B3 has announced the launch of the Copom Option Contract on its electronic trading platform. The Copom Option Contract is a new instrument that allows...

B3 has announced the launch of the Copom Option Contract on its electronic trading platform. The Copom Option Contract is a new instrument that allows for the safe and transparent trading of the Selic Target Rate variation decided at each meeting of the Monetary Policy Committee (Copom), which is linked to the Central Bank of Brazil.

The Selic rate is a key element of the Brazilian economy and indicates the “price” of money. It affects, for example, the demand for credit or the profitability of various investments. Copom members convene regularly to set the Selic Target Rate in order to meet the government's inflation target.

“Aware of the impacts of monetary policy decisions and market demand, B3 decided to add this innovative interest rate market derivative to its product portfolio,” says Marcos Skistymas, head of fixed income and forex at B3.

Skistymas stresses that the Copom Option Contract not only enables trading of the Selic Target Rate variation decided at each Copom meeting, but also offers other advantages to investors.

"It is a standardized product traded in the stock exchange environment. It is also very transparent as to the expectations of each meeting, allowing independent trading for each Copom decision while expanding the range of strategies available to hedge investment portfolios," Skistymas points out.

The premium traded under the Copom Option Contract can vary on a scale from 0 to 100 points and directly reflects the probability of a given scenario occurring. Each point is worth BRL100.00 and each strike price represents a possible variation in the Selic Target Rate defined by Copom.

The payoff on maturity is of the cash-or-nothing type and, in the event the option is exercised, the amount to be received by the option buyer is 100 points, which is equivalent to BRL10,000.00. The Contract is automatically exercised upon expiration and corresponds to the business day following the meeting’s end date.

Practical example

To better understand the product’s dynamics, Skistymas gives an example. “Let’s suppose a scenario with two Copom meetings: one scheduled for October 6 and 7 (1^st meeting) and one for November 17 and 18 (2^nd meeting). When trading a hypothetical Copom option contract for the 2^nd meeting, the investor expected the rate to remain the same. The traded premium was 64.4 points – equivalent to a 64.4% probability of this scenario occurring – with BRL100.00 being the point value,” explains Skistymas.

In this example, the acquisition value would be obtained by calculating 64.4 x 100 x 1 (where the Acquisition Value = Traded Premium x Point Value x Number of Traded Contracts). In other words, the cash settlement of the premium would be BRL6,440.00 for the option.

“In this example, let's assume that the 1^st Copom meeting resulted in a 0.25% drop in the Selic Target Rate and at the 2^nd meeting, the Committee decided to maintain the rate,” the officer continues.

“Therefore, as the strike price of the traded option was equal to the variation calculated for the Selic Target Rate at the 2^nd meeting, the option will be exercised with the payment from the seller to the buyer of a fixed amount of BRL10,000.00 per option, providing a profit of BRL3,560.00, that is, the BRL10,000 strike price minus the BRL6,440.00 cash settlement of the premium,” adds Skystimas.

Skistymas recalls that, for any other decision taken by Copom at the 2^nd meeting, the contract would expire without value to the holder and without generating any payment or compensation besides the premium paid by the buyer at the beginning of the transaction. “We should also remember that the decision disclosed at the 1^st Copom meeting in this example was not related to the payoff received by the investor,” concludes the officer.

For further information, contact your RM.