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My plan to make R1 million on the JSE continued (Part 2)

Being far short of the goal, and with only a small portfolio, drastic action is called for.

The possibility of success with my master plan – to grow R100 000 to R1 million over the next two years, by investing in a few neglected shares and others that offer recovery potential – looks extremely slim.

After doing a lot of reading and number crunching it looks like the best I can hope for is that the little portfolio will grow to R241 000.

That in itself is a very optimistic goal. Every share in the portfolio must basically more than double to reach the rather disappointing figure. In addition, the calculations exclude brokerage and other costs.

Proposed portfolio

Share Price Shares Cost Target Value
Comair R2.69 8 000 R21 520 R7 R56 000
Sasol R286.73 100 R28 673 R800 R80 000
Sasfin R27.30 900 R24 570 R50 R45 000
Astral R166.58 150 R24 987 R400 R60 000
      R99 750   R241 000

Source: Own calculations

A few of the shares are also quite risky propositions as indicated by their low standing in the market. The basic assumption of strong recovery from big problems is equally risky, thus demanding a high return.

My solution to get even higher returns from the risky portfolio is to increase the risk even further by supercharging performance with massive gearing by ignoring the stock market and rather getting exposure to the shares with derivatives.

A few alternatives are available, with single stock futures (SSF) contracts and contracts for difference (CFDs) the two more commonly traded and very liquid alternatives. They are similar in the aspect that an investor can get exposure to a share by putting down a deposit of only around 15% of the value of the ‘shareholding’.

Instead of investing around R21 000 to buy 8 000 Comair shares at R2.69 each, an investor can put down the R21 000 as margin on a CFD or SSF trade and acquire a much larger position. The margin requirement for larger companies is 15% of the share price, while brokers require a margin of 17.5% in the case of smaller companies such as Comair.

An investor can thus buy exposure to 45 000 Comair shares to the value of more than R121 000 with a margin of around R21 000. An increase of 20% in the share price to R3.22 would push the value of the 45 000 shares to nearly R145 000, boosting the return from 20% on the R21 000 investment to nearly 600%.

Unfortunately, the opposite is also true. If the share falls by 20%, an investor does not lose 20% of their investment, but everything. In fact, their loss would be greater than the R21 000 they invested.

It is with good reason that Warren Buffett, credited as the world’s most successful investor, called derivatives the “weapons of mass destruction” of the financial world.

Brokers that make a market and offer platforms to investors and speculators to trade SSF and CFDs also warn their clients about the high risks inherent in trading derivative instruments. They all have similar examples to the one above to show the effect of gearing on profits and losses.

PSG Wealth, the online stockbroking arm of the PSG Group, warns its clients that while trading CFDs can be very profitable, it involves significant risks. “You can lose more money than you started with,” it states on its website.

The reason why losses can exceed the initial margin is that the investor is gaining exposure to the full value of the underlying shares. If Comair falls by 40% (in the case of buying 45 000 Comair shares), my total loss will be more than R48 000, exceeding the initial deposit of R21 000.

Investors are liable for these losses as they effectively ‘own’ all the shares. They would also receive all the dividends paid on the total number of shares in the transaction.

“CFDs require a high-risk appetite, time to watch the markets and expert knowledge on markets and trading,” continues PSG. “You should not trade CFDs if you do not have this knowledge or are an inexperienced trader.”

‘High risk of losing money rapidly’

Another popular market maker to offer trade in CFDs, IG Markets, says CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. It warns clients and prospective clients on its website that 75% of retail investor accounts lose money when trading CFDs on its platform.

This figure gets updated from time to time and has occasionally reflected a higher percentage.

“You should consider whether you understand how CFDs work and whether you can afford to take the high risk of losing your money,” says IG.

Other brokers warn clients to trade only with money they can afford to lose.

In addition, CFDs are not regulated by the JSE, despite a lot of JSE brokers facilitating trade. The buying and selling of CFDs are over-the-counter transactions between the investor and the broker, who acts as principal in the transactions and as market-maker. Most brokers would hedge the CFD positions by buying and selling the underlying shares on the JSE.

Dangerous, yet appealing

The message is that derivatives are dangerous instruments, but the appeal for boosting performance in my portfolio remains. After all, a supercharger worked well for Mad Max back in 1979.

There are different ways to handle risk.

  • Firstly, I am willing to accept the risk of further declines in the prices of the selected shares, as it looks like further downside is limited.
  • Secondly, the four shares offer a bit of diversification over different sectors. These shares will be affected by different factors, and will hopefully not decline all at once.

It might help a bit to reduce risk, even if the portfolio is by far not optimally diversified with perfect negative correlation, as taught in investment management courses at university or calculated by highly-paid risk analysts working for portfolio managers.

Best defence

The best defence against the dreaded margin call is not to push the leverage to its maximum. Putting down a margin of 35% to 40% of the value of the portfolio would give enough leverage to enhance returns, but leave ample leeway for temporary adverse movements in the share prices.

This level of gearing would increase the exposure to the shares from the initial R100 000 to R310 000.

Leveraged portfolio

Share Price Shares Exposure Margin Target Value
Comair R2.69 40 000 R107 600 R37 660 R7 R280 000
Sasol R286.73 400 R114 692 R40 142 R800 R320 000
Sasfin R27.30 2 000 R54 600 R19 110 R50 R100 000
Astral R166.58 200 R33 316 R11 661 R400 R80 000
      R310 208 R108 573   R780 000

Source: Own calculations

Eventually, the portfolio ended up looking a lot different from the initial idea of investing an equal amount in each of the four shares on the JSE. Bigger exposures were taken in Comair and Sasol, unfortunately at the expense of Sasfin and Astral.

In my view, Comair offers good recovery potential with lower risk, while Sasol can benefit from rand weakness and the attention of global investors. And buying 378 Sasol shares seemed to make little sense.

The end result after another two days of working is still not close to the promised R1 million, but there is still hope of making it to the finish line.

The last step of the two-year plan is to reinvest the returns.

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“You may find some old traders, and you may find some bold traders, but you won’t find any old, bold traders.”

The trader who uses gearing must not only pick the rights stocks, he must also buy them at the right moment. When you use gearing, you must be right at the right time. If you are right too soon, you will go broke. Compound growth needs time to work. This implies that time is the best fund manager. When the trader uses gearing, he is short of time, because he cannot wait for the position to recover if the share price slides. So, the geared trader is shorting the best fund manager.

85% of traders who use gearing lose their capital within the first 12 months because they are right at the wrong moment. This is why we need a timing tool if we use gearing. Entering leveraged positions on fundamental information only is the recipe for ruin.

I agree with Sensei – if youre making bread it needs time to rise!
And the risk of WMD does not appeal either.
I see that Comair has moved from R2.67 to R3.30 since Part 1 ( in 24 hrs) so you seem to be on the right flight path. Lol.

WMD as in Weapons of Mass Destruction?!

Nice article on speculation…

Part 1 was still investing; since you wanted to grow the potential prices of the shares (you did not state that you would sell at that point)

Part 2 is speculating since you are only profiting or losing on price movements and not from the improvement of the businesses themselves…

The easiest way to end up with a million on the JSE is to give R1.5m to a fund manager. A few years of fees and poor performance = you have R1m.

Reminds me of the maxim, if you want to make a small fortune, start off with a big fortune and give it to a fund manager.

This is great, THIS is what Moneyweb used to be about. Great article Adriaan. Though you dont have allocation to BTC or crypto and its 100% JSE dog inc, so I cannot approve entirely haha.

The 600% gain calculation looks suspect. I’d say, given the figures in the example, the gain would be aprox 115%.

E&O expected.

The only drawback of derivitives, especially CFD’s is the charges. You pay interest on the amount you loan plus you pay a higher interest on the amount the share has appreciated in exposure… So you simply working for the broker. You win he wins you lose he wins… That’s why the USA has banned CFD trading.

We should at least be allowed options at small retail scales.

Boombang

I recently physically traded out and back in on a share that moved from 225 down to 150 and then I bought back at say average 160 a few months later. So call it 65 “made” It is a large offshore with enormous range and depth of options. Afterward I looked at what would have happened if I had sold covered calls at 225 and bought them back to close off at 160. That, excluding option trading fees, would have only returned 35.

Options game is Greek to me.

Selling covered calls, in this case, cannot be compared to selling out and buying back as you did. If we want to compare what you did with an option position you would have sold(written) double the number of put options to get a delta of one. But you are correct, options are so greek that very few people understand the risks involved.

You are correct. CFD’s offer gearing at low cost….in theory. You don’t have to roll over the position like with futures or options and you don’t pay securities tax on the exposure. The interest rate that is charged by local brokers on the amount you borrow to get gearing, is prohibitively expensive though. The interest rate can easily be 12% on the gearing. This makes options and futures a cheaper alternative.

Some international platforms finance at an interest rate of 3%. The lower rate of interest makes u a huge difference in the performance. Some international platforms charge low brokerage rates that are about 10% of local rates.

Just remember that CFD’s carries a counterparty risk that futures and options don’t have.

Sensei : selling covered calls should after everything washed out, amount to the same thing as selling and buying back minus the friction of option market. Friction is obv heavily influenced by time.

It is time we all get real about where the friction goes. Say we were in a bar in the Old West, and me owning 1000 cattle, took a bet with you by which you have the right to buy my cattle at today’s price of $800z in December. Cool, you pay $775 for the bet, per head.

We go to the Great Western Bar again early December. Steer are trading at $500 a head. I buy 1000 steer at $480 from John for December delivery and cede them to fulfill your right to come collect my cows.

Friction cost is the dream / marketing / fluff. I had to incentivize you by $25 and John incentivized me $20. $5 net cost on a swing of $300.

Instead, the banker from OldTown Investment Bankers takes $295 for writing up our agreements! And the wanker probably would not know a bull from a cow PLUS he took ZERO risk as my cows were covered in full by my 1000 steer and John’s 1000 steer. It is madness out there

@Adriaan, this is insightful, thank you. I would like to know if a layman like me can “opt in” to a strategy like this through options though? I’m not a fundi on the mechanical details and maths, but what if one could buy the option to purchase Sasol at say R320-R350 in 12-24 months’ time? If the option costs R32-R35 (10% of the price), you can risk 10% of your capital only, for the same effective exposure. If the price fell after that period, you’ve only lost 10% at most. If the price rose you get the benefit. You would also have had 90% of your capital left to something else with. The difference to the CFD’s is that you don’t have to remain solvent all the time during the ride. I guess the downside is the specific timing of “calling” the option. Can this be done in SA? And are options even offered over such long periods?

It is easier to find companies to short rather than find companies to go long on.

Imagine if you had shorted Aspen, Steinhoff, Hullets etc ..

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