Gearing uncovered: How single stock futures can boost your profits

by , 12 March 2015

Some investors may use single stock futures as a way of hedging their portfolio. By shorting shares they hold long positions in, they can offset losses.

But the main reason behind most investors using single stock futures is the gearing they offer. By trading single stock futures, you can potentially make quick, substantial profits.

Let's take a closer look at how this works…


How gearing works with single stock futures


The gearing you achieve trading single stock futures comes from trading on margin. When you trade single stock futures, for each contract you buy, you put down an initial margin amount.

Let’s have a look at how this works with the aid of an example…

You think that shares in Top Company are going to rise, so you decide to put on a long single stock futures trade. Shares in Top Company are trading at R28 each.

When you speak to your broker, he tells you the margin requirement for each contract is R280. The JSE’s Equity Derivatives Market sets the margin on each available single stock futures contract. Each single stock futures contract is equal to 100 underlying shares.

You want to trade 1,000 underlying Top Company shares, so you buy 10 single stock futures contacts (1,000/100). To open the position, you need to put down an initial margin of R2,800 (10 x R280).

Through your margin of R2,800, you have exposure to R28,000 (R28 x 1,000) worth of Top Company shares. This gives you a gearing of 10 (R28,000/R2,800).


What gearing means to your profits


This means for each R1 you have down in the trade in margin, you have exposure to R10 on the underlying market.

With 10 times gearing, a 1% movement in the underlying share price means you’ll gain or lose 10% of your trading capital (margin amount).

So if shares in Top Company move up 2%, you’ll make a 20% gain. On the other hand, if shares in Top Company fall 2%, you’ll make a 20% loss.

It’s this gearing aspect of single stock futures that gives you the potential to make quick profits and quick losses. If you decide to trade single stock futures, you have to understand that they’re risky instruments and you can quickly make a loss.

It’s also this gearing aspect that attracts so many traders to single stock futures trading.

So there you have it, how single stock futures can boost your profits.

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