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
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.
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