Introduction of the derivatives market at the Nairobi Securities Exchange, dubbed "Next" two years ago, transformed the capital markets landscape in Kenya by offering investors an opportunity to diversify their investment portfolios. Next facilitates trading of futures contracts in the Kenyan market.
A derivatives contract is an agreement between two or more parties, usually a buyer and a seller, whose value is derived from that of an underlying asset such as a currency, stock or commodity.
When the value of the underlying asset changes, that of the derivatives contract takes a similar course.
Although the only products available are single stock futures and equity index futures, there is scope for introduction of more products with time.
Equity index futures are derivative instruments that give investors exposure to price movements on an underlying index, which in Kenya is the NSE 25-Share Index, while the equity single stock futures are based on price movement of several equities including Safaricom, KCB Group, Equity Group, Absa Bank, EABL and BAT.
There are two types of derivatives contracts. Those that are traded over the counter (OTC) and exchange-traded derivatives. OTC derivatives are often unregulated and are traded in private between banks, hedge funds, and other market players. Exchange-traded derivatives are highly regulated, standardised, and anyone can trade them on an exchange.
One simple way of trading derivative contracts is by using futures. Futures contracts are exchange-traded derivatives that give a trader the right and obligation to buy or sell an underlying asset at a specific price at a future specified date.
All futures contracts have an expiry date, upon which the underlying asset is delivered to the contract holder. Futures contracts are often leveraged, have low transaction fees and are settled in cash.
Another way of trading derivatives contracts is by using contracts for difference (CFDs). A CFD is a deal between two parties to exchange the value of a derivatives contract in cash between contract open and expiry. CFDs are very similar to futures except that it expires when a trader chooses to close the initial position.
To put it into perspective, a local online forex trading broker such as Scope Markets Kenya, may offer a trader the option to deal in Safaricom CFD shares. The Safaricom CFD contract will derive its value from the actual market value of physical Safaricom shares trading on the NSE.
If a trader buys one CFD share at a price of say Sh42 today, and then sells […]
