How to Use Individual Share Futures

George Morgan

The June Queen’s Birthday long weekend of 2001 was a very significant time in the history of the share price of Telstra Corporation. In the week prior to that weekend, the price broke to the up-side from a period of consolidation and looked like it was heading much higher. The Friday closing price was $6.72. Over the weekend the Chief Executive Officer, Ziggy Switkowski made a shock announcement. Profit performance was to be downgraded. The market reacted savagely when trading resumed on the Tuesday. The stock opened at $6.28 and traded as low as $6.05, closing at $6.08. The bar chart below tells the story.

TELSTRA CORPORATION DAILY BARS

Let’s look at this situation from a few different points of view and use it to show us how different people would fare using Individual Share Futures.

The Speculator

To the trader, such a situation is manna from heaven.

You see, futures markets were set up to enable participants to minimise their risk, that is to hedge themselves against such a drop in price. However the markets have evolved into such an efficient forum for trading that speculators today generate probably ninety percent of the activity in them.

The word ‘speculate’ comes from the Latin speculari that means to spy out and observe. I prefer to use the term ‘trader’.

You form a judgement of what you believe will take place and then you make a move in a market that tests that judgment. If you are correct you make a profit, and if you are wrong you lose.

Let’s say our speculator in the above situation has a medium size account with a futures broker of say, $30,000. He is aware of what has happened and decides to move aggressively, risking a full ten percent of his trading capital. He believes that the chart shows a classic ‘bull trap’. This is where people would have bought anticipating it was going up and would now be in a hurry to sell and so dump the stock. This would cause a calamitous drop in price.

On the Tuesday morning he phones his broker and places an order to sell 15 contracts of July Telstra Futures at the market on open. This represents 15,000 shares. He is filled at $6.25 and places a stop-loss order at $6.45. This means he will be automatically closed out if the share goes up to that price giving him a loss of 20 cents per share, or $3,000. He also sets his profit target of $1.00 per share, or a price of $5.25.

The shares in fact trade up into the mid-$6.30’s giving him some concern but they fail and trade down to their lows. Our speculator holds his position and takes his profit $1.00 lower at $5.25. On the chart you can see that level was reached about three weeks later. This represents a profit of $15,000, minus Commission.

On the other hand, of course, if the stock staged a recovery over the days after he sold it, he would have lost the $3,000 plus Commission. In fact he probably would have lost slightly more because the Stop-Loss order is executed at the market price. This means it would have been filled at say, $6.49.

This is a nice little trade and there are a lot of lessons built into our example.

The Hedger

What if you were a long-term holder of a large parcel of Telstra stock? What would be your options if you didn’t want to dump your holdings?

I will discuss this in detail in my next article.