Title: Advanced Equity Trading
1Advanced Equity Trading
- Gavin Bramley
- Share Direct
2Know this about every share in your portfolio
- Financial year end interims
- LDR last day to register
- Earnings Yield
- Low Highly rated
- High poorly rated
- Level of borrowings
- Profit trend (EPS)
3Finding winning shares
- Structured / organized search - wide
- Consider best sectors potential
- Narrow list with criteria
- Volume test (liquidity test) min R500.000 / day
recommended - Earnings Yield (Not too high or too low)
- Is share in Upward or downward trend
- Avoid Extremes share doubled..in future
- Trend (5-10 years)
4Fundamentals
- Gearing exposure
- Asset intensive depreciation
- Consumer monopoly vs commodity type
- Be interested in what they do
5Analyse Gold Mine
- Mature
- Established
- Developing
- Short life
6Principles of Fundamental Analysis
- We are principally looking at which shares we
would want to buy, but remembering that we would
only do so if the price is right from a business
perspective. - In fundamental analysis we would typically adopt
a long-term buy and hold strategy - Consumer monopoly vs Commodity
7Intrinsic Value
- Warren Buffett
- ..the intrinsic value of a business is the
projected annual compounding rate of return that
the investment will produce. - This annual compounding rate of return is then
compared to other investments. If the money to be
invested can generate a higher return elsewhere
for the same or lesser risk, then the proposed
investment should go to that investment. - Determine business value in 10 years
- We want to invest in companys whose earnings we
can predict.
8Two types of business
- a commodity-type business whose earnings
fluctuate making the task of forecasting earnings
difficult if not impossible and - a consumer monopoly whose earnings (EPS) can be
forecast as they have little or no competition
and so profitability is assured. Consumer
monopolies are more profitable than commodity
type businesses and hence our focus is on these
types of businesses.
9Consumer Monopoly
- Price does not affect the quantity sold because
it is the only firm in the market or because its
products not substitutes for another product. - Barriers to entry. Investment in infrastructure.
- Protected environment - Telkom
- Consumer monopolies generate large sales revenues
- Unlikely to experience a cash flow problem or to
be in debt. - Household names such that it would be unhealthy
for other businesses NOT to stock products coke
/ Castle
10Commodity-type
- Competes on price
- Products are substitutes
- Needs to retain earnings to replace capital
items. Depreciation - May be highly geared borrows to supplement cash
flow
11Selecting the profitable equities?Look for
consistent returns (EPS)
12Calculate the Per Share Growth Rate
HP 10 B Calculator.
13NextCalculate the Initial Rate of Return
- The earnings per share are determined by the
performance of the company, but you must decide
on the price that you will pay for that share - the higher the price you pay for the share, the
lower your internal rate of return will be - you may have to be patient and wait for the price
to fall before you buy if IRR is too low.
14Calculate IRR - example
The less you pay the higher IRR and visa-versa.
15Put them together
CRM as a bond would give us an initial return on
investment of 11.56 per annum but would increase
this return by 36.34 p.a.
16Predicted EPS and Share Price at ROI on
16.09.2003 of CRM
17Ensure that return on shareholders equity is
high (ROSE).
18Projected Values 10 years hence
19Buys back its own shares?
- Be warned, though, if company profits remain the
same and you decrease the number of shares in
circulation, the earnings per share and share
price will go up. - If you increase the number of shares in
circulation, the earnings per share and the share
price will go down.
- Management of companies know this and can abuse
this principle to make very ordinary results look
a lot better. - A simple check is to compare the companies
actual net earnings annual compound growth rate
with the annual compounding growth rate for per
share earnings.
20Are retained earnings being used to increase
shareholder value?
- Companies do not usually pay the full earnings
per share as a dividend preferring to retain a
portion for further expansion, replacing assets
or to bolster their performance when times are
tough. - As investors we would want to know what
management are doing with our profits. Are they
using them effectively? - My rule is, If management can use the retained
earnings of the company effectively to generate
further increases in the share price, then I am
happy to let them keep those retained earnings.
If not, then I would rather have the retained
earnings paid to me as a dividend.
21How do I get the information?
- Identify the companies that you wish to evaluate.
- Phone them. Tell them you are managing a small
portfolio, and that you would like to consider an
investment in their company, but that you require
ten years worth of financials to make that
decision. - Ask them to send you the information in whatever
format is easiest for them. You may end up with
some photocopies, but the bulk will have their
annual reports, dating back ten years, in all its
glossy glory. - You might also find that this information is sold
in the format of computer programs offering
regular updates of all fundamental information by
the various companies who sell stock market
charting software.
22Rights Issues
- Raises money from existing shareholders
- Growth, premises, R D
- Cheaper than overdraft
- Interest vs. dividends from surplus cash
- Starts with S/holders meeting motion to issue
shares decision 1 share for x held - S/holders must note important dates.
23Rights Issues NB dates
- Last Day to Register
- Day on which eligiblity is determined for offer
- Ex-Rights date date after LDR
- Opening date of offer
- Date from which company accepts letters of
allocation - Closing date of offer
- Date by which letters of allocation must be
returned
24Rights Issues Nil Paid Letter (NPL)
- Are transferable to ensure take-up
- Also offered at below market price
- NPLs have a tradable value on the stock market
(separate listing) - Owners of NPLs must still pay the take-up price.
25Example ( 6 for 10)
26Impact on shareholder
- Each share now worth 262.5
- Rights offer at only 200, profit 62.5
- Value of NPL is thus 62.5 being the difference
- NPLs can be geared
- After closing date NPLs are worthless
27Share price raises 20
NPL (300 200 100) Increase of 60
28Underwriting Sponsoring
- Rights issues require
- Underwriters guarantee to take up unwanted shares
to ensure finance is raised. - Paid a fee for doing so
- Sponsoring Broker
- Advises on structure of the issue
- Assists with getting issue accepted by JSE
committee
29New Listings
- Requirements to list
- Certain size
- Minimum pre-tax profits
- Reasonable trading history
- Minimum number of shareholders
- Spread of shares amongst the public
30New Listings Prospectus
- To make public aware of financial position of the
company and why it needs additional capital - Promotes ability to make an investment decision
- Prospectus includes
- Articles of association, directors remuneration,
borrowing powers of directors, shares application
form, assets of the company, auditors report,
loan capital and borrowings, statement of assets
liabilities, profit history, subsidiaries,
material contracts, expenses of the issue,
brokerage fees, underwriting minimum
subscription, dates and times of the offer
31Private Placement
- a new listing not accompanied by an offer of
shares to the general public - usually means the publics portion of the shares
has been allocated by way of a private placing - A private placing is a preferential offer to
institutions and companies associated with the
company seeking a listing. - offered via a sponsoring broker
- offers enormous profit potential because
companies that are able to arrange a private
placing are normally high-profile
32Public Offer
- Public may subscribe
- Stag apply and sell on listing to make quick
profit - Oversubscribed only get a - pay 100
- Many small applications vs One large app.
-
33Companys reasons to list
- Cash flow
- Reduce gearing (investment vs borrowings)
- Expansion programs
- Disinvestment from a country
- May allow existing owners to realise
(re-invested) profits. (Bull market make it
attractive) - Family owned Vs professionally managed
34Cycles
- Technical analysis is based on the assumption
that share prices move in repetitive patterns - trends, formations and cycles
- Past modules dealt with trends and formations
- We shall deal with cycles and waves
- Recall psychology
35Cycle theory
- and group investor behaviour suggests that
natural cycles such as the seasons, the phases of
the moon and perhaps some mystical biorhythm of
mankind, influence investors to trade at
predetermined intervals. - Some cycles are obvious coal / orange juice
- Dow Theory, Elliott Wave, Kondratieff
36Difference between cycles and waves
- wave theories postulate a regular pattern
- Elliott is a wave theory
- cycle theories postulate a regular time frame.
- Kondratieff is a cycle theory
37Cycle theorists
- maintain that shares, share markets, sectors,
commodities, exchange rates and almost every
commercial data stream move in regular cycles. - They suggest that cycles are repetitive and of
relatively fixed duration making them predictable
38Three cycles moving together
39Cycles
- help to identify the lows and highs and to time
your transactions - use momentum indicators of different lengths
- a 5-day momentum simply takes each days price
and subtracts from it the price of 5 days ago - difference oscillates around zero - the more
pronounced peaks and troughs should highlight the
underlying cycles - NB other cycles at work may obscure
40Cycles - warning
- Need Volume to test for cycles
- Thinly traded not enough investors at play
- One investors actions can nullify calcs.
41How do I reduce risk?
- Diversification
- Warren Buffett, one of the worlds richest men,
cautions that diversification is something people
do to protect themselves against their own
stupidity
42How is this possible?
- The answer lies in the fact that these four asset
classes do not move in perfect synchronisation.
Their movement creates a wave-like effect, in
that as some assets struggle, others help to push
the portfolio along. To take advantage of this
effect you have to periodically rebalance the
portfolio by selling some or a portion of the
winners of each year and investing the proceeds
into the losers. - The market works in cycles
434 Assets and a Portfolio
44KONDRATIEFF
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47Kondratieff
- is a wave of commodity prices rather than
business activity levels or stock market prices.
- It is a cycle of inflation and deflation, not of
boom and bust.
48Kondratieff Phase 1- spring summer
- 20 years of strong growth and rising commodity
prices, which end with a major war. - Associated with major technological advances and
rising confidence. - Businesses reach production capacity and begin to
expand capacity. - Over investment finally causes distortions which
are reflected in political tensions, economic
instability and eventually war. - The wars referred to are the war of 1812, the
American Civil war, World War 1 and Vietnam. - Opponents point out that there was no World War
2.
49Kondratieff Phase 2 - Autumn
- The war is followed by a sharp primary recession
lasting three or four years and then by a
decisive recovery. - This is followed by a declining plateau of
commodity prices where normal business conditions
reach periods of intense prosperity.
50Kondratieff Phase 3 - Winter
- A deflationary collapse in which the money supply
shrinks dramatically as a result of bank
collapses. - This draws the stock market down and general
business activity levels decline sharply with
spending power.
51Kondratieff
- Based on economically active lifespan of mankind
54 years - Deflation crash (1929) memory eventually fades,
debt levels rise - People need to learn from their own mistakes !
- People live longer
- Communications and derivatives
- Economic knowledge has improved lessening effects
52Kondratieff Elliott Wave
53STOCHASTIC INDICATOR George Lane
- OB/OS and momentum (oscillate around 0) can be
misleading hence - Marginal mine reaches OB/OS levels at /- 30
whereas blue chip may be heavily oversold at
-10. - Stochastic overcomes this
- It standardizes buy and sell lines irrespective
of their volatility using a mathematical formula
that oscillates between 0 100
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56Stochastic - Calc
- works on the principle that shares in a rising
trend tend to close near the top of their periods
high - and shares in a falling trend, tend to close near
the bottom of their periods low.
57JSE index - as the index rose higher, the share
closed closer to its high. As the bull trend
matures and loses momentum, the index closes
closer to its low.
58Stochastic determine the period
- Periods must coincide with your investment
strategy - ensure all indicator periods match each other to
prevent false signals
59Example
- Close - Low x 100
- High - Low
- The following diagram best illustrates the
formula - When looking at share "A", notice that according
to the formula, the value of the stochastic must
be 100. If the low was subtracted from the high
and the close, the answer will be the same
because the high and close are identical. - B 0
When the close is nearing the high of the day,
the value tends towards 100 and when the close
tends towards the low, the stochastic nears zero
60Trading the Stochastic
- To establish buy and sell lines use both the
stochastic and the moving average. - Sharefriend defaults to 50 (stk) and 30 (mva)
days. - Where the stochastic breaks down through the 80
line and the 3/5 (of the period of the
stochastic) moving average is also in a downward
trend, then a clear sell signal is given. - When the stochastic breaks up through the 20 line
and the 3/5 moving average is in an up trend, a
buy signal is generated.
61Breaks down 80, MVA down Sell Breaks up 20,
MVA up buy
62RSI Wells Wilder
- Internal strength index as it measures the share
against itself. - Originally recommended a 14 day RSI. 9 25
gained popularity since. - Period used will affect volatility. (Smaller
periods are more volatile than longer periods)
63RSI - Calc
- Where U An average of upward price changes
- D An average of downward price
changes - The RSI is a more sophisticated momentum
oscillator, oscillating between 0 and 100 and
takes into account the variations that occur over
a period of time.
64RSI - Example
12 up days and 9 down days
65RSI - Trading
- Apply either a trendline or moving average to the
RSI. - Any break of the trendline or moving average
signifies a buy/sell point.
66Also.
- RSI also shows when a share is overbought
/oversold - above 70 - the share is overbought and below 30
it is oversold. Any break up/down through the
30/70 levels, respectively, is a buy/sell signal.
67RSI Example 1
The graph represents a 21-RSI with a 14-day MA
and the closing graph of Sasol. Looking at the
buy/sell signals generated by the RSI, see that
they match the cycles of the closing graph,
offering a number of trading opportunities.
68RSI Example 2
- The other method of interpreting the RSI is to
buy when the indicator is at 30 and to sell when
the indicator is at 70. The RSI often provides
buy/sell signals prior to share price movements.
69MAC-D (Intro) - Gerald Appel
- MAC-D is a lagging indicator.
- a trend following momentum indicator that shows
the relationship between two moving averages of
prices.
70MAC-D (Calc)
- The MAC-D is calculated by subtracting the value
of a 50-day exponential moving average from a
21-day exponential moving average. - A 9-day moving average, called the "signal" line,
is plotted on top of the MAC-D to show buy and
sell opportunities.
71MAC-D Trading
- The MAC-D is a "Trending Indicator" and proves
most successful on a long-term view. There are
three popular ways to interpret the MAC-D - Crossovers
- Overbought/Oversold conditions
- Divergences
72MAC-D Crossovers
- The basic rule is to buy when the MAC-D crosses
up through the signal line and sell when the
MAC-D crosses down through the signal line. - It is also possible to use the MAC-D as a buy and
sell signal when it crosses up and down through
the zero line (there would be a greater lag if
this was done).
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74MAC-D (overbought/oversold)
- The MAC-D is also useful as an overbought/
oversold indicator. - When the shorter moving average pulls away
dramatically from the longer moving average
(i.e., the MAC-D rises), it is likely that the
share price is over extending and will soon
return to more realistic levels. - MAC-D overbought/oversold levels vary from share
to share.
75MAC-D (Divergences)
- The current trend is near an end when the MAC-D
diverges from the share price. - A bearish (negative) divergence occurs when the
MAC-D is making lower highs while the share price
graph makes higher highs. - A bullish (positive) divergence occurs when the
MAC-D is making higher lows while the share price
continues to make lower lows. - Both these divergences are most significant when
they occur at relatively overbought/oversold
levels.
76MAC-D Graph 1
77MAC-D (Example)
- Notice that buy and sell signals were plotted on
the price graph every time the MAC-D crossed
through the signal line. - This does not give a good trading pattern
- Success was only generated when the MAC-D crossed
over the signal line in oversold (below zero) or
overbought (above zero) territory (that is five
trades for the period next ..).
78MAC-D Graph 2
When the MAC-D indicator is rising, hold on to
the share (trending indicator) and when the MAC-D
is falling, trade the share (use trading
indicators).
79Standard Bank Buy sell lines
80Elliott Wave
81A Traders Trading Rules
- Learn how to take your losses quickly and
cleanly. - Dont expect to be right all the time.
- If you have made a mistake, cut your losses as
quickly as possible - of the greatest traders never rely on more than
two or three core indicators and never listen to
the opinions of others.
- Ignore the news media.
- Determine the stock or stocks to trade in
- 4 loss rule
- It is better average up than to average down.
- Know when to get out before you get in
- When in doubt, do nothing.
- Never be sentimental about a stock.
82Trading Rules
- Use stop loss orders
- Trade with the trend. The trend is your friend!
83Watch List
- 800 companies on the JSE
- Watch list of (Buffetology) shares
- Diversify with 5-15 shares
- Reduces risk upto 15 shares
84Dividends
- On the day following the last day to register for
a divided (also known as the ex-div date), the
share price should fall by exactly the amount of
the dividend. - Such a sudden fall in the price of the share
could push it through your stop-loss level.
85Averaging Down
- Admit you got it wrong
- Danger is that it keeps falling
- Stop out and wait for the next opportunity
86Risk and Return
- Big Dog syndrome
- Higher return implies higher risk
- Diversify
- Manage losses, profit will take care of themselves
87Portfolio Structure
- Four main areas
- Blue Chips
- Growth
- speculative
- Warrants / Equity Futures
- cautious of subjective warrant (option) pricing,
prefer to offer leveraged IEFs, which are a more
effective and cost efficient mechanism to
leverage or to hedge - a safe, long-term, low-return area a medium-term
growth area and a high-risk, short-term area
88Warrants and Volatility
- most important aspect of warrant pricing is the
calculation of the volatility of the share
itself. - Market makers (options) bet on the volatility of
the asset either rising or falling whilst
constantly maintaining a neutral position in the
asset itself. - when you buy a warrant, you are buying the
underlying volatility of the asset. If volatility
falls, you are at risk, regardless of the move in
the price. - EG You could buy a put warrant and the share
price falls but the price of the warrant remains
the same due to a change in volatility.
89IEFs
- The warrant situation cannot happen
- Either right or wrong in your view and profit /
loss based on a change in price of the underlying
share - No time decay effects either
- IEFs less complex than warrants
- A 1c move in share price 1c change in IEF price
- Leveraged
- Not subjective (as is volatility)
90IEFs
- Open Safex account (24 hrs)
- Afrifocus will monitor your account daily (20
margin) - Top 40, most of Indi 25 can be traded
- Shorts!!!
- delta means portfolio is geared to a rising
market, - delta means you are short the market
91IEF - Example
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93IEF Additional info
- Although the initial margin cost of the IEF is
R12,000, the total margin deposit would be
R22,000 in order to cover any variation margin
requirements should the price of Sasol have
fallen. - Margin deposits earn interest at the SAFEX rate.
- The effects of leverage using IEFs are clear. It
is therefore important to note that the downside
risk can also be severe.
94Note Prices used as at 10/09/2002
95IEFs (Volatility repricing)
- SAFEX generally recalculate the initial margin
prices about every 3 months according to historic
volatility counts. Therefore, as prices change,
the effective gearing levels will fluctuate too.
As a rule of thumb, the average gearing is about
8 times.
96Planning your strategy
- Geared or ungeared
- Warrants
- IEFs
- Longs
- Hedged or not
- Warrants
- IEFs
97Warrants
- Is an option, providing the holder with the right
but not the obligation to buy (or sell) the
underlying asset on or before a specified date. - Calls
- Puts
- American before or on exercise date
- European exercised on the date only
98Warrant Terminology
- Underlying assets
- This is the asset on which the warrant is written
e.g. a currency or share - The issuer
- This is the institution which writes the option
e.g. STD Bank, Deutsche Bank, Gensec or Investec - Strike price
- This is the price at which the warrant holder can
either buy or sell the underlying asset. - Maturity Date
- The date on which the warrant is to expire.
- Time decay
- Also known as theta to the Greeks. In short this
means that a warrant looses value with every
passing day. - Premium
- This is the Price paid for the warrant
- Cover ratio
- This is the number used to determine how many
shares in the underlying share as warrant holder
you are entitled to. Example, 101, the warrant
holder would be entitled to 1 share for every 10
warrants held. - Delta
- If a warrant has a delta of say O.5, it means
that the warrant has a 50 chance of being in the
money at expiry. - Gearing
- Accelerates potential profit
- In the money
- Share price is past the strike price in the
direction that leads to profit - Out the money
- Share price has not reached the strike price in
the direction of profit
99Call Warrant
100Put Warrant
101Advantages
- Costs less than underlying share
- Can limit losses to cost of option
- Small downside, higher upside
- One stock may have many warrants to choose from
- Puts (shorting), calls, time periods
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103Comparing Costs
104Trading the ups and downs
105Influences on Warrant Price
106The Greeks
107Delta
108Delta
109Effective Gearing
110Impact of Dividends
111Interest Rates
112Matrix
113Intrinsic Value
114Interest Saving
115Matrix Pricing
116Price Determinants
117Trading Warrants
118Tips
119Tips part II
120Currency Trading
- What is Forex?
- 24 hr market
- USA open is NB!
- Quoted in pairs
- 1st currency is base currency
- 2nd called the counter
121Forex
- Bid and ask quoted in real time ensures fair
price - USD/JPY Bid _at_ 131.40 Ask _at_ 131.45
- 5 pip spread defines cost!
- Margin good faith deposit against trading
losses. Allow gearing/leverage of 1001 - Rollover interest is charged on daily positions
- Profit in up or down market
- Deal direct with market maker reduces
transaction costs - Great for technical analysis due to volatility
122Futures
- Originate 16th century
- Secured prices and stock 12 months ahead
- If one party reneged the deal collapsed
123Exchange facilitates
- Facilitates trading brings counter parties
together - Liquidity parties are able to trade (close out)
their positions at any stage - Prices reflect market conditions
- Margins reduces risk
124Futures contract defined
- An agreement and obligation to buy (a long
position) or sell (a short position) - A standard quantity (called contracts.)
- Of an asset (commodity/financial)
- On a specified date (expiry date)
- At a price determined at time of entering into
the contract.
125SAFEX (South African Futures Exchange)
- A non profit association
- SAFEX can be seen as a huge on line market
computer and connected to the computer are - Clearing member
- Represent a financial institution with a net
worth of R20 million and have further guarantee
of R10 million - Each provide R250 000 to guarantee loan fund
- Have a position limit with SAFEX (their
guarantee) - Maintain the integrity of the system
- Non clearing member must be affiliated to a
clearing member - SAFEX is therefore the guarantor to every
transaction in other words, they become the
buyer to every seller and the seller to every
buyer, thereby taking the risk of non-payment
away. - Interest is received on margin at a competitive
rate.
126Financial Futures
- This is a contract where the underlying asset is
a financial instrument, currency, notional asset
or equity and the contact price depends on an
interest rate, yield or share index. All
financial futures are cash settled. - The following financial futures are traded in
RSA. - Stock index futures All Share Index
- Industrial Index
- Financial Index
- Mining Index
- Long Bonds E168
- R150, R153, R162
- Currency futures Rand-Dollar (foreign account
holders only)
127Stock Index Futures
- 1. Underlying asset
- This future contract is based on some of the
major indices on the JSE - An index is a basket of shares.
- The index is normally compiled on a weighted
basis (price moves of the larger shares will have
a greater impact on the index than moves of the
smaller shares). - An index is used to track performance and trends.
- With the buying and selling of futures investors
can participate in the movement of these indices.
128Margin
- Not a transaction cost, but a payment to SAFEX to
minimise risk - A fully refundable amount provided profits are
earned. - Initial margin depends on the type of contract.
- Margin usually ranges between 5 and 10 of the
contract value, but volatility plays a major role
in this pricing system. - Margins are set equal to the greatest loss that
position could reasonably be expected to occur
from one day to the next. - For example, the September Indi allows for a move
of 800 points (R8000/R10) - Initial margin must be deposited before the
opening of the next day after your trade. - Daily losses must be met by the client by
depositing further collateral, known as variation
margin, into his/her account. - This is required by the close of business the
following day. - In the same manner, profits are added to your
account.
129Futures
- Tick Size
- This minimum price movement in a futures contact.
- For example
- SAFEX
- 1 point R10
- S P 500
- 0.05 point 25
- FTSE
- 0.5 point 12.50
- Broking Fees
- Low compared to equity transaction, but once
again you must shop around for fees that suite
you. - For the small client (gt100 contracts/month) R70
per round turn for an exposure of R70 000 you
will pay 0.1 broking fees - For the larger client (gt100 contracts/month)
R50 per round turn for an exposure of R70 000
you will pay 0.7 broking fees.
130Futures
- Closing out of futures contracts
- Occurs when you want to get out of a position.
- Liquidity is important
- Contracts can be closed out with an equal
opposite contact any time.
- Expiry day / close out day
- The expiry date of the contract.
- Four expiry dates per year usually the first
business day after the 15th of March, June,
September and December. - On this day the future and the index (spot)
become the same, in other words, the basis
becomes zero - All contracts are closed out, unless rolled over.
131Futures
- Mark-to-market (M-t-M)
- SAFEX extracts a value form the future market on
a daily basis this figure is known as the
M-t-M. - The M-t-M is taken at 16h30 each day at mid pint
of the best dib and offer prices. - Depending on the move the futures from the time
of your transaction to the M-t-M the buyer or
seller will make a profit/loss. - A cash settlement will be made on the following
business day.
- Cash settlement
- Since we cannot deliver an index/basket of share,
cash is used as a substitute. - Profit or loss made by the buyer of the future
contracts exactly equal to the profit or loss
made by the seller of the contract known as a
Zero Sum Game. - The amount of profit/loss to be settled between
the two parties would be the difference between
the agreed contract price when entered and at the
time it was closed.
132Futures
- Pricing of futures
- Generally speaking, there are 3 elements that
determines the price of a future contract, i.e.
its fair value (FV) - Spot price of the underlying asset (counts the
most) - Financing costs (e.g. interest, storage and
insurance) - Income generated by the underlying asset
- Therefore, FV spot financing costs income
from asset.
- Supply and demand can cause the actual future
price to be at a premium or discount to the FV. - The difference between the futures price (FP) and
spot is known as the basis - If FP gt spot gt future is at a premium to spot
and is called contango. - FP lt spot gt future is at a discount to spot and
is called backwardation.
133Pricing a stock index future
- The following factors are taken into account
- Current spot index value (index value tick
value) - Dividends paid on shares making up the index
- If person had bought a basket of shares dividends
would accrue this income is lost by buying a
future. - Short term interest rate
- A person buying a basket of shares would have to
borrow or reduce cash. They save this interest
cost by buying a future. - time until maturity of the future
- Therefore, FV 1 (1r/100 DY/100) compounded
by d/365 - Where,
- FV fair value of the future
- I current value of the spot index 10
- R short term interest rate per annum
- DY dividend yield paid on shares making up the
index - D number of days until expiry
134Trading Procedure
- Investor places an order with the broker
(clearing or non clearing member) and stipulates
his/her price - Broker discusses with the client whether the
price is plausible - Trade takes place, one party buys (long position)
and the other party sells (short position) - Both buying and selling brokers enter the deals
into the SAFEX computer - The positions are registered in the names of the
each party - SAFEX sends a note to each party confirming their
positions - Contract holders wishing to maintain a position
may roll it forward into next expiry month. A
new contract has to be entered into.
135Bonds
- A bond is a long-term loan that is made by an
investor to the issuer of the instrument. The
terms of the bond covenant oblige that the issuer
(the borrower) will make regular interest
payments to the holder of the bond
(lender/investor) on predetermined dates
throughout the lifespan of the bond and on
expiration, repay the capital.
136Bonds time to maturity
- is the number of years over which the issuer of
the bond has contracted to meet its payment
commitment - issued with a fixed maturity or redemption date
on which the nominal value of the bond is repaid - one to three years (short term),
- three to ten years (medium term) or
- ten to thirty years (long term)
- TTM has a direct impact on the risk and
ultimately the return (yield) of a bond
137 Bonds
- Face Value
- also known as par value, principal or maturity
value - Value of the bond on expiration (usually R1M)
- When a bonds price is below face value it trades
at a discount, if above, it trades at a premium
- Coupon Interest
- is the fixed interest, expressed as a percentage
the issuer agrees to pay each year - Calculated on the face value of the bond
- EG bond with 14 coupon rate pays R140 on a bond
with a R1000 face value
138Final Terms