De­riv­a­tives be­com­ing more pop­u­lar

A quick way to in­crease your ex­po­sure

Finweek English Edition - - Companies & markets - LLEWELLYN JONES

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.


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