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Why investors should warm to single-stock futures deals



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Why investors should warm to single-stock futures deals

Stockbrokers at the Nairobi Securities Exchange. FILE PHOTO | NMG 

Single-stock and index futures are off to a slow start. It doesn’t look like they’re going to take off anytime soon. Open interest – the total amount of outstanding derivatives contracts that have not been settled or closed – was only 63 in the debut quarter ending September.

One contract (Safaricom Single-stock future) dominated trade with an average quarterly open interest of 44. The same single-stock future accounted for 71 percent of contracts traded during the quarter (a total of 349 contracts were traded).

Gross Notional Exposure (GNE) – the total value a security theoretically controls – traded amounted to Sh12.75 million, according to the latest Capital Markets Authority (CMA’s) soundness report.

But before we go any further, what are Single-stock futures? For starters, these are risk-management tools. Institutional investors can now hedge positions on particular securities with newly minted single-stock and index futures. In other words, they give the sophisticated trader a better way to target the market. In our case, the Nairobi Securities Exchange (NSE) NEXT derivatives exchange has on offer contracts on five stocks – Safaricom, Equity, KCB, EABL and BAT – plus the 25 share index.

Each contract comprises 1,000 shares of the underlying security and investors have to put up at least 10 percent of the value. To give an example, if Equity Group is trading at Sh50 a share (its futures contract could be trading at Sh50.5), one needs to put up 20 percent or Sh10,100 (Sh50.5 times 1,000 shares times 0.2) to control 1,000 shares of Equity.


In a typical trade, the investor agrees to deliver shares of a specific stock at a future date. By doing so, they lock in a future price at which to buy or sell the contract, and acts as a hedge. Futures contracts expire on the third Thursday of the contract month.

Nonetheless, investors don’t have to wait until delivery – or expiration, they can settle the contract before the last trading day of the delivery month (March, June, September or December are the settlement months in the case of NEXT).

That said, part of the initial slow start may have to do with the fact that they’re new securities and people need to become more familiar with them. So, in order to get things active, here are two strategies that can juice up this new market.

First is the “matched pairs” strategy which seeks to match pairs of highly correlated stocks. Here an investor trades on the relative value of two stocks in the same industry, such as buying Equity futures and selling KCB futures – if you think Equity’s on the rise and KCB is sinking. This offers a better return and risk ratio than picking the next hot stock.

Second is the custom strategy. Here the investor is able to customise their exposure to a market index. For instance, if you believe a market crash is coming, however, you believe Safaricom would not be affected. You can short-sell the 25 share index futures and buy the stock in the normal market. That way, one gets to exercise their market theory.

All in all, the new market shows a lot of promise. It presents a new way to transfer risk. Investors should warm to the idea.

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