CFM50560 | Derivative contracts: underlying subject matter: payments on variable dates

CTA09/S583(6)

Interest rates used as a computational factor: example

A company pays a premium for a call option over shares in another quoted company. The holder of the option can, if they exercise the option, choose either to take physical delivery of the shares or to settle in cash. The company exercises the option and chooses cash settlement. The cash sum it receives is based on the difference between the market price of the share at the exercise date, and the strike price specified in the contract.

The company exercises the option on a Friday. The terms of the contract are that cash settlement is to be made on the business day next following the exercise date, so the company receives the cash on the following Monday. The contract also specifies that if one or more non-business days precede the settlement date, the settlement amount is increased to compensate the option holder for the delay in getting their money. The increase is calculated with respect to market rates of interest.

The provision at CTA09/S583(6) ensures that we do not regard an interest rate as being an USM of the contract. The option has only one USM - the quoted shares.