Wednesday, January 23, 2008

Short-selling Part 4 1 comments



(P.S: Sorry for any disturbances the advertisements above may have caused you)
Derivatives, and warrants in particular, have become very popular instruments on the SGX over the past few years, and the SGX must be given credit for its successful promotion of this instrument the second time round (the first attempt in the 90s fizzled out). As more and more issuers enter as market-makers, there is now a critical mass and warrants form a substantial part of market trading volume.

For shorting in particular, exposure via derivatives is the cheapest method of all the alternatives, and the main instruments are index futures and put warrants. Cheap because there are no ridiculous financing costs as in the case of CFDs or SBL, although there still exist time expiry for both instruments.

Index futures on the SGX are offered for several North Asian markets and of course the local market, among which the Hong Kong index futures has become wildly popular due to its strong bullishness. Futures are very simple. You either go long (ie. bullish) or short (ie. bearish); the contract parties are the longist and the shortist. Typically both parties only have to put up a small amount of equity, but margin top-up is required when positions move against one of the parties. It is a useful instrument if one wishes to take a short position on an entire market, though he'd better be familiar with the index components!

Put warrants are not only offered on country markets (STI, HSI, KLCI and Nikkei), but more importantly also on individual stocks, in the most popular form known as structured warrants. Without going too much in details, put warrants offer the buyer the chance to profit from downside while limiting the potential loss to the initial cost of the put warrant. I have written on the perils of buying warrants in an earlier article: Buying warrants vs buying shares. Yet when used correctly, put warrants can be a cheap way of hedging one's portfolio by buying protective index puts such that when the underlying stock moves down, the index put gains in value and cushions the fall (hopefully, the index doesn't rise instead).

Another common put strategy is the straddle. Buying both puts and calls is the long straddle strategy; both seem to cancel each other out but in the event of volatile markets, both call and put gain in value. It is effectively a play on market volatility --- quite appropriate in today's markets. On the other hand, selling both call and put is a reverse play on declining market volatility, known as the short straddle. This strategy is not feasible anyway in Singapore because individuals can't write options.

Although cheap, the biggest problems with put warrants are their limited choice and their time expiry. The latter is a characteristic of the instrument, while the former means specific shorts on single stocks are near-impossible. This limits puts to probably hedging instruments, in my view, through the use of the above protective put; though if one is really bearish, he can always take directional bets.

For such reasons, I seldom buy puts because I have more conviction in my stock-picking skills than my ability to read the market in general. I eagerly await single-stock futures which are said to be launched sometime in the future. If I remember correctly, these futures existed in the past but died off after being blamed for the 1985 Pan-Electric debacle.

 

 

1 Comments:

Anonymous QUALITY STOCKS UNDER FOUR DOLLARS said...

I have never been a fan of short selling Your risk on the upside is unlimited.

1/03/2013 1:41 PM  

Post a Comment

<< Home