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Reasons why and how to hedge a share position using CFD’s

Promoted by City Index.

The big four Australian Banks post the Global Financial Crisis became the cornerstone of many investors share portfolios. Buoyed by record bank profitability, bank shareholders enjoyed the twin benefits of impressive share price gains as well as attractive fully franked dividend yields. The Commonwealth Bank of Australia for example currently trades on a dividend yield of over 6.2%.

In more recent times, bank shares have fallen out of favour.

The flow of money out of the big four banks and the AMP gathered momentum, post the establishment of the Hayne Royal Commission which has since shown banking behaviour and culture in an unfavourable light. At the same time, there have been high-profile court cases involving banks that included charges of cartel-like behaviour, money laundering and rigging of benchmark rates.

As a result, banks are likely to be subject to increased regulatory scrutiny, increased compliance costs and more responsible lending practices. All of which is happening at a time when housing prices are falling, and consumer spending remains subdued. An uncertain environment at best.

A study of the charts doesn’t instil confidence. National Australia Bank recently traded at levels last seen in 2016. Likewise, the share prices of Westpac and the Commonwealth Bank recently traded to their lowest levels since 2013. It remains to be seen whether the bounce in banks share prices which commenced in mid-June is the start of a sustained recovery or a temporary relief rally.

If an investor in Commonwealth Bank was of the opinion that bank earnings and share prices might have peaked and that the recent bounce in the share price was a temporary relief rally yet did not wish to sell their Commonwealth Bank shares, they might choose to protect themselves against a further price decline by using CFD's to hedge their position.

A CFD is a derivative that allows traders to both speculate and hedge against price movement without needing to own the underlying asset. The profit and loss from a trade is the difference in the price of the underlying instrument from when the contract is opened and closed. CFD’s are a leveraged product, which allows the buyer or seller to gain full market exposure while only outlaying part of the total notional value of the instrument.

Let's assume the investors' original investment of 1000 shares has a value of $75,000 (with CBA's share price at $75.00). If the share price were to fall by $10.00 to $65.00 their investment would then be worth $65,000 and represent a paper loss of $10,000. However, if the investor was to put in place a CFD hedge by selling 1000 CFD’s at $75.00 and the stock falls to $65.00, the profit from that CFD position would be $10,000, thus protecting the investor against the fall in the underlying share price.

If on the other hand, the investor’s concerns proved to be unfounded and Commonwealth Bank shares rose by $10.00, the profit on the physical holding of the shares would be offset by a loss on the CFD hedge, thus cancelling out the gains on the physical shareholdings.

Hedges using CFD’s are most useful when investors feel there is uncertainty around a share and there is more risk to the downside than to the upside. Keep in mind that hedges are most effective when used as a short-term strategy. If a share position is 100% hedged at all times, the hedge would completely offset any gains in the share price.

Source Tradingview. The figures stated are as of the 28th of June 2018. Past performance is not a reliable indicator of future performance. This report does not contain and is not to be taken as containing any financial product advice or financial product recommendation

 

DISCLAIMER

GAIN Capital Australia Pty Ltd, 100 Harris street, Pyrmont, NSW 2009 (ACN 141 774 727, AFSL 345646) is the CFD issuer and our products are traded off exchange.

Any analysis, opinion, commentary or research-based material on our website is for information and educational purposes only and is not, in any circumstances, intended to be an offer, recommendation or solicitation to buy or sell. You should always seek independent advice as to your suitability to speculate in any related markets and your ability to assume the associated risks, if you are at all unsure. No representation or warranty is made, express or implied, that the materials on our website are complete or accurate. We are not under any obligation to update any such material.

As such, we (and/or our associated companies) will not be responsible or liable for any loss or damage incurred by you or any third party arising out of, or in connection with, any use of the information on our website (other than with regards to any duty or liability that we are unable to limit or exclude by law or under the applicable regulatory system) and any such liability is hereby expressly disclaimed.

While every care has been taken in preparing this material, we do not provide any representation or warranty (express or implied) with respect to its completeness or accuracy. This is not an invitation or an offer to invest nor is it a recommendation to buy or sell investments.

GAIN Capital recommends you to seek independent financial and legal advice before making any financial investment decision. Trading CFDs and FX on margin carries a higher level of risk, and may not be suitable for all investors. The possibility exists that you could lose more than your initial investment further CFD investors do not own or have any rights to the underlying assets.

It is important you consider our Financial Services Guide and Product Disclosure Statement (PDS) available at www.cityindex.com.au, before deciding to acquire or hold our products. As a part of our market risk management, we may take the opposite side of your trade.


TECH-FX TRADING PTY LTD (ACN 617797645) is an Authorised Representative (001255203) of JB Alpha Ltd (ABN 76 131 376 415) which holds an Australian Financial Services Licence (AFSL no. 327075)

Trading foreign exchange, futures and CFDs on margin carries a high level of risk and may not be suitable for all investors. The high degree of leverage can work against you as well as for you. Before deciding to invest in foreign exchange, futures or CFDs you should carefully consider your investment objectives, level of experience, and risk appetite. The possibility exists that you could sustain a loss in excess of your deposited funds and therefore you should not invest money that you cannot afford to lose. You should be aware of all the risks associated with foreign exchange, futures and CFD trading, and seek advice from an independent financial advisor if you have any doubts.

Any advice provided is general advice only. It is important to note that:

  • The advice has been prepared without taking into account the client’s objectives, financial situation or needs.
  • The client should therefore consider the appropriateness of the advice, in light of their own objectives, financial situation or needs, before following the advice.
  • If the advice relates to the acquisition or possible acquisition of a particular financial product, the client should obtain a copy of, and  consider, the PDS for that product before making any decision.
Reasons why and how to hedge a share position using CFD’s
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