What do I need to take into consideration if I short the ASX200?

Question:

Hi, with the market going down shorting the ASX200 or other indexes must be a popular move.

What do I need to take into consideration if I do this, and are there any strategies I can employ when shorting the index?

Response:

Since the global financial crisis, short selling has grown in popularity with retail investors. Unlike traditional investment vehicles that only profit with rising prices, with futures and options you can make money when the market indices fall.

The S&P/ASX200 Index is recognised as the benchmark for trading the Australian equity market. It is approximately 75-80% of the total Australian equity markets capitalisation. The S&P/ASX200 Index Futures contract (Share Price Index – SPI) is the most actively traded Australian equity Index futures contract available. One SPI point (tick size) is worth AUD$25. When trading the SPI, there is an initial margin (IM) requirement set by the exchange, the current IM for a SPI contract is $6,000. This IM is held for as long as there is an open position. When trading the SPI, it is advised to always trade the front month contract which is the most liquid thus preventing large spreads and slippage which increases the cost of trading and hence profitability.

One strategy for profiting from a falling market is to sell the SPI futures and then buy the contract back once the price has fallen. This is known a going “short”. For example, by posting a $6,000 IM with the exchange you can sell one SPI contract, say at 4500. You could then place a take profit buy order at 4400. Should the market fall as predicted and you buy your one short SPI contract back at 4400, you will make a profit of ($25×100) $2,500 (less exchange & brokerage fees). This would equate to a better than 40% return (2500/6000=0.4166).

An alternative strategy to profit from a falling market would be to trade SPI options. For example, you could buy one 3450 SEPT 2011 PUT option for a price of say 22 points. By paying the price of the option (premium=$25×22) $550 you have bought the right to sell a futures contract at 3450 before the options September expiry.

The diagram shows the potential profit or loss on the strategy for different index futures SPI prices at expiry. Since a $550 premium was paid for the option, a futures price below the break-even point at 3428 will result in a profit on the option. The diagram shows that while the futures price is above 3428 the option PUT buyer would be making a loss. The most the PUT option buyer would lose is the option premium of $550. The diagram shows had the futures contract price fallen to 3300 by expiry the profit would be $3,200.

Some basic rules when trading is to not to be emotional with your open positions by always placing stops on your trades, this will prevent small losses turning into large losses. Never average losing trades (scaling), when you are wrong get out of your position for a small loss. Don’t over-trade, trade for profit not for excitement.

There is a multitude of overseas equity indices for you to trade also, not just the local SPI futures & options contract. Some of the most liquid contracts internationally are;

Most contracts have E-Mini equivalents which you can trade, thereby lowering your capital requirements and risk exposure to market volatility, which is excellent for new traders. Don’t be afraid to ask your broker any questions you have about trading the market, they are there to help.

Happy Trading!

Disclaimers: The views expressed in this article are those of the author and is not intended as general advice. This does not constitute a recommendation nor does it take into account your investment objectives, financial situation nor particular needs.