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The recent slump in equity markets has brought home the harsh reality that “buy and hold” strategies might have run their course. The current environment calls for a complete re-thinking of investment techniques. This needs not be complicated as the financial services industry now offers flexible and efficient tools that allow investors to manage their risk and take advantage of opportunities in adverse market conditions.
After the longest bull market in history investors start to appreciate that stocks can indeed head south for a long period of time but that doesn’t necessarily mean that they should sit and watch while the value of their portfolios is being destroyed.
Traditionally increased volatility in financial markets has always meant increased opportunities for the active investor who knows how to select the right tool at the right moment. However until recently most of these tools were only available to the professional traders.
All this has changed with the introduction of Euronext.liffe’s Universal Stock Futures (USF). Launched in January 2001 these contracts are futures listed on a range of 113 international stocks and they are offered by Easy2Trade as an attractive alternative to trading cash equities.
USF combine the benefits of trading shares on margin and the possibility to trade individual stocks across 13 different markets through one single entry point in one neat package.
One of USF main advantages is to allow investors to “play” the downside of a stock without having to borrow the underlying stock or trading complicated OTC instruments. USF are traded electronically in a centralised, transparent market where the liquidity is guaranteed by a group of designated market makers. These market makers are usually large investment banks or specialised market making firms. This means that investors are sure that there will always be a price in the market at which they can trade out of a position. The contracts have a maturity of up to six months and closely track the price changes of the underlying stock. At maturity investors have the choice to let the contracts expire or “roll” them into a longer maturity.
Compared with a traditional investment in a cash stock, two additional advantages of USF are that they offer the possibility to trade UK stocks free of stamp duty, and that investors don’t have to put up all the value of the investment but only a fraction of the amount. This is called “initial margin”.
In order to trade USF through Easy2Trade we will require investors to deposit £5,000 to open an account and we will charge £4.00 per lot, per transaction.
But let’s concentrate on some practical examples of how to use USF to profit from the opportunities created by the existing weakness in equity prices.
Example 1 – Play the downside of the market
In the period from 14 January 2003 to 2 February 2003 shares in Vodafone went from 125.5p down to 108.75p. In % terms it represents a loss of more than 13% in sixteen trading days.
One of the characteristics of USF is that one contract represents a fixed number of underlying shares. In the case of Vodafone the number of shares is 1,000. This is also known as the “size” of the contract.
14 January 2003
Vodafone shares cash price 125.50p
USF Vodafone March 2003 125.75p
Sell to open 1 USF March 2003 @ 125.75p
Margin requirement £150.00
Transaction cost £ 4.00
2 February 2003
Vodafone shares cash price 108.75p
USF Vodafone March 2003 110.50p
Buy to close 1 USF Vodafone March 2003 @ £110.50
Transaction cost £ 4.00
Gross profit = ((125.75p-110.50p)1,000)1 £152.50
Net profit = £152.50 - £8.00 £144.50
Return on investment 96%
Investment is represented by the initial margin of £150
Example 2 – Managing risk of an existing investment
USF can be sold short in order to manage risk in a portfolio and “freeze” the performance of an existing investment by establishing an opposite position. Euronext.liffe’s USF track the price movements of the underlying shares and by using them the investor can “neutralise” the fall in value of his existing position thus offsetting his risk without being forced to sell his shares at a loss.
On 14 January the investor could have sold short 1 USF contract expiring in March 2003 to cover his holding of 1,000 shares. The price he would have obtained for such a sale would have been 125.75p. On 10 February 2003 he could have closed his position by buying back the contract at 112.00p. The profit realised in the short USF position would have compensated the loss on the position in the portfolio.
Unprotected portfolio
14 January 2003
Long 1,000 Vodafone shares @ 125.50p
2 February 2003
Long 1,000 Vodafone shares @ current price 108.75p Total loss £162.50
(125.50p – 108.75p) x 1,000 shares
10 February 2003
Long 1,000 Vodafone shares @ current price 112.00p Total loss £135.00
(125.50p – 112.00p) x 1,000 shares
USF protected portfolio
14 January 2003
Long 1,000 Vodafone shares @ 125.5p
Short 1 USF March 2003 @ 125.75p
2 February 2003
Long 1,000 Vodafone shares @ current price 108.75 Loss £167.50
Short 1 USF March 2003 @ current price 110.50 Profit £152.50
Total position profit/loss -£15.00
10 February 2003
Long 1,000 Vodafone shares @ current price 111.75 Loss £137.50
Short 1 USF March 2003 @ current price112.00 Profit £137.50
Total position profit/loss £0.00
excluding transaction costs
Example 3 – Shorting an international stock
Another point in favour of USF is that they can be used to access international markets without having to set up costly separate accounts with local brokers. This is a major benefit for investors who want to broaden their horizons and take advantage of opportunities worldwide in an efficient and cost effective way.
On 3 December 2002 Nokia was trading at €18.33. An investor who took a negative view on the stock could have sold short through Easy2Trade 1 USF Nokia March 2003 in order to take advantage of the potential downside.
3 December 2003
Nokia shares cash price €18.44
USF Nokia March 2003 €18.69
Sell to open 1 USF March 2003 @ €18.69
Margin requirement €220.00
Transaction cost £ 4.00
10 February 2003
Nolia shares cash price €12.62
USF Nokia March 2003 €12.76
Buy to close 1 USF Nokia March 2003 @ €12.76
Transaction cost £ 4.00
Gross profit = ((€18.69-€12.76)100)1 €593.00
Net profit = £392.00 - £8.00 £384.00
The contract size for Nokia USF is 100 shares per contract. Nokia contracts are physically settled
£/€ exchange rate 1.51
The last example highlights how with USF investors can start to take advantage of opportunities across the border through one single entry point and without having to contend with different market rules – USF are regulated by the FSA - and complicated settlement systems. All USF are traded on the same trading platform and cleared through the same clearing house: the London Clearing House.
Summary
At Easy2Trade we pride ourselves on being able to offer cutting edge financial products to investors. It is therefore natural that a product that has being defined by Richard Sandor one of the fathers of the futures markets “A revolution in equity trading” is part of product palette. The conclusion that maybe better encapsulates the essence of this product is to be found in the study on single stock futures published by David Lascelles, professor at Reading University and Co director of the Centre for the Study of Financial Innovation:
“The more global that markets become, the more that investors take an active interest in their holdings, and the more value is at stake on stock exchanges, the more investors will want ways to manage their affairs quickly and cheaply. This report has stressed the efficiency of dealing in stocks through Single Stock Futures. Equally important, though, is the fact that users of LIFFE and the US exchanges will be able to deal in large numbers of stocks from leading industrial countries through a single exchange and settlement system. This is very new.”
D. Lascelles
“Single stock futures the ultimate derivatives”
CSFI – January 2002
David Wenman is Chief Executive Officer at Easy2Trade. Easy2Trade is the new way to access the world's financial markets online. Delivered over the Internet directly to your PC, Easy2Trade offers an easy to use and competitive execution-only and clearing futures trading service. For a free demonstration of the Easy2Trade online trading platform for futures go to www.easy2trade.com
Easy2Trade are a LIFFE Market Designated Broker.
For more information about Universal Stock Futures including free live prices and a simulated trading game, visit www.liffeinvestor.com or call 020 7379 2200 for a free information pack.
USF contract specifications
Universal Stock Futures (cash settlement) on UK Shares
Unit of Trading One future normally represents 1,000 shares
Delivery Months Nearest 2 of March June September December, plus nearest two serial months such that the nearest three calendar months are always available for trading
Last Trading Day Third Wednesday of the delivery month
Settlement Day First business day following the last trading day
Quotation pence per share
Minimum Price Movement
(Tick Size) 0.5 pence
0.25 pence
Tick Value £5.00
£2.50
Trading Hours 08:00 - 17:00 (London time) ), Last Trading Day 08:00 - 16:30 (London Time)
Universal Stock Futures (cash settlement) on Continental European Shares
Unit of Trading One future normally represents 100 shares, except for Italian futures where one future normally represents 1,000 shares
Delivery Months Nearest two of March, June, September and December, plus nearest two serial months such that the nearest three calendar months are always available for trading
Quotation Euro per share
Sweden SEK per share
Switzerland CHF per share
Minimum Price Movement
(Tick Size) €0.01
Sweden SEK 0.01
Switzerland CHF 0.1
Tick Value €1.00
Italy €10
Sweden SEK 1.00
Switzerland CHF 10
Last Trading Day Germany, Ireland, Netherlands, Spain, Sweden, Switzerland: third Friday of the delivery month
France: Penultimate business day of the delivery month
Italy: Business day immediately preceding the third Friday
of the delivery month
Settlement Day France, Germany, Ireland, Netherlands, Spain, Sweden, Switzerland: First business day following the Last Trading Day
Italy: Two business days following the Last Trading Day
Trading Hours France, Ireland, Italy, Netherlands, Spain, Sweden, Switzerland: 08:00-17:00, Last Trading Day 08:00 - 16:30
Germany: 08:00-18:00, Last Trading Day 08:00 - 19:00
Universal Stock Futures (physical delivery) on Continental European Shares
Unit of Trading One future normally represents 100 shares
Delivery Months Nearest two of March, June, September and December, plus nearest two serial months such that the nearest three calendar months are always available for trading
Quotation Denmark DKK per share
Euro per share
Norway NOK per share
Minimum Price Movement
(Tick Size) €0.01
Denmark DKK 0.5
Norway NOK 0.5
Tick Value €1.00
Denmark DKK 50
Norway NOK 50
Last Trading Day Denmark, Finland: third Friday of the delivery month
Norway: third Thursday of the delivery month
Settlement Day Denmark, Finland, Norway: Fourth business day following the Last Trading Day
Trading Hours Denmark, Finland: 08:00 - 16:30, Last Trading Day 08:00 - 16:00
Norway: 08:00 - 16:30 (London Time), Last Trading Day 08:00 - 15:00 (London Time)
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