Copyright© JSE Limited 2008 Magnus de Wet, James Boardman, Rudolf Oosthuizen 09 March 2011 Introduction to Single Stock Futures Educational

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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Click to edit Master title style

Click to edit Master text styles

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Introduction to interest

+(50% or 0.50)

= +

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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


R150*(1+50%) = R225

(R100*(1+50%)) *(1+50%) = R225

R100*(1+50%)^2 = R225

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R150*(1+50%) = R225(R100*(1+50%)) *(1+50%) = R225

R100*(1+50%)^3 = R337.50


((R100*(1+50%)) *(1+50%)) *(1+50%)= R337.50

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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 % 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%


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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1 Market maker

16 Jun 2011

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17 Mar 2011

10 Market maker





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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

• [email protected]

• [email protected]

• +27 11 520 7051

Documents

Copyright© JSE Limited 2008 Magnus de Wet, James Boardman, Rudolf Oosthuizen 09 March 2011 Introduction to Single Stock Futures Educational