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Copyright© JSE Limited 2008
www.jse.co.za
Magnus de Wet , James Boardman, Rudolf Oosthuizen
09 March 2011
Introduction to Single Stock Futures
Educational Seminar 101
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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
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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.
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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
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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
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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
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Risk Management Stucture
The Risk Management philosophy when trading Safex Derivatives is very simple - "You stand good for your client".
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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
SSF: Futures Example – Share Price increase
Date Equity Price
Derivative CP (MtM)
10%
Initial Margin
15%Variation Margin
Buyer Cash Flows
Seller Cash Flows
Trade Date 100 110 15 0 -15 -15
3 Months Later 110 119 0 9 9 -9
6 Months Later 105 111 0 8 -8 8
9 Months Later 115 118 0 7 7 -7
12 Months Later – Close out 120 120 15 2 17 13
Profit/Loss 20 10 -10
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SSF: Futures Example – Share Price decrease
Date EQ Market
CP
Derivative CP (MtM)
10%
Initial Margin
15%Variation Margin
Buyer Cash Flows
Seller Cash Flows
Trade Date 100 110 15 0 -15 -15
3 Months Later 90 97 0 13 -13 13
6 Months Later 95 100 0 3 3 -3
9 Months Later 85 88 0 12 -12 12
12 Months Later – Close out 80 80 15 8 7 23
Profit/Loss -20 -30 30
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
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Introduction to interest
+(50% or 0.50)
= +
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Introduction to interest
Initial Value Return % Extra Return Total R 100.00 50% R 50.00 R 150.00
R100*50% = R50
R100 *(1.50) = R100*(1+50%) = R150
Initial Value Return % Extra Return Total R 150.00 50% R 75.00 R 225.00
R150*(1+50%) = R225
(R100*(1+50%)) *(1+50%) = R225
R100*(1+50%)^2 = R225
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Introduction to interest
Initial Value Return % Extra Return Total R 150.00 50% R 75.00 R 225.00
R150*(1+50%) = R225(R100*(1+50%)) *(1+50%) = R225
R100*(1+50%)^3 = R337.50
Initial Value Return % Extra Return Total R 225.00 50% R 112.50 R 337.50
((R100*(1+50%)) *(1+50%)) *(1+50%)= R337.50
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Introduction to interest
Compounding returns
What is Prime? 9%
Compounding Monthly ? =
9%/12 = 0.75% per Month
R100*(1+50%)^3 = R337.50
R100*(1+R)^t = ?
R100*(1+9%)^12 = ? =R100*(1+0.75%)^12
Starting Value Rate % Compounding 1Year Value R 100.00 9% 12 R 109.38
R 281.27 ?
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Starting Value Rate % Compounding1Year Value R 100.00 9% 1 R 109.00
Starting Value Rate % Compounding1Year Value R 100.00 9% 2 R 109.20
Starting Value Rate % Compounding1Year Value R 100.00 9% 12 R 109.38
Starting Value Rate % Compounding1Year Value R 100.00 9% 365 R 109.42
Starting Value Rate % 1Year Value R 100.00 9% R 109.42
R 109.4162
R 109.4174
Compounding
S
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Credit Risk
Repo = 6.5%Prime = 9% 3.5%
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Interest formulas
Formula for Interest =
Can work out returns
R100 capital turns into R105.11 in 6 months
Starting ValueEnding Value Compounding Number of Years % Return
R 100.00 R 105.11 12 0.5 10.00%
R
N )( 1
(T*N)
=CV FV)(1
( )*
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Deriving future prices
2 Mar 2011
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Current date Expiry Date Compounding Date Diff Years2011/03/02 2011/06/16 12 0.2904
Spot Bid Future Bid Difference % Interest Year R 366.50 R 371.31 R 4.81 4.50%
Spot Offer Future Offer Difference % Interest Year R 367.00 R 372.99 R 5.99 5.59%
Spot Spread Future Future Spot Sread % Future Sread % R 0.50 R 1.68 0.14% 0.45%
Deriving future prices
16 Jun 2011
% Interest 1.31%
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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%
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Spread Cost
Future Spread = R371.31 – R372.99 = R1.68
In percentage of exposure =
R1.68 /((R371.31+R372.99 )/2) = 0.45%
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Current date Expiry Date Compounding Date Diff Years2011/03/02 2011/06/16 12 0.2904
Spot Bid Future Bid Difference % Interest Year R 366.50 R 371.31 R 4.81 4.50%
Spot Offer Future Offer Difference % Interest Year R 367.00 R 372.99 R 5.99 5.59%
Spot Spread Future Future Spot Sread % Future Sread % R 0.50 R 1.68 0.14% 0.45%
Deriving future prices
1 Market maker
16 Jun 2011
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Deriving future prices
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Deriving future prices
17 Mar 2011
10 Market maker
Current date Expiry Date Compounding Date Diff Years2011/03/02 2011/03/17 12 0.0411
Spot Bid Future Bid Difference % Interest Year R 366.50 R 367.33 R 0.83 5.52%
Spot Offer Future Offer Difference % Interest Year R 367.00 R 368.05 R 1.05 6.97%
Spot Spread Future Future Spot Sread % Future Sread % R 0.50 R 0.72 0.14% 0.20%
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Market maker Double
R100R99 R101
R1.5
R1.5
R1
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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
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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.
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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…
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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!
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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
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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
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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
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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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