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Advanced Equity Trading

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Title: Advanced Equity Trading


1
Advanced Equity Trading
  • Gavin Bramley
  • Share Direct

2
Know 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)

3
Finding 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)

4
Fundamentals
  • Gearing exposure
  • Asset intensive depreciation
  • Consumer monopoly vs commodity type
  • Be interested in what they do

5
Analyse Gold Mine
  • Mature
  • Established
  • Developing
  • Short life

6
Principles 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

7
Intrinsic 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.

8
Two 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.

9
Consumer 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

10
Commodity-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

11
Selecting the profitable equities?Look for
consistent returns (EPS)
12
Calculate the Per Share Growth Rate
HP 10 B Calculator.
13
NextCalculate 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.

14
Calculate IRR - example
The less you pay the higher IRR and visa-versa.
15
Put 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.
16
Predicted EPS and Share Price at ROI on
16.09.2003 of CRM
17
Ensure that return on shareholders equity is
high (ROSE).
18
Projected Values 10 years hence
19
Buys 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.

20
Are 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.

21
How 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.

22
Rights 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.

23
Rights 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

24
Rights 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.

25
Example ( 6 for 10)
26
Impact 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

27
Share price raises 20
NPL (300 200 100) Increase of 60
28
Underwriting 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

29
New Listings
  • Requirements to list
  • Certain size
  • Minimum pre-tax profits
  • Reasonable trading history
  • Minimum number of shareholders
  • Spread of shares amongst the public

30
New 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

31
Private 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

32
Public 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.

33
Companys 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

34
Cycles
  • 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

35
Cycle 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

36
Difference 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

37
Cycle 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

38
Three cycles moving together
39
Cycles
  • 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

40
Cycles - warning
  • Need Volume to test for cycles
  • Thinly traded not enough investors at play
  • One investors actions can nullify calcs.

41
How 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

42
How 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

43
4 Assets and a Portfolio
44
KONDRATIEFF
45
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46
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47
Kondratieff
  • 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.

48
Kondratieff 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.

49
Kondratieff 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.

50
Kondratieff 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.

51
Kondratieff
  • 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

52
Kondratieff Elliott Wave
53
STOCHASTIC 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

54
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55
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56
Stochastic - 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.

57
JSE 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.
58
Stochastic determine the period
  • Periods must coincide with your investment
    strategy
  • ensure all indicator periods match each other to
    prevent false signals

59
Example
  • 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
60
Trading 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.

61
Breaks down 80, MVA down Sell Breaks up 20,
MVA up buy
62
RSI 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)

63
RSI - 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.

64
RSI - Example
12 up days and 9 down days
65
RSI - Trading
  • Apply either a trendline or moving average to the
    RSI.
  • Any break of the trendline or moving average
    signifies a buy/sell point.

66
Also.
  • 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.

67
RSI 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.
68
RSI 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.

69
MAC-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.

70
MAC-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.

71
MAC-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

72
MAC-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).

73
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74
MAC-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.

75
MAC-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.

76
MAC-D Graph 1
77
MAC-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 ..).

78
MAC-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).
79
Standard Bank Buy sell lines
80
Elliott Wave
81
A 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.

82
Trading Rules
  • Use stop loss orders
  • Trade with the trend. The trend is your friend!

83
Watch List
  • 800 companies on the JSE
  • Watch list of (Buffetology) shares
  • Diversify with 5-15 shares
  • Reduces risk upto 15 shares

84
Dividends
  • 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.

85
Averaging Down
  • Admit you got it wrong
  • Danger is that it keeps falling
  • Stop out and wait for the next opportunity

86
Risk and Return
  • Big Dog syndrome
  • Higher return implies higher risk
  • Diversify
  • Manage losses, profit will take care of themselves

87
Portfolio 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

88
Warrants 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.

89
IEFs
  • 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)

90
IEFs
  • 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

91
IEF - Example
92
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93
IEF 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.

94
Note Prices used as at 10/09/2002
95
IEFs (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.

96
Planning your strategy
  • Geared or ungeared
  • Warrants
  • IEFs
  • Longs
  • Hedged or not
  • Warrants
  • IEFs

97
Warrants
  • 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

98
Warrant 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

99
Call Warrant
100
Put Warrant
101
Advantages
  • 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

102
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103
Comparing Costs
104
Trading the ups and downs
105
Influences on Warrant Price
106
The Greeks
107
Delta
108
Delta
109
Effective Gearing
110
Impact of Dividends
111
Interest Rates
112
Matrix
113
Intrinsic Value
114
Interest Saving
115
Matrix Pricing
116
Price Determinants
117
Trading Warrants
118
Tips
119
Tips part II
120
Currency Trading
  • What is Forex?
  • 24 hr market
  • USA open is NB!
  • Quoted in pairs
  • 1st currency is base currency
  • 2nd called the counter

121
Forex
  • 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

122
Futures
  • Originate 16th century
  • Secured prices and stock 12 months ahead
  • If one party reneged the deal collapsed

123
Exchange 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

124
Futures 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.

125
SAFEX (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.

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Financial 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)

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Stock 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.

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Margin
  • 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.

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Futures
  • 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.

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Futures
  • 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.

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Futures
  • 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.

132
Futures
  • 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.

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Pricing 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

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Trading 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.

135
Bonds
  • 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.

136
Bonds 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

138
Final Terms
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