Futures: Retail market offers scope for derivatives

YOU may secretly yearn to take a punt on gold options a la George Soros or cash in on a soya bean price rally. Or you may simply wish to limit your foreign exchange rate losses during a year's study in France. But for individuals, it is not easy to play in the derivatives markets or to use them to manage financial risk.

Most of the booming global business in futures and options - contracts for purchase or sale of financial instruments or commodities - takes place between banks, investment houses, governments and big companies. There are few openings for private citizens or even small firms in this burgeoning sector.

Regulated derivatives exchanges are cautious about courting the retail public because their products are too complicated and risky for most people. Regulators enforce strict marketing guidelines. And an increasing number of stockbrokers would rather not provide derivatives services for Joe Bloggs, because they involve high-cost, small transactions and can result in losses for the inexperienced.

But an independent think-tank, the Centre for the Study of Financial Innovation, chaired by Sir Kit McMahon, the former Midland Bank chairman, has published a study which argues that futures and options could play a greater role in the retail market.

Derivatives evolved to help users in the wholesale markets limit financial uncertainty, and this is how most big operators use them. But Andrew Dobson, author of the study and an investment banker with retail finance experience, says that virtually the only way retail investors can use them is through highly risky speculation.

In the UK, the public can participate in hedge funds, phone discount futures brokers to make individual trades, or place bets with financial bookmakers. But fees can be high, and little advice is offered.

Mr Dobson says that even with fixed-rate mortgages - an attempt to lock in interest rates not dissimilar to hedging in futures markets - most of the benefit goes to the institution offering the product.

He proposes several ways that derivatives could be applied to the retail market to reduce financial risk.

Housing finance: a home-buyer seeking a mortgage could simultaneously take out a loan and a hedge against changes in interest rates, reducing his exposure to fluctuating loan repayments.

Property indexation: a home- owner could protect himself against unwelcome house price movements by using futures contracts based on an index of house prices.

Household expenses hedging: a derivative product based on utility services could give householders a way of controlling outlays. It could include the price of a kilowatt hour of electricity, a therm of gas and a telephone unit.

Pension management: pension holders could use derivatives based on bond and share indices, or currencies, to protect against losses.

Foreign exchange exposure: small businesses, currently priced out of the foreign exchange market, would welcome tailored products to hedge their currency exposures.

The study suggests that the products could be adapted to small clients by established market-makers such as banks, which could package small deals into sizes they could trade on established exchanges.

Alternatively, they could reduce the products to their core components, such as commodities prices or exchange rates, and trade them over the counter in what could become standardised contracts.

It would be challenging to design and market these complex products. They would have to be simplified to the level of a mortgage so retail customers would understand them. But the question is, would people want them? The study believes so, but not immediately.

Presumably, they could be sold by providers of mortgages or pensions. But until they caught on with building societies and insurers, financial advisers and the designers of the products would initially be the main marketing agents. Would it be worth their effort?

Jean Eaglesham, spokeswoman at the Consumers Association, said her organisation would be interested in such innovations if they brought wider consumer choice. But it would be concerned about protection for unsophisticated investors against abuses. 'We want people to appreciate the downside in derivatives markets,' she said.

Karin Forseke, director of equity options products at the London International Financial Futures and Options Exchange, says Liffe believes that options are the only safe derivatives for retail investors because losses are limited.

Mr Dobson believes his approach could appeal to the public's caution as well as its greed. Compelling as his ideas are, it may be some time before the public and the providers are ready to dive in.