This article appeared in the May 2010 ASX Investor Update email newsletter. To subscribe to this newsletter please register with the MyASX section or visit the About MyASX page for past editions and more details.
By Aaron Stambulich, RBS
More investors are assessing the merits of other asset classes, such as commodities, after the bear market in equities. Traditionally, if investors wanted exposure to commodities markets they would buy shares in BHP Billiton, Rio Tinto or other miners. They would seldom acquire direct exposure to the commodities market itself.
The reasons were mostly to do with ease of access and the method of investing in commodities markets. It is not that convenient to invest in oil or gold physically. You can do that, but it is not as easy or transparent as investing in a company that is listed on, and regulated by, ASX.
(Editor's note: take a free ASX online warrants and instalment course to learn more about the features, benefits and risk of warrants).
Generally, one of the more common ways to get exposure to commodities on a regulated exchange is via the futures market. Commodity futures are standardised contracts among buyers and sellers of commodities that specify the amount and grade/quality of a commodity to be traded at a particular date and price. Commodity trading with futures contracts takes place at a futures exchange, which has similar rules and operating procedures as a sharemarket.
This makes it easier to get exposure to commodities (rather than physically buying, say, barrels of oil) but it also requires sound knowledge of, and access to, a futures market. For retail investors, that is not so simple. Furthermore, futures contracts over commodities are highly leveraged and losses associated with trading can exceed an investor's initial capital.
A new way to participate in the movement of selected commodities is through RBS Commodity MINIs, which are listed on, and supervised by, ASX. A Commodity MINI is a listed warrant that tracks the price of selected commodity futures contracts, including Comex Gold and Nymex Oil.
The Commodity Exchange, Inc (COMEX) is the primary market for trading metals such as gold, silver, copper and aluminium. COMEX Gold is listed on the Commodity Exchange (CMX) and is denominated in US dollars per troy ounce. Nymex Oil (Crude Oil) is the world's most traded commodity.
The Nymex Division Light, Sweet Crude Oil Futures is traded on the New York Mercantile Exchange and is the most liquid forum for crude oil trading. The contract is denominated in US dollars per barrel and is used as a principal international pricing benchmark.
Commodity MINI Longs give traders a leveraged position in a rising market; Commodity MINI Shorts give traders a leveraged position in a falling market.
MINIs are economically similar to a contract for difference (CFD)-style product, which mirrors the performance of an underlying asset (such as a share or a commodity) and offers the benefits of trading without having to pay the full amount of the transaction. Apart from being listed on ASX, the biggest difference is that MINIs offer a free stop-loss feature that ensures investors will never lose more than their initial capital outlay. This makes MINIs less risky than CFDs or commodity futures.
The pricing components of a Commodity MINI are as follows:
- Value of a Commodity MINI Long = [(Level of the Commodity Futures - Strike Price) / Exchange Rate] / Multiplier
- Value of a Commodity MINI Short = [(Strike Price - Level of the Commodity Futures) / Exchange Rate] / Multiplier
The exchange rate in the formula is applied if the underlying futures contract is denominated in foreign currency. Investors can get information on the Multiplier in the production disclosure statement for the MINIs available from RBS.
Strike price set daily
To purchase a Commodity MINI, investors pay a fraction of the Commodity price upfront (capital outlay). The strike price of a Commodity MINI is set daily. As a result, investors do not have to pay funding costs upfront - they are added to the strike price daily for Commodity MINI Longs and deducted from the strike price daily for Commodity MINI Shorts.
To better understand how Commodity MINIs work, let's follow an example, ZCGKZA - which is the ASX code for a MINI that tracks the Comex Gold futures contract price.
Trading example - Gold MINI Long (ZCGKZA)
|Action||Units||Futures levels (USD)||Strike price $||AUD/US exchange rate||MINIs price level per unit ($)||Stop loss per unit ($)||Profit / (Loss) per MINI $||Return %|
|Scenario one: Futures contract rises to 1100 points|
|Scenario two: Futures contract falls to 900 points|
The example above shows what might happen if an investor wants to take a long position in gold because they believe its price will rise. They can buy ZGCKZA, which is worth $2.78 per unit with the Comex Gold Futures Level at 1000 and the AUD/USD exchange rate at $0.90.
Readers can apply the formula provided earlier to calculate the prices for themselves. If the investor's view on the price of gold proves to be correct, as in Scenario 1, and the underlying gold contract rises by 10 per cent, the holder of the MINI can crystallise a 40 per cent profit. This is because the MINI enables them to be leveraged to the movement in price they correctly anticipated.
However, the effect of leverage also works in reverse, as can be seen in Scenario 2. That is, if the Commodity Futures Level falls by 10 per cent, the investor could lose 40 per cent. The effect will be the same for any underlying asset class (currently Commodity MINIs are available on Comex Gold and Nymex Oil contracts) and investors need to understand how this can affect their investment capital.
Before making an investment decision in Commodity MINIs, investors should refer to the product disclosure statement for a detailed explanation about investment risks and further information about the product in general.
Bearing the risks in mind, Commodity MINIs are a simpler, more transparent way for experienced investors to access commodities markets because they are traded on, and supervised by, ASX. This ensures trading activity is always carried out under ASX trading rules.
About the author
Aaron Stambulich is head of public distribution, Asia, at RBS.
More information on ASX Warrants is available on the ASX website. Also worth viewing is the range of portfolio studies undertaken by ASX to compare the performance of a hypothetical portfolio of instalments to shares. The ASX Warrants Strategy Library also offers a wealth of background educational information.
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