How Nigeria’s Newly Launched Exchange-Traded Derivatives Market Can Benefit Stock Investors

With liquidity in Nigeria’s stock market worryingly low compared to January and daily transaction size miles away from its pre-pandemic level, capital market authorities launched the West Africa’s first exchange-traded derivatives market, marked by Thursday’s introduction of two futures contracts, the NGX 30 Index and the NGX Pension Index. The combined value of transactions executed on the exchange last year was N1.9 trillion, according to the NGX Domestic and Foreign Portfolio Investment Report published in January. That suggests a 12.4 percent contraction compared to a year earlier. The trend has reversed further this year, with Q1 transaction value adding N591.8 billion compared to N676.5 billion a year earlier and a lot of the smart money leaving stocks for safer havens, instead particularly fixed income securities. Nigerian Exchange Limited (NGX) has lined up seven derivatives contracts for the first phase, all of which have obtained the consent of the industry watchdog, the Securities and Exchange Commission. In addition to NGX Pension Index Futures and NGX 30 Index Futures, there are MTN Nigeria Communications Plc Stock Futures, Dangote Cement Plc Stock Futures, Zenith Bank Plc Stock Futures, Access Bank Plc Stock Futures and futures on shares of Guaranty Trust Bank Plc. The last five have yet to debut. With the move, the exchange hopes to deepen “Africa’s position in global financial markets through ETDs, as well as improve liquidity and mitigate price, duration and other financial risks that can arise from sophisticated financial transactional activities,” said Temi Popoola, the executive director. Understanding Derivatives and Stock Futures Derivatives are a class of securities, the value of which depends on the performance of an underlying asset or pool of assets as opposed to individual shares, for example, whose value comes directly from the activity of their shares in the market. “You can get exposure to the NGX pension index, the NGX 30 index without necessarily, for example, paying the full amount you would have needed (if you bought the individual shares that make up the contract),” Ahmed Jinad, who leads the investment. research at broker Meristem Securities Limited told PREMIUM TIMES. In this way, the value of derivatives is subject to fluctuations in the prices of the financial instrument or the basket of assets that comprise it. The component securities can be bonds, stocks, or currencies. They come in the form of an executed contract between two parties who have agreed to buy or sell an asset at an agreed date and time, among other terms and conditions. Futures, a type of derivative, require the buyer and seller to meet their obligations under the contract at a future date based on the price set at the time the contract is entered into, regardless of whether the market price of the asset has changed. changed when the contract ends. The buyer takes delivery of the asset when settlement is made at the point of expiration of the contract. “Essentially, what you will do with derivatives is generally hedge risk based on what kind of forecast you have about the market or the strength of the index and where you expect it to be at some future date,” Jinad said. “So there are different types of positions you can take on top of the long-only option that we’ve had for a long time,” he added, referring to the buy, hold and sell mode the market had operated for years. before launch. Portfolio managers use futures to gain a speculative advantage, such as taking a position in stocks that offer strong prospects for price appreciation by buying them early to sell when the time is right. Futures can also be used for hedging purposes, allowing traders and investors to take steps to prevent potential price swings in an unfavorable direction, thereby mitigating risks. It is possible to use futures to lock in profits in cases where a stock has appreciated to a point where a decline could possibly follow. “One problem with thinking of hedging transactions strictly as insurance is that, unlike insurance, there is a third possibility that inexperienced investors often overlook, namely that the investment will appreciate in value, but just a small amount,” said James Chen, an analyst at financial education website Investopedia. ALSO READ: Nigerian stocks advance for fifth trading day as investors chase MTN, bank stocks “In that scenario, the investor may find that the small gain has turned into a loss when the cost of the hedging transaction is taken into account.” Futures are quite similar to forward contracts, an important distinguishing feature lies in the fact that the former are traded on an exchange through brokers, while trading on the latter is carried out. on the counter. Types of stock futures Stock futures can be individual stock futures or stock index futures. Single stock futures have only one underlying security tied to the contract, with each contract typically controlling 100 shares. advertisements Five of NGX’s proposed derivatives, including Access Bank Plc Stock Futures, Guaranty Trust Bank Plc Stock Futures, MTN Nigeria Communications Plc Stock Futures, Dangote Cement Plc Stock Futures and Zenith Bank Plc Stock Futures, fall into this category. Holders of stock futures contracts do not enjoy dividends or voting rights unlike investors in common stock. Single stock futures facilitate both the asset and risk management process of the underlying security by concentrating on a single stock rather than a mixed bag of stocks. Stock index futures are contracts derived from an index, which in turn tracks the prices of various stocks under it. NGX Pension Index Futures and NGX 30 Index Futures, which have just been introduced, are notable examples. Index futures help investors with holdings in many stocks hedge against the risk of falling stock prices by selling stock index futures. According to Investopedia, “in the event of a market downturn, the stocks within the portfolio would lose value, but the index futures contracts sold would gain in value, offsetting the stock’s losses.” The NGX authority has set the third Friday of each month as the expiration date for the seven contracts, while the Monday before the expiration day will be the trading day. “Risk managers can apply certain equity index futures strategies to efficiently create a long equity position,” the NGX said at a workshop for market participants in August. “This way, they can get the stock market exposure they want, using only a fraction of the capital.” Mr. Jinad believes that bringing in stock futures to dilute the mix of investment options may not increase interest in stocks, at least for now, considering that participation in trading in the new securities is likely to tend to test the water at this stage. “For things like that, you want to give it time for the market to adopt it. People are not going to invest because something is new, they are going to invest based on the potential advantage they think they can get from it,” he said. “The underlying constituents of the contracts that will be available are still the same stocks that have been in the market, that sentiment about them appears to be muted at this point.” Institutional investors and investment managers, according to the analyst, are the class of market participants who will be more inclined to trade futures for now and will need to leverage the strategy to make it productive. Read More Related News Here Let here it in the comment below if you do have an opinion on this; How Nigeria’s Newly Launched Exchange-Traded Derivatives Market Can Benefit Stock Investors