Managing trading risk
A London International Financial Futures and Options Exchange case study

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Page 3: Benefits of LIFFE

London International Financial Futures And Options 4 Image 2Anyone who is exposed to potential losses caused by adverse movements on interest rates, commodity prices, or equities, may find LIFFE's contracts useful tools for risk management. Approximately 3,000 traders, working on behalf of over 200 member companies, trade contracts for their company or on behalf of their clients. These member companies represent a variety of sectors and geographical areas of the international commodity and financial community, including banks, institutional investors, corporations, commodity traders and private investors.

How LIFFE works - an overview of open-outcry

A client wishing to buy or sell futures or options telephones their broker who is a member of LIFFE. The broker contacts their booth on the LIFFE trading floor with the client’s instruction. The order is received in the booth, written onto a 'client order slip' and then stamped with the time when the order was received. The pit trader is given the information either by hand signals or by a written order from the booth clerk. It is then offered to other traders in the pit.

The first trader to respond by calling, for example, 'Buy 100' or 'Sell 100', becomes the counterparty to the deal.  Once executed, the order slip is time stamped again to show the exact time the trade took place. The broker then informs his client that his order is filled. Both parties then input the trade details into the matching system. Matched trades are passed to the London Clearing House which acts as a central counterparty.

London International Financial Futures And Options 4 Diagram 2In simple terms, therefore, futures are contracts - legally binding agreements - to buy or sell 'something' in the future. In the context of this case study, that ‘something’ is a contract to secure given amounts of commodities.

There are two kinds of options - calls and puts. The buyer of a LIFFE commodity call option acquires the right, but not the obligation, to buy a futures contract at a predetermined price on a given date. The buyer of a Liffe commodity put option acquires the right, but not the obligation, to sell a futures contract at a predetermined price on a given date. Call and put options can be bought and sold.

In each case, the seller of an option earns the premium, which is the agreed price of the option, but may be called upon to sell (call option) or buy (put option) a futures contract should the buyer exercise the right to buy (call option) or sell (put option) a futures contract.

London International Financial Futures and Options Exchange | Managing trading risk
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