Look-Alike Contracts
What Are Look-Alike Contracts?
Look-alike contracts are a cash-settled financial product in light of the settlement price of a comparative exchange-traded, physically settled futures contract. Look-alike contracts are traded over the counter and they carry no risk of genuine physical delivery no matter what the terms of the underlying futures contract.
Futures look-alike contracts are regulated by the Commodity Futures Trading Commission (CFTC).
Grasping Look-Alike Contracts
Look-alike contracts are basically options where the underlying is a futures contract with a specific settlement date. For instance, the ICE Brent Crude American- style Option Product has an ICE Brent Crude Futures Contract as its underlying. The contract terms of a look-alike contract closely compare with the contract terms of the futures contract. Look-alike contracts might be offered in both American and European styles.
Look-Alike Contracts and Position Limits
Where look-alike contracts get interesting is the point at which they cover contracts traded on other exchanges, permitting the exchange to capture a portion of the trading activity on a commodity they are not known for. This permits a portion of the pure risk speculation to occur away from the actuals in the underlying futures contracts.
Moreover, since the physical commodities are not really engaged with the look-alike contract trading, the position limits intended to treat commodity speculation can be avoided.
Reactions of Look-Alike Contracts
In the same way as other derivative products, look-alike contracts have their share of doubters. The fundamental purpose of the futures market is customarily to aid in price discovery and permit supply and demand risks to be hedged or offloaded onto parties better prepared to handle them.
Look-alike contracts leave the physical commodity behind by being a derivative of a derivative. Rather than affecting the price of oil, for instance, look-alike contracts permit traders to wager against each other while seemingly giving no new market price signals. Traders of look-alike contracts really do contend that last point, as they are market participants so the volume and open interest of their speculation gives market data on their viewpoints on the price performance of the underlying futures contract.
Former CME Group CEO, Craig Donohue called look-alike contracts "parasitic, second-request" derivatives in 2011. At that point, of course, ICE was forcefully making look-alike contracts utilizing CME-traded futures as a benchmark. The competition between the two exchanges presumably shaded his viewpoints. All things considered, look-alike contracts are the same than other over-the-counter products in that they permit undeniable level market participants to make wagers with money they are prepared to risk in an unmistakable manner.
Features
- A look-alike contract is a OTC derivatives contract that is cash-settled that has otherwise comparative specifications to a physically settled futures contract.
- Since physical settlement isn't an issue, traders don't need to worry about closing out open positions to try not to make or taking delivery.
- Pundits contend that look-alike contracts fuel speculation and create market failures since they are taken out from the underlying asset that they track.
