KEY POINTS:
French bank Societe Generale said on Thursday that fraud by a single trader betting on stock index futures had caused a 4.9 billion euro ($7.1 billion) loss - potentially the biggest loss racked up by a rogue trader.
Following is a summary of how futures work:
Futures are financial instruments which trade on exchanges and allow investors to place bets on the direction of a market, from the price of gold to the level of a major stock index such as the FTSE 100 or Dow Jones industrial average.
They are risky financial instruments because an investor can control a large portfolio of commodities or financial securities for a small initial deposit, or "margin".
For example, someone who either bought (went "long") or sold ("shorted") one FTSE 100 futures contract on NYSE Euronext would be betting on a contract worth 10 pounds ($19.58) per index point - or more than 58,000 pounds, given where the index traded on Thursday afternoon.
The initial margin would be 3,000 pounds, according to data from LCH Clearnet Ltd, which clears UK futures on NYSE Euronext.
So an investor who bought, say, 10,000 FTSE 100 futures contracts at the start of the year when the underlying index was around 6,450 points would be nursing unrealized losses of almost 88 million pounds by Monday, when the market plunged by more than 300 points to close at 5,578.2 points.
However, the initial deposit of 30 million pounds (10,000 contracts multiplied by 3,000 pounds) required in the example would have been topped up with additional margin demanded by LCH Clearnet Ltd to cover any losses which accrued on a daily basis.
Banks' internal risk-management systems were tightened after rogue traders Nick Leeson and Yasuo Hamanaka accumulated losses of $1.4 billion and $2.6 billion at Barings and Sumitomo Corp respectively in the 1990s.
- REUTERS
