OneChicago NoDivRisk contracts

[dr_trick]

Hi all,

I'd like some help understanding the NoDivRisk futures contracts on OneChicago please.

From the name, does this mean that if I am short a futures contract I have no dividend liability at all? For example, if I am short a stock, I have to send any dividends paid to the stock lender. Is this requirement removed from the NoDivRisk contracts?

The wording on the site is a bit ambiguous.

thanks in advance.

 

[dgdowney]

Hello,
OneChicago lists two types of SSF. Our original "1C" contract is priced by adding to the current price the cost of carry (this reflects the interest foregone by borrowing from yourself by taking monies out of your bank to invest) and deducting any Dividends that will be paid during the life of the contract. (Actually the Present value of the expected dividend is priced in but for this discussion the full Div amount is used).
SSF1C= Stk_price * (1 +i) - Div

There are thus two risks associated with the SSF. Interest rates may change and DIvidend expectations may change. If the Div that is priced in gets cut or eliminated the SSF value will immediately rise irrespective of the stock movement causing marked to market losses for the Short holder of the SSF. Conversely if the dividend is increased then the SSF will fall in price causing losses for the Long Holder.

Pricing SSF out to time with multiple dividend events is risky.

Our OCX.NoDivRisk contract addresses this Dividend Variation risk. In the "1D" contract the pricing is simply:
SSF1D= Stk_price *(1 + i)

As you can see it is a simple cost of carry equation....a financing trade. Put another way it explains the interest rate the long holder will pay to carry the position out to time. If the interest rate implied in the SSF is lower then the rate being charged by your broker in a margin account you will save costs and thereby increase yields by carrying the delta exposure via the SSF with the lower rate.

Now what happens if the Stock pays a dividend? On the morning of ex-date the settlement price of the SSF is adjusted by the the then known dividend amount prior to the opening with no pay/collect cycle for variation margin.

If you buy a SSF at $10 , this becomes your basis in the stock position if you eventually take delivery. If the 1D contract gets adjusted for a .10cent dividend then the price you 'paid' is adjusted down from $10 to $9.90. The seller of course gets adjusted as if he sold at $9.90 as well.

Two things to note:
1. If the dividend expectation is accurate then the 1C and the 1D will have identical returns on the morning of ex_date.
2. For short sellers who must pay a Dividend in lieu (very different from a dividend for tax purposes) then the result in the 1D is identical. The "sell" price is reduced by the amount of the dividend and the Long holder sees a boost in ordinary income from the reduction in the price. This income is taxed exactly like Dividend in Lieu payments.

Which contract is best to use? It all depends on your ability to forecast dividend streams. If you want to remove the dividend variation risk then the 1D is the better choice.

One last point I would like to make is that the professional market makers who support the product make deeper and tighter markets in the 1D contracts. Why?

Less risk.

Hope this helps.

David G Downey
CEO
OneChicago, LLC