Suppose the settlement prices for the SiMSCI Futures
September contract over the period from the 24th to the 31st
of August are as shown in Column (3) of the accompanying
table. Since Mr Tan buys one contract at 180.0 on 24 August
and the settlement price at the close of that day's trading
is 182.4, he makes a gain of 2.4 points. The profit of $480
(being $200 x 2.4) will be credited to his margin account.
Suppose Mr Tan remains bullish on the Singapore stock
market and does not close out his position till 31 August.
Then, his daily gain (or loss) will be determined by the
settlement price at the end of each day. This daily computation
of profits and losses will be carried out until the position is
squared off by an offsetting trade. In the table, Mr Tan's
daily gains (or losses) are shown in Columns (4) and (5).
After each day's settlement, if the balance of his margin
account is above the "maintenance margin" level of $4,000,
Mr Tan will not get a "margin call". Once the balance
touches $4,000, however, Mr Tan must replenish his margin
account to the initial margin level of $5,000 if he does not
want his position to be forced-closed. As such, in our
example, Tan will need to meet a margin call for $2,240 when
the index falls 6.4 points on 27 August and his margin
account dips to $2,760.
Suppose Mr Tan finally decides to close out his position
on 31August at a price of 165.2 points. After deducting his
final day's loss of $960, he can withdraw the $4,280 left in
his margin account.
Over the eight-day period, Tan loses a total of $2,960 (=
$200 x (165.2-180.0)). This can be verified by his cash
flows: Altogether he pays $7,240, the sum of the initial
margin $5,000 and a margin call of $2,240. However, at the
end of the game, he only gets back $4,280.
On total cash outflows of $7,240, the loss of $2,960
amounts to a 40.9% loss while the index drops by a
relatively small 8.2%. Such is the power of "leverage" or
"gearing", i.e., being able to bet on something worth
$36,000 with only a capital of $7,240.
When a speculator bets wrongly, gearing blows up the
damage. If the bet is placed on the right side of the table,
the reward will be similarly magnified. If Mr Tan foresees
the market downtrend correctly and sells the contract at
180.0 on 24 August and buys it back at 165.2 on 31 August,
his investment will be just $5,000 (since he will not face
any margin calls). He will have a profit of $2,960, a 59.2%
rate of return.
First of all, as with all speculative financial
activities, profits are made when the bet is proven right;
losses result if the bet turns out to be wrong. To speculate
on broad market movements using SIF, one must be aware of
the blow-up effect of gearing mentioned above.
Compared with an actual investment in a basket of shares,
taking a long position in SIF has another shortcoming. When
the market drops, both shares and the long position in SIF
will lose value. However, shares do not "expire" (unless the
company goes bankrupt and is liquidated) and if an investor
with the holding power decides to hold on to the shares, he
can always do so. This however does not apply to SIF. Each
SIF has a "maturity date" when any outstanding position in
that contract must be closed. In other words, one can choose
not to realise paper losses when one invests in shares; but,
one will be forced to realise such losses with SIF
contracts. Of course, investors still bullish or bearish on
the broad market can always place their bets on other SiMSCI
Futures contracts still outstanding.
First of all, as illustrated above, a bullish investor
needs only a relatively small sum of money to bet on the
broad trend of the 35 stocks included in the MSCI index. For
those who are bearish about the broad market movement, a
short position in SIF allows them to profit from this view
if it turns out to be right.
Secondly, for investors who have a view on the broad
market, but are not interested in picking specific counters,
SIF is an ideal instrument.
Thirdly, the transaction costs for trading SIF contracts
will
