# Equity Perps

## WHY DERIVATIVES? 

<table><thead><tr><th width="225.800048828125">Users</th><th width="253.79998779296875">Underlying Risks</th><th>Derivative Types</th></tr></thead><tbody><tr><td>Commodity manufacturers</td><td>Commodity price</td><td>Commodity derivatives</td></tr><tr><td>Multinational companies</td><td>Funding cost of foreign debt issuance and investments</td><td>Cross-currency swaps / FX forwards</td></tr><tr><td>Life insurers</td><td>Asset-liability management</td><td>Interest rate swaps or swaptions</td></tr><tr><td>Corporate treasurers</td><td>Funding cost before debt issuance</td><td>Forward rate agreements</td></tr><tr><td>Construction firms</td><td>The cost of raw materials</td><td>Commodity derivatives</td></tr><tr><td>Exporters</td><td>Foreign exchange (FX) fluctuations</td><td>Cross-currency swaps / FX forwards</td></tr><tr><td>Bank or loan portfolio managers</td><td>Credit risk of bond or loan exposures</td><td>Credit default swaps</td></tr><tr><td>Equity investors</td><td>Equity prices</td><td>Equity derivatives</td></tr><tr><td>Governments</td><td>Interest rate risk on new bond issuance</td><td>Interest rate swaps</td></tr></tbody></table>

<https://why-derivatives.netlify.app/>

### Use cases

<mark style="color:red;">**Chevron**</mark> is exposed to market risks related to the price volatility of crude oil, refined products,
\
natural gas, natural gas liquids, liquefied natural gas and refinery feedstocks. The company
\
uses commodity derivatives to manage these exposures on a portion of its activity, including
\
firm commitments and anticipated transactions for the purchase, sale and storage of crude oil,
\
refined products, natural gas, natural gas liquids and feedstock for company refineries. The
\
company also uses commodity derivatives for limited trading purposes16.

<mark style="color:red;">AT\&T</mark> is exposed to market risks primarily from changes in interest rates and foreign currency
\
exchange rates. The company uses derivatives, including IRS, interest rate locks, foreign
\
currency exchange contracts and cross-currency swaps, to manage its debt structure and foreign
\
exchange exposure. This enables the firm to manage its capital costs, control financial risks and
\
maintain financial flexibility over the long term15.

<mark style="color:red;">**Apple**</mark> uses derivatives to partially offset its business exposure to foreign currency and interest
\
rate risk on expected future cashflows, net investments in certain foreign subsidiaries, and
\
certain existing assets and liabilities. The company enters into interest rate swaps (IRS) to
\
manage interest rate risk on its outstanding term debt. IRS allow the company to effectively
\
convert fixed-rate payments into floating-rate payments or floating-rate payments into fixed rate.
\
The company also uses forwards, cross-currency swaps or other instruments to protect its foreign
\
currency denominated term debt or marketable securities from fluctuations in foreign currency
\
exchange rates14.

<mark style="color:purple;">WHY BLOCKCHAIN-SETTLED PERPETUAL FUTURES?</mark>

No expiration, thus no need to roll over contracts. perpetual futures contract = perpetual swap&#x20;

<details>

<summary>Swap</summary>

• A swap is a contract calling for an exchange of
\
payments, on one or more dates, determined by
\
the difference in two prices.
\
• A swap provides a means to hedge a stream of
\
risky payments.
\
• A single-payment swap is the same thing as a
\
cash-settled forward contract.

</details>

<details>

<summary>What is a clearinghouse?</summary>

Matches buy and sell orders
\
Keeps track of members’ obligations and payments
\
After matching the trades, becomes counterparty

</details>

<details>

<summary>Futures contract</summary>

Futures are legally binding agreements to buy or sell a standardized asset on a specific date or
\
during a specific month. These contracts are standardized and traded on futures exchanges.

A futures contract is an exchange-traded, standardized, forward-like
\
contract that is marked to the market daily. Futures contract can
\
be used to establish a long (or short) position in the underlying
\
commodity/asset.

</details>

## Contract for differences (CFD)

Similar to a forward or futures contract that is cash settled. The amount of the cash settlement will represent the difference between the underlying asset's price agreed at the outset of the contract and its market price at the date of the settlement of the contract. CFDs can be long (that is, where the holder gains from a rise in the price of the underlying asset) or short (that, is where the holder gains from a fall in the price of the underlying asset).

However, unlike forwards and futures, CFDs are open-ended contracts with no fixed settlement date and can be closed out by the holder on demand. CFDs can offer exposure to a variety of financial assets, including single or multiple share indices, [*debt securities*](https://uk.practicallaw.thomsonreuters.com/0-207-6955?originationContext=document\&transitionType=DocumentItem\&contextData=\(sc.Default\)\&ppcid=1daa1f536b0145579299f9531df88b82), commodities and currencies. When applied to shares, a CFD is an equity [*derivative*](https://uk.practicallaw.thomsonreuters.com/0-107-6094?originationContext=document\&transitionType=DocumentItem\&contextData=\(sc.Default\)\&ppcid=1daa1f536b0145579299f9531df88b82) under which the holder generally does not have voting rights or a call option over the underlying shares.

## Spread-betting

1\. Send USD to broker margin account\
2\. Open long spread bet at broker offer price\
3\. Broker locks required margin\
4\. Market moves up → broker credits cash P\&L\
5\. Market moves down → broker debits cash P\&L\
6\. Each night broker debits financing (long) or credits financing (short)\
7\. Broker applies dividend credit (long) or debit (short)\
8\. If margin falls below threshold broker demands top-up or auto-closes\
9\. Close position → broker settles P\&L and releases remaining margin

<mark style="color:red;">auto-closes = auto de-leveraging?</mark>

### CFDs vs. Blockchain Equity Perpetuals

Similar payoff structure: both are synthetic exposure to price movements without delivery of underlying asset.

* Both cash-settled and&#x20;
* Both no expiry
* Both replicate PnL = size × (price change) over time

Key difference is how price anchoring is enforced.

## Futures vs. Forwards

Settled daily through mark-to-market process  low credit risk
\
Highly liquid  easier to offset an existing position
\
Highly standardized structure  harder to customize

Derivatives explained

| ASSET CLASS | FLOW OF FUNDS | PRICING LOGIC |
| ----------- | ------------- | ------------- |
|             |               |               |
|             |               |               |
|             |               |               |

## Close-out netting

Close-out netting is a process involving the termination of obligations under a contract with a
\
defaulting party and subsequent combining of positive and negative replacement values into a
\
single net payable or receivable. The diagram demonstrates payment obligations with and without
\
close-out netting.

<figure><img src="/files/z3IvgH8i7WeoLlAFLlLR" alt=""><figcaption></figcaption></figure>

As close-out netting drastically reduces credit exposure between counterparties, it is the primary
\
tool for mitigating credit risks associated with over-the-counter derivatives. Close-out netting is an
\
essential component of the hedging activities of financial institutions and other users of derivatives.

## Physical vs. Financial Settlement

An industrial producer, IP Inc., needs to buy 100,000 barrels of oil 1 year from today and 2 years from today. The forward prices for deliver in 1 year and 2 years are $20 and $21/barrel. The 1- and 2-year zero-coupon bond yields are 6% and 6.5%.

IP can guarantee the cost of buying oil for the next 2 years by entering into long forward contracts for 100,000 barrels in each of the next 2 years. The PV of this cost per barrel is:

![](/files/OT6wl1IYrnha61CISJtZ)

Thus, IP could pay an oil supplier $37.383, and the supplier would commit to delivering one barrel in each of the next two years.

### Physical settlement

<figure><img src="/files/aTVQDtiZO6Z4qhcIIeYW" alt=""><figcaption></figcaption></figure>

### Financial settlement

The oil buyer, IP, pays the swap counterparty the difference between $20.483 and the spot price, and the oil buyer then buys oil at the spot price.

If the difference between $20.483 and the spot price is negative, then the swap counterparty pays the buyer.

<figure><img src="/files/82RdyrKaKiKN47cdIgl5" alt=""><figcaption></figcaption></figure>

<table><thead><tr><th width="172.5999755859375">Feature</th><th>Equity Swap</th><th>Total Return Swap (TRS)</th><th>CFD</th></tr></thead><tbody><tr><td>Target User</td><td>Institutional</td><td>Institutional</td><td>Retail + Professional</td></tr><tr><td>Underlying Asset</td><td>Equity index or basket</td><td>Any return-generating asset (stocks, index, bond portfolio, etc.)</td><td>Stocks, indices, forex, crypto, commodities</td></tr><tr><td>Dividends &#x26; Gains</td><td>Usually equity price return only</td><td>Includes dividends + capital gains</td><td>Reflected in price, not paid directly</td></tr><tr><td>Leverage</td><td>Not common</td><td>Possible, but structured</td><td>Built-in, broker-defined</td></tr><tr><td>Contract Form</td><td>OTC, bilateral</td><td>OTC, bilateral</td><td>OTC, broker-standardized</td></tr><tr><td>Use Case</td><td>Hedging, passive exposure</td><td>Synthetic ownership, balance sheet optimization</td><td>Trading, speculation, short-term views</td></tr><tr><td>Settlement</td><td>Periodic cash flows</td><td>Periodic cash flows</td><td>Open-ended; exit anytime</td></tr></tbody></table>

<table><thead><tr><th width="191.4000244140625">Feature</th><th>CFDs</th><th>Equity Swaps</th></tr></thead><tbody><tr><td>Target User</td><td>Retail traders and professionals</td><td>Institutions only (banks, funds, corporates)</td></tr><tr><td>Underlying Assets</td><td>Stocks, indices, forex, commodities, crypto</td><td>Usually indices or custom equity baskets</td></tr><tr><td>Leverage</td><td>Available, broker-defined</td><td>Not typical, exposure usually unleveraged</td></tr><tr><td>Use Case</td><td>Trading, speculation, short-term positioning</td><td>Synthetic exposure, hedging, tax optimization</td></tr><tr><td>Settlement</td><td>Open-ended; gain/loss realized at close</td><td>Periodic cash flows exchanged based on contract terms</td></tr><tr><td>Contract Form</td><td>Standardized by broker, OTC</td><td>Fully customized bilateral OTC agreement</td></tr><tr><td>Execution &#x26; Access</td><td>Direct from trading platforms, fast entry/exit</td><td>Requires negotiation, legal framework, counterparty agreement</td></tr><tr><td>Market Familiarity</td><td>Easy to start, platform-based execution</td><td>Requires legal/compliance infrastructure and knowledge of swap mechanics</td></tr></tbody></table>

## Novation

Novation = P2P bilateral transfers?

<figure><img src="/files/4xioSTtyKQ25KhiQITwD" alt=""><figcaption></figcaption></figure>

For pensions

<figure><img src="/files/Ose565wbh4PBraDEI451" alt=""><figcaption></figcaption></figure>

For electricity generation

<figure><img src="/files/rhvL0eyipkxp17xyAVGu" alt=""><figcaption></figcaption></figure>

## DTCC

<figure><img src="/files/irtDZuW4MBe2MY8LvW7b" alt=""><figcaption></figcaption></figure>

[Source](https://www.cls-group.com/media/h5zc5qfp/clssettlement_otc_derivatives_feb2024_v1.pdf)

## ETF Replication

Characteristics of Physical ETFs and Synthetic ETFs

<table><thead><tr><th width="213.7999267578125"></th><th width="235">Physical ETFs</th><th>Synthetic ETFs</th></tr></thead><tbody><tr><td>Underlying Holdings</td><td>Securities of the Index</td><td>Swaps and Collateral</td></tr><tr><td>Transparency</td><td>Transparent</td><td> Historically Low</td></tr><tr><td>Counterparty Risk</td><td>Limited</td><td>Existent (higher than physical ETFs)</td></tr><tr><td>Costs</td><td>Transactions Costs Management Fees</td><td>Swap Costs Management Fees</td></tr></tbody></table>

<figure><img src="/files/CjPvORFZbLuGfwxPMILy" alt=""><figcaption></figcaption></figure>

The unfunded model&#x20;

<figure><img src="/files/4f78PJ4wn7HW5vO7VlOI" alt=""><figcaption></figcaption></figure>

<figure><img src="/files/8PvGn5ixt3Rr00nXF0Ju" alt=""><figcaption></figcaption></figure>

Fully funded&#x20;

<figure><img src="/files/5I3hqgHj4RSRUM0vseaM" alt=""><figcaption></figcaption></figure>

<figure><img src="/files/izJsjWIukj6zNxdezu9K" alt=""><figcaption></figcaption></figure>

<figure><img src="/files/uCbpjjyXzXmpq7homulh" alt=""><figcaption></figcaption></figure>

**Centrally-cleared derivatives**

<mark style="color:purple;">COUNTERPARTIES</mark>

End user – the reporting entity hedging its risk
\
Swap execution facility – the trading system used to provide pre-trade information (i.e., bid and offer prices) and the mechanism for executing swap transactions
\
Swap dealer – the market maker in swaps that regularly enters into swaps with counterparties
\
Clearing member – a member firm of a clearing house and a derivative exchange

<figure><img src="/files/2SGc5jaqKMV2F2Xst7yW" alt=""><figcaption></figcaption></figure>

Parties to an OTC derivative

<figure><img src="/files/Tecr3DGsybVtbFfaKRMl" alt=""><figcaption></figcaption></figure>

***

RESOURCES

[Professor Ian Giddy: Futures and Options](https://pages.stern.nyu.edu/~igiddy/futures.htm)

<https://www.ceem.unsw.edu.au/sites/default/files/documents/ceem-derivatives.pdf>

[Overview of the EMR Settlement Process](https://www.emrsettlement.co.uk/document/working-practice/wp1-overview-of-settlement/)

[G24 – CfD Generator
&#x20;Payments](https://www.emrsettlement.co.uk/document/guidance/g24-cfd-generator-payments/)

[BNY CFD pricing and best practices](https://eagledocs.atlassian.net/wiki/spaces/IE/pages/1658978621/Contracts+for+Differences+CFD+Best+Practices)

[Ukraine - Settlement diagrams.pdf](https://apps.rbcits.com/RFP/gmi/marketprofiles/Ukraine%20-%20Settlement%20diagrams.pdf)

[ISDA Legal Guidelines for Smart Derivatives Contracts](https://www.isda.org/a/bPYTE/ISDA-Legal-Guidelines-for-Smart-Derivatives-Contracts-FX.pdf)

[ISDA OTC Commodity Derivatives
&#x20;Trade Processing Lifecycle Events](https://www.isda.org/a/d0DDE/commoditieslifecycleevents-april-25.pdf)

[ISDA Overview of OTC
&#x20;Equity Derivatives
&#x20;Markets: Use
&#x20;Cases and Recent
&#x20;Developments](https://www.isda.org/a/1IhgE/Overview-of-OTC-Equity-Derivatives-Markets-Use-Cases-and-Recent-Developments.pdf)

[FSB Implementing OTC Derivatives Market Reforms](https://www.fsb.org/uploads/r_101025.pdf)

[Rollover Hedging and Missing Long-Term Futures Markets](https://onlinelibrary.wiley.com/doi/abs/10.2307/1241588)

[A Primer on Equity Swaps](https://bsic.it/a-primer-on-equity-swaps/)

[SURREY PENSION FUND SYNTHETIC EQUITY](https://mycouncil.surreycc.gov.uk/documents/s13818/Annex%202.pdf)

[OTC derivatives: A primer on market infrastructure ](https://www.chicagofed.org/-/media/publications/economic-perspectives/2014/3q2014-part2-ruffini-steigerwald-pdf.pdf?sc_lang=en)

[Princeton asset pricing ](https://www.princeton.edu/~markus/teaching/Fin501/09Lecture.pdf)

[IRS and Currency Swaps w/ good hedging flows ](https://rpc.cfainstitute.org/sites/default/files/-/media/documents/book/rf-publication/1995/rf-v1995-n4-4453-pdf.pdf)

[Vanguard ETF replication ](https://www.nl.vanguard/professional/vanguard-365/investment-knowledge/etf-knowledge/etf-basics)

[Euroclear OTC derivatives](https://www.euroclear.com/campaigns/en/innovation/OTC-derivatives-A-paradigm-shift.html)

[Swap ETFs: Synthetic replication of ETFs](https://www.justetf.com/en/academy/synthetic-replication-of-etfs.html)

[FI Security Handbook](http://docs.finance.free.fr/DOCS/Bloomberg%20Press,.Fixed%20Income%20Securities%20and%20Derivatives.pdf)

[Princeton Credit Default Swaps](https://www.princeton.edu/~markus/teaching/Eco467/10Lecture/CDS%20Presentation%20with%20References.pdf)

[MIT Lecture 5: Forwards and Futures Lecture 5: Forwards and Futures](https://web.mit.edu/astomper/www/univie/pof/Chapter%205.pdf)

[The CDO Machine](https://fcic-static.law.stanford.edu/cdn_media/fcic-reports/fcic_final_report_chapter8.pdf)


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