News articles have cautioned that the bear market is upon us in recent weeks amidst macroeconomic and geopolitical headwinds. A bear market is usually associated with a decline of 20% or more from the recent high.
The S&P 500 Index was said to have entered a bear market on June 13 after it closed more than 20% below the high recorded on Jan 7. Closer to home, the FTSE Straits Times Index (STI) is not yet in a bear market yet, given how Singapore’s key index is down less than 10% as of July 18 from its recent peak of April 5.
For investors who buy stocks expecting prices to go up over time, the bear market now can be an extremely painful experience as the value of their investments drop day after day.
Yet, there are ways for investors to turn this trend on its head. Instead of merely seeking refuge from the marauding bears, they can look for opportunities to profit from too. One way to do so is to go short on stocks. In other words, sell stocks with the view that the prices will go even lower, instead of buying stocks hoping they will go higher.
Taking a short position is not for everyone as it usually involves a higher level of risk and requires a closer monitoring of your position.
How does shorting work?
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There are generally two ways to initiate a short position — short-selling, or using a short instrument. Short-selling involves selling a stock that you do not own. To do this, you must borrow the stock to short-sell so that you are able to hold the short position for a longer duration, otherwise you will have to cover the short position by buying back the stock within the same trading day.
Short-selling activity is reported on the Singapore Exchange (SGX) website and the trend has been going up (see chart “Weekly short sell value in SGD reported by SGX”) as the investors look to profit from the stock price declines in the SGX market.
A major risk to short-selling, however, is the potential for unlimited losses. If you short a stock at $30, your maximum gain is $30 if the stock goes to $0. If the stock goes up to $100 or even higher, you have to pay $100 or higher to close out your short position. This asymmetry between a capped profit potential versus an unlimited loss potential is probably one of the key reasons why short-selling is often frowned upon.
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Another way would be to initiate a short position using a short instrument. Short instruments allow you to achieve the same profit potential as short-selling while limiting your potential losses.
Buying a short DLC listed on SGX
One such product is the Daily Leverage Certificates (DLCs), which are listed on the SGX and thus can be traded by investors using their regular stock brokerage account if they meet the necessary qualifications. There are two types of DLCs — a long DLC and a short DLC. The short DLC can be used to profit from a fall in the underlying asset price while limiting the potential loss if the underlying asset price rises.
A short DLC magnifies the daily performance of the underlying asset (e.g. index or single stock) by a fixed leverage factor. For example, if the STI declines by 1% from its previous close, the 5x short DLC on STI will gain in value by 5% from its previous close, and vice versa decline in value by 5% if the STI had gained by 1%, before costs and fees.
By taking a short position using a DLC, you will never lose more than your initial investment amount even if the underlying moves adversely against you, thereby limiting your potential loss. For example, if the underlying stock price rises intraday by 25% from the previous day close, multiplied by 5x leverage, this translates to a theoretical loss of –125% on the 5x short DLC. However, the maximum loss to investors holding the DLC is capped at 100% or their entire investment amount and never more than that.
Time horizon matters
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While there is no time limit in which you can hold a short position, initiating a short position usually involves a form of borrowing, and these come with funding costs or interest charges. These charges will be incurred for as long as you hold your short position, and the costs can add up over time. Similarly, short instruments like the DLC have an overnight funding cost and should not be held for a long period of time.
Know the risks and the product
Taking a short position involves a certain level of complexity and risk, while using a short instrument requires one to also understand the additional complexity and risk associated with the instrument. However, if you understand what the instrument can offer and use it wisely, it can become a powerful tool within your investment portfolio.
Marcus Ng is vice-president of cross asset listed distribution, Asia Pacific, at Société Générale
Over 250 DLCs have been issued by Société Générale and listed on the SGX, including DLCs that track the S&P 500 Index, Hang Seng Index, Straits Times Index, and a wide range of single stocks. Visit Société Générale’s website at DLC. socgen.com to learn more about the product features including the associated risks of trading the DLCs. SGX Weekly short sell value in SGD reported by SGX
Disclaimer: This article is brought to you by Société Générale, Singapore Branch which is regulated by the Monetary Authority of Singapore (MAS). The content of this article does not form part of any offer or invitation to buy or sell any DLCs, and nothing herein should be considered as financial advice or recommendation. Investments in DLCs carry significant risks, the price may rise and fall in value rapidly and holders may lose all of their investment. Any past performance is not indicative of future performance. The DLCs are for specified investment products (SIP) qualified investors only. This advertisement has not been reviewed by the MAS.
