- What is a derived block?
- Why are they being introduced?
- Which products are eligible?
- What underlying instruments can be used as part of the hedge?
- How will a derived block be agreed to?
- How can the related market hedge be executed?
- What does the order entry screen look like?
- Will a specific transaction identifier be associated with this order type?
- What is an example of a Credit futures derived block trade?
1. What is a derived block?
A derived block trade is a block trade consummated by a party eligible to engage in block trades, in which the price and quantity of the trade depends on one or a series of hedging transactions in an eligible related market. The methodology for executing the hedging transaction and the derivation of the price of the futures trade shall be determined and agreed upon by the two counterparties prior to the execution of the hedging transaction. Rules pertaining to block trades are governed by Rule 526 of CME Group designated contract markets (the “Exchange” or “CME Group Exchanges”). For official regulatory guidance on Exchange Rule 526 regarding block trades, reference the applicable Market Regulation Advisory Notice.
2. Why are they being introduced?
Derived block functionality will provide greater liquidity and execution flexibility to eligible listed futures contracts by allowing liquidity to be sourced from the related market. Given the success of derived blocks on Sector futures, derived blocks are now available on 11 more Equity Index futures (view the SER to learn more) and Credit futures (SER).
3. Which products are eligible?
View the block trade cheat sheet to see all eligible products.
Derived blocks are also available on all outright Credit futures.
Note: Derived block trades are available solely in contracts identified here, at the existing block trade minimum threshold applicable to those products. Derived block trades are not permitted in any other product (see Rule 526 Market Regulation Advisory Notice).
4. What underlying instruments can be used as part of the hedge?
For Equity Index futures, permitted hedging vehicles may include but are not limited to stock baskets and/or other cash market instruments, e.g., ETFs and ETNs, that can be construed as bona fide hedging instruments for the Equity Index futures in the derived block trade.
For Credit futures, permitted hedging vehicles may include but are not limited to baskets of corporate bonds and/or other cash market instruments including ETFs that can be construed as bona fide hedging instruments for Credit futures.
5. How will a derived block be agreed to?
Prior to the execution of any hedging transactions, the block liquidity provider and client must consummate the block trade and determine and agree upon the following:
- The quantity of futures or the notional value of the block trade, which must meet or exceed the applicable block trade minimum quantity threshold;
- The execution methodology for the dealer’s hedging transaction(s);
- The markets in which the dealer’s hedging transactions will take place; and
- The pre-determined basis to be used by the dealer in determining the price of the block trade after the hedging transactions have been concluded.
More information can also be found in the Rule 526 Market Regulation Advisory Notice.
6. How can the related market hedge be executed?
Pre-defined hedging types are:
- Volume weighted average price (VWAP)
- Time weighted average price (TWAP)
- Percentage of volume (POV)
- Limit price
For other hedging methodologies, select “Other” under the hedge description in CME Direct and specify in the free text field.
7. What does the order entry screen look like?
A derived block tick box is available on the CME Direct block entry screen.
Once ticked, you will be required to enter details such as block hedge type, reference hedge product, basis, start time and end time.
8. Will a specific transaction identifier be associated with this order type?
Derived block trades will be disseminated with a marker clearly indicating them as such. For example, on the block trade page, derived blocks will have a distinct identifier attached to the line item. Per the Rule 526 Market Regulation Advisory Notice, the block trade must be accurately identified within CME Direct by checking the derived block checkbox.
9. What is an example of a Credit futures derived block trade?
Participants agree on a futures reference of 3470 against LQD reference of 100. Participants also agree on a hedge ratio of 0.81 = 6.8 / 8.4, reflecting the duration difference between IQB futures (6.8 years) and LQD (8.4 years).
Participants agree on a hedging method and window for the reference hedge: a TWAP from 11:00 a.m. - 12:00 p.m. ET.
A liquidity provider conducts their hedging transactions in the related market and determines the TWAP to be 101.
Because the TWAP is 1% higher than the reference price, the futures price will be adjusted by that amount, multiplied by the agreed hedge ratio.
Result:
FuturesRef x [1+ [(TWAP/Ref -1) x AdjustmentFactor]
= 3470 x [1+ (101/100 - 1) x 0.81]
= 3470 x 1.0081
= 3,498.11 (rounded to the nearest 0.01 Index Points)
