For futures on the DAX® EX ETF, each contract will have a nominal value of EUR 1 multiplied by the level of the DAX® Index. As of November 2003, this gives a nominal value of approximately EUR 3,600. In contrast, the DAX® Future has a contract value of EUR 25 per index point, giving it a nominal value of around EUR 90,000. Applications Derivatives are often used to easily initiate new long positions, especially at times of extreme volatility. For instance, an investor might decide that a market has fallen far enough, but to buy the individual equities required for a portfolio can often prove difficult. Using ETF derivatives, or even the cash product, enables the exposure to be easily initiated. This then gives the investor time to switch out of the derivative position and purchase the individual equities at a point in the future when the market has calmed down. There are numerous strategies that allow investors to increase the effective yield on their assets. A common one, used when the investor’s view is neutral to bearish, is to write (sell) out-of-the-money covered calls. If prices fall or move sideways, as the investor expects, he will benefit by collecting option premium. If the market does surprisingly move higher and the option is exercised, the investor is covered because he holds the underlying assets. Derivatives are extremely useful tools that allow investors to precision manage their cash flows, hedge their portfolios and increase the yield on their assets. Eurex’s product range has already proved extremely successful and the innovative ETF derivatives provide an additional tool for hedging, arbitrage and yield-enhancement strategies within the investors’ portfolios. Further information regarding ETFs is available at www.eurexchange.com. http://www.eurexchange.com/products/overview/ETF_strategies.html  copyright hegdeweek 2004