Transcript WHAT ARE SSFs?

WHY SSFs?
SSFs have fundamentally changed the landscape of derivative trading globally by allowing investors to
easily and with minimum capital hedge their portfolio and exploit market opportunities to achieve
maximum returns on their investment. South Africa currently hosts the largest single-stock futures
market in the World, trading on average 700,000 contracts daily. The SSF trading market in SA is
hosted by SAFEX which when established in1999 offered 4 leading shares but now covers over 250
counters.
THE INCREDIBLE BENEFITS WHEN YOU TRADE SSFs:
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Impressive hedging capabilities - you are able to fully exploit market movement by selling short in falling markets
and buying long in rising markets
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Highly capital efficient - they are highly geared investments giving exposure to a large amount of underlying
shares for only a small initial deposit.
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Low brokerage costs - they incur lower brokerage costs than when trading in the underlying shares
Very liquid - easily traded using PSG Online’s Direct Market Access platform
Earn interest - your initial margin earns interest for the duration of the contract
Benefit from Corporate Actions - corporate actions which affect the underlying share are also taken into account
in pricing SSFs
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Cheaply diversify risk - you are able to leverage your funds on a number of investments due to the low cost of
trading with SSFs
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Protect your Portfolio - hedge your risk by selling SSFs in the same companies
Benefit from pairs trading - by entering into a trade one long and the other short in the correct ratios a net positive
profit can be realised
Why SSFs Cont.
The Higher The Risk The Greater The Reward
Remember the higher the risk the greater the reward and SSFs are
no exception to the rule. Due to the high degree of leverage in
SSFs both profits and losses are felt immediately as they are
realized on a daily basis, and therefore although there potential to
earn significant returns on your investment is impressive, you may
also incur severe losses.
WHAT ARE SSFs?
By Definition:
Single-stock futures (SSFs) are a legally binding agreement (an exchange-traded contract) based on an
underlying stock. This futures contract gives the holder the ability to buy or sell the underlying asset at a fixed price on
a future date. Being futures contracts they are traded on margin, thus offering leverage. When purchasing SSFs there
is no transmission of share rights or dividends. If you hold a SSF until expiration you either have to take delivery or
make delivery of the underlying – or you have to roll over the position into the next dated futures contract in the same
underlying instrument.
A futures contract is:
1.
2.
3.
4.
A standardised contract
That is listed on the South African Futures Exchange (SAFEX), a subsidiary of the JSE
Of a standard quantity (100) of a specific underlying asset , usually a listed share
That expires on a predetermined future date, usually the third Thursday of every March, June, September and
December
5. At a price reflecting the ruling price of the underlying asset on the expiry date, including all relevant dividends and
interest
Remember that SSF contracts equate to100 shares of the underlying instrument and therefore orders for SSF
contracts must be placed in multiples of 100, e.g. 1 SSF contract = 100 shares of the underlying. Because SSFs are
created at the close of trading for all matched orders, all unmatched SSF orders expire at the end of the trading day. All
partially matched orders – i.e. orders for lots of 100 shares that have not filled 100 shares of the underlying instrument
– will be cancelled at the end of the day.
HOW DO SSFs WORK?
What This Means:
SSFs are contracts entered into between 2 parties, where 1 party commits to buy a set quantity of stock and 1 party
agrees to sell a set quantity of stock at a specified future date. This creates the right for the buyer to take delivery of
that stock on the date of the contract’s expiry, i.e. the buyer doesn’t purchase the stock but rather a ‘deposit’, known
as the initial margin is made and used as security against the right to take delivery of the stock at the specified
contract’s future date. Most clients do not, however, take delivery of SSFs – rather clients close out positions every
quarter or roll positions over to the next expiry date. A SSF contract is made up of 100 shares of the underlying and the
margin is geared at around 15% of the underlying instrument’s share price.
An example:
INVESTOR A (Equity / Share Trader)
INVESTOR B (SSFs Trader)
• Investor A is confident that Sasol Ltd shares will
increase in the oncoming months.
• Investor B is confident that Sasol Ltd shares will
increase in the oncoming months.
• She has R35,000 which she can invest.
• Sasol’s share price is R350, therefore he buys a Long
Sasol SSF contract.
• Sasol’s share price is R350, therefore she buys
100 shares.
• 3 months later the price has increased by 10% so
she sells her shares to make a R3,500 profit. Her
return on her investment is 10%.
• The initial margin set by the broker is R5,250 which is
paid by the buyer.
• After 3 months the price has increased by 10% and the
investor closes out his position and sells out of the Sasol
SSF contract he is holding. His profit is R3,500 but his
return on his investment is 67%.
Essentially, SSFs allow investors the ability to benefit from the price movement of the underlying share but require a
much smaller capital investment to gain the same exposure when equity trading.
TERMINOLOGY:
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Going Long – is when an investor buys a SSF contract to benefit from an increase in the underlying share’s
price.
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Going short – is when an investor sells a SSF contract to benefit from a decrease in the underlying share’s
price.
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Closing a position – this is when investors choose to sell the position if they hold a long SSF contract or buy the
position if they hold a short SSF contract.
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Expiry date – the date at which the SSF contract is set to expire. SSF contracts expire automatically every
quarter on the third Thursday of March, June, September and December of every year. Therefore, contracts
bought in January 2009 will automatically expire in March 2009. All contracts are automatically rolled over to the
next valid expiry date unless investors specifically arrange otherwise with PSG Online in writing.
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Initial margin – the deposit made in order to secure the SSF contract. The exact amount is specified as a cents
per share amount and fixed by SAFEX, but it usually equates to about 15% of the value of the contract.
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Variation margin – the daily process through which the unrealised profits and losses are processed onto the
client’s cash account. Should this account move into a negative balance, the client will be required to settle that
negative balance through either depositing a cash amount or closing positions to the value of the unrealised loss.
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Rolling a position – the quarterly process through which a SSF contract is automatically closed and then reopened with the next dated expiry date for a SSF contract in the same underlying instrument. This is the default
option for all SSF contracts.
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Underlying instrument – SSFs are derivatives because they derive their value from the underlying instrument.
These will be mostly shares listed on the JSE and certain Exchange Traded Funds (ETFs).
HOW TO “GO LONG”
A PRACTICAL EXAMPLE:
Assume that Sasol Ltd shares are trading at R410 and the SSF price is R413.
You have heard that a hurricane is predicted to hit oil rigs in the Gulf of Mexico in the ensuing week,
which may affect output rates due to the damage. You believe that this will cause the price of oil to
increase as supply decreases. You decide to buy a Long SSF and purchase one DEC08 SOLQ
contract which gives you the equivalent exposure of 100 Sasol shares.
The contract value is R41,300 and the initial margin is R6,195. This amount will be taken from your
SSF account and deposited in a trust with SAFEX, which earns interest at the specified rate. Your
exposure is now 1 contract.
The hurricane hits oil rigs in Mexico and this has affected the price of oil causing the share price to
increase by 20%, from R413 to R495. You believe that the share price won’t increase much further
and so decide to close out your position and sell out the one DEC08 SOLQ contract you are holding.
At this point your initial margin along with the difference between the value of the underlying shares
when you opened and closed the contract is refunded which is 100 shares x (R495 – R413) = R8200
which equates to a profit of 132% for an initial capital outlay of R6,195.
The realised profit and initial margin returned are available for new positions immediately, even
though the cash will only be processed onto the trading account at the conclusion of the trading day.
HOW TO “GO SHORT”
A PRACTICAL EXAMPLE:
Assume that Standard Bank shares are trading at R94 and the SSF price is also R95.
You have been doing some research and have found that most economists argue that inflation data
soon to be released will be worse than predicted. You believe these arguments to be true and know
that this news will create negative sentiment in the financial market, causing bank stocks to fall. You
decide to buy a Short SSF and sell two DEC08 SBKQ contracts, which give you the equivalent
exposure of 200 Standard Bank shares.
The value of each contract is R9,500 – therefore R19,000 in total – and the initial margin is R2,850.
This amount will be taken from your SSF account and deposited in a trust with SAFEX, which earns
interest at the specified rate. Your exposure is now two contracts.
The inflation data released is worse than predicted causing markets to fall. Your Standard Bank
shares fall by 4% on the same day as the data is released. The share price decreases from R94 to
R90. You decide to close out your position and sell out the two DEC08 SBKQ contract you are
holding.
At this point your initial margin along with the difference between the value of the underlying shares
when you opened and closed the contract is refunded which is 200 shares x (R90 – R94) = R800
which equates to a profit of 28% for an initial capital outlay of R2,850.
The realised profit and initial margin returned are available for new positions immediately, even
though the cash will only be processed onto the trading account at the conclusion of the trading day.
WHAT ARE THE FEES & CHARGES?
The following fees are involved with SSF trading:
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0.5% (excl VAT) + R60 booking fee
o
o
o
Brokerage at 0.4% (excl VAT) of the value of the transaction
Market maker’s commission at 0.1% (excl VAT) of the value of the transaction
Booking fee of R60 per future code in which a new position is opened per day –
therefore you pay only for the opening leg of all transactions, and only once per day
per future code
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Interest payable on the SSF will be determined daily by the market maker in relation to the
ruling SAFEX rates. The final SSF price will include this interest.
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Interest will be paid on cash balances in the SSF account at the JSE Trustees rate.
HOW IS THE PRICE OF AN SSF
DETERMINED?
Part One:
The following variables are used to calculate the price of an SSF:
 The underlying share price
 Eg R100 in the case of ABSA (ASA)
 The interest to be paid on the total cost of the SSF
 Eg 12.5% on R10,000 (R100 per share * 100 shares per contract) for 3 months
 The dividends that are expected to be paid on the shares held within the SSF
 Eg R5 per share
 Market maker’s commission and brokerage
 Eg 0.5% per transaction
HOW IS THE PRICE OF AN SSF
DETERMINED?
Part Two
The following example will illustrate these costs:
Calculation of a SSF price based on an underlying share
Purchase price of underlying shares (cents)
SSF purchase date
SSF close-out date
Days between purchase date and close-out date
SSF interest rate per year
SSF interest rate up for duration of SSF contract
Market maker's commission and brokerage included in SSF price
Dividend expected (cents)
Dividend adjustment for interest to be earned (cents)
LDT for dividend expected
10000
22 September 2008
18 December 2008
87
11.93%
2.84%
0.50%
300
306
15 October 2008
SSF price including all costs and dividends expected*
10028
* SSF price = Underlying price (adjusted for interest payable)
- Dividend expected (adjusted for interest receivable)
+ Market maker's commission
10284
-306
50
10028
WHAT ABOUT DAILY
MARGIN CALLS?
 All realised profits and losses are processed onto accounts immediately after trading – and
therefore realised profits and returned initial margin will be available for trading
immediately.
 Should positions remain open overnight, they will have produced either unrealised profits
or unrealised losses. These are processed by SAFEX as cash journals on the SSF account.
Therefore, if an account has a cash balance of R5,000 and total unrealised losses of
R7,500 at the close of trading, SAFEX will process the loss of R7,500 on the account to
leave the account with a negative cash balance of R2,500.
 All standard SSF account holders will be required to pay in that R2,500 as variation margin
by 16:00 on the following trading day – regardless of intraday share movements on that
following trading day. If an account holder fails to deposit the required variation margin,
the PSG Online dealing desk will close out sufficient contracts to cover the unrealised loss.
WHAT ABOUT THE SSF
EXPIRY DATE?
SSFs expire every quarter – usually on the third Thursday of March, June,
September and December of each year.
The holder of a SSF may take delivery of the actual underlying instruments, but
this will only be the case if the holder of the SSF has arranged in writing for PSG
Online to take delivery of the instruments. In the absence of any specific
instruction to this effect, PSG Online will simply roll the SSF to the next available
SSF expiry date for the same underlying instrument.
WHAT ABOUT CORPORATE
ACTIONS AND SSFs?
Corporate actions will be processed onto SSF contracts by the JSE and owners
of SSF positions will not be prejudiced by movements in the underlying
instruments.
Dividends expected during any given quarter are priced into SSFs – including
the expected interest to be received on the dividend payment – and therefore
investors do not receive dividends as a cash payment even though they do
benefit from them. By way of a very simple example, if a share trades at R100
and a R5 dividend is expected before the next SSF expiry date, the SSF price will
be R95 because the dividend will be paid out and the share price will fall
commensurately before the SSF expiry date.