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Bet big, or lose your shirt

Single stock futures are steadily overtaking warrants as the drug of choice for those in search of investment thrills.

Stories abound of individuals making profits of 50% or even 100% on single stock futures (SSFs) over two or three days, but less well told are the stories of investors nursing monstrous losses over a similar time frame.

A SSF is a futures contract on an individual share, and there are about 176 JSE Securities Exchange-listed stocks on which SSFs are issued. Like most futures contracts, SSFs expire every March, June, September and December, which makes them popular with short-term traders.

Each SSF contract entitles the holder to acquire 100 of the underlying shares at the price quoted on the day of purchase, for settlement in any one of these four months. Very few traders hold SSFs this long as they are not interested in buying the underlying shares. They want to profit from very short-term moves in share prices, and it’s not uncommon for shares to move 10% in a week or two, which can translate into a 100% profit (or loss) for the SFF trader.

Allan Thompson, director of equities and derivatives trading at the JSE, says SSF volumes have trebled in the past two years, with upwards of 120 000 contracts trading per day.

”This makes the JSE the fourth-largest SSF exchange in the world. There is huge interest in SSFs from retail investors looking for alternatives to shares that offer gearing, flexibility and low trading costs.”

The main attraction of SSFs is gearing — the ability to make large profits (or losses) on relatively small movements in the underyling share. Another advantage is the ability to profit from rising and falling markets. Share investors typically buy shares in the hope of profiting from a price rise (known as ”going long”), but ”shorting” an SSF allows the investor to profit from an anticipated price drop. This allows investors with share portfolios to hedge against expected market declines.

Take an investor who has 1 000 Anglo American shares, currently worth about R155 000 on the JSE, who believes the share price is about to drop. Rather than sell the portfolio — which incurs costs of about 2% — the investor is able to ”short” an equivalent value of Anglo American shares via SSFs at 10% of the share value, or R15 500. This assumes the investor chooses a gearing factor of 10 times. Any drop in the share price is made up through profits on the SSFs, resulting in no loss of capital to the investor, other than costs of about 1% on the SSF investment.

Assume Anglo’s share price drops by about 5% to R147, a loss of about R8 000 on the original capital of R155 000. The investor would have made roughly the equivalent profit by shorting SSFs, a return of 50% on the initial capital outlay of R15 500.

Most SSF volumes are generated by traders who bet that the market will move either up or down. This is the high-risk end of the market and most use charting systems to fine-tune their points of entry and exit. One such programme is Instaquote, which has about 2 500 users in South Africa, according to the company’s CEO Rick Potgieter. The software has been tailored for SSF trading and includes newsletters pointing out potential buys and sells on the JSE.

Edwin Smit, SSF specialist at Equity Derivatives Investment in Pretoria, says the company runs regular workshops to educate clients on the benefits and pitfalls of SSF trading. ”The biggest problem we find among losing clients is poor money management. This is not an activity for someone in financial distress, looking for a quick way out.”

Those who are able to withstand the occasional losses and spread their SSF exposure over several underlying shares will generally survive to fight another day and perhaps make a respectable profit.

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Ciaran Ryan
Guest Author

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