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Trading Singapore MSCI Index Futures

A Trading Case Study

© Christopher Ting

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Obligations at Maturity

Physical delivery A deliverable futures contract stipulates that the long will

pay the agreed-upon price to the seller, who in turn will deliver the underlying asset to the buyer, a process called delivery.

Cash settlement An alternative procedure, called cash settlement, permits

the buyer and seller to pay the net cash value of the position on the delivery date.

© Christopher Ting

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Futures Expiration Month

© Christopher Ting

Code Month

F January

G February

H March

J April

K May

M June

N July

Q August

U September

V October

X November

Z December

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Codes for Maturity Months

© Christopher Ting

FGH JKM NQU VXZ

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Example of Physical Delivery: Wheat Futures

Contract Size 5,000 bushels (~ 136 Metric Tons)

Deliverable Grade#2 Soft Red Winter at contract price, #1 Soft Red Winter at a 3 cent premium, other deliverable grades listed in Rule 14104.

Pricing Unit Cents per bushel

Tick Size (minimum fluctuation)

1/4 of one cent per bushel ($12.50 per contract)

Contract Months/SymbolsMarch (H), May (K), July (N), September (U) & December (Z)

Last Trade DateThe business day prior to the 15th calendar day of the contract month.

Last Delivery DateSecond business day following the last trading day of the delivery month.

© Christopher Ting

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Futures Exchanges

CME Group

Eurex

Osaka Securities Exchange (now part of JPX Group)

Hong Kong Exchange

Korea Exchange

Taiwan Exchange

Singapore Exchange (known as SIMEX before demutualization)

© Christopher Ting

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Clearing House

© Christopher Ting

When the farmers sell futures contracts, they do not sell directly to the buyers. Rather they sell to the clearing house of the futures exchange.

The clearing house guarantees that all of the traders in the futures market will honor their obligations. No counterparty risk!

The clearing house serves this role by adopting the position of buyer to every seller and seller to every buyer.

Every trader in the futures market has obligations only to the clearing house.

The clearing house takes no active position in the market, but interposes itself between all parties to every transaction.

So as far as the farmers are concerned, they can sell their goods to the clearing house at the price of the futures contract when the contract expires.

Buyer Seller

goods

funds

goods

funds

Clearing House

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Clearing Members

© Christopher Ting

For cash-settled futures, clearing members act as the counterparty

Clearing Member

A

Clearing Member

B

sellbuy

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Index Futures’ Fair Price

© Christopher Ting

What’s the fair price of an index futures?

In index points

Fair price = cash price

+ costs incurred to hold the index’s stocks

– benefits from holding the index’s stocks

Essentially, futures seller holds the underlying asset on behalf of the futures buyer until maturity.

For index futures, the cost is mainly opportunity cost, i.e., interest earned from cash deposit in a bank

Benefit includes corporate distributions: dividends, stock dividend, specie in kind, rights etc

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Final Settlement Price

The final settlement price is the value of the MSCI

Singapore Free Index (SIMSCI) computed based on

the Special Quotation methodology applied on each

component stock SIMSCI on the day following the last

trading day.

The Special Quotation is calculated by MSCI using the

first traded price of each component stock, irrespective

of when these stocks first trade on the SGX trading day.

If any component stock is not traded by SGX market

close on the day following the Last Trading Day, the

last official closing price of that stock will be used to

calculate the Special Quotation.© Christopher Ting

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Motivation

SIMSCI cash index is updated about every 15 seconds.

It would be nice to calculate the futures fair price by knowing also how to compute the cash index level.

After all, there are only about 28 stocks.

The cash index is dominated by 5 stocks:

SingTel

DBS

OCBC

UOB

Keppel Corp

© Christopher Ting

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Pricing Forward Contract the Quant Way

Seller creates a self-financing and assured cash flow.

Today 0 Sell a futures contract with agreed price F(0,T)

Borrow money at an interest rate r0 for a sum of S0 to buy the asset at the price of S0

At maturity T Sell security to the buyer at the agreed price F(0,T)

Pay back S0 plus interest

0 T

S0

S0

Borrow money

Short a forward contract

Buy security

F(0,T)

(1+r0T)S0

Sell security at forward contract price

Pay back

© Christopher Ting

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Insight!

The net cash flow at time 0 is zero.

Since the cash flow at time T is exactly determined today, there is no uncertainty, and thus no risk!

If no risk, then no risk premium.

The net cash flow at time T has to be zero.

Of course, the seller is not foolish to agree with a F(0,T) that is less than (1+r0T) S0 and giving money away.

On the other hand, if F(0,T) > (1+r0T) S0, the seller will gain without taking risk.

© Christopher Ting

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Insight!

Law of one price (no arbitrage)

Future net cash flow pre-determined or fixed in advance (today) must equal today’s net cash flow to annihilate arbitrage opportunities.

Today

S0 – S0 = 00

At time T

F(0,T) – (1+r0T) S0 = 0T

The formula F(0,T)=(1+r0T) S0 is called the fair (forward) price.

F(0,T) = (1+r0T)S0

© Christopher Ting

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© Christopher Ting

Trading Application?

© Christopher Ting

Knowing the fair price is important to have a feel of the market dynamics.

Market futures prices for SIMSCI is not usually the same as the fair price.

Strategy

If P(t, T) > F(t, T), sell the futures

If P(t, T) < F(t, T), buy the futures

Will this algo strategy work?

Answer: NO!

16 Nov 2015

Fair price 323.85

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Application: X Factor

Futures market prices P(t, T) does not always follow what the theory says about the fair price F(t, T).

Especially for relatively not so liquid futures such as SIMSCI futures, the market price tends to be traded at

P(t, T) = F(t, T) + X

The X factor is usually –10 ticks when related futures markets are “sentimentally soft.”

Conversely, the X factor can be +10 ticks when the markets are “sentimentally strong.”

The X factor may be –20 ticks for a period of time in the day when the markets are under stress.

© Christopher Ting

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Detailed Calculations of SIMSCI

Cash Index

© Christopher Ting

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© Christopher Ting

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QF206 Week 3SIMSCI Index Component Stocks as at end of December 13, 2013

The cash index value is 353.31.And the divisor value is673,384,854.58

No Name Last Done Shares FIF Adj FX Market Cap1 SingTel 3.570 7,971,788,475 1.00 28,459,284,8542 DBS 16.560 1,710,465,694 1.00 28,325,311,8933 UOB 20.240 1,272,395,153 1.00 25,753,277,8934 OCBC Bk 9.850 2,580,882,664 1.00 25,421,694,2385 Kep Corp 10.760 1,445,610,899 1.00 15,554,773,2756 GLP 2.910 3,092,143,906 1.00 8,998,138,7657 Genting SP 1.455 6,112,399,924 1.00 8,893,541,8898 Capitaland 2.960 2,562,816,510 1.00 7,585,936,8709 Wilmar 3.380 1,923,197,732 1.00 6,500,408,33310 SPH 4.000 1,599,890,221 1.00 6,399,560,88411 SGX 6.990 857,313,920 1.00 5,992,624,30112 ST Engg 3.780 1,551,529,508 1.00 5,864,781,54013 SIA 10.050 539,932,958 1.00 5,426,326,22914 Semb Corp 5.220 983,151,253 1.00 5,132,049,53915 CapitaMall 1.860 2,420,416,821 1.00 4,501,975,28616 Ascendasreit 2.140 2,039,497,608 1.00 4,364,524,88017 Noble Grp 1.025 4,211,905,889 1.00 4,317,203,53618 HPH Trust US$ 0.640 5,226,660,613 1.251 4,184,673,55319 ComfortDelGro 1.935 2,011,987,105 1.00 3,893,195,04820 GoldenAgr 0.550 7,060,652,500 1.00 3,883,358,87521 CITYDEV 9.470 409,185,450 1.00 3,874,986,21223 SembMar 4.350 835,904,043 1.00 3,636,182,58622 Jardine C&C 34.000 106,713,798 1.00 3,628,269,13224 CapitaComm 1.400 2,002,562,727 1.00 2,803,587,81825 UOL 6.030 462,144,692 1.00 2,786,732,49526 CapMallsAsia 1.925 1,362,497,730 1.00 2,622,808,13027 StarHub 4.050 602,416,512 1.00 2,439,786,87228 KepLand 3.370 695,612,539 1.00 2,344,214,25629 Yangzijiang 1.155 1,918,538,500 1.00 2,215,911,96830 Olam 1.435 1,465,445,921 1.00 2,102,914,897 © Christopher Ting

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© Christopher Ting© Christopher Ting

Symbol Name Weight Last Price FX Free-Float Shares Market Cap

MSCI SINGAPORE FREE 221,948,622,146.51

D05 DBS GROUP HOLDINGS LTD 14.16% 17.740 1 1,772,036,854.70 31,435,933,802.38Z74 SINGAPORE TELECOMMUNICATIONS 13.11% 3.650 1 7,971,788,474.50 29,097,027,931.93

O39 OVERSEA-CHINESE BANKING CORP 12.90% 9.100 1 3,145,297,022.25 28,622,202,902.48

U11 UNITED OVERSEAS BANK LTD 12.12% 20.770 1 1,295,656,081.60 26,910,776,814.83

BN4 KEPPEL CORP LTD 3.89% 5.930 1 1,454,328,144.00 8,624,165,893.92

C31 CAPITALAND LTD 3.45% 2.990 1 2,564,630,247.60 7,668,244,440.32

F34 WILMAR INTERNATIONAL LTD 3.25% 3.750 1 1,921,020,331.80 7,203,826,244.25

MC0 GLOBAL LOGISTIC PROPERTIES L 2.69% 2.240 1 2,664,400,872.10 5,968,257,953.50

S68 SINGAPORE EXCHANGE LTD 2.61% 7.220 1 803,731,800.00 5,802,943,596.00

T39 SINGAPORE PRESS HOLDINGS LTD 2.57% 3.560 1 1,600,649,121.00 5,698,310,870.76

G13 GENTING SINGAPORE PLC 2.52% 0.925 1 6,047,013,412.00 5,593,487,406.10

C52 COMFORTDELGRO CORP LTD 2.49% 2.560 1 2,156,193,663.00 5,519,855,777.28

A17U ASCENDAS REAL ESTATE INV TRT 2.45% 2.270 1 2,393,890,129.65 5,434,130,594.31

C6L SINGAPORE AIRLINES LTD 2.39% 9.810 1 539,932,958.10 5,296,742,318.96

S63 SINGAPORE TECH ENGINEERING 2.31% 3.290 1 1,561,247,598.50 5,136,504,599.07

C38U CAPITALAND MALL TRUST 2.11% 1.890 1 2,479,884,250.20 4,686,981,232.88

C07 JARDINE CYCLE & CARRIAGE LTD 1.80% 40.370 1 98,809,072.25 3,988,922,246.73

T82U SUNTEC REIT 1.79% 1.650 1 2,406,674,292.00 3,971,012,581.80

C09 CITY DEVELOPMENTS LTD 1.52% 8.250 1 409,185,450.00 3,375,779,962.50

NS8U HUTCHISON PORT HOLDINGS TR-U 1.51% 0.445 1.4445 5,226,660,613.20 3,359,710,508.82

S58 SATS LTD 1.49% 4.890 1 674,433,765.00 3,297,981,110.85

C61U CAPITALAND COMMERCIAL TRUST 1.39% 1.490 1 2,070,164,195.40 3,084,544,651.15

E5H GOLDEN AGRI-RESOURCES LTD 1.38% 0.435 1 7,060,651,705.80 3,071,383,492.02

U14 UOL GROUP LTD 1.32% 6.080 1 483,587,761.80 2,940,213,591.74

U96 SEMBCORP INDUSTRIES LTD 1.30% 2.940 1 983,151,252.60 2,890,464,682.64

CC3 STARHUB LTD 0.77% 2.830 1 606,078,005.05 1,715,200,754.29

BS6 YANGZIJIANG SHIPBUILDING 0.70% 0.810 1 1,918,538,500.00 1,554,016,185.00

2016-12-21 5 PM and the divisor is 683,505,151.45

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Free Float

Number of shares that are available to the public. This figure is calculated by subtracting the shares held by insiders and those deemed to be stagnant shareholders from the shares outstanding.

Stagnant holders include

Employee Stock Ownership Plans

Employee Share Ownership Trusts

Qualifying Employee Share Ownership Trusts

Employee Benefit Trusts

Corporations not actively managing money

Venture capital companies

Governments

© Christopher Ting

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Divisor

MSCI Singapore Index is a free-float market cap weighted index.

To convert the market cap into index points, a divisor is needed.

Also, the interest and dividends in dollars are to be divided to compute the fair futures price.

What is the intuitive meaning of divisor?

© Christopher Ting

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Where and How to Find the Divisor

MSCI official web sitehttps://app2.msci.com/eqb/custom_indexes/sg_performance.html

Step by Step demo and hands-on practice

Compute the market capitalization of each stock in Singapore dollars.

Aggregate the market capitalizations of all stocks.

Divide the aggregate market capitalization by SIMSCI index value.

The divisor remains unchanged unless there are changes to the component stocks or review of free floats, etc.

© Christopher Ting

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Example

As at 28 Sep 2013, the total market cap of MSCI Singapore index’s 30 component stocks is S$246,760,012,464.

The divisor is 673,384,854.58.

The MSCI Singapore index value is therefore

246,760,012,464 / 673,384,854.58 = 366.45

© Christopher Ting

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From Cash Index to Futures’ Fair Price

© Christopher Ting

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Interest Rate and Dividends

Having calculated the cash index from its component stocks, the next two things to do are

(1) Obtain an interest rate

(2) Check for dividends

Use SIBOR to compute the interest amount. Check outhttps://abs.org.sg/rates-sibor

For dividends and other corporate actions, check outhttp://www.sgx.com/wps/portal/sgxweb/home/company_disclosure/corporate_action

© Christopher Ting

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Interest Amount in Index Points

Interest Amount =

Cash Index × (SIBOR in Percent /100 )

× (Days to Maturity/365)

Example

366.45 × (0.3167%/100) × (31/365) = 0.10 index points

© Christopher Ting

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Dividend Forecasts

It is practical to concentrate on a few stocks that influence the index most.

Forecast whether a company will pay dividends based on past dividend.

Example:

Likely, Singtel will pay 10.7 cents per share in Aug 2017.

© Christopher Ting

Company Name

Type Ex-DateRecord Date

Date Paid/Payable

Particulars

SINGTEL DIVIDEND 19-Dec-16 21-Dec-16 11-Jan-17 SGD 0.068 ONE-TIER TAX

SINGTEL DIVIDEND 02-Aug-16 04-Aug-16 17-Aug-16 SGD 0.107 ONE-TIER TAX

SINGTEL DIVIDEND 21-Dec-15 23-Dec-15 13-Jan-16 SGD 0.068 ONE-TIER TAX

SINGTEL DIVIDEND 30-Jul-15 03-Aug-15 19-Aug-15 SGD 0.107 ONE-TIER TAX

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Then the dividend payable in dollars is

D = Free float shares × dividend per share

Also the interest from the ex-date to the expiration on the dividend must be paid, i.e.,

D × days × r0 /365

In total, adjustment for dividend is

D × (1 + days × r0 /365)

Adjustment for Dividends

Today Ex-date Expiration date

days

© Christopher Ting

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Example

A dividend of 4 cents per share is declared for a component stock.

The free float is 857,313,920 shares.

Suppose the ex-date of a dividend is 10 days before the near month expiration and 40 days before the far month expiration.

Suppose the 1-month SIBOR is 0.30% per annum and the 2-month SIBOR is 0.35% per annum.

The divisor is 673,384,854.58.

© Christopher Ting

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Dividends in Index Points for Near Month

The dollar amount is obtained by

$0.04 × 857,313,920 = $34,292,556.80

The total amount is

$34,292,556.8 0 × (1 + 10 × 0.003/365) = $34,295,375.37.

To obtain the total dividend in index points, divide by the divisor:

$34,295,375.37 / 673,384,854.58 = 0.05 index points

© Christopher Ting

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Putting Everything Together

Earlier, we have computed that the interest amount in index points is 0.10.

The fair price of the front month is,

Fair price = cash price

+ costs incurred to hold the index’s stocks

– benefits from holding the index’s stocks

= 366.45 + 0.10 – 0.05

= 366.40.

© Christopher Ting

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Class Activity

Use the latest information from https://app2.msci.com/eqb/custom_indexes/sg_performance.html to compute the divisor, the fair price of the front month SIMSCI futures.

Compute the fair price of the spread between near- and far-month futures.

© Christopher Ting

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Time of the Day Effects: Abrupt Movements

8:30 a.m.: SIMSCI index futures call auction to open

8:58 a.m.: Cash market call auction

9:00 a.m.: Cash market starts continuous trading

5:00 p.m.: Cash market stops continuous trading

5:05 p.m.: Cash market call auction

From 5:05 p.m.: to 5:10 p.m.:, SIMSCI futures price fluctuates because traders want to close their positions.

Some traders want to take profits

Some traders want to cover losses

5:15 p.m.: SIMSCI index futures call auction to close

© Christopher Ting

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Useful Tips for Trading SIMSCI Index Futures

Before the cash market open, between 8:45 a.m. to 8:58 a.m., SIMSCI index futures tends to follow the Taiwan MSCI index futures.

At 8:58 and 9 a.m., there may be abrupt futures price movements.

At 9:15 a.m., HSI index futures opens in Hong Kong, and SIMSCI index futures starts to follow HSI index futures.

At 3:00 p.m. (2:00 p.m. DST), DAX index futures opens

At 4:00 p.m. (3:00 p.m. DST), DAX cash market opens

At 4:15 p.m., after the HSI index futures closes, SIMSCI futures may be influenced by DAX index.

© Christopher Ting