The daily loss of value, whether trading in futures, CFDs or leveraged products, is a significant factor for long-term investments. As a rule, however, it is almost always underestimated. For this purpose, we take a look at the concrete figures in a direct duel.
Whether you trade futures, CFDs or derivatives, there is one thing you cannot avoid: a daily loss in value. Whether this is called current value for options and derivatives, financing costs for CFD transactions or fair value for futures: the long side of the market is getting expensive every night. How expensive, and how big the differences between the instruments are, we want to look at with this article.
We use the popular Dax30 index as an illustrative example.
A new Future-Dax contract is launched every 3 months. And most traders should have noticed that the price of the FDax differs from the spot Dax. A new contract will trade about 20 points higher than the spot Dax, and will approximate the spot Dax by the end of its 3-month term.
Who is interested in the concrete formula:
F = K x (1-c)^t
Explanation: F = futures price; K = spot price, c = net financing cost rate p.a. and t = duration of the remaining term of the future in years.
We can therefore state that bullish investors lose or have to pay 20 points per night : 90 days = 0.22 points approx. for the investment beyond the close of trading.
Financing costs for CFDs are due, because you trade on the credit of the broker, so to speak. This is because usually only 1% margin has to be deposited for trading with the most important indices. I.e. for 1 Dax-CFD you have to deposit a margin of 90€ at a level of 9,000 points. The broker pays for the rest and charges interest.
At least these can be calculated simply and exactly. On average, providers charge the interest rate of the Euribor + 2.5% for a long position in the Dax30 CFD. Concrete example:
9,660 (Dax rate) * (0.25% (Euribor) + 2.5% ) / 360 = 0.74 points per night
That is already much more than with the top class, the future, now to the last asset class.
The time value is the difference between the warrant price and its intrinsic value.
Time value = warrant price – intrinsic value
The factor fair value is determined by the remaining term to maturity, the underlying interest rate, the current price of the underlying, the volatility of the underlying and the amount of the dividend (in the case of shares). The fair value is subject to an increasing decline in value. The closer the warrant approaches maturity, the more the time value shrinks.
You can already see that in contrast to CFDs, it is much more complex to find out the time value of warrants and certificates. This is not only annoying, but also simply not transparent to the customers. Because the underlying volatility is also constantly changed by the issuers, so that the investor never knows exactly how the price of the derivative actually comes about.
Fortunately, various databases at least show the “intrinsic value” in the warrant’s profile.
Example Dax-Call ISIN DE000HV9PBX4, strike price 9,500, expiration on 17.06.14. This is about 4 months after the creation of this article, and the call is easily in the money at a current Dax level of 9,660 points.
Its intrinsic value is 1.6€, the warrant is quoted at a price of 4.36€. This means that the warrant loses time value until the end of its term in 4 months = 4.36 – 1.6 = 2.76€ time value until the end of its term if all other parameters would remain the same. Converted to the subscription ratio taking into account 120 days remaining term, this is a loss of 2.3 points per day or 9% p.a.
Although only in the grey theory, since umpteen parameters can change constantly. But pi times thumb, this is an appropriate, frightening value. I didn’t pick an extreme example, with similar notes both in and out of money and with different remaining terms I get overnight costs of 1.5 to 4.2 points.
The many different types of certificates make a comparison difficult. Therefore I will concentrate on the most popular type, the KO certificates. Here you have to differentiate between certificates with endless and those with limited duration. The latter also have a premium for the time value, which decreases until maturity and has to be paid by the investor. However, this premium is almost always cheaper than for warrants; a glance at comparison calculators shows a premium of 0.8-5.6% p.a., depending on the distance of the knock-out threshold and the remaining term.
While notes that run endlessly receive an adjusted knockout threshold from the issuers on a regular basis, which also implies that a premium is collected. However, this is difficult to quantify, but it will remain within a similar range.
Conclusion and trading advice
If you want to invest bullishly in the long term, the FDax is of course the best choice. But you also need very well filled pockets. When holding a contract overnight we are talking about a margin of about 20.000€, i.e. under a 50.000€ account you don’t really need to think about it. And of course you move completely different sums with the future, namely 25€ per daxpoint.
Much more comfortable to denominate and finance are the CFDs. Usually you can trade for 1€ per point, and with a margin of 1% you don’t even have to deposit 100€ for trading. The ideal choice for smaller purses, and who likes to do flexible money management.
With a longer holding period, it will of course be more expensive than the future, but there are also one or two CFD brokers, who with their Dax CFDs represent the future. This means that no financing costs are due. The CFD loses just like the FDax also its approx. 20 points in the course of the 3-month term. And one must pay attention to roll the contract manually into the next if one wants to remain invested beyond the expiration date. In addition, you can usually trade with 0.01 lot, which corresponds to a denomination of 0.25 € per daxpoint.
Within the family of leveraged products, certificates come closest to a transparent price position, as at least the implicit vola does not play a role here. And the time value does not hurt as much as with warrants, but still more unpleasantly than with CFDs.
Whoever uses warrants in the long term should know exactly what he is doing. There are certainly many special strategies for which this asset class is suitable. For beginners, however, the price positions are not really comprehensible, and the loss in fair value becomes enormous, especially towards the end of the term.
One such special strategy could be to act as a writer of options, for example. Because here one profits as an opposite side even from the time value decline. But that would go too far at this point, for that a separate article will follow in due course.