Financial Instruments / Financial Derivatives

Single Stock Futures…

WHAT ARE SINGLE STOCK FUTURES?

Single-stock futures (SSF’s) are futures contracts with the underlying asset being one particular stock, usually in batches of 100. When purchased, no transmission of share rights or dividends occur. Being futures contracts they are traded on margin, thus offering leverage. They are traded in various financial markets, including those of the United States, United Kingdom, Spain, India and others. South Africa currently hosts the largest single-stock futures market in the world, trading on average 700,000 contracts daily. (Source: Wikipedia)

SSFs an be used to hedge the risk of a share-portfolio or to speculate. They allow you to either take a long or short position:

  • A Long position in financial futures would be taken with the view that the underlying will go up in price.
  • A Short position in financial futures would be taken with the view that the underlying will go down in price.

SSF’s offer a gearing factor (average 10x) and, compared to the trading of actual shares, avoid some of the costs appearing, i.e. UST. Some futures contracts may call for physical delivery of the asset, while others are settled in cash.

Contracts For Difference (CFDs)…

WHAT ARE CFD’S?

A contract for difference (or CFD) is a contract between two parties, buyer and seller, stipulating that the seller will pay to the buyer the difference between the current value of an asset and its value at contract time. In share trading this means, CFDs are financial (equity) derivatives, that allow investors to speculate on share price movements without the need to own the underlying shares. Contracts for difference allow investors to take long or short positions, and unlike Single Stock Futures, have no fixed expiry date or contract size.

Trades are conducted on a leveraged basis, which means you do not have to pay the full value of the underlying asset, but rather a margins typically ranging from 1% to 30% of the underlying share’s value. Benefits of trading CFDs are:

  • Gearing. CFDs are a geared (leveraged) product, so you can trade on margin without having to tie up large amounts of capital.
  • Going short. Enables you to profit in both falling and rising markets with an equal ease.
  • Hedging opportunities. If you are a shareholder, and prefer to hold your shares even if their prices fall, you can open a short position in CFDs for one share (or the whole portfolio). As a result, your losses on the underlying asset will be offset by the profit on the relevant CFD.
  • Dividends. You may be entitled to receive the dividends with the CFD in much the same way as you would if you were trading shares. If you have a short position the dividends will be debited from your trading account. You will not however, be entitled to any voting rights if you hold share CFDs as opposed to holding shares.
  • Short term trading. The ability to gear up your trading capital by trading on a margin makes CFDs an ideal instrument for short-term trading.

Options Trading…

WHAT IS OPTIONS TRADING?

In Options Trading, the client is not trading the stocks itself, but rather the right to buy or sell the underlying stocks – known as stock options. Stock Options are derivative instruments like Single Stock Futures and like this are also geared instruments. Stock Options cost a fraction of the price of the underlying share and allow you to control the profits on the underlying stocks as if you owned those stocks. If the price of the stock goes up after you purchase it’s stock options, you would make the same profits without buying the stocks itself. There are 2 classes of options, CALL OPTIONs and PUT OPTIONs. Both classes not only takes care of bullish as well as bearish markets, but can be traded long (to buy in order to establish a position) as well as short (to sell in order to establish a position).

In today’s global market, currency is becoming more of a concern and is thus traded continuously around the globe. South Africa holds the most liquid currency within the African continent and therefore provides very good opportunities within a multitude of trading areas.

Currency Futures/yield x…

WHAT ARE CURRENCY FUTURES?

Trading of currency futures can be used for the following:

  • Hedging. This is if you have an interest in the underlying currency e.g. due to business operations conducted abroad. One can use futures to minimise the risk of violent movement in the currency and thus protecting your offshore investments.
  • General Investing. Currency futures can be used for long term investors in order to enhance their overall performance.
  • Speculative Investing. The speculator is interested in short term movements and therefore generally has no investment interest in the underlying currency. Profits are made through large quantities and small movements in the price (noise).

Pricing
Currency futures are more sensitive to price change than the spot price of the currency. This is due to both the movement on the underlying and the interest rate differential between the two countries in question.

Margin requirements change often however they are very cheap considering the underlying values. A gearing of approximately 10X is observed and thus on a US$ contract one may find the margin being approximately R7 000 if the Dollar/Rand is trading R7/$. The contract size is 1 000 units of the foreign currency i.e. 1 US$ contract = US$1 000 exposure