The equities markets continue to trade higher, led by the banks and other high yielding stocks (which we identified back on 11 October). Today we’ll show you a strategy that has the potential to significantly ramp up your returns in your portfolio.
The dividend season cycle is one of the more reliable market cycles and today we discuss how you can take advantage of this using Capped Instalment Warrants. This trade builds on the yield trades that we have discussed over the past month, including Boosting Dividend Yield in Your Self-Managed Super Fund (SMSF), Investing in Dividends in Your Super Fund and Franking Credits in Your Super Fund.
In this article we discuss using Capped Instalment Warrants which allow investors to generate higher franked dividend income compared to a direct share investment and can be traded in your self-managed super fund (SMSF) to ramp up your dividend income through franking credits (credits for tax already paid by the company paying the dividends).
Capped Instalment Warrants
Capped Instalment Warrants are the latest generation of Instalments Warrants providing straightforward and transparent leveraged exposure to Australia’s leading companies. For self-managed super funds, Capped Instalment Warrants are one of the few means of gaining leverage in a portfolio and they’re listed and traded on the Australian Securities Exchange. There are no margin calls, no credit checks and importantly investors are unable to lose more than their original investment amount.
These warrants are designed for individuals and SMSFs seeking medium-to-long-term exposure. Investors gain the economic benefits of share ownership, including dividends and available franking credits, for a small portion of the cost of purchasing the shares outright. As the loan is non-recourse in nature it is an approved investment product for SMSFs.
Capped Instalment Warrants are a type of warrant listed on the ASX:
• They are a leveraged trading instrument that provides investors with upward of 80% gearing on the underlying asset, while having all the benefits of share ownership.
• Investors can choose their level of leverage based on their own risk profile, as there are a number of Capped Instalment Warrants (or leverage levels) available for each stock.
• Before trading Capped Instalment Warrants , traders need to read and understand the ASX Understanding Warrants Booklet and then sign the Warrant Agreement form. Speak to your broker or contact us at D2MX on 1300 610 024 for more information.
• Capped Instalment Warrants are traded and regulated on the ASX.
• You can trade long and participate in the dividends and franking credits.
• There are NO margin calls.
• An efficient way to trade dividend-paying stocks to boost yields.
• Capital gains will be limited to the capped level.
• No credit checks or approvals required.
In summary, Capped Instalment Warrants are geared products that are listed on the ASX, have known risks, are simple, flexible and transparent, while having all the benefits of share ownership and there is no risk of a margin call.
The main benefits of trading Capped Instalment Warrants on dividend-paying stocks:
• Because they’re listed and traded on the ASX, Capped Instalment Warrants offer flexibility and transparency.
• Increased dividend income and franking credits, through leveraged exposure to movements in the share price.
• A lower capital outlay is required to achieve the same dividend income.
• Capital gains will be limited to the Capped level.
• Can offer potential tax benefits.
• The maximum loss is limited to the initial outlay.
• Pay the Final Instalment any time prior to maturity and receive the underlying shares.
• Can be traded in your self-managed super funds (SMSF).
Trading Risks – Capped Instalment Warrants
The risks of trading Capped Instalment Warrants:
• As with any leveraged investment product, the price of the underlying asset may fall prior to the time of sale (or even prior to the ex-div date).
• The value of the Capped Instalment Warrant could fall or be significantly less valuable on its Maturity Date, or may expire worthless, resulting in a total loss of the initial monies outlaid for the trade.
• Leverage is a two-edged sword: it enhances any gains but would also increase any loss sustained. On the Maturity Date, your Capped Instalment Warrant may be significantly less valuable or may expire worthless.
• If the stock trades above the Capped Level then the capital gains are capped.
• Dividends are not final and not guaranteed to be paid.
Capped Instalment Warrants Terminology
The Capped Instalment Warrant is made up of 4 parameters: the Instalment Value (the price at which it trades), the Final Instalment Price (the loan amount), Capped Level (where profits are capped) and the Maturity Date (the date on which the Instalment ceases to trade or is rolled).
Capped Instalment Warrants have a six letter code, eg. NABISI. The first 3 characters identify the underlying stock, the fourth letter the warrant type (I=Capped Instalment), the 5th letter is the issuer, and the last letter identifies the series (or leverage).
Banks generate consistent dividends which allows us to reliably forecast dividends into the future. We have compiled the table below to give an estimate of dividends through until this time in 2014.
TABLE 1: Dividend Estimates through to November 2014.
TABLE 2: Dividend Estimates through to November 2014.
The Capped Instalment Warrants give you the flexibility of being able to pick up two or three of the next bank dividends and you can see from the table above the grossed up yields you could expect to receive.
Sam wants to trade NAB for the dividend and franking credits and is looking to boost her returns. She planned to trade NAB on 31 October 2013 when NAB was trading at $35.39 (and the Capped Instalment Warrant NABISI, which is entitled to the next two dividends, was trading at $4.63). NAB is expected to go Ex-div $0.97 on 7 Nov 2013.
Note: this case study is general in nature and does not incorporate any specific tax or personal circumstances of the investor. Investors should not rely on the information and should obtain specific advice before investing in this product.
Chart: NAB Trade (produced in d2mxIRESS platform)
Table : The NAB Capped Instalment Warrant (NABISI) trade parameters
The Capped Instalment Warrant and Share Trade Comparisons
The trade needs to be held for at least 45 days to qualify for the franking credits, but we have allowed another 15 days for the NAB share price to recoup its dividend. The calculations are done assuming no capital gain – that is assuming the NABISI warrant price pulls back to our original buying price. The trade calculations are as follows (assuming traders tax rate is 46.5%):
TABLE 3: Trade performance assuming the NABISI warrant recoups the dividend (within 60 days)##
If Sam traded NAB using shares and NAB rebounds back to her original purchase price after the 60-day holding period and the position is closed, there would be no capital gain on the holding, but Sam would get to collect $2,740, plus $1,158 worth of franking credits for a grossed up yield of 3.9% in 60 days.
However if Sam traded the NABISI Capped Instalment Warrant, then she would collect $20,950 in dividends, plus $8,855 worth of franking credits for a grossed up yield of 29.8% in 60 days, i.e. if she traded NAB using Capped Instalment Warrant and it traded back to her purchase price (note there would be a funding cost of $0.46 cents per share, part of which would be tax deductible). Of course if NAB is trading above the purchase price after the 60 day holding period, then there would be an additional capital gain (and conversely a capital loss if NAB was the purchase price).
Capped Instalment Warrants are the latest generation of Instalments Warrants and are a highly geared investment which gives the investor all the benefits of share ownership, including access to the full cash dividend amount and the associated franking credits. SMSF investors can gain the economic benefit of the share ownership for a fraction of the cost of purchasing the underlying shares outright. SMSF investors can gain the economic benefit of the share ownership for a fraction of the cost of purchasing the underlying shares outright.
When considering this type of trade you need to make a judgment call on whether you want to hold the warrant until expiry and then whether you want to be eligible for two or three dividends. Also note the high level of gearing over 85% and the fact the delta for the warrant is around 0.4 to 0.5 depending on the price of the underlying stock. You also need to make a judgement call on where you think the stock will trade in the life of the warrant, which dictates the capped level you are comfortable with.
If you want to take advantage of the bank dividend season, then the Capped Instalment Warrants are an excellent way to boost your yield. Contact us at D2MX now on 1300 610 024 and we can help you trade using Capped Instalment Warrants to boost your returns. Each Capped Instalment Warrant has a PDS document which details all the features of the specific warrant.
Note that before trading Capped Instalment Warrants , traders need to read and understand the ASX Understanding Warrants Booklet and then sign the Warrant Agreement form, or contact us at 1300 610 024 or email email@example.com or register online at www.d2mx.com.au.
The market has provided some excellent opportunities this year. There are a number of dividend investment 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 firstname.lastname@example.org 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 Investing Report, which provides a daily serving of insightful market analysis from the D2MX Advisory team, including:
• Trade ideas and strategies
• Dividend enhancement strategies
• Market scans to watch
• International market analysis, and
• Highlights from the S&P/ASX 200
Investment Adviser – D2MX Advisor
##Funding Cost Calculation – In order to calculate the amount you are paying in funding costs for holding the NABISI over the 45 days (assumed holding period), use the following calculation:
Funding Cost = Loan Amount (=STRIKE Price @ Entry_date) *Funding_Rate * Holding_Period/365
= $33.18 * 8.5% * 60 /365 = $0.46
More in This Series:
This report was prepared by Michael Hevern, Authorised Representative of D2MX Pty Ltd (AR 417348). 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.