The hot new idea of the
past two years in listed equity derivatives has been dividend
futures and options. Exchanges all over the world have started
to offer them, and the main contracts have attracted brisk
trading. As Roger Aitken reports, many equity
derivative specialists are convinced the product is here to
On June 16, as costs mounted from
BP’s Gulf of Mexico oil spill, the company
announced it would cancel its first quarter dividend, due to be
paid five days later, and its second and third quarter
The move had been widely expected
but was still a blow to UK equity investors. BP’s
dividends usually make up a staggering 12% of all dividends
paid by FTSE 100 companies. BP’s shares lost 5p on
the day to £3.37.
Yet one group of investors was
happy – those who had hedged their exposure to UK
dividends using a new product.
derivatives: the basics
Index dividend futures
track the dividends paid by all the companies in the
index during one calendar year.
On the ex-dividend date,
when the dividend is about to be paid, the monetary
value of each dividend is converted into a number of
index points and added to the index.
Providers such as Stoxx
tend to publish the value of the index
"What one is basically
doing when buying such a future is essentially buying
the value that will be realised at maturity," says Eric
Jullien De Pommerol, head of the delta one desk at JP
Morgan in London. "For example, if a market participant
buys a December 2011 contract, they’ll be
buying the number of points which are going to be
realised between December 2010 and December 2011
The FTSE 100 Dividend
Index Futures are worth £10 an index point, while
for the Euro Stoxx 50 equivalent, a single point
represents €100. At CBOE, it is $100 a
Nearly all the activity
at Eurex is in 2011 contracts. "There is a lot of
certainty in the 2010 contracts and investors are
looking forward to 2011, 2012 and beyond," says Stuart
Heath, the exchange’s product manager for
Derivatives that convey exposure
to dividends only, rather than companies’ share
prices, have been traded over the counter in Europe for at
least a decade, often under the name of dividend swaps. The
instrument can be linked either to the dividends of a single
company, or to those of all the companies in an
Then, in June 2008, Eurex became
the first exchange to list such a contract, with its futures on
the dividends of the Euro
Since then other exchanges have
followed, first in Europe and recently in Asia. Safex,
the derivatives branch of the
Johannesburg Stock Exchange, has caught the bug too, with
dividend futures on three stocks – Marks &
Spencer, General Electric and AT&T.
JP Morgan was one of the first
banks to begin offering the product OTC. Eric Jullien De
Pommerol, head of the bank’s delta one desk in
Europe, says the story started with banks offering their
clients structured equity products, often capital-guaranteed.
The banks were left with considerable dividend risk exposure on
their books, and wanted a way to pass it on.
Now, De Pommerol says, "a large
majority" of JP Morgan’s dividend futures trades
are with listed contracts. "It began initially and mainly with
hedge funds, fast money and relatively sophisticated clients
trading dividend futures, " he says. "Then, when futures open
interest grew, we began to see some more traditional clients
and even some retail types."
JP Morgan’s European
delta one desk now trades dividend futures heavily, for clients
and the bank itself. Most of its flows are from Europe, some
from further afield.
"Market participants who usually
invest in European dividends are normally very familiar with
European companies," De Pommerol says. "And, given that
we’re a client-facing business, most of the risk
in our books is based on client products.
"So, we can have dividend exposure by
selling some forwards, for example, even if the dividend may
not be the primary reason for the trade. Alternatively, we can
deal dividend derivatives directly with clients
John O’Neill, head
of product development for equity and OTC derivatives at NYSE
Liffe in London, is another enthusiast.
"What we have witnessed over the
past couple of years is the launch of a very successful asset
class," he says. "The volumes for our FTSE 100 Dividend
Futures, launched in May 2009, have been excellent.
We’re pleased with the product."
By the end of June 1.3m contracts
had been traded, with 400,000 lots of open interest. "That
level of open interest points to an extremely healthy long term
product," O’Neill contends.
Eurex’s Euro Stoxx
50 Index Dividend Future traded just 100 times in its first
month, but picked up quickly – this year at least
200,000 contracts have been exchanged every month, with a
record of 519,000 in May. Open interest at the end of May was
Eurex followed up in January by
launching dividend futures on the individual companies in the
Euro Stoxx 50. So far, 350,000 of these contracts have been
In May came options on the Euro
Stoxx 50 futures – they traded 4,750 times in their
Since then the exchange has
considered two national indices: the SMI for Switzerland and
Dax for Germany.
Eurex’s product manager for dividend derivatives,
says: "We’ve also looked at a couple of the more
specialist indices that are selected on the basis of dividend
payments, namely the Select Dividend 30 from the Euro Stoxx and
the DivDax part of the German market."
Heath, who became head of the
exchange’s London office on July 1, agrees with De
Pommerol that the market is underpinned by the long dividend
exposure of banks that offer structured products. "They will
always be interested in offsetting that risk and hedging in an
efficient way, " he says. "Our dividend products offer exactly
Heath acknowledges that he cannot
say for certain if dividend futures will carry on growing at
the same speed.
He compares the roughly €6bn
of open interest in Eurex’s index dividend futures
with the approximately €60bn of dividends that Euro Stoxx
50 companies paid in 2009. "This might imply that that in
effect only a tenth of the market is hedged," he
Of course, not all investors are
ever going to hedge their exposure, any more than their
exposure to share prices. But that one tenth is perhaps a
For comparison, the Euro Stoxx 50
companies have a market capitalisation of about €1.5tr,
yet open interest in Euro Stoxx 50 Futures at the end of June
was €61bn – just 4%.
The true extent of dividend
futures trading is probably larger, too. De Pommerol says there
are "still some OTC derivatives out there in the market that
have not expired and have not been novated into listed
Heath suggests that the Euro
Stoxx 50 dividend futures "account for probably around 50% of
the European dividend swap market".
Over time, the mix of users has
broadened, taking in a range from sophisticated hedge funds to
more traditional asset managers. "Now that dividend futures
have been brought on exchange, there are significantly more
buy-and-hold-type investors such as pension funds," says Heath.
"It’s not just a specialist market."
Heath believes there will be "an
ongoing need [for investors] not only to hedge their flows, but
perhaps also to speculate on the growth of those
Encouraged by the success of its
FTSE 100 product, NYSE Liffe, too, has been expanding its
offering, adding dividend futures on the French CAC 40 index in
December and on Amsterdam’s AEX index in May.
O’Neill says both contracts are "coming along
nicely [in terms of volume]".
The critical customer demand
typically starts in Europe, O’Neill says, but
these indices attract global interest, so he expects the
product to be internationalised more and more.
"Typically, as an asset class
becomes increasingly popular, one sees a wide range of players
joining in," says O’Neill. "And
that’s really what makes a successful market,
which we have definitely seen for this product since we
launched in May 2009."
Asia warms to simplicity of trading on
In Asia, the Singapore
Exchange became the first exchange to offer dividend
futures in mid-June, when it launched its Nikkei
Dividend Point Index Futures, based on dividends of
companies in the Nikkei Stock Average.
Although the contract had
been slated for listing in the third quarter, SGX beat
the Tokyo Stock Exchange to the punch by launching
By June 22, five days
after their debut, the futures’ open
interest had reached ¥600m ($6.8m). On July 6, this
had risen to over ¥8bn ($92m), with a total volume
traded so far of ¥10bn.
The product complements
SGX’s existing range of Nikkei products
– its Nikkei 225 Index futures account for 30%
of global trading of the contract.
"The contract provides
price discovery, transparency and central clearing for
over-the-counter dividend swaps," says Chew Sutat,
SGX’s head of market development. "As a
result, we’ve seen some migration of OTC
dividend swap activity to SGX."
Although it is early
days, Sutat said the exchange was "delighted" with
Janice Kan (pictured),
senior vice-president of derivatives at SGX, says
investors are using the contract to hedge and trade
their Japanese dividend exposure, hedge the dividend
element of structured products based on the Nikkei 225,
to strip out dividends so they can maximise their
exposure to share price appreciation, and to trade
implied dividend yield spreads.
In Japan, the TSE will
list three new dividend futures, on the Nikkei 225,
Topix and Topix Core 30 indices, starting on July
Hong Kong Exchanges and
Clearing is also considering launching dividend futures
on its Hang Seng Index and Hang Seng China Enterprises
"Dividend futures are
definitely a phenomenon in Asia," says Benjamin Dufour,
head of forward trading for BNP Paribas’s
global equities and commodity derivatives division in
Tokyo. "The OTC dividend swap market on Nikkei has
reached a very mature stage, with numerous counterparts
involved, high liquidity, standardised contracts and
now with more than five years of history."
Dufour expects the market
to grow "exponentially" as a result of the listed
product at SGX, which he said had made an impressive
Most of the volume has
been generated by what Dufour calls "regular actors" in
the OTC dividend swap market, who started to shift
trading to the exchange. As time goes on, he expects
"new actors" to arrive, mainly those who did not have
Isda documentation in place with the OTC dividend swap
Other attractions of the
SGX product are price transparency and commitment of
market makers such as BNP Paribas and
The exchange talks continually to
market participants about new product ideas, including dividend
options and single stock dividend futures. O’Neill
hints that announcements on these could be imminent.
Gareth Pickard, senior equities
broker at MF Global, says: "Current demand is not in the league
of some of the derivatives exchanges’ star
products, such as the Euro Stoxx. However, they’re
definitely not a fad and I feel they are here to
He argues that the example of BP
shows why investors need to be able to hedge or speculate on
dividends and the implications of changes in dividend
expectations on indices like the FTSE 100.
"Portfolio managers and in
particular income managers are naturally long dividends, and
therefore they’re candidates to use these products
as hedging tools," says Pickard.
"Hedge funds have exposure to
dividends through underlying positions and will want to use
these products to speculate and hedge," he adds. "Exotics,
index and single stock desks at investment banks all have
dividend exposure through their underlying delta hedges to
Yet despite the organic need for
hedging – and attractions of speculating on dividends
– market players say the product’s growth
will depend most of all on the amount of open interest there is
in structured derivative products.
"If one has a large volume of
structured derivatives on say the FTSE 100 or Euro Stoxx 50,
naturally you will have a large interest in dividend futures,
since there are both buyers and sellers," says De Pommerol. "If
not, then it’s likely to be a bit more
complicated, as one does not have the natural seller
Pickard argues that most of the
interest in exchange-traded dividend derivatives is speculative
– and it’s a momentum-driven
"In general, if the market is up
then dividends are also up, and conversely the reverse is true.
Hence they act as a proxy," he says. But equally,
"There’s a real case for more widespread use as a
hedging tool by income fund managers and others," Pickard
believes. "Hopefully this kind of activity will follow as
markets become more liquid."
As dividends are event-driven
there is little movement day-to-day – prices tend to
move in jumps as companies release information.
"This reduces the optionality in any possible
trade, as there is little volatility to trade around short
term," Pickard explains. "Trades and ideas need to be
researched and formulated well in advance of a possible event
as there is – at present – very little
liquidity. Consequently, the chance of getting a trade on as an
event is unfolding is highly unlikely."
Nevertheless, the product has
several attractions, Pickard argues, making it an "extremely
clean way" to hedge or speculate on dividend risk.
"They are not capital-intensive,
since they’re essentially CFDs [contracts for
difference] and therefore subject to initial and variation
margin – as opposed to payment in full," he
The modern product is an
improvement on the labour- and capital-intensive methods used
before, including cash baskets and creating synthetic
Being listed on exchanges also
means there is no counterparty default risk as the trades are
cleared through a central counterparty.
Strategies involving dividend
futures are fairly simple and straightforward. Investors use
them as a delta one product – that is, one in which
the derivative’s movements match those of the
underlying. They can be used to go long and short outright, or
to trade the calendar spread for year-on-year
However, Pickard stresses that
the research involved in predicting changes in dividend
expectations is "far from simple and is therefore the domain of
the investment banks and research houses".
This, he warns, could hinder the
growth of liquidity as derivatives often rely on smaller market
makers and individuals to provide competitive pricing and
US getting there
Despite their healthy beginnings
in Europe, dividend derivatives are at an earlier stage in the
US. While the Securities and Exchange Commission has approved
the trading of cash-settled dividend index options, the
Commodity Futures Trading Commission has yet to sign off
The Chicago Board Options
Exchange is therefore leading the way. On March 5 it listed S&P 500 Dividend
Index Options with a quarterly accrual period, for users with quarterly dividend
Then on May 25 came options on
the S&P 500
Annual Dividend Index, initially with December
2010 and December 2011 expiries.
Paul Stephens, the
CBOE’s head of institutional marketing (pictured),
says that before the launch, "many of our customers told us
that they felt it would take some time for dividend options to
Longer term, the exchange is
optimistic about the potential. Stephens says education is
critical. "We’ve been working closely with global
investment banks to get the word out to potential new
customers, primarily institutional investors that have traded
similar products OTC in the US, as well as OTC and listed in
Europe," he says.
The CBOE expects most of the
early appetite to come from institutions looking to "capture
the difference between implied and realised
Both hedge funds and more
traditional investment managers could become "significant" user
bases, Stephens believes. "We also expect dividend options to
appeal to any investors looking to hedge dividend exposures
within their equity portfolios or within their equity index
options positions – as a way to take views on the
level and timing of future dividends."
At NYSE Euronext,
O’Neill is encouraged by the interest of other
exchanges around the world, which he sees as confirming that
the product has a long term future.
Pickard at MF Global would like
the exchanges to do more. "At the moment it seems the costs
being levied by the exchanges in these products are prohibitive
to growth," he says. "This is unusual, as to promote products
the exchanges usually offer fee holidays or drastically reduced
fees until growth is established."
As a broker, MF Global wants to
see developments to "encourage more aggressive pricing and
But he’s a believer,
too. "Growth is a definite possibility," he says. "Though I
doubt these products will eclipse contracts such as Euro Stoxx,
Dax or FTSE futures and options, there is and will be a desire
for them going forward."