A little over a month ago, NEXT — the derivatives arm of the Nairobi Securities Exchange — adjusted their initial margin requirements or performance bonds, for their single stock futures.
Out of the six single stock futures (plus the two index futures), only Absa’s margins were increased by Sh100, Sh200 and Sh100 for contracts with expiry dates ending in June, September and December, respectively.
All part of a day's job for the risk management committee when daily price moves become more volatile, they typically raise margins to account for the increased risk and vice versa.
What does all this mean? If a previous initial margin was at Sh7,100 and it was decreased by Sh500, its initial margin would now be Sh6,600.
In other words, to open a new position of 1,000 shares, if Equity’s share is trading Sh49.9 a share, one will need to put up only 14.2 percent of the contract value or Sh49,900 (Sh49.9 times 1,000 shares).
But let's step back. What are single stock futures for? Essentially, they give the investors a better way to hedge the market. In the three months ending December 2021, a total of 485 futures contracts were traded with a value of Sh62 million, according to data shared by the Capital Markets Authority.
In one trade, December 25 contracts of Safaricom (its contract volumes command a big chunk of the market share) traded at Sh22 million while the underlying stock declined some 12 percent in the same period.
Possibly, some clever investors were on the short side to hedge against the fall — either partially or fully. Same thing applies if one feels the whole market is going down the sewer — they can hedge their portfolio against the NSE Share Index or its mini-version (Mini NSE 25 Share Index).
For speculators, although one can still trade these instruments without owning any shares, they have to make sure they are comfortable with leveraged trading. Unhedged positions in futures carry higher high risks because one can lose by the magnitude of the underlying stock.
To go back to our theme, we understand that the need to cover all possible volatility environments is the driver behind margin variations.
That said, with the recent “revised-down’’ margins, one may wonder: is the exchange signalling that volatility is going to be damped down?
I have doubts since the most obvious example of a market impacting event is an election.
Relying on Value At Risk (VaR) models to influence margin variations can be a dangerous affair; they have been proven incapable of capturing all risks.
But then again margins tend to drop as contracts near expiry — last variation was done in March.
In general, there tends to be more liquidity in close expiries. Nonetheless, for investors to be in control, the only cure is to hold sufficient margins to cover for any future variations.
This may feel like over-funding your account but one is better than a margin call.
Note: For shares trading below Sh100, one contract equals 1,000 underlying shares. For those trading above Sh100, one contract equals 100 underlying shares.
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