BULL or BEAR Market, you can make money

Bull or bear market, you can make money
By Lorna Tan
For the past months, many stock investors have been caught in a roller-coaster ride, no thanks to the current financial turmoil.
It is common to hear investors lamenting about how much they have sunk into the stock market, only to see the value of their stocks plummet.
If you have a stock portfolio and are bearish on where the market is heading, there are two things you can do: sell your stocks now, which may mean a loss, or just hope for the best.
Rather than do nothing, you may also want to check out the recently relaunched Straits Times Index (STI) Futures, which provide retail investors an opportunity to profit even from a falling market.
For those unfamiliar with the topic, the benchmark STI represents the performance of the top 30 stocks of the Singapore market, based on market capitalisation. They include Singapore Press Holdings, Singapore Exchange (SGX), SingTel and the local banks.
STI Futures are contracts or agreements between buyers and sellers to buy or sell the STI portfolio of 30 stocks at an agreed price (futures price) to be settled at a specific future date.
STI Futures were launched in 2000 but not many retail investors were aware of this tool. With the relaunch last Thursday, there will be firms that provide ready buy and sell prices for STI Futures. This will lead to greater liquidity of the product.
It is a useful tool for investors who wish to take a position on where the local market is heading - that is, whether they believe that the STI will trend up or down - by buying or selling STI Futures contracts.
This means trading based on broad market movements instead of single stock movements. This reduces the need for individual stock selection; your risk is also diversified over 30 stocks instead of being pegged to a single stock.
At the same time, it can help to protect you against, or help you profit from, fluctuations in the stock market.
Here are some things you need to know about STI Futures:
What is the value of one STI Futures contract?
The value of each STI Futures contract is equal to $10 multiplied by the current index trading level.
For instance, if the index is trading at 2,300, holding a futures contract will be equivalent to investing $23,000 in the stock portfolio of the 30 listed companies.
This means that when a STI Futures contract is traded, the seller has, in essence, agreed to sell $23,000 and the buyer has agreed to buy $23,000 worth of stocks, as measured by the STI.
How are STI Futures transacted?
You are not required to cough up the full payment equivalent to the contract value. But the buyer or seller must each put up an initial margin deposit with the broker in order to secure the contract.
This margin, which is decided by SGX, is typically about 5 to 15 per cent of the contract value. The prevailing initial margin is $1,625 for one contract.
The margin essentially means that the STI Futures allow the investor to trade a portfolio of 30 stocks at a mere fraction - about 5 to 15 per cent - of its value.
At the end of each trading day and all following days that your position remains open, the contract value is "marked-to-market".
Your account is credited or debited based on that day's trading session. If your margin deposit falls below a certain maintenance level - currently set at $1,300 - your broker will request additional funds to replenish your trading account. If your position generates a profit, you may withdraw any excess funds from your account.
Margin levels prescribed by SGX are based on the movement of the underlying stock market as represented by the STI. The margin levels, therefore, will fluctuate depending on the historical and prevailing movement of the STI.
Do I need to own any of the stocks included in the STI in order to trade the futures contract?
You do not need to own any stock in order to trade the STI Futures. In stock index futures trading, you do not actually deliver or receive any stocks.
How can I profit from trading the STI Futures?
Like trading stocks, the point is to buy low, sell high.
The STI Futures offer the flexibility of buying and selling in whatever order you want.
That is, you can "buy first, sell later" or you can "sell first, buy later". If you think prices are going up, you may establish a "long" (buy) position, and if you think prices are going down, you may initiate a "short" (sell) position.
In addition, with the STI comprising a portfolio of 30 stocks, you can effectively participate in the broad market movements without the hassle of stock-picking. Each index point movement has a value of $10.
In other words, you gain $10 per index point rise if you have a long position or per index point fall for a short position.
Below are two trading scenarios:
Scenario A
Day 1: You are bullish about the Singapore stock market and decide to buy a September STI Futures contract at 2,400.
Contract value = 2,400 x $10 x 1 contract = $24,000
Initial margin required (at $1,625 per lot) = $1,625
The STI rises that day.
End-of-Day 1 settlement price = 2,425
Daily marked-to-market profit = (2,425 - 2,400) x $10 x 1 = $250
You now have a paper profit of $250.
Margin account balance = $1,625 + $250 = $1,875
As you have not liquidated your contract, you have one lot of open position.
Day 2: Market rallies further to 2,438. You feel the price is good and decide to take profit, selling your September STI Futures contract at 2,438.
Daily marked-to-market profit = (2,438 - 2,425) x $10 = $130
Margin account balance = $1,875 + $130 = $2,005
Total net profit = $130 + $250 = $380
In this scenario, your bullish outlook holds and you ultimately make a net profit of $380 when you liquidate your position.
Scenario B
Day 1: You are bearish about the short-term prospects of the Singapore market and decide to sell a September STI Futures contract at 2,400.
Contract value = 2,400 x $10 x 1 contract = $24,000
Initial margin required (at $1,625 per lot) = $1,625
Contrary to your initial bearish view, the market turns bullish; the STI closes higher.
End-of-Day 1 settlement price = 2,435
Daily marked-to-market loss = (2,435 - 2,400) x $10 x 1 = $350
You now have a paper loss of $350.
Margin account balance = $1,625 - $350 = $1,275
Maintenance margin required (at $1,300 per lot) = $1,300
You have a margin call and must deposit additional funds now because your margin account balance of $1,275 is below the maintenance margin of $1,300.
You need to top up $350 to bring it back to the initial margin level of $1,625.
Day 2: The market shows a decline.
You want to cash in on this move by liquidating your position by buying a September STI Futures contract at 2,388.
Daily marked-to-market profit = (2,435 - 2,388) x $10 = $470
Total net profit = - $350 + $470 = $120
In this example, you ultimately make a net profit of $120 on Day 2 when you liquidate your position.
How long should I hold on to a position?
As stock markets can be volatile, you take advantage of price movements by getting in and out quickly. Depending on your personal preference and perspective, you may wish to adopt a short-term trading approach (taking a position for one day, one hour, or even just a few minutes); or medium-term approach (several days to several weeks); or long-term (months at a time).
What are the risks?
The initial margin deposit is relatively small compared to the contract's value. The transaction may lead to quick and substantial profits, but the reverse is true for losses too when prices do not move in the expected direction. Investors should also be mindful of margin calls if the margin account falls below the maintenance margin.
It is possible that you may lose more than the amount you have in your margin account under circumstances of extreme market movements. Investors are strongly advised by financial experts to use only excess funds that they can afford to invest.

This article was first published in The Straits Times on October 5, 2008.