The investors toolbox how to use spread betting, CFDs, options, warrants and trackers to boost returns and reduce risk

toolbox2_fullcover_final:Layout 20/3/07 17:24 Page This book is a simple practical guide to how you can use some of the newer investment products like spread betting, binary betting, contracts for difference, covered warrants and exchange-traded funds, as well as older ones like futures and options, to help your investing In different ways, each of these products allows you either to: • boost the returns you get in exchange for taking on greater risk; • hedge your bets in exchange for slightly lower returns; • use much less capital to achieve the same market exposure; or • move money into and out of a range of markets and sectors efficiently The author believes that these are tools that all investors need to know about and be able to use when the occasion demands it They should help you successfully confront any lengthy period of trendless or volatile markets While recently we have seen a generally strong upward trend in stock markets, this is not bound to continue Periodic volatility is the natural order of things Interestingly enough – despite what appears to have been a bull market – recent years have also seen increased use by private investors of many of the tools described in this book Proof, if needed, that they work, and can be applied, in all market conditions Peter Temple has been working in and writing about financial markets for the last 36 years After an 18 year career in fund management and stock broking, he became a full time writer in 1988 His articles appear in the Financial Times, Investors Chronicle and a range of other publications He has written more than a dozen books about investing, mainly aimed at private investors He and his wife live in part of a converted bobbin mill in the Lake District National Park www.harriman-house.com/toolbox Hh Harri man House Publ i shi ng The Investor’s Toolbox How to use spread betting, CFDs, options, warrants and trackers to boost returns and reduce risk Fully revised and updated 2nd edition Peter Temple Peter Temple Peter Temple The Investor’s Toolbox Fully revised and updated second edition ISBN 9781905641048 £19.99 Hh Hh Harriman House The Investor’s Toolbox How to use spread betting, CFDs, options, warrants and trackers to boost returns and reduce risk by Peter Temple HARRIMAN HOUSE LTD 3A Penns Road Petersfield Hampshire GU32 2EW GREAT BRITAIN Tel: +44 (0)1730 233870 Fax: +44 (0)1730 233880 email: enquiries@harriman-house.com website: www.harriman-house.com First edition published in Great Britain in 2003 Second edtion published in Great Britain in 2007 Copyright Harriman House Ltd The right of Peter Temple to be identified as author has been asserted in accordance with the Copyright, Design and Patents Act 1988 ISBN 1-905641-04-4 978-1-905641-04-8 British Library Cataloguing in Publication Data A CIP catalogue record for this book can be obtained from the British Library All rights reserved; no part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, or otherwise without the prior written permission of the Publisher This book may not be lent, resold, hired out or otherwise disposed of by way of trade in any form of binding or cover other than that in which it is published without the prior written consent of the Publisher Printed and bound by Cambridge Printing, University Printing House, Cambridge No responsibility for loss occasioned to any person or corporate body acting or refraining to act as a result of reading material in this book can be accepted by the Publisher, by the Author, or by the employer of the Author About the author Peter Temple has been working in and writing about financial markets for the last 36 years After an 18 year career in fund management and stockbroking, he became a full time writer in 1988 His articles appear in the Financial Times, Investors Chronicle and a range of other publications He has written more than a dozen books about investing, mainly aimed at private investors He and his wife live in part of a converted bobbin mill in the Lake District National Park Acknowledgements Any author writing a factual book relies on a diverse range of contacts both for information and for the benefit of their experience Many individuals helped with both editions of this book Philip Jenks embraced the original idea of this book and backed it when – during depressed times for investment publishing – few other publishers wanted to take on new projects Myles Hunt at Harriman House has taken up the baton and has been instrumental in producing the second edition Stephen Eckett deserves special mention for firming up many of the disjointed ideas I originally had about what this book should cover into a firm coherent plan, and for some useful and detailed comments on the finished manuscript of both editions I have been writing on a regular basis about derivatives in one form or another since the mid 1990s Tony Drury, at that time a publisher of financial books, commissioned my first book on the subject This book, Traded Options – a Private Investor’s Guide, was first sponsored by LIFFE (as it was then called, before Euronext came on the scene) and ProShare It has been a consistent seller over 11 years and three editions Tony Hawes and several other LIFFE employees contributed greatly to my initial education about the options market Jonathan Seymour at LIFFE provided some specific help with screenshots related to LIFFE products in the first edition of The Investors Toolbox, and re-used in this edition Ian Tabor at LIFFE also provided help on this edition Staying on options, I have talked to a number of futures and options brokers over many years John Paul Thwaytes, Bill Newton and James Bateman at ODL Securities and MyBroker are long standing contacts, as are Bruce Williams at Renzburg, John Newman (now at Natexis Metals), and Frank Freeman and Julia Williams at Sucden All of them have had some input into the book James Bateman provided some specific help with screenshots in Chapter of the first edition On spread betting I have dealt personally through Cantor Index for some time, and David Buik was a mine of information on the various articles I have written on the subject, as well as dealing with a number of specific queries relating to the first edition of this book In the course of compiling the first edition, Brian Griffin at CMC Markets spent time with me and was of immense help in getting me to understand the mechanics of their approach to spread betting and also understanding how CFDs work I originally came across exchange-traded funds in the course of researching a lengthy article on investment funds for a Pearson publication Adam Seccombe and several v The Investor’s Toolbox other colleagues at BGI were of considerable help in getting me to understand the nuances of these novel and highly effective ways of investing Esther Nass-Fetzmann has helped with more recent queries, particularly on the subject of metals-related ETFs Technical analysis is a vital component of using these products successfully In terms of understanding technical analysis and market timing, I owe a considerable debt to long-standing contacts David Linton and Jeremy du Plessis at Updata, Martin Stamp at Ionic Information, and particularly John Ingram at Winstock Software Steve Hunter at Ultra Financial Systems has spent a considerable time talking to me about market timing theories and I have also used Nigel Webb’s Optimum option pricing software as an example in many books and articles because of the clear and simple way it deals with this complex topic Peter Hoadley’s OptionStrategy software has also been invaluable in getting my own mind around some of the more complex strategies explained in the later parts of this book I have never met either Peter Hoadley or Nigel Webb, but their efforts have been of great help to me, whether they have realised it or not I have written on these subjects over many years in a variety of publications, with the forbearance of a long list of editors Matthew Vincent, Rosie Carr and Richard Anderson at Investors Chronicle have commissioned articles from me on stock futures, traded options, and technical analysis software Emma Lou Montgomery and Richard Beddard at Interactive Investor have allowed me free range writing about a number of the ideas covered in this book, and specifically on hedging, portfolio strategy and exchange traded funds Deborah Hargreaves, Kevin Brown and Rob Budden at the Financial Times have commissioned articles on a range of the investment concepts and techniques included in this book They too have my thanks for thus making me keep my knowledge up to date in these areas Finally, my wife Lynn has contributed to both editions of this book with her usual diligence The appendices on information sources and further reading are primarily her work, as is the glossary of web addresses She has read the manuscript with some care from the standpoint of an ordinary private investor to make sure I did not lapse too often into the jargon it is all too easy to use when talking about derivative products Any errors or lack of clarity that remain are entirely my own doing Peter Temple September 2006 vi Contents Preface Introduction Derivatives History Futures ix xv Basic Concepts 23 Contracts for Difference (CFDs) 71 Spread Betting Options 49 89 111 Warrants 137 Dealing 177 Exchange-Traded Funds (ETFs) 10 Trading Strategies I – Futures, CFDs and Spread Betting 11 Trading Strategies II – Options and Warrants 12 Developing Your Plan Appendices 159 199 221 243 Derivatives Comparison Chart 265 Software 281 Finding the Information Further Reading Glossary of Web Sites Index 267 283 295 299 vii Preface What the book covers This book is intended to be a simple practical guide to how you can use some of the newer investment products like spread betting, binary betting, contracts for difference, covered warrants and exchange-traded funds, as well as older ones like futures and options, to help your investing In different ways, each of these products allows you either to: • boost the returns you get in exchange for taking on greater risk; • use much less capital to achieve the same market exposure; or • • hedge your bets in exchange for slightly lower returns; move money into and out of a range of markets and sectors efficiently I believe they are tools that all investors need to know about and be able to use when the occasion demands it They should help you confront successfully any lengthy period of trendless or volatile markets While the past three years has seen a generally strong upward trend in stock markets, this is not bound to continue Periodic volatility is the natural order of things Interestingly enough – despite what appears to have been a bull market – recent years have also seen increased use by private investors of many of the tools described in this book That’s proof that they work, and can be applied, in all market conditions Who the book is for I wrote the first edition of this book primarily for private investors like you and me The second edition follows exactly the same pattern There is no advanced mathematics or fancy formulas to master It is a practical guide for those who already have some experience of investing in shares, but who want to take their investing strategies on to the next level I hope as well that finance students and individuals who are just embarking on a career in the financial markets may find it a useful way of getting to grips quickly and easily with some of the concepts they will be expected to master in great detail as their careers progress ix Appendix – Glossary of Websites This glossary provides a list of relevant web addresses and the categories of derivative in which they trade In some cases, particularly private client stockbrokers, it should be noted that many of these firms are primarily dealing in stocks and shares Inclusion in this glossary indicates that they are also prepared to deal for clients in options, covered warrants and so forth A ADM Investor Services (www.admisi.com): options, futures ADVFN (www.advfn.com): covered warrants, general B Berkeley Futures (www.bfl.co.uk): options, futures BWD Rensburg (www.bwd-rensburg.co.uk): options C Cannon Bridge (www.cannonbridge.co.uk): futures, options, CFDs Cantor Index (www.cantorindex.com): spread betting CFD Trading (www.cfdtrading.com): CFDs Charles Stanley (www.charles-stanley.co.uk): options Cheviot Capital (www.cheviot.co.uk): options Chicago Board of Trade (www.cbot.com): futures Chicago Board options Exchange (www.cboe.com): options Chicago Mercantile Exchange (www.cme.com): futures City Index (www.cityindex.co.uk): spread betting, CFDs CMC Spreadbet (www.deal4free.com): spread betting comdirect (www.comdirect.co.uk): covered warrants, ETFs, general Commerzbank (www.warrants.commerzbank.com): covered warrants 295 The Investor’s Toolbox D Deal4Free (www.deal4free.com): CFDs Dresdner Kleinwort Wasserstein (www.warrants.dresdner.com): covered warrants Durlacher (www.durlacher.co.uk): covered warrants, CFDs, options E Easy2Trade (www.easy2trade.com): futures F Financial Spreads (www.finspreads.com): spread betting Fyshe Horton Finney (www.fyshe.co.uk): options G GNI (www.gni.co.uk): futures, CFDs, options Goldman Sachs (www.gs-warrants.co.uk): covered warrants Goy Harris Cartwright (www.ghcl.co.uk): options H Hargreaves Lansdowne (www.h-l.co.uk): covered warrants, CFDs Harris Allday (www.harrisallday.c.o.uk): covered warrants I iDealing (www.idealing.com): covered warrants, spread betting, CFDs Ifx (www.ifx.com): CFDs IG index (www.igindex.co.uk): spread betting, CFDs Incadamy.com (www.incademy.com): training Ionic Information (www.sharescope.co.uk): software iShares (www.ishares.com): ETFs 296 Appendix – Glossary of Websites J James Brearley (www.brearley.co.uk): options JP Morgan (www.jpmorganinvestor.com): covered warrants K Killik (www.killik.co.uk): covered warrants Kyte Group (www.kyteclients.com): options, futures L LIFFE (www.LIFFEinvestor.com): options, futures London Stock Exchange (www.londonstockexchange.com): covered warrants, ETFs M Man Direct (www.mandirect.com): futures, options,CFDs MyBroker (www.mybroker.com): options, futures O ODL Securities (www.odlsecurities.com): covered warrants, options Optimum (www.warp9.org/nwsoft): software Option Strategy (www.hoadley.net/options): software P Philip J Milton (www.miltonpj.net): options R Redmayne Bentley (www.redmayne.co.uk): covered warrants, options 297 The Investor’s Toolbox S Seymour Pierce Bell (www.seymourpierce.com): options SG Warrants (www.warrants.com): covered warrants Spreadex (www.spreadex.co.uk): spread betting Sucden (www.sucden.co.uk): options, futures, CFDs T TD Waterhouse (www.tdwoodhouse.co.uk): covered warrants The McHattie Group (www.tipsheets.co.uk): covered warrants Thomas Grant (www.thomas-grant.com): options TradIndex (www.tradindex.com): spread betting Trading Lab (www.tradinglab.co.uk): covered warrants Trustnet (www.trustnet.com): ETFs U Ultra (www.ultrafs.com): software Updata (www.updata.co.uk): software V Voltrex options (www.voltrex.net): options, futures W Walker, Cripps, Weddle, Beck (www.wcwb.co.uk): covered warrants 298 Index B Barclays Capital xviii Barclays Global Investors 167 Bernstein, Peter 6, Black, Fisher 11, 12 Black-Scholes formula 12 C Capital fulcrum point – see Warrants CBOE – see Chicago BoardOptions Exchange CBOT – see Chicago Board of Trade Chicago Board of Trade 9, 268 Chicago Board Options Exchange 11, 14, 276 Contracts for difference 'Rules' 82-87 Brokers 269-270 Commissions and tax 76 Comparison to spread betting 75-76 Dealing 187-188 Definition 75 Explanation of 73-74 Margin requirements 83 Mathematics of 78-79 Trade sizes 88 Trading costs 87 Covered Warrants – see Warrants 299 The Investor’s Toolbox D Delta – see The Greeks Derivatives Basic concepts 25-48 Cash settlement 31 Contract Status 27-28 Expiry 32 Fair Value 34-35 Gearing 36-37 Hedging 38 Indexes 39 Margin 43-44 Short selling 45 Time value 46 Volatility 46 Dealing CFDs 189-190 Comparison chart 265 Covered Warrants 194-195 Essential questions 179 Exchange-traded funds 196-197 Futures 182-184 Opening an account 181 Options 191-192 Spread betting 185-188 Diversification Using CFDs 88 History Ancient Greece Biblical references Early timeline Farming futures Feudal Japan Futures timeline Italian merchants Options timeline 11 300 Index E Shakespeare Tulipomania ETFs – see Exchange-traded funds Euronext 15 Exchange-traded funds F Compared to unit trusts 166 Dealing 195 Early development 19 Exchanges 167-168 Explanation of 161 Hedging of 174 History of 162-163 How they work 163-164 Market outlook 175 Non-UK ETFs 175 Pluses and minuses 165-166 FTSE 100 40 Futures Brokers 267-268 Contracts traded 58-59 Dealing 182-183 Exchanges 16 Gearing of 54 Interest rate futures 64-65 Margin on 53-54 Pricing of 56-57 Standardisation of 51-52 Strategies 201-220 Universal Stock Futures 61-63 301 The Investor’s Toolbox G Gamma – see The Greeks Gearing Explanation of 36-37 On CFD contracts 88 On futures contracts 54 with Options 131-133 Greeks, The 127-129 H Hedging Explanation of 38 of ETFs 174 Strategies 218-219 with Options 134-136, 225 with Warrants 152 Hurdle rate – see Warrants I IG Index 18 Indexes and ETFs 168 Explanation of 39-40 Futures contracts 60 Options on indexes 135, 136 Interest rate futures 64-65 iShares – See Exchange-traded funds 279 L LIFFE Development 15 Equity options 130 Futures contracts 59 German Bund 15 302 Index M Interest rate futures 64-65 Universal Stock Futures 61-63 Website 273-274 London Stock Exchange 279 Long Term Capital Management 12 Mackay, Charles Margin CFDs requirement 83 Explanation of 43-44 on Futures contracts 53 McHattie Group, The 278 Meriwether, John 12 Merton, Robert 12 Money management – see Trading Plans N NASDAQ 100 19, 41 Nikkei xvi, 41 Notional trading requirement 96 NTR – see Notional Trading Requirement Nymex O Optimum – see Software Option Strategy software – see Software Options American style 129 and Hedging 134-136 Black-Scholes formula 12 Brokers 274-275 Calls and Puts 115 303 The Investor’s Toolbox R Comparison to futures 114 Dealing 191-192 European style 129 Exchanges 130 Gearing 131-133 Greeks, The 127 on Indexes 135-136 Pricing 124-127 Pricing software 259-260 Relationship to underlying 117 Volatility 120-121 Writing of 136 Rho – see The Greeks S S&P500 39 Scholes, Myron 12 Short Selling Software 254-262, 281 Using CFDs 80-81 Spread betting Advantages of 92-93 Cash bets 101 Controlled risk bets 104 Dealing 185-188 Early development 18 Explanation of 91 Firms (bookmakers) 271-272 Longer-term bets 102 Margin 96 NTR 98-99 Opening an account 109 Rolling cash bets 102 Use of stop-losses 95 304 Index T Technical analysis 254-259 Theta – see The Greeks Time value Concept of 46 Trading Plans Cutting losses 246-247 Emotional discipline 245 Flexibility 246 Money management 248-250 Trading strategies U Futures strategies Cash extraction 205-206 Hedging 216-218 Long-only or short-only 202-205 Pairs trading 208-212 Relative value trades 213-216 Options & warrants Covered writes 227-230 Hedging 225 Spreads 227 Straddles and strangles 227 Tulipomania Ultra software – see Software Universal Stock Futures 61-63 Updata software – see Software V Vega – see The Greeks Volatility Beta 171 Concept of 48 Options 120 305 The Investor’s Toolbox W Warrants Barrier warrants 157 Covered Warrants Compared to options 145 Compared to traditional: 145 Explanation of 144 Issuers 149, 276-277 Valuation of 149-150 Dealing 193 In Europe 20 Knock-out warrants 157 Market outlook 155 Strategies 152-153 Cash extraction 152-153 Hedging 153 Traditional warrants Compared to options 140 Explanation of 139 Valuation of 141 306 .. .The Investor’s Toolbox How to use spread betting, CFDs, options, warrants and trackers to boost returns and reduce risk by Peter Temple HARRIMAN HOUSE LTD 3A Penns Road... returns; move money into and out of a range of markets and sectors efficiently I believe they are tools that all investors need to know about and be able to use when the occasion demands it They... because they saw the merit in standardising the size of the contract and specifying the quality required, and because they took steps to ensure that all the participants adhered to the terms of the