Derivatives becoming more popular
A quick way to increase your exposure
IT USED TO BE only the directors of financial services companies who occasionally availed themselves of complex financial instruments when dealing in their shares.
But the appearance of these complex constructs has become much more commonplace, making our job a little harder as we endeavour to understand and make sense of the transactions. This week is a good example of where we’re confronted by a host of these instruments.
One of the most common instruments we’re seeing directors use is the single stock future (SSF) as in the case of African Dawn Capital this week, where non-executive chairman Isaac Mophatlane sold shares and bought single stock futures.
This has become quite common because SSFs are leveraged instruments – typically the buyer only has to put up a fraction of the face value of the underlying instrument that he’s buying. This means that he can significantly ratchet up his exposure to the company.
Directors at IT group Datapro, particularly CEO Doug Reed, have made extensive use of SSFs to increase their investment in the company. This week, however, Reed purchased a Contract For Difference (CFD) over Datapro shares.
As the name suggests, a CFD is essentially an agreement between two parties to pay out the difference in the price movement of the underlying share. The buyer of the contract gets paid out if the price rises, but has to pay in if (or when) the price falls. Once again, it’s a highly leveraged instrument with buyers only having to put up a fraction of the face value of the underlying instrument.
CFDs are designed for active traders who want to have extra leverage in their share trading and are certainly not for novice investors. We have to assume that Reed knows what he’s doing given that Datapro’s corporate adviser is the Metier Group headed up by financial whizkid Thiery Dalais.
Other directors of Datapro and its subsidiaries were also seen shelling out hard cash for Datapro shares this week in a vendor placing of stock that financed the acquisition of Orion Telecom.
If you think that’s complicated, how about the “delta hedge” that GP Byrne, a director of a subsidiary of Esor, took out over the engineering group?
Delta hedging is an options strategy that aims to reduce (hedge) the risk associated with price movements in the underlying asset by offsetting long and short positions. The change in premium for each basis-point change in price of the underlying asset is the delta, and the relationship between the two movements is the hedge ratio. For example, the price of a call option with a hedge ratio of 40 will rise 40% (of the stock-price move) if the price of the underlying stock increases.
So, in a nutshell, a delta hedge reduces the magnitude of a price movement of the underlying asset.
Finally, Mustek’s David Kan last week took an option collar over a portion of his stake in the IT hardware group he co-founded. The most common option collar we have seen in this column is the Zero Cost Collar. It’s essentially a series of put and call options which lock in the value of a stock within a certain range. The “zero cost” part comes from the fact that the premiums of the put and call options cancel each other out.