What Are Look-Alike Contracts?
Look-alike contracts are a cash-settled financial product in keeping with the settlement price of a an identical exchange-traded, physically settled futures contract. Look-alike contracts are traded over the counter and they carry no chance of actual physically provide irrespective of the words of the underlying futures contract.
Futures look-alike contracts are regulated by means of the Commodity Futures Purchasing and promoting Price (CFTC).
Key Takeaways
- A look-alike contract is an OTC derivatives contract that is cash-settled that has otherwise an identical specifications to a physically settled futures contract.
- Because of physically settlement is not an issue, patrons do not need to worry about ultimate out open positions to avoid making or taking provide.
- Critics argue that look-alike contracts fuel speculation and generate market inefficiencies since they are removed from the underlying asset that they practice.
Working out Look-Alike Contracts
Look-alike contracts are essentially possible choices where the underlying is a futures contract with a specific settlement date. For example, the ICE Brent Crude American-style Chance Product has an ICE Brent Crude Futures Contract as its underlying. The contract words of a look-alike contract sparsely correspond with the contract words of the futures contract. Look-alike contracts may be offered in each and every American and European sorts.
Look-Alike Contracts and Position Limits
Where look-alike contracts get attention-grabbing is once they quilt contracts traded on other exchanges, allowing the unreal to grab one of the purchasing and promoting procedure on a commodity they don’t seem to be known for. This allows one of the herbal chance speculation to occur transparent of the actuals throughout the underlying futures contracts.
Moreover, since no longer one of the vital physically commodities are interested by the look-alike contract purchasing and promoting, the position limits supposed to temper commodity speculation can be skirted.
Criticisms of Look-Alike Contracts
Like many by-product products, look-alike contracts have their proportion of detractors. The principle goal of the futures market is traditionally to help in price discovery and allow supply and demand risks to be hedged or offloaded onto occasions upper in a position to take care of them.
Look-alike contracts go away the physically commodity at the back of by means of being a derivative of a derivative. Instead of influencing the price of oil, for example, look-alike contracts allow patrons to bet in opposition to 1 some other while arguably providing no new market price signals. Consumers of look-alike contracts do argue that remaining point, as they are market folks so the amount and open pastime of their speculation gives market wisdom on their reviews on the price potency of the underlying futures contract.
Former CME Team CEO, Craig Donohue referred to as look-alike contracts “parasitic, second-order” derivatives in 2011. At the time, actually, ICE was once as soon as aggressively creating look-alike contracts the usage of CME-traded futures as a benchmark. The contest between the two exchanges unquestionably colored his reviews. All in all, look-alike contracts aren’t some other than other over-the-counter products in that they allow high-level market folks to make bets with coins they are in a position to chance in an overly specific means.
