Read fine print, be mindful of risks

PHOTO: Read fine print, be mindful of risks

Derivatives used to be a no-go area for retail investors and with good reason, given their complexity, but the tide is turning fast with trading volumes soaring.

The Singapore Exchange's derivatives trading business has continued to grow steadily over the past few months, with daily trading volumes up 8 per cent last month from July.

One attraction of derivatives is that little capital is required.

For as little as $200, depending on the instrument, investors can take a position of as much as $10,000, said Mr Justin Harper, market strategist at contracts-for-difference provider IG.

Many people investing in derivatives or products that contain them tend to be more sophisticated investors, such as high net worth individuals or family offices which manage the wealth of rich families.

But with greater public awareness of the potential gains, more retail investors are attracted as well.

Mr Goh Nai De, 25, an undergraduate at Singapore Management University, said he was introduced to derivatives in late 2007 by his retiree uncle.

Since then, he has made a "comfortable" five-figure sum trading them, he said.

Another reason derivatives and related products are becoming popular boils down to one word - flexibility.

Derivatives allow investors to make bets and profit even if the market goes down, notes Ms Grace Chan, director of sales and marketing at Phillip Futures.

In contrast, an investor who buys stocks profits only when the price rises.

The investment environment is growing increasingly complex as financial institutions introduce new products that aim to give investors more room to manoeuvre when times are tight.

"In instances where valuations have been more depressed, the (market's) volatility often allows us to introduce products which provide clients both upside and some downside protection," said Ms Tan Su Shan, managing director and group head of wealth management at DBS Bank.

But to avoid taking on risks they are unaware of, investors need to read the fine print.

Derivatives

A derivative is a type of product whose value is derived from, or depends on, an underlying financial asset such as stocks, bonds, currencies, commodities or indexes like the Straits Times Index.

Common derivatives include options and futures.

Investors in Singapore tend to go for index futures, though commodity futures are gaining ground.

"There is a preference from customers for derivatives linked to Asian broad market indices or Singapore blue chips," says Ms Radhika Bangaru, director for investments at Citibank Singapore.

Ms Chan added that commodities futures for crude oil, copper, gold and soya beans are also becoming more popular.

Structured products

These combine both assets and derivatives. The derivative is used to link the structured product's return to the performance of the underlying asset.

For example, if you buy a structured note whose return is linked to the Straits Times Index (STI), the value of the structured note will vary depending on the STI's level.

The more popular structured products here include equity-linked notes and dual currency deposits, which DBS' Ms Tan described as the "bread-and-butter business for the vast majority of private and priority banks across client segments".

Risks

Though the prospect of higher returns may seem tempting, investors expose themselves to the credit risk of the issuer, market risk and general investment risks.

Derivatives also carry what is called counterparty risk - this is the danger that the other party in the transaction fails to carry out its side of the bargain.

Another risk comes from using margins. Derivative products like futures require the investor to place an initial amount of cash with a broker at the start of the contract.

This cash is called the margin.

The broker may occasionally ask the investor to put up additional margin, known as a margin call, if the derivative's market value drops.

Depending on how many margin calls there are and the performance of the derivative, the investor could end up losing more than the initial investment amount.

melissat@sph.com.sg

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