By Arab News
By Basil M.K. Al-Ghalayini*
The Saudi Stock Exchange (Tadawul) is launching a derivatives market, which is one of the key initiatives in the Financial Sector Development Program under the Kingdom’s Vision 2030 reform plan.
The first product to be offered will be the MT30 Index Futures, an index futures contract based on the MSCI Tadawul 30 index (MT30). The MT30 index provides investors with a benchmark of the largest and most liquid securities listed on Tadawul.
Derivatives are financial contracts whose value is linked to the value of an underlying asset. They are complex financial instruments that are used for various purposes, including hedging and getting access to additional assets or markets. A derivative is also a contract between two or more parties whose value is based on an agreed-upon underlying financial asset, index, or security.
There are many types of derivatives, including options, swaps, warrants, forwards, and futures. Derivatives are often used for commodities, such as oil, gas, gold and currencies.
As a recent example in another emerging market, the National Stock Exchange of India (NSE) has become the world’s largest exchange by trading volumes, outpacing the US-based CME group, the world’s largest derivatives marketplace. Most of the world’s 500 largest companies use derivatives to lower risk. Derivative contracts can be traded either over the counter or through exchanges.
Speculators can buy an asset at a low price in the future, based on a derivatives contract, even when the price rises in the future. They can also sell assets at a high price in the future when market prices are actually going down.
The most important benefit of the derivative is hedging risk. It helps in hedging risk against unfavorable price movements of an underlying asset.
By entering into a forward contract, the buyer and seller agree to complete the deal at a pre-decided price at some specific date in the future. Any unexpected price hikes or drop will not influence the contract value, thereby providing protection against these types of risks. Derivatives are used for transferring the risk from one party to another, which is a buyer of a derivative product to the seller. Also, it provides access to unavailable assets and markets.
In my opinion, derivatives will give institutional investors, locally and internationally, more opportunities to gain exposure to the fast-growing Saudi economy and allow them to effectively manage and hedge risks in the largest stock market in the region and one of the top 10 globally.
*Basil M.K. Al-Ghalayini is the chairman and CEO of BMG Financial Group.