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Why you should tread carefully in derivatives market

Lewis Njoka @LewisNjoka

Financial experts are cautioning would-be investors in the recently launched Nairobi Securities Exchange (NSE) derivatives market against investing in futures without proper understanding of the financial instrument.

But NSE CEO Geoffrey Odundo allays fears about the possibility of losing money to fraudsters on the bourse saying the trade was centralised, highly regulated and would be under constant surveillance from both NSE and CMA.

“There are funds set up to compensate investors in case of a loss. Anti-money laundering and know-your-customer regulations at NSE are strict to curb against illegal activities,” said Odundo.

Proper research

Despite the guarantee that parties involved in futures contract will honour their promises, thanks to the clearing house, trading in futures is still a risky venture because it depends on how well one can predict future market behaviour.

Trading in futures normally requires fairly large amounts of money compared to buying shares, hence, a loss has a significant effect on the investor.

It requires that one makes projections based on current and reliable data, something professionals do using statistical models. Without access to these, the chances of one trading based on faulty predictions are very high.

Sterling Capital chief executive John Kirimi warns that it is very easy to lose money in the trade if one’s projections are not based on proper research.

“It is advisable to use a qualified intermediary when trading in futures as they have access to a lot of information that you may not have. Just make sure they understand what you intend to achieve with your investment,” said Kirimi.

“It’s all about locking deals in the future. Go to an intermediary, he will tell you what to look out for. It’s a good thing but understand it first,” he added.

He said while a layman could trade in derivatives himself, as some are already doing on foreign exchanges, the chances of failure are very high.

Alexander Owino, a financial sector specialist advised ordinary Kenyans seeking to participate in the derivatives market to do so in organised groups such as Saccos saying the sophisticated market was best for institutional investors.

Describing the derivatives market as a natural development of the stock exchange, Owino said it would help investors manage risks better and allow them to exchange current assets for future ones.

“It will help investors manage their future by exchanging risks with speculators. It will also help ordinary Kenyans manage their incomes by stabilising prices,” Owino said.

“The derivatives market will integrate our market with international markets, enable better management of risks and offer young people a chance to join and experience the stock market,” he added.

Noting that the derivatives could enhance market volatility if poorly managed, Owino called on CMA and NSE to keep out rogue traders from the market to protect ordinary Kenyans.

He pointed out that commodity futures would be a big boost for farmers, a key pillar of the country’s economy, as it would help stem the current volatility witnessed in agricultural products.

To lock a price in a futures contract, experts consider geopolitical and other factors and how they are likely to impact prices in days to come. Luckily, there exists statistical models that help them do this with a reliable degree of accuracy.

“Use professional intermediaries, their research is much deeper than a layman would. If you choose to do it yourself, then conduct proper background checks before investing,” he said.

Economic growth

Despite the risks involved, the introduction of the derivatives market at the Nairobi bourse is a welcome development as it will broaden and deepen the capital market in Kenya which used to trade only in equities before.

Kirimi praised the move by NSE saying it was long overdue and would benefit not just the traders but the entire economy considering that it would help stabilise prices of the financial instruments traded.

He, however, lamented how interest rates and currencies were traded currently saying it was still crude.

The risks involved in futures trading are best illustrated by the Kenya Airways fuel hedging programme, an arrangement where an oil company guarantees to supply fuel at a particular price in future regardless of price fluctuations, that saw the airline lose billions of shillings in 2015 and subsequent years after global oil prices dipped sharply.

Kirimi called on the NSE  to educate the public on the terms and benefits of the new market, saying it will attract more investors.

He called on the CMA to make the commodities market a reality as it offers more opportunities for common citizens.

For now, only equities futures can be traded on the derivatives market. Interest rate futures and currency futures, and others, are not available.

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