We have seen some fantastic gains in many stocks since the market bottomed back in late July. The ASX200 is up 17% from those lows, the Financials sector is up 19% in that time, while the materials index is up 23%.
After such a strong run it can be timely to hedge your position(s), in case of a pullback in the near term. One recent trade we recommended was for Orica, but there are also opportunities in the banks post their Ex-div dates.
We thought now would be a good time to discuss how you can hedge in this market – that is profit from falling share prices, while still limiting your risk. We have discussed previously how you can use options to hedge in the market, but today we will discuss the MINI warrants hedging strategy.
MINI warrants are a relatively new trading instrument, which are gaining in popularity, where you can trade the market short or long, with a predetermined risk. The MINI trading warrants have been designed to compete with the CFD market, and have a number of features that make them a far superior product as outlined below. This warrant market can give you exposure to ASX200 stocks, indices (ASX200, Dow Jones, S&P500, NASDAQ, Hang Seng etc), commodities (gold, silver, copper and oil) and currencies (EURUSD, GBPUSD, AUDUSD, AUDEUR, AUDGBP, etc) and you can even trade US shares.
One of the major risks with trading CFDs is that you stand to lose more than your initial outlay, if the market gaps against you. This is not the case when trading MINI warrants.
MINI warrants are a type of warrant listed on the ASX:
• They are a CFD-style trading instrument that provides investors with a 1 for 1 participation with the underlying asset (ie. a 1 cent rise or fall in the stock price equates to a similar 1 cent move in the MINI).
• Investors can choose their level of leverage based on their own risk profile, as there are a number of MINIs (or leverage levels) available for each stock.
• Before trading MINIs, traders need to read and understand the ASX Understanding Warrants Booklet and then sign the Warrant Agreement form. Speak to you broker or contact us at D2MX on 1300 610 024.
The key features of MINIs include:
• MINIs are traded and regulated on the ASX Stock exchange
• You can trade long and short directional moves simply
• There are NO margin calls
• No optionality, since there is no expiry date, though there are financing charges
• Transparency through 1 for 1 participation between the move in the underlying asset and the MINI
• No expiry dates – open ended investments
• Efficient way to short sell and they can be used to hedge existing share positions
• No credit checks or approvals required.
In summary, MINIs are a geared product that are listed on the ASX, have known risks, are simple, flexible and transparent, and there is no risk of a margin call. You should note that simplicity, a regulated market on the ASX and the predefined trade risks are the major advantages over the CFDs.
MINI Warrant Terminology
The MINIs market was established in 2007 by RBS and in 2011 Macquarie Bank and Citi Bank joined in to expand the MINI warrant offerings. MINIs have a six letter code, eg. BHPKMD: the first three characters identify the stock, the 4th identifies the warrant type (K=MINI), the 5th character identifies the issuer and the last letter the series (or leverage).
The MINI warrant is made up of three parameters: the MINI Value (the prices at which it trades), The Strike Price (indicates the loan amount) and the Stop Loss price (the price at which the MINI ceases to trade and the position is closed out).
Value of MINI Short = (Strike Price – Ref Asset Price)/Conversion_Factor##
eg. For a $40 stock, with a MINI Strike Price of $34 the MINI Long Value =($40-$34)=$6,
ie. leverage is 85%. ## Note the Conversion Factor for Stocks is 1.
The Strike Price – reflects the amount of leverage (loan amount); is adjusted daily for financing cost and dividends and index futures roll are reflected in the strike and the stop loss level.
The Stop Loss Price – is the price at which the MINI ceases to trade and the position is closed out. The PDS document details how this is done.
Recent Orica Trade
Sam owns 2500 Orica (ORI) shares that he has held since mid July (cost $18.00). Orica ran up 21% through to mid-September to $21.40 and then pulled all the way back to $19.40. It has since run back up to this key resistance level around $21.40 and is due to go Ex-div mid November.
Sam was concerned that Orica could pullback again. At the start of November he took the opportunity hedge his position using MINI Short Warrants when Orica fell below the $21.00 level, so that he is protected from any significant fall below that level.
TABLE 1: Orica Hedge trade parameters
You can see from the chart below that Orica has regular periods of distribution, providing ideal opportunities to hedge or go short.
Chart 2: Orica (ORI) Trade (produced by d2mxIRESS)
To date (8-Nov-13) Orica has in fact traded lower and Sam’s hedge is in profit by 24%, up $2,155.
TABLE 3: Orica Trade Progress
The profit on the MINI Short position is offsetting the losses on his Orica shares, so that the portfolio position is now (after 7 days) as follows:
TABLE 4: Orica Hedge position status
Unrealised profits are NOT money in the bank and Sam needs to make a judgement call about when to take profits (close out his hedge). Sam may choose to take profits on his short MINI position if Orica hits his target, in which case he gets to hold onto his Orica shares – avoiding a capital gains tax event – and gets to keep his dividend as well.
Post Note: Orica closed the week out on its low and with Orica reporting next week, this allowed Sam to take profits on his Short MINI warrants at $4.65 (equivalent of Orica shares trading at $19.65), for a profit of around $2,700 (less costs). Sam can reassess his need for a hedge next week.
If you feel that some of the stocks in your portfolio have had a great run and may be due to see some profit-taking near-term, then the MINI warrants are an excellent way to hedge your position(s), as shown in this example. MINIs can be used to trade stocks in either the bullish or bearish direction, as we have discussed in previous articles.
The strategy discussed today can also be used in order to take advantage of any pull back in the banks post their Ex-div dates. Note each MINI warrant has a PDS document which details all the features of the specific warrant.
We here at D2MX Advisory can assist you with taking action to hedge your investment portfolio and have strategies designed specifically for various scenarios that can generate consistent, scaleable income and returns. Contact us at 1300 610 024 or email firstname.lastname@example.org or register online at www.d2mx.com.au
Note that before trading MINIs, traders need to read and understand the ASX Understanding Warrants Booklet and then sign the Warrant Agreement form, or contact us at D2MX now on 1300 610 024.
The market has provided some excellent opportunities this year. There are a number of hedging opportunities setting up right now, that you could potentially profit from. If you would like more information please contact me at 1300 610 024 or email email@example.com or register online at www.d2mx.com.au.
For investment ideas and recommendations on how to trade in this market, sign up for a free trial of the D2MX Daily email, which provides a daily serving of insightful market analysis from the D2MX Advisory team, including:
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• Highlights from the S&P/ASX 200
Investment Adviser – D2MX Advisor
More in This Series:
Part 1: Shorting With Limited Risk Using MINIs
Part 2: Boosting Dividend Yield Using Warrants
Part 3: Boosting Dividend Yield Using Instalment MINIs
Part 4: Boosting Dividend Yield Using Capped Instalment Warrants
This report was prepared by Michael Hevern. It represents the views and opinions of the author. It is not intended for use by any third party, without the approval of Michael Hevern. While this report is based on information from sources which are considered reliable, its accuracy and completeness cannot be guaranteed. Any opinions expressed reflect my judgment at this date and are subject to change. Contracting Hevern Pty Ltd is a Corporate Authorised Representative No. 408868 of D2MX Pty Limited ABN 98 113 959 596, AFSL No. 297950 (D2MX), and Michael Hevern has been appointed as an Authorised Representative of Contracting Hevern Pty Ltd. Opinions, conclusions and other information expressed in this report are not given or endorsed by D2MX, unless otherwise indicated. The information contained in this Report is General Advice only, as the information or advice given does not take into account your particular objectives, financial situation or needs.
Disclaimer: Using leverage to invest can be a two edged sword, as it can magnify your returns when the stock price rises, but will in turn magnify the losses if the trade does not perform as expected.