single stock futures educational seminar

Copyright© JSE Limited 2008

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Magnus de Wet, James Boardman, Rudolf Oosthuizen

10 March 2011

Single Stock Futures

Educational Seminar

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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

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Agenda

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Markets in the US have evolved

From this

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Where people would behave like this

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To this- a lot quieter and calmer and more efficient

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A level playing field

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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

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SSF: Derivatives within the JSE (2009 Financials)

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SSF: Parties involved with Derivative Trading

JSECentral Counterparty

Client A

BuyingMember A

ClearingMember A

DataVendors

Client B

SellingMember B

ClearingMember B

Cash Flows

Ca

sh

F

low

s Cash Flows

Da

ta

Trading Trading

Ca

sh

F

low

s

Ca

sh

F

low

sC

as

h

Flo

ws

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SSF: Guarantee Hierarchy

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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…

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He is very good at saying NO

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

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

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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*(1+50%) = R150

Initial Value Return % Extra Return Total R 150.00 50% R 75.00 R 225.00

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

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

Initial Value Return % Extra Return Total R 225.00 50% R 112.50 R 337.50

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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

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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

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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

R

N )( 1

(T*N)

=CV FV)(1

( )

EXP* (R ) = FVCV ( )T* LN

**

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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 Spread Spot Spread % Future Spread % R 0.50 R 1.68 0.14% 0.45%

Deriving future prices

16 Jun 2011 Expiry

% 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 =

R0.50/((R367.00+R366.50)/2) = 0.14%

BIDOFFER

BIDOFFER

(

(

)

)

2*= Spread%

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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 Spread Spot Spread % Future Spread % R 0.50 R 1.68 0.14% 0.45%

Deriving future prices

16 Jun 2011 Expiry

1 Market maker

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Deriving future prices

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Deriving future prices

17 Mar 2011 Expiry

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 Spread Spot Spread % Future Spread % 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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Deriving future prices

2 Mar 2011

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Practice

10 Mar 2011

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Deriving future prices

17 Mar 2011 ExpiryCurrent date Expiry Date Compounding Date Diff Years

2011/03/10 2011/03/17 12 0.0192 Spot Bid Future Bid Difference % Interest Year R 352.61 R 352.68 R 0.07 1.04%Spot Offer Future Offer Difference % Interest Year R 353.15 R 353.00 R -0.15 -2.21%Spot Spread Future Spot Spread % Future Spread % R 0.54 R 0.32 0.15% 0.09%

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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

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Dividend Neutral Contracts

N- Contracts

2 Contracts

Interest agreed up front

Adjusts contract for dividend received in Spot

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Stock Dividend

AGL

AGL Dividend

R 1,000,000

AGL +

R 900,000 R 100,000 = R 1,000,000

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Price Flow

TIME

Value

R1M

R1,1M

R0.9M

R1.05M

R 0.1M Dividend

R0.1M*(1+10%*0.5) = R 0.105M

T =0.5T =1 T =0

R1.05M-0.945M = 0.105M

R0.9M*(1+10%*0.5) = R 0.945M

Adjustment down to compensate for Long holder not receiving dividend

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Spot Price and CFD Cost

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Spot and SSF Price

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Cost Comparison

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SSF: SSFs vs. CFDsSSFs

• 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

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

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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…

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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 – TBC

23 November 2011 – TBC

07 December 2011 – TBC

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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