Single Stock Futures Educational Seminar

1. Single Stock FuturesEducational Seminar Magnus de Wet, James Boardman, Rudolf Oosthuizen 10 March 2011

2. Agenda 201 • Introduction • New market- new ways of trading – why then and why now? • What is an Exchange for? • Central order book • Pricing and trading futures- Rudolf • Futures vs CFD’s • CFD’s worked examples vs Futures on interest costs • How to trade on the market • Costs associated with trading • Questions & Contact Details

3. Agenda

6. Markets in the US have evolved • From this

7. Where people would behave like this

8. To this- a lot quieter and calmer and more efficient

9. A level playing field

10. SSF: Introduction • JSE’s 5 Markets • Equity Market • Equity Derivative Market • Commodity Derivative Market • Currency Derivatives • Interest Rate Derivative and Spot • Derivative • A financial instrument that derives its value from the value or return of another asset. • 2 Most popular derivatives at the JSE: • Futures • Options

11. SSF: Derivatives within the JSE (2009 Financials)

12. SSF: Parties involved with Derivative Trading Client A Client B Cash Flows Cash Flows JSE Central Counterparty Buying Member A Selling Member B Trading Trading Cash Flows Cash Flows Cash Flows Cash Flows Data Clearing Member A Clearing Member B Data Vendors

13. SSF: Guarantee Hierarchy

14. SSF: Futures Theory • An agreement between two parties to buy/sell an asset at a certain time in the future for a predetermined price • Exchange standardise agreements/contracts • Contract sizes (nominal) standardised • Contracts expire every 3rd Thursday of March, June, September and December • Daily Margining (Zero Sum Game – For every winner there’s a loser) • 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 • How does it really work? Futures price different from spot price…

15. He is very good at saying NO

16. In a central order book The bank managers COMPETE on rates. Hoping for you to say YES! You

17. 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

18. SSF: Futures – 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

19. Now Rudolf is going to walk you through some useful calculations on the Time value of Money.

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

21. Introduction to interest R100*(1+50%) = R150 R100*(1+50%)^2 = R225 R100*(1+50%)^3 = R337.50

22. Introduction to interest • Compounding returns • What is Prime? 9% • 9%/12 = 0.75% per Month R100*(1+R)^t = ? R100*(1+0.75%)^12 R100*(1+0.09/12)^12 = R109.38

23. Compounding

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

25. Interest formulas • Formula for Interest = • Can work out returns 1 (T*N) ( ) ) ( ) ( R CV 1 * = FV * N ) ( ) ( ) ( CV = LN FV EXP * T R *

26. Deriving future prices 2 Mar 2011

27. Deriving future prices 16 Jun 2011 Expiry

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

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

30. Deriving future prices 16 Jun 2011 Expiry 1 Market maker

31. Deriving future prices

32. Deriving future prices 17 Mar 2011 Expiry 10 Market maker

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

34. Deriving future prices 2 Mar 2011

35. Practice 10 Mar 2011

36. Deriving future prices 17 Mar 2011 Expiry

37. Dividend Neutral Contracts • Fair Value = Spot + Cost – Benefit • = Spot + Interest – Div • N-Contract = Spot + Interest • Dividends? • AGL div assumed = 2.88 for the June Expiry

38. Dividend Neutral Contracts • N- Contracts • 2 Contracts • Interest agreed up front • Adjusts contract for dividend received in Spot

39. Stock Dividend AGL R 1,000,000 R 900,000 = R 1,000,000 R 100,000 AGL AGL Dividend +

40. Price Flow R0.1M*(1+10%*0.5) = R 0.105M R1.05M-0.945M = 0.105M R1.05M R1,1M R0.9M*(1+10%*0.5) = R 0.945M Value R1M R0.9M Adjustment down to compensate for Long holder not receiving dividend T =0.5 T =0 T =1 TIME R 0.1M Dividend

41. Spot Price and CFD Cost

42. Spot and SSF Price

43. Cost Comparison

44. SSF: SSFs vs. CFDs • CFDs • Unregulated • Trades OTC • No Expiry Date • Principle amount could change daily • Interest fluctuates daily • Retail interest rates • No best execution obligation • Captive markets • Opaque • Not guaranteed by SAFCOM • Manufactured dividends • Not fungible • Never physical delivered • SSFs • Regulated by JSE/FSB • Exchanged traded product • Expiry Date= Rollover costs • Set principle amount • Interest agreed upfront • Wholesale interest rates • Best execution • Free markets • Transparent • Guaranteed by SAFCOM • No dividend paid/received • Fungible financial instrument • Can take physical delivery

45. SSF: Benefits and Risks associated with Futures • Benefits • 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 • Guaranteed • Risks • Gearing – significant losses…

46. 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 – TBC • 23 November 2011 – TBC • 07 December 2011 – TBC

47. 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

48. 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