Equity markets have been on a wild ride this year, first spooked in January by a crumbling oil price and China’s economic woes and then in June by the Brexit saga.
This makes for volatility — and that’s where equity derivatives can come into their own.
"Brexit day [June 24] was our third busiest day ever," says Brett Duncan, director of retail derivatives at Standard Bank. "We did 10% of our normal monthly turnover that day."
Derivative traders have no shortage of choice. Among the products available to them are futures on indices, commodities and currencies, single stock futures (SSF), contracts for difference (CFD), warrants and options.
They all allow investors to go long (bullish view) or short (bearish view) and use margin trading to gear their view.
On CFDs, for example, margins range from 15% (seven times gearing) of the underlying value of shares such as Naspers and Aspen up to 17.5% on the likes of Nampak and PPC.
Though the JSE launched SSFs in 1999, preceding CFDs by around five years, CFDs are emerging as the most popular equity derivative.
"Most of the action on Brexit day was in CFDs," says Duncan. "We have 10,000 retail clients trading CFDs, which now account for about 90% of our turnover."
Investec Specialist Bank’s experience is somewhat different. "Our SSF and CFD books are of almost equal size," says equity derivative specialist Richard Swain. "But CFDs have been growing faster while trade in SSFs has remained steady."
The reason CFDs are growing in popularity is that they are far easier to understand than SSFs, argues Duncan.
He explains that an SSF’s price is linked to an underlying future’s price while a CFD’s price reflects an underlying share’s spot price.
"People prefer a spot price," says Duncan.
As another plus, he says, futures require positions to be rolled over every three months while CFDs are perpetual instruments and are settled only when closed out.
The level of sophistication of retail derivative players has increased hugely over the past decade.
But for many there is still a way to go.
"Many SA investors have an aversion to going short," says Swain. "For instance, we have written 10 call and 10 put warrants on the same share and while all calls traded, only two puts did so."
This year investors’ preference for long positions has not backfired on them.
"All market corrections have been under 10%," says Duncan. "Most investors have done well going long into weakness."
It was a different story for many long-only financial sector derivatives players last year.
In the nine months to January they backed a JSE financial 15 index that tumbled 25%. "Many players got burnt badly," says Duncan.
They learnt the hard way that while it is great when a position geared multiple times to the movement of an underlying share or index goes in your favour, it can be devastating when it goes against you.
Here the really big risk lies in "gappers", market jargon for a share price that opens heavily down on the closing price on the previous trading day.
African Bank provided a vivid example of the risk when its share price gapped down 30% between two trading days in November 2013.
More recently Anglo American’s price gapped down 7% on February 16 in reaction to the announcement of its turnaround strategy.
In general it is a time for investors to be extra cautious. "We do not know where the next market shock is going to come from," says Duncan. "But there are a lot of [impossible to predict] potential black swan events out there."
Duncan’s advice is simple. "Do not trade at maximum gearing," he says. "Put in more margin than the minimum required."