The recent adoption of derivatives contracts on the Nigerian Exchange has continued to generate curiosity among investors on how it will impact the market and their investment. The Nigerian Exchange Group (NGX) announced the approval of seven derivatives contracts by the Securities and Exchange Commission (SEC).
The approved contracts are Access Bank Stock Futures, Dangote Cement Stock Futures, Guaranty Trust Bank Stock Futures, MTN Nigeria Communications Stock Futures, Zenith Bank Stock Futures, NGX 30 Index Futures, and NGX Pension Index Futures.
How will this impact the market? Why the preference of just five stocks among several others listed on NGX? What happens to other stocks that were not mentioned? How will the preferred stocks fare going forward? These are the trending questions from investors as regards their investment.
A derivative is a contract between two or more parties whose value is based on an agreed-upon underlying financial asset or group of assets. Common underlying instruments include bonds, commodities, currencies, interest rates, market indices, and stocks. The basic principle behind a derivative contract is to earn profits by speculating on the value of the underlying asset at a future date. As such, derivatives are used as a risk management instrument and are suited to both professional and private investors who wish to hedge an open position or gain exposure to assets and markets without necessarily holding the underlying assets.
Through a derivative contract, the value of an underlying asset is locked for a future date (settlement date) to protect the risk of price fluctuation and speculate the future value of the asset. This locked price, known as the strike price, is the value reference or consideration upon which the contract will be settled and the underlying asset will be transferred to the buyer on the settlement date.
Derivatives may be used by trading companies to protect them from risks that are peculiar to their business interests by lenders to redistribute their risk exposure on a transaction or by institutional investors to manage their investment portfolios.
In a chat with Mrs Busola Ogbonna, CEO Advisory of Cedrus Group Africa, the capital market guru stated thus:
“Derivatives contracts on the Nigeria Exchange is long overdue. We have been playing within the equity space; people have been buying shares with fear in their heart without having an instrument they can use to hedge their position in the equity market. Having the derivative market on board is long overdue because it’s a very good tool for risk management. So if you are going into the equity market, at least you have a derivative market that you can use to hedge your exposure.
“The derivatives market is a different market entirely different from the equity market. It is another Asset Class entirely. You have played, in the equity market, so they are now saying come and play in the derivative market, come and use derivatives market to hedge, manage your risk in the equity space. This is a value add to investors. Where the risk is that, if you don’t know how to use those instruments, it could lead to losses. People need to be trained to know how to use derivatives instrument so that they can join the moving train.
On the choice of Access Bank, Zenith, GT Bank, Dangote Cement and MTN that were chosen to pioneer the derivatives contracts on NGX, Mrs Ogbonna stated thus:
“These securities are dividend paying securities. They are toasts of investors. They have large volume of trades. When you look at their transactions on NGX, you will realize they are heavily traded. Since there are so many exposures on these securities, The Exchange decided to start derivatives contacts from them to manage those people who are already exposed within that space”.
“Apart from having derivatives contracts on single securities like Access Bank, GT Bank, Zenith, Dangote Cement and MTN we can equally do derivatives contracts on indices. That is NGX 30 and NGX Pension Index. NGX 30 means 30 most capitalized stocks listed on the Nigerian Exchange Group. NGX Pension Index means those stocks that can be traded by PFAs that is acceptable by PenCom. NGX Pension tracks the top 40 companies in terms of market capitalization and liquidity. These are baskets of stocks and derivatives contracts can be done on this index”.
“In advance countries of the world, there are so many derivatives contracts on indices, so ours should not be different at all”.
Commenting on the choice of the 5 equities chosen by NGX to kick start derivatives contract, Mr Aruna Kebira, MD/CEO of Global View Capital Limited stated thus:
“The exchange would have gone through stringent process and due diligence to qualify these 5 stocks they are using as pioneer stocks for derivatives contracts. It is akin to the vote of confidence on these stocks by the exchange management. Discerning investors will continue to align their portfolios to take positions in these stocks. For the reason that the daily value of the contract is dependent on the daily price of these underlying stocks, the market might likely have regard and demand for them”.
“These stocks would have passed through a lot of tests. When it was announced, we saw the prices of these stocks rising like Access Bank touching N10, Zenith touching N25. To a very large extent, the choice of these is going to affect these underlying stocks positively. Dangote Cement and MTN are one of the major determinant of the direction of the All Share Index; anytime they move, the ASI moves with them. At that, their inclusion in the derivatives contracts is good for the market going forward”.