Index futures not for faint-hearted

(Shanghai Daily)
Updated: 2010-04-07 10:58
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Chinese stock market punters are no doubt overjoyed to see index futures and other derivative products added to their box of investment tools, but riskier avenues heighten the perils of losing money as well as making it.

China will launch stock index futures on April 16, two weeks after the Shanghai and Shenzhen exchanges initiated pilot projects for margin trading and short selling for a handful of brokerages. The introduction of derivative products is part of the nation's measured reforms aimed at creating modern, multi-tiered markets similar to those overseas.

It seems natural for investors to want to pile more of their funds into stocks, after equity exchanges surged 80 percent last year and while deposit rates at banks trail inflation.

But with more new products on offer, the stock market becomes a more complicated playground for mom and pop investors anxious to get better rates of return on their money. It's not a game for the faint-hearted.

Index futures are cash-settled contracts to buy or sell an index at a preset value on an agreed date. In other words, you can bet on the direction of equity indexes. If you think they will rise, you buy contracts. If you think they will fall, you sell contracts. Index futures are often used as hedging tools, allowing an investor to cover potential losses.

It works like this. If you have a portfolio of shares and you are worried that their value will drop in coming months, you take out an index futures contract betting that the index will drop. If it does, the money you gain by having bet correctly offsets the lower value of underlying shares. It's a cheaper insurance policy than selling a whole portfolio of shares, given brokerage fees.

Related readings:
Index futures not for faint-hearted Index futures contracts on the way
Index futures not for faint-hearted Stock index futures to start trading on April 16
Index futures not for faint-hearted Banks barred from index futures investment
Index futures not for faint-hearted China to test index futures system

It all sounds so simple and foolproof, but those who think derivatives trading is a piece of cake had better think twice. After all, it was sophisticated derivative products that traders didn't fully understand that triggered the global financial meltdown.

More than 80 percent of investors who participated in a virtual program trading stock index futures ended up losing money, according to Chinese media reports.

"I don't think this is something that ordinary domestic stock investors should play with," said Zhu Yuchen, general manager of China Financial Futures Exchange, where the stock index futures will be traded. "This is purely for professional investors, and that's why some restrictions are needed."

Indeed, individual investors will be required to have a minimum of 500,000 yuan ($73,250) to open a derivatives-trading account. They will also have to participate in mock trading lessons for at least 10 sessions.

The minimum trading account requirement is well beyond the means of many retail investors, especially with banks under government orders to rein in lending.

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