Single Stock Futures ( SSF ) Simple and constant gearing

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1 Single Stock Futures ( SSF ) Simple and constant gearing 1

2 Content Situation 3 Simple geared share trading simple constant gearing single stock futures Solution 4 What are single stock futures? 5 Gearing 6 Margins 7 Liquidity 8 Pricing Success factors 10 Fees 11 Why use single stock futures 12 That s great, but what should I be aware of? 14 Why Deutsche Bank? 15 Important notice 16 Make a well-informed decision Annexure A How do we work together? A1 South African SAFEX members A2 South African non-safex members A3 Non-South African s 2

3 Simple geared share trading Cheap exposure Geared returns Short sales Simple Cheap and geared There are many investors who have strong views on the expected movement in a particular company s share and would like to benefit to the maximum extent possible from this predicted price movement. They may however have cash flow constraints that may restrict them from purchasing the Rand exposure to the share they would ideally like to have. Single Stock Futures ( SSF ) allow an investor to either purchase exposure to a company s share for 10% 1 of the initial value; or purchase 10 1 times the exposure to a company s share for the same initial value What happens if the investor does not in fact own the shares currently but would still like to benefit from this price movement? The majority of retail investors are not in the same position as institutional investors, as they do not have the option of borrowing shares in order to enter into a short sale. Their only option is therefore to short a SSF. This opens up a number of trading strategies to the retail investor that would otherwise not be available long / short trades long / short portfolios reduce or remove to a large degree market risk from their portfolio Simple Short sales An investor may have a view that a company s share that he currently holds will decrease in value in the next month but still believes that there is long term value what are the alternatives? The investor can either sell the share today and then buy back at a lower price in a months time; or enter into a short SSF contract and close the contract out in a months time The SSF can be viewed as a simple and cost efficient (but potentially more risky) way of gearing an investors participation in upward or downward price movement of shares without having to consider the additional complexities of probability or optionality that are traditionally associated with share instalments, warrants and waves. 3

4 What are Single Stock Futures? Exchange traded forward contracts Deutsche Bank Exchange traded forward contracts A SSF contract is a forward contract that is listed on the SAFEX exchange. The contract creates a legal obligation between a buyer and a seller to buy or sell a specified underlying share at the exchange delivery settlement price ( EDSP ) on the exchanges pre-defined settlement date ( closeout date ). In South Africa there are 4 quarterly closeout dates annually, which are set as the third Thursday of March, June, September and December (or the previous business day). Each SSF contract is equivalent to being exposed to 100 of the underlying shares. If an investor bought 1 share of Company A at a market price of R10 his Rand exposure is R10. In contrast if an investor bought 1 SSF on Company s A shares at a market price of R10 his Rand exposure is R1,000 (1 SSF * 100 shares * R10). The SAFEX exchange does not require the investor to pay for his entire exposure upfront, but rather only requires the payment of 10% 1 of the Rand exposure, this is called the initial margin. The exchange then requires the daily settlement of the profit or loss on the SSF contract, this is called the variation margin. If the investor is long the SSF and the underlying share increases in value the variation margin call will result in a positive inflow for the investor (and vice versa). The SAFEX exchange guarantees counterparty credit and settlement through these margining requirements. Deutsche Bank The Deutsche Bank team are a part of the Deutsche Bank South Africa Equity Derivatives team that were ranked #1 Equity Derivatives team in South Africa in 2006, while at the same time leveraging the global capabilities of Deutsche Bank and their global structured products service offering. The structured product range currently offers JSE Limited exchange listed warrants, waves, local and offshore exchange traded funds and listed certificates ( This structured product offering is now complimented with SSF market making. The Deutsche Bank team do not have a retail stock broking service offering and as such retail investors will need to trade SSF s through their brokers. The Deutsche Bank team does however provide SSF market making and broking services to South African and Foreign institutional clients. 4

5 Gearing Geared returns Constant gearing Geared returns As an investor if you have R1,000 to invest and believe, based on your analysis, that the price of the shares of Company A are going to increase in value from R10 to R11 in the next 30 days, what are your alternatives in order to participate from this price movement? Alternative 1 : Shares Purchase 100 shares of Company A for R1,000 (100 * R10). At the end of the 30 day period sell your share for R1,100 (100 * R11). Your profit is R100 (R1,100 R1,000), or expressed as a % return, 10% (R100 / R1,000) Alternative 2 : Single Stock Future Purchase 10 SSF s on Company A shares which would cost you R1,000 in your initial margin that is payable immediately and give you exposure to 1,000 shares (or R10,000 of Company A s shares). At the end of the 30 day period sell your single stock future. Your profit is R1,000 (R2,000 R1,000), or expressed as a % return, 100% (R1,000 / R1,000). Extremely important to understand is that losses are also geared when the share price of Company A moves in the opposite direction to your expectations. In the above example you would loose R1,000 if the share price moved from R10 to R9 (refer Appendix for detailed calculations). Constant gearing A SSF price moves 1:1 with the movement in the underlying share price. Unlike options (e.g. share instalments, warrants, waves, etc.), which have probability factored into the options price, which means the option moves asymmetrically relative to the movement in the underlying price, the future gearing is obtained through the use a constant margin requirement of 10% 1. This example reflects the gearing that is inherent within the SSF. For the same investment of R1,000, using the SSF you were able to gear your return 10 times (R1,000 / R100) using the SSF. 5

6 Margins Initial margins Variation margins / Margin calls Margin balances The secret to the gearing of the SSF s lies in a concept called margining. A SSF is just a contract to buy or sell a company s share on a specified date in the future at a specified price. This could also be called a forward contract. The difference is that the futures contract is listed on an exchange. In the South African market the exchange used for all Company share based futures is SAFEX. Initial margin SAFEX guarantees the settlement of all SSF s contracts and manage their risk by requiring every party to deposit 10% 1 of the value their futures position at inception of the trade with SAFEX ( initial margin ). SAFEX will in certain circumstances allow for set-off of initial margin requirements across multiple positions underlying's on related entities position in 2 consecutive expiries positions across index futures Variation margin As the underlying share price changes so will the value of the related SSF. If the value of the SSF increases SAFEX will credit your account with the increase in value (profit). On the same basis if the value of your SSF decreases in value you will be required to deposit this decrease (loss) with SAFEX. These deposits are referred to as variation margins or margin calls and they are calculated and payable on a daily basis based on closing market prices. Margin balances SAFEX will pay interest based on daily overnight interest rates on any balances in the investors margin account. Any balance in the margin account over and above the initial margin is available for withdrawal by the client on a daily basis. The initial margin is available for withdrawal as soon as the position is closed out by the investor. 6

7 Liquidity Market structure Market structure investors broker safex market maker Market maker Trading services Investors who would like to trade SSF will need to open an account with a SAFEX registered broker, who will facilitate all SSF trades with SAFEX on the clients behalf. Market Maker Market makers effectively provide investors in SSF with financing; and liquidity Investors would like to know that any time they can either buy or sell a SSF at current market prices and in the size that they are looking for. The market maker guarantees that an investor will always have a counterparty to trade with, at the time the investor wants to open their position and/or at the time the investor wants to close their position. As a result market makers are generally large banks or financial institutions that can effectively use their balance sheets to hedge the SSF position. An investor can close out a SSF position at any time during the life of the contract prior to expiry by entering into the opposite trade to their current position, adjusted for any cost of carry left to contract expiry. Where a SSF contract is held to maturity the investor will be required to settle the physical shares (buy or sell). The alternative is for the position to be rolled forward to the next SSF contract period. Although the investor only deposits 10% 1 of his SSF position, the market maker, in order to hedge themselves will go and buy 100% of the exposure in the underlying shares, effectively funding 90% of the investors position. An important attribute of a market maker is that they do not trade against the investor. Although the market maker holds the opposite SSF position to the investor they immediately go and hedge their position by buying (or selling) the underlying company shares equivalent to the SSF position (the delta ) so as not to have any exposure to market movements. The market maker makes money by charging a SSF commission, similar to the commission charged by the broker to the client. The market maker commission is included within the SSF price paid by the investor, whereas the broker commission is charged separately by the broker. Trading services With access to the Deustche Bank South African cash trading desk we are able to facilitate large trade sizes where investors require us to assist in purchasing the underlying shares at a specified level. 7

8 Pricing Buying ( going long ) Selling ( going short ) Long Short Cost of carry Dividends Cost of borrowing Spot share price - Dividends + Cost of carry + Commission SSF Price Spot share price - Dividends + Benefit of carry - Cost of borrowing - Commission SSF Price market maker has to buy the delta position and therefore borrows the money to fund the purchase and pays interest on this funding (cost of carry) market maker has to sell the delta position and therefore has to borrow the delta position on which he gets charged a borrowing fee market maker receives cash from the sale of the delta position and passes on the interest received (benefit of carry) Dividends The cost of the SSF is always reduced by the value of the predicted dividends. This is because the holder of the SSF is not entitled to receive dividends. Cost / Benefit of carry 1 + ( funding rate * ( days to expiry / 365 ) ) Cost of borrowing The cost of borrowing is determined by the Deutsche Bank South Africa script lending desk and depends on the liquidity and availability of the related shares 8

9 Pricing Example data 2 Examples Spot share price: Forecast dividend: Lending interest rate: Deposit interest rate: Scrip lending rate: R R % 8.75% 0.6% Trade date: Next close out date: Days to SSF contract expiry: Trading period: 1 April June Fees: 0.15% Buying ( going long ) Selling ( going short ) Opening position Spot Dividend (1.00) 2 Cost of carry SSF Fair Value Fees SSF Traded Price ====================== 2 (( ) * (9.5% * (81 / 365))) 3 ( * 0.15%) Opening position Spot Dividend (1.00) Benefit of carry Cost of borrow 5 (0.13) SSF Fair Value Fees 6 (0.15) SSF Traded Price ====================== 4 (( ) * (8.75% * (81 / 365))) 5 (( ) * (0.60% * (81 / 365))) 6 ( * 0.15%) Closing position Spot Dividend (1.00) 2 Cost of carry SSF Fair Value Fees (0.15) SSF Traded Price ====================== 2 (( ) * (9.5% * (76 / 365))) Closing position Spot Dividend (1.00) Benefit of carry Cost of borrow 5 (0.12) SSF Fair Value Fees SSF Traded Price ====================== 4 (( ) * (8.75% * (76 / 365))) 3 ( * 0.15%) 5 (( ) * (0.60% * (76 / 365))) 6 ( * 0.15%) 9

10 Fees Open and close Conversion Open and close Intra day Roll over Conversion Volume trades Trading costs All trades to open and close positions will be charged at 15 basis points (0.15%) dividend assumptions will be kept constant interest assumptions will be kept constant Intra day Where a trade is opened and closed within the same trading day opening the position will be charged at 15 basis points (0.15%) closing the position will be charged at 5 basis points (0.05%) Roll over Where an investor would like to convert their SSF position into the underlying shares the conversion will be charged at 10 basis points (0.10%) Volume trading Please contact your relationship manager in order to discuss a customised service and fee solution. Trading cost Trading costs will depend on clients operational requirements and should be confirmed with their service providers. Where an investor would like to roll their SSF position over to the next SAFEX expiry date contract, the rolled contract will be charged at 10 basis points (0.10%) dividend assumptions will be revised interest assumptions will be revised 10

11 Why use single stock futures Gearing Free up capital Gearing Short sales Hedging Cheap Fee up capital Pairs The fact the investor only has to pay 10% 1 of his initial exposure provides geared investment returns from 10 times, Short sales The ability to short the SSF gives the retail investor access to short sales, which he would otherwise not have had, allowing him to benefit from falling share prices. As the investor is only required to commit cash of 10% 1 of the value of his exposure, he has effectively freed up 90% of his capital to invest in alternative vehicles. Trading strategies The access to the ability to short sell opens up trading strategies that would otherwise not be available to the retail investor. Hedging The SSF can be used as a cheap alternative to hedge a position in a particular share. This is particularly relevant where the investors long term view is positive and that they would like to be invested in share, but believes that the share will decrease in value in the short term. An example of this is pairs trading. This involves buying one share and selling another attempting to profit from the relative outperformance. Cheap The market makers spread is very competitive with less than or equal to 15 basis points charged in all scenarios. 11

12 That s great, but what should I be aware of? Geared downside risk Dividend assumptions Special dividends Interest rates Geared downside risk Investors should be aware that to the same extent that they are geared to the upside should the market and/or share price move in their favour, so they are equally exposed to the downside should the market turn against them. This may be particularly relevant where liquidity in the underlying shares becomes an issue preventing the investor and the market maker from closing their positions. Special dividends Any special dividends declared that had not been factored into the SSF price will be adjusted for by SAFEX. SAFEX will calculate the impact that the special dividend has on the SSF price. They will then allocate additional SSF contracts to the investors portfolio at no cost. This puts the investor in the same position as he was before the special dividend declaration. Dividend assumptions All dividend assumptions are based on the forecasts of the highly rated Deutsche Bank equity research team. Interest rates The Deutsche Bank team uses the Deutsche Bank South Africa interest rate trading desk in order to get competitive borrowing and lending rates in the market to price the SSF. The Deutsche team does not look to benefit (nor loose) from a situation where the actual divided paid was greater than what was priced into the SSF based on dividend forecasts. Any adjustment necessary will be made retrospectively. The Deutsche team does not look to benefit (nor loose) from a situation where the actual interest rate differs to that priced into the SSF on opening the position. Where there are changes in the underlying interest rate/s during the period of the SSF the prevailing interest rates at time of opening the position will be used when calculating the SSF price for closing out the position. Due to the largely insignificant impact any interest changes have on the SSF price no adjustments are generally made for short dated contracts. 12

13 That s great, but what should I be aware of? No direct market access The right contract EDSP No direct market access The current Deutsche Bank / Perfix solution although offering numerous efficiencies, will initially not allow for direct market access for clients / brokers. The requested trades will be monitored by the Deutsche Bank trading desk but will be manually authorised prior to be entered into the market. On the basis of ongoing trading relationships this structure will be reviewed to potentially consider a direct market access environment. The right contract Unlike shares, SSF s expire and must therefore be closed out, rolled over or exercised on or before expiry date. Therefore the timing of the SSF s purchase should be based on fundamental and/or technical analysis. Exchange delivery settlement price ( EDSP ) On the day of futures close out the final value as set by SAFEX for settlement of all futures contracts is determined over a 100 minute period. The futures price is taken every minute for 100 minutes between 12h00 and 13h40 and the average of these prices is the final settlement price. This can lead to large volatility during this period which investors should be aware of. As an investor it may be more prudent to either close-out or roll your SSF position prior to this period. 13

14 Why Deutsche Bank? Strategic relationship Price transparency Strategic relationship Service levels Tight spreads Price transparency Supplementary services The Deutsche Bank team does not have a retail distribution network within the South African market and does not effectively compete with its client base by offering product to the retail market space. As a result we look to create true mutually beneficial partnerships that leverage the Deutsche Bank product expertise with the retail distribution expertise of our partners. Service levels The Deutsche Bank team is focused on delivering quality and transparent product combined with superior service levels. This is an ongoing process and will largely depend on client and partner feedback on where we can improve our service levels in order to develop long lasting mutually beneficial partnerships. Tight spreads All inputs (interest, dividends, etc.) used in order to determine the SSF price are made completely transparent to the investor, alleviating debate and clarity to SSF pricing. Systems Deutsche Bank is committed to providing the most efficient and effective solution to trading SSF. The team is committed to investment in systems where enhancements are required or integration with clients is a necessity. Supplementary services Clients that generate significant SSF business volume would potentially qualify for access to the additional supplementary services provided by Deutsche Bank. This could include access to certain levels of market information flow, research material, conferences, et al. Access to the global Deutsche Bank interest rate trading and stock borrowing desks allows Deutsche Bank to use wholesale lending and borrowing rates to provide the competitive pricing otherwise unavailable to the retail market. 14

15 Important notice Past performance is no guarantee of future returns. Neither is any form of guarantee made that an investment instrument described herein will generate positive returns. Although the information contained herein has been obtained from sources that are believed to be reliable, no liability is accepted for its accuracy, completeness or fairness. Opinions and estimates may be changed without notice and involve a number of assumptions, which may prove invalid. A single stock future which is denominated in a currency that is not the investor s local currency is subject to exchange rate fluctuations that may have a negative effect on the value, price, or yield of the security. Single stock futures are not suitable for all types of investors and an investment could have legal and tax implications and investment risks. It is therefore necessary to seek professional advice before making any investment. Investors are urged to seek advice from a tax or financial advisor before making investments. Please contact the appropriate Deutsche Bank representative for clarification on any of the features of Single Stock Futures. Footnotes 1 Margin requirements are set by SAFEX and may vary based on underlying. Private client stock brokers may also choose to set their own margin requirements for their client base. 2 Examples are based on information at the time of drafting of this brochure. For updated information please contact the Deutsche Bank team. Examples are based on the purchase of 1 share or 1/100 th of a SSF contract. 15

16 Make a well-informed decision Notes 2007 Deutsche Bank AG London. The above information represents a brief summary of the securities presented in this document. For the complete terms and conditions of the instrument please contact Deutsche Bank. The information provided in this document does not constitute investment advice; its sole purpose is to provide a description of the product. Investment decisions should always be made on the basis of the relevant prospectus. All statements of opinion reflect the current assessment of Deutsche Bank, which may change without prior notice. Although the information herein has been obtained from sources believed to be reliable, Deutsche Bank does not guarantee its accuracy, completeness or fairness. Past performance is no guarantee of future returns. 16

17 Single Stock Futures simple constant gearing price transparency low transaction costs guaranteed settlement Further information Internet: Sales: Trading: References JSE Single Stock Futures: March 2007 Deutsche Bank AG London This brochure has been printed on environmentally friendly paper. 17

18 Annexure A : How do we work together? South African SAFEX members South African SAFEX members South African non- SAFEX members In order for South African investors and brokers to efficiently use the Deutsche Bank market making services there are a number of different alternatives depending on needs, preferences and current technology solutions. Non-South Africans Perfix Perfix + OD Perfix + Market Maker Delta SAFEX + OD SAFEX + Market Maker Delta The characteristics of these individual solutions have been set out in Annexure A. South African non-safex members Refer to Annexure B for the section on South African non-safex members. Non-South Africans Refer to Annexure C for the section on Non-South Africans. 18

19 Annexure A1 : South African SAFEX members Perfix Perfix Delta management + SSF management Perfix is an independent application that has been developed and is managed and supported by Peresys. The application is an internet browser application that provides brokers and market makers with tools in order to efficiently manage their SSF trading positions. broker single trade capture brokers perfix market makers perfix SSF trade equity trade safex safex jse The broker and the market maker each have a contract with Perfix with their own customised Perfix views and they interact as follows broker captures the quantity of shares he wishes to buy and the price at which he would like to buy them on his Perfix view the trade appears on the market makers view to check and accept the trade once the market maker has bought (or sold) the shares (referred to as the delta as relates to the delta hedge required to be done by the market maker) he marks the shares as dealt Perfix manages booking process with the JSE directly through its Hermes platform Perfix takes the dealt trade details and automatically books the SSF leg to SAFEX 19

20 Perfix + OD Perfix jse SSF management OD Delta management equity trade OD equity trade broker SSF trade brokers perfix market makers perfix SSF trade safex safex This option is generally preferred by investors and / or brokers when broker manages all his positions SSF using the Perfix application broker already has the underlying shares and would like to convert position from a cash position to a SSF position broker prefers to control the trading of the underlying shares in order to ensure he gets a price for the entire position that he is comfortable with broker has bandwidth issues and is concerned that the delay in data feeds between his Perfix trading environment and the market makers Perfix trading environment may cause him to miss a price at which he would have liked to have traded It is important to understand that the additional cost implications in this scenario As the broker has to trade the equity he would pay the related transaction fees rather than the market maker picking up these fees for trading the delta The main differences between this alternative and the complete Perfix solution are as follows broker calls the market maker to arrange to OD (transfer the Option Delta) the shares to the market makers account instead of the market maker trading the delta 20

21 Perfix + Market maker delta Perfix SSF management Maret maker Delta management jse phone call equity trade broker SSF trade brokers perfix market makers perfix SSF trade safex safex This alternative is generally preferred by investors and / or brokers when broker uses Perfix to manage all his SSF positions broker has bandwidth issues and is concerned that the delay in data feeds between his Perfix trading environment and the market makers Perfix trading environment may cause him to miss a price at which he would have liked to have traded The main differences between this alternative and the complete Perfix solution are all positions of both the investor / broker and the market maker are managed using custom applications 21

22 SAFEX + OD SAFEX SSF management OD Delta management jse equity trade OD equity trade broker SSF trade safex safex This alternative is generally preferred by investors and / or brokers when broker does not have Perfix and manages his SSF positions using custom applications broker already has the underlying shares and would like to convert position from a cash position to a SSF position broker prefers to control the trading of the underlying shares in order to ensure he gets a price for the entire position that he is comfortable with The main differences between this alternative and the complete Perfix solution are all positions of both the investor / broker and the market maker are managed using custom applications the investor / broker controls the price of the underlying shares at which the SSF is traded 22

23 SAFEX SSF management Market maker Delta management SAFEX + Market maker delta jse phone call equity trade broker SSF trade safex safex This alternative is generally preferred by investors and / or brokers when broker does not have Perfix and manages his SSF positions using custom applications broker would like the market maker to trade the delta on his behalf The main differences between this alternative and the complete Perfix solution are all positions of both the investor / broker and the market maker are managed using custom applications 23

24 Annexure A2 : South African non-safex members Perfix Perfix SSF management Perfix is an independent application that has been developed and is managed and supported by Peresys. The application is an internet browser application that provides non-safex members with tools in order to efficiently manage their SSF trading positions. client single trade capture client perfix market makers perfix deutsche safex account client sub-account market making sub-account SSF trade SSF trade equity trade safex safex jse The market maker has a contract with Perfix who installs and supports customised views for both the market maker and the client who interact as follows client captures the quantity of shares he wishes to buy and the price at which he would like to buy them on his Perfix view the trade appears on the market makers view to check and accept the trade once the market maker has bought (or sold) the shares (referred to as the delta as relates to the delta hedge required to be done by the market maker) he marks the shares as dealt Perfix manages booking process with the JSE directly through its Hermes platform Perfix takes the dealt trade details and automatically books the two SSF leg to SAFEX to the market makers account, one leg in the clients subaccount and the other leg in the market-makers sub-account. 24

25 SAFEX SAFEX SSF management client phone call deutsche safex account client sub-account market making sub-account SSF trade SSF trade equity trade safex safex jse This alternative is generally preferred by clients when client does not have Perfix and manages his SSF positions using custom applications client would like the market maker to trade the delta on his behalf The main differences between this alternative and the Perfix solution are all positions of both the client and the market maker are managed using custom applications 25

26 Annexure A3 : Non-South Africans Non-South African Client non south african margin calls margin payment single trade capture perfix w eb front end Internet Deutsche Johannesburg perfix server Deutsche London jse safex equity trade SSF trade market makers perfix DB-L Reference safex SSF trade client view perfix DB Operations team DB Operations team DB-L reference Perfix DB-L reference Perfix Telephone An non-south African that would like to trade South African SSF s will need to have a clearing relationship with Deutsche Bank London. This involves obtaining a DB-L reference number. New clients will need to undergo compliance and credit approval. This DB-L reference will allow the Deutsche Bank London operations team to incorporate the South African SSF margin calls and the related settlement processes as part of the international futures margin and settlement processes. The DB-L reference number in London will be associated with a SAFEX account. The SAFEX account will be a client (sub-account) of Deutsche Bank Johannesburg who is the registered SAFEX member. The non-south African client will be granted a user and password to log onto a secure internet site allowing them to capture their SSF orders. Deutsche Bank Johannesburg will book the client positions and pass the positions over to Deutsche Bank London to manage settlement with the client. Telephone Where the client would prefer not to use the Perfix solution the alternative is to call the Deutsche SSF trading desk. The trading desk will facilitate and book all necessary trade data and then hand over to the operations team to settle through the DB-L reference number and related process. 26

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