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Single Stock Futures

  • Single Stock Future

     

     

    September 2009

  • Overview

    Description 

    A futures contract is a legally binding agreement that gives the investor the right to buy or sell an underlying financial instrument (if physically settled) at a fixed price on a future date.

    Explanation 

    Single Stock Futures (SSFs) are futures contracts on individually listed shares. They are standardised contracts with set specifications regarding size, expiry dates and tick movement.

    The value of a SSF contract is normally equal to 100 times the particular share’s futures price.

    Example:
    If company X is trading at R10 then 1 futures contract is the equivalent of holding R1000 in company X shares.

  • Trading Positions

    Description 

    When trading in futures contracts an investor can take one of two positions: Long (buy) or Short (sell)

    Explanation 

    When you buy long you believe the price of the underlying share will increase. If it does by the time the contract expires you will realise a profit.

    When you sell short you believe the price of the underlying share will go down. If it does by the time the contract expires you will realise a profit.

  • Initial Margin

    Description 

    You are required to pay a deposit upfront (initial margin) when trading in SSFs.

    Explanation 

    The initial margin payment is used to eliminate counterparty risk (the risk associated with one of the parties defaulting). It is usually calculated on the maximum amount that can be lost in one day – approximately 10 to 30% of the value of the underlying shares.

    The initial margin payment is held by the exchange and you earn daily interest on this payment. When you close your position, your initial margin plus interest is paid into your margin account.

  • Variation Margin

    Description 

    The daily profit / loss payment for each contract, as independently calculated by the exchange.

    Explanation 

    At the end of each trading day contracts are Marked-to-Model (M-t-M). The exchange calculates a fair value (closing price) for each contract.

    The difference between your traded price (if traded on the day) or the previous day’s M-t-M (if brought forward position) is calculated as a profit/loss.

    Example:
    On 25 April investor A buys one futures contract on company X for R50.
    On 26 April the exchange calculates the closing price for this future to be R52. This is the M-t-M price for investor A’s contract.

    This represents a positive movement for the buyer (Investor A) and he will realise a profit of R200.
    1 x R2 (R52-R50) x 100 (nominal per contract)
    = R200

    However, this represents a negative movement for the seller of the contract who will be required to pay R200 into his variation margin account. This amount will be paid into the buyer’s variation margin account.

  • Expiry of Contracts

    Description 

    The JSE offers four expiration dates for contracts: the third Thursday of March, June, September and December respectively.

    Explanation

    Investors have three options on expiry:

    1. Physical settlement (the actual underlying shares will be traded between counterparties)
    2. Cash settlement (at expiry cash will change hands, no physical delivery of the shares)
    3. Contract rolled over to the next expiry date

    You can exit a futures contract before the expiry date; this is called closing your position.

  • Advantages of SSFs

    Description 

    SSFs offer investors the opportunity to get exposure to shares at a much lower cost than actually buying the shares.

    Explanation Example:

    Example:
    Investor X thinks the shares in company A will increase and buys 100 shares worth R250 each, costing R25 000 in total. Three months later company A’s shares are worth R300 each and investor X sells his shares for R30 000 and makes a profit of R5 000.

    Investor Y also thinks that company A’s share price will increase, and also wants exposure to 100 shares worth R25 000 . Instead he buys one futures contract at a price of R250. He has to put down a deposit (initial margin) of approximately R2 500 but is still exposed to his desired 100 company A shares. Three months later company A’s share price increases to R300. Investor Y decides to close his position. He makes a profit of R5 000 but also gets his deposit back (R2 500) plus interest. His return on investment is much higher.

    
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