Malaysia Financial Law - Commodities Law

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FINANCIAL LAW - Commodities Law

Related Topics : Banking Law . Offshore Banking Law . Broker Disputes . Commodities Law . Investment Terms . Raising Capital . Securities Law . Buying On Hire Purchase . Exchange Control Rules . Danaharta Act

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WHAT IS OPTIONS CONTRACT ?

An options contract is a standardized agreement that gives (the buyer) the right, but not the obligation, to buy or sell a specified quantity and quality of an underlying product at a specified price within a specified time period. The seller of the option has a contingent liability or an obligation to fulfill if the buyer chooses to exercise that right.

The buyer of the option pays a premium for this privilege to only complete the deal if price movements are favorable. Consequently, the buyer is protected against undesired market movements but still able to gain from movements in his favor. The seller of the option, on the other hand, receives the premium but takes on an obligation in the event that the option buyer chooses to exercise his option.

An option contract, being a contract at law, creates a legal relationship between both the buyer and the seller. This relationship can remain in place until the option is exercised or, allowed to lapse, i.e., not exercised prior to expiration. Alternatively, it is possible for the two parties to the contract to enter into an "opposite" contract and for these contracts to be offset against each other.

WHAT ABOUT CALL AND PUT OPTIONS ?

A call option gives the option buyer the right, but not the obligation to buy a specified quantity and quality of an underlying product at a specified price within a specified time period. Upon exercise of that right, the option seller is obliged to sell the underlying product under the specified conditions to the option buyer.

A put option gives the option buyer the right, but not the obligation to sell a specified quantity and quality of an underlying product at a specified price within a specified time period. Upon exercise of that right, the option seller has the obligation to buy the underlying product from the option buyer under the specified conditions.

The process by which the option holder uses the right conveyed by the option is known as exercise and the time by which exercise has to have taken place is expiry. An option that can be exercised at any time during its life is known as an American style option whereas a European style option can only be exercised at expiry.

WHAT ARE THE TWO COMPONENTS THAT MADE UP THE OPTION PREMIUM ?

Its intrinsic value and time value.

An option's intrinsic value is based on the difference between the exercise price and the current price of the underlying product. The intrinsic value is that part of the premium which could be realized if the option were exercised. Such an option is referred to as "in-the-money". A call option has intrinsic value only if the underlying product price is above the option price. Conversely, a put option has intrinsic value only if the underlying product price is below the option price.

The second component of an option premium is time value. Time value is the amount, if any, by which an option's premium exceeds its current intrinsic value. Time value reflects the willingness of buyers to pay for the right offered by the option and the willingness of seller to incur the obligations of the options. Therefore it represents the value placed on the possibility that, at some time up to the expiry date, the option may become profitable to exercise. It also means that this value decays over time and its value at expiry is zero.

WHY REGULATION FOR THE FINANCIAL FUTURES AND OPTIONS MARKETS ?

Regulation of the financial futures and options markets is aimed at promoting professional conduct among intermediaries, ensuring fair and transparent markets and minimizing the risk of default by one institution leading to defaults in the entire market and/or the other markets.

WHAT IS THE REGULATORY FRAMEWORK IN MALAYSIA ?

The regulatory framework for the futures and options markets in Malaysia is governed by the Futures Industry Act 1993 (as amended) (FIA) and the Regulations enacted thereunder and it comes under the jurisdiction of the Ministry of Finance. The FIA was enacted "to provide for the establishment of futures exchanges and to regulate trading in futures contracts and to provide matters connected therewith or incidental thereto". The implementation of the FIA is vested in the Securities Commission ("the Commission") and the Commission is responsible for the overall supervision of the futures industry in Malaysia.

The Commission's role is to ensure integrity of the futures industry's market place in order to protect the public interest. It makes sure that adequate and effective measures are available to protect the public and it can exert emergency powers if necessary. The Commission is also responsible for licensing of futures brokers, futures fund manages, futures trading advisers and their respective representatives. The issuance of a futures broker's license is subject to the approval of the Minister of Finance.

As the FIA primarily aims to protect clients when dealing in futures contracts, it defines the futures contracts that are captured under the legislation. Essentially they include all deliverable and cash settled future and options contracts traded on an approved exchange company in Malaysia. This includes contracts relating to instruments that are capable of being delivered under an agreement for delivery, including a document creating or evidencing a thing in action or any other thing that is prescribed to be an instrument, as well as adjustment agreements.

Information compiled and extracts
from COMMEX Malaysia

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