Life cycle of an option trade

Life Cycle.

What is a 'Life Cycle'

The course of events that brings a new product into existence and follows its growth into a mature product and into eventual critical mass and decline. The most common steps in the life cycle of a product include the following phases:

BREAKING DOWN 'Life Cycle'

It is important for investors to understand a company's product life cycle. Firms that are predominately in the development phase will likely be characterized with small levels of sales and are more speculative in nature than firms in the growth or maturity phase.

Finance Articles.

Monday, October 31, 2011.

Trade Life Cycle/Securities trade life cycle.

To understand trade life cycle we need to understand detailed steps involved in trade life cycle.

Below mentioned are the important steps:

1. Order initiation and delivery. (Front office function)

2. Risk management and order routing.(middle office function)

3. Order matching and conversion into trade.(front office function)

4. Affirmation and confirmation.(back office function)

5. Clearing and Settlement.(back office function)

PICTORIAL VIEW OF TRADE CYCLE.

A s we know that getting trades settled lies with the broker, if any client makes any trade default, then the same has to be made good by the broker to the clearing corporation by broker.

When orders are accepted and sent to exchange these orders go through various risk management checks institutions and retails clients. Although the risk management checks are more for retail investors , the underlying assumptions is that they are less creditworthy also due to online trading the client has become faceless so the risk has increased more. Its not same for institutional investors because they have a large balance sheet compared to the size of orders they want to place. They also maintain collateral with the members they push their trades through. Their trades are hence subjected to fewer risk management checks than retail clients.

Client logs into the trading portal provide credential and places orders. The broker validates that the order is coming from a reliable source. Lets say the client places buy order, in this case the broker places query to verify whether the client has sufficient balance(margin money) and passes the order to the exchange, in case the client does not have sufficient margin then order is rejected. If client has the margin money then the order is accepted and margin money is reduced from the available margin so that client is aware of the real time margin available to him for trade, also to make sure that he/she does not place order more than margin money available so later on the broker need not make good on behalf of client to the exchange. Lets say the client places sell order, in this case the broker places query to verify whether the client has sufficient stocks to place the order in case of there are no sufficient stocks then the order stays rejected, if there are sufficient stocks available then the order is accepted and stocks are blocked for sale and remaining stocks are shown as balance available for sell. Once the above risk management check passes then the order is passed to the exchange. On receipt of the order, the exchange immediately sends an order confirmation to the broker's trading system. Depending upon the order terms and the actual prices prevailing in the market, the order could get executed immediately or remain pending in the order book of the exchange.

Order matching and conversion into trade.(front office function)

Below are the steps:

All the orders are collated and sent to the exchange for execution, exchange tries to allot the shares in the best price available to the investors. Broker has the record of all the orders that were received from whom , at what time, against which stock, type of order and quantity. Broker maintains these records against client ID. Brokers are in real time conversation with exchange so that they have details of how many orders are still pending and and how many have been executed in the exchange. Once the order is executed it turns into trade and exchange sends sends notification of the trade to the broker. The broker in turn communicates these trades to the client either immediately or end of day. Official communication from broker is done to the client through contract note, which contains details of the trade executed along with taxes being charged and commission being charged by the broker and other institutions like clearing corporation, custodian etc.

Whether trade has happened on the desired security. Whether the trade is correct i. e buy or sell. The price at which rate it was executed. Whether the charges are as per the agreement.

As we know that there are hundreds and thousands of trades being executed everyday and all these trades needs to be cleared and settled. Normally all these trades gets settled in T+2 days, which means the trade will gets allotted to the investor to his/her demat account in 2 days from trade date.

The clearing corporation has obligation to every investor in form of.

Funds (for all buy transactions and also to those transactions that are not squared for the sale positions). Securities(for all the sale transactions done)

2 comments:

Would suggest to Include the information on exchange and settlement between clearning house , clearing members and central depository. I mean clearing corporation instructs the depository to debit ( in case of sell order) the clearing members account and credit it's own account ( clearing corporation's account). And instruct the clearing bank to debit its own account and credit clearing member's account . And vice versa for buy deal.

Also can include sentence on EOD trade report to be sent by exchange to the clearing house.

Trade Life Cycle Tutorial.

Most investors have no idea about the life cycle of a trade. This is because they rarely have occasion to work with the middle or back office. The middle and back office are support functions for the front, or sales, office. The back office works on trade settlement and the middle office is concerned with confirmations. All three contribute to the actual buying or selling of stock along the trade life cycle.

Back Office.

The back office exists for three reasons: clearance, settlements and accounting. These three function interact directly with external agencies like the custodian (actual holder of the security), the clearing firm (third party) and a commercial bank. The back office maintains external relationships and control functions and is where the trade ends.

Middle Office.

The middle office, as the name implies, is a hybrid function between the front and back office. The middle office handles validations (of stock orders), bookings (orders) and confirmations. Technically, these are all back office operations, however, they often require the help of front office staff to resolve.

Front Office.

The front office is responsible for trade capture and execution. This is where the trade originates and the client relationship is maintained. The front office makes/takes orders and executions. Traders and sales staff are considered front office staff.

Option Cycle.

DEFINITION of 'Option Cycle'

The expiration dates that apply to the different series of options. An option cycle is the pattern of months in which options contracts expire. The cycles apply to stock and index options, as well as commodity, currency and debt instrument options. There are three common option cycles:

JAJO - January, April, July and October.

FMAN - February, May, August and November.

MJSD - March, June, September and December.

Note that the options on the January cycle have contracts available in the first month of each quarter (January, April, July and October). Options assigned to the February cycle use the middle month of each quarter (February, May, August and November). And options in the March cycle have options available during the last month of each quarter (March, June, September and December).

BREAKING DOWN 'Option Cycle'

In addition to the January, February and March option cycles, individual stock and index options typically also expire in the current month (now) and the subsequent month (next month). This provides the opportunity for investors to trade or hedge for shorter terms. For example, assume options for stock ABC trade on the March cycle. If it is now June, there would be listed June and July contracts (the current and subsequent months), as well as September and December contracts. Because stock and index options have contracts for the current and next month, one cannot tell the cycle by looking at the first two months; rather, it is necessary to look at the third and fourth months to determine if it is on the January, February or March cycle.