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Introduction to Single Stock Futures Educational Seminar 101

Introduction to Single Stock Futures Educational Seminar 101. Magnus de Wet , James Boardman, Rudolf Oosthuizen 09 March 2011. Agenda. Introduction to Derivatives Futures Theory Risk Management for the exchange Risk Management for you Cash flows of a future

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Introduction to Single Stock Futures Educational Seminar 101

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  1. Introduction to Single Stock Futures Educational Seminar 101 Magnus de Wet , James Boardman, Rudolf Oosthuizen 09 March 2011

  2. Agenda • Introduction to Derivatives • Futures Theory • Risk Management for the exchange • Risk Management for you • Cash flows of a future • Interest and the time value of money • How to trade- Speculate, Hedge or Arbitrage • Costs associated with trading • Single Stock Futures compared to CFDs • Questions & Contact Details

  3. SSF: Introduction • JSE Futures are based on following underlying assets: • Equities • Commodities • Currency • Bonds • International Blue Chip Companies (IDX) • This presentation focuses on Single Stock Futures but the concept is the same on any of the underlying assets traded on the JSE which are listed above.

  4. SSF: Futures Explained • An agreement between two parties to buy/sell an equity/share at a certain time in the future for a predetermined price • In reality futures contracts can be seen as loan agreements where a financial institution lends you the money to buy a share today but only sells it to you on a future date. • Misconception: Investor does not guess price. Investor guesses direction of the share or underlying asset • Futures Price: Current Price plus Interest. Dividends play role but not covered in this presentation

  5. SSF: Futures Terminology • As with share trading, you need a buyer and seller before a trade can occur. Buy = Long Think the share price is going up Short = Sell Think the share price is going down

  6. SSF: Futures Terminology • Variation Margining (Zero Sum Game – For every winner there’s a loser) • Removes big surprises at end of contract • Limits risk of default • Risk mitigated by way of Initial Margin: • Covers exchange against default • Worst possible loss in 1 days movement • Returned with interest • Approximately 10% - 20% of underlying exposure • Gearing • Exchange standardise agreements/contracts • Contract sizes (nominal) standardised • Contracts expire every 3rd Thursday of March, June, September and December

  7. Risk Management Stucture • The Risk Management philosophy when trading Safex Derivatives is very simple - "You stand good for your client".

  8. SSF: Futures Example – Share Price increase • Physically settled Futures – On Futures Close Out (FCO) the buyer will buy the physical share from the seller at the closeout price (R120), reporting it to TradElect with trade type OX. • Adding the R10 profit made he only paid R110 for the share as originally agreed

  9. SSF: Futures Example – Share Price decrease • Physically settled Futures – On FCO the buyer will buy the physical share from the seller at the closeout price (R80), reporting it to TradElect with trade type OX. • Adding the R30 loss made he paid R110 for the share as originally agreed

  10. Introduction to interest +(50% or 0.50) + =

  11. Introduction to interest R100*50% = R50 R100*(1.50) = R100*(1+50%) = R150 R150*(1+50%) = R225 (R100*(1+50%)) *(1+50%) = R225 R100*(1+50%)^2 = R225

  12. Introduction to interest R150*(1+50%) = R225 (R100*(1+50%)) *(1+50%) = R225 ((R100*(1+50%)) *(1+50%)) *(1+50%)= R337.50 R100*(1+50%)^3 = R337.50

  13. Introduction to interest R100*(1+50%)^3 = R337.50 • Compounding returns • What is Prime? 9% • Compounding Monthly ? = • 9%/12 = 0.75% per Month R100*(1+R)^t = ? R100*(1+9%)^12 = ? R 281.27 ? =R100*(1+0.75%)^12

  14. Compounding S

  15. Credit Risk Prime = 9% 3.5% Repo = 6.5%

  16. Interest formulas • Formula for Interest = • Can work out returns • R100 capital turns into R105.11 in 6 months 1 (T*N) ( ) ) ( ) ( R CV 1 = FV * N

  17. Deriving future prices 2 Mar 2011

  18. Deriving future prices 16 Jun 2011

  19. Spread Cost • Offer – Bid = Spread • Spot Spread = R367.00 – R366.50 = R0.50 • Cost of getting in and out • In percentage of exposure = • (Offer – Bid)/((Bid + Offer)/2) = Spread% • R0.50/((R367.00+R366.50)/2) = 0.14%

  20. Spread Cost • Future Spread = R371.31 – R372.99 = R1.68 • In percentage of exposure = • R1.68 /((R371.31+R372.99 )/2) = 0.45%

  21. Deriving future prices 16 Jun 2011 1 Market maker

  22. Deriving future prices

  23. Deriving future prices 17 Mar 2011 10 Market maker

  24. Market maker Double R1.5 R1.5 R1 R99 R100 R101

  25. SSF: When do you use Futures? • Hedging / Risk Mitigation • Own something (shares, agricultural commodities, interest rate instruments, currency) and want to limit your risk • Planning something (project, holiday) in the future • Speculating • Think the price is going up • Think the price is going down • Arbitraging • locking in a riskless profit by simultaneously entering into two or more transactions. • Difference in spot and future price • Difference between expiries

  26. SSF: SSFs vs. CFDs • SSFs • Exchanged traded product • Expiry Date • Interest agreed upfront • Regulated by the JSE and FSB • Guaranteed by SAFCOM • Fungible financial instrument • Free markets • CFDs • Trades OTC • No Expiry Date • Interest fluctuates daily • Unregulated • Not guaranteed by SAFCOM • Not fungible • Captive markets • CFDs are not JSE products and are therefore not traded, regulated or guaranteed by the JSE.

  27. SSF: Benefits and Risks associated with Futures • Benefits • Regulated by JSE and FSB • Guaranteed by SAFCOM • Opportunity to protect/hedge your share portfolio by trading SSFs in the same underlying share. • SSFs incur lower brokerage costs than actually trading in the underlying shares. • Your initial margin earns interest for the duration of your contract. • SSFs are characteristically liquid and easily traded. • Gearing – significant returns… • JSE independently calculates and values positions • Wholesale Interest Rates • Risks • Gearing – significant losses…

  28. So what have you learnt? • Derivatives are risk management tools • Futures are essentially loans • The time value of money • How futures daily cash flows work • The risk management hierarchy of the exchange • The risks and rewards of gearing • The benefits of on exchange trading • The economics of information asymmetry • Futures can be very useful trading tools and a tremendous amount of fun!

  29. To the Future Chef’s and Rally Drivers of derivatives trading • Trading is hard work there is no free lunch • Trading successfully is a skilled profession. You don’t expect to become a rally driver or a gourmet chef immediately. • It takes dedication, discipline and planning to succeed • Good luck with your trading! • There will be further presentations on topics in derivatives throughout the year • Go to http://www.jse.co.za/seminars to register

  30. SSF: Future Educational Seminars • 9 March 2011 – Single Stock Futures 101 • 10 March 2011 – Single Stock Futures 201 • 11 April 2011 – Commodity Futures • 24 May 2011 – Currency Futures and Options • 21 June 2011 – Introduction to Safex Style Options • 19 July 2011 – Safex Style Options in Depth • 23 August 2011 – Broker Showcase • 20 September 2011 – Inside Options Guest Speaker • 25 October 2011 – Dividend Neutral Futures • 23 November 2011 – International Derivatives (IDX) • 06 December – Single Stock Futures 101 • 07 December – Single Stock Futures 201

  31. SSF: Useful websites/tools • Equity Derivatives Market: • www.safex.co.za/ed • Equity Derivatives Products: • www.safex.co.za/equityindexfutures • www.safex.co.za/options • www.safex.co.za/idx • www.safex.co.za/ssf • www.safex.co.za/cando • www.safex.co.za/dividendfutures • Equity Derivatives calculators: • www.safex.co.za/margincalculator • www.safex.co.za/bookingfeescalculator • Equity Derivatives Data Files: • www.safex.co.za/contractdata • www.safex.co.za/mtm • www.safex.co.za/marginrequirements • www.safex.co.za/EDMstats • www.safex.co.za/minimums • Members • www.safex.co.za/members

  32. SSF: Questions & Contact Details • Parking tickets! • Magnus de Wet • James Boardman • Rudolf Oosthuizen • DerivativesTrading@JSE.co.za • Options@JSE.co.za • +27 11 520 7051

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