Johannesburg - Listed companies Vox Telecom, Simmer & Jack (S&J), ConvergeNet and African Dawn Capital have all been on the wrong end of margin calls involving single-stock futures (SSFs), and questions are being asked about the instrument's suitability in volatile markets.
"When the market changes its nature as it has so viciously over the last six months, inadequate or outright dangerous risk management processes [both institutional and individual] are revealed for what they are," said Andrew Kinsey, head of risk management at trading firm GT247.
Kinsey said it is easy to manage risk while prices are moving up but significantly harder when there is huge volatility in the market: "Your models go out the window."
"They are great instruments in a bull market, but traders may get lulled into a false sense of security that shares always go up," said Michelle Krastanov, a non-executive director at listed technology stock ConvergeNet.
On Thursday the company announced that more than 6% of its shares changed hands following a margin call on open SSF positions held by two of its executives.
In 2006, the JSE became the world's largest SSF market following a strong marketing push that has seen the instrument become popular with traders. In recent years, a number of directors in listed companies exchanged their shares for the more highly geared SSF positions in search of greater profits.
How SSFs work
In its announcement, ConvergeNet singled out the 420% increase in initial margin required by the issuer before entering into an SSF trade. This increase has been attributed to increased market volatility.
Single-stock futures provide a highly geared instrument that allows traders to take advantages of moves in the underlying share price. Issuers require an initial margin to be lodged with the South African Futures Exchange (Safex) as a "deposit" when traders enter into these contracts.
At the end of each day, the closing price is taken and the instrument is "marked-to-market" with traders either realising a profit or having to pay in to balance their account.
Directors and traders in the stock of AltX-listed financier African Dawn have also been burnt by large-scale SSF exposure. The high growth prospects that the business had offered saw traders take almost a third of the issued share capital in the form of futures contracts.
"This opened us up to short-selling," said CEO Marius van Tonder, indicating that a number of large open positions may have resulted in pressure selling as traders were forced to meet margin calls.
Van Tonder and other directors had invested heavily in SSFs banking on continued upward movement in the underlying share price. When the market crashed in October 2008, those with open positions came under pressure to meet margin calls. "There's no question about it that the increase in initial margin played a large part in our decision to exit these contracts."
Risk management important
Kinsey believes that risk and cash management is an integral part of the SSF market and all players, including the banks which allow traders to take large speculative positions in the market, need to take reasonable steps to manage this instrument in volatile times.
He said: "Cash management is a cornerstone of trading longevity and being overleveraged exposes traders to sudden and large margin that they may not be able to cover. Having to accept huge losses is the natural consequence of ignoring appropriate risk management practices.
However, Kinsey believes that volatility in the market is likely to decrease over the next six months as the world adapts to a new trading environment.
Single-stock futures took centre stage in 2008, when failed derivatives trader Dealstream saw traders being wiped out, particularly those holding large positions in Vox Telecom and S&J.
As a result of this exposure Rand Merchant Bank - which was serving as the SSF counterparty to the contracts for difference (CFDs) offered by Dealstream - took delivery of about half a billion rands' worth of shares in Vox and S&J at well below market value.
In the case of ConvergeNet the counterparty, rumoured to be Absa, has taken delivery of 56 million shares (roughly 6% of the issued share capital of the business) at a price of 26c a share. The company's shares are currently trading at 80c.
- Fin24.com