Buying instalments for short term trading

Are you looking to day-trade a bullish view of the market?

During periods of increased volatility, such as during the reporting season, the market delivers many opportunities for short-term (day) traders.  Traders can take advantage of this bullish sentiment by using short dated highly geared instalments to maximise their returns.

Short dated view - short dated instalments

There are a number of investment banks that quote instalments on ASX with relatively short terms to maturity of 3 to 6 months.  These instalments are targeted at traders who have a very short-term bullish view and are looking to use leverage to accelerate their returns by comparison to buying the underlying share.  Most of these instalments are geared, between 80 - 110%. 

You can calculate the gearing level by using the following formula:

Gearing level = Loan amount / Share price

For example, with the share price trading at $17.75 there is an instalment with a loan amount.

Gearing level = $15.00 / $17.75
                         = 84.5%

The added benefit is if the shares pay a dividend, you will be entitled to the dividend and franking credits.  In addition, if the share price moves unfavourably you are not required to repay the loan. So you get the leverage with limited risk.

It is important for short-term traders to match the instalment product to their tolerance for risk.  Generally the short dated instalments are very highly geared and therefore carry higher risk and the potential for a greater return than trading shares or regular geared instalments.  In addition there will be an increase in protection costs as the loan amount is significantly higher. 

Example

If you had a bullish view on BHP (22.02.05) you could have purchased the shares at $17.75.  Selling the shares the following day at $18.43 your short-term view would return 3.8% in 24 hours.  Alternatively if you traded short-dated highly geared instalments, such as BHPIMX, your capital outlay would be significantly less.  However you would continue to benefit from the rally in BHP's share price, increasing by $0.60 in 24 hours, representing a 17.9% return on investment.  This is illustrated in the following table:

BHP BHPIMX                                     (Loan amount - $15.00)  
Gearing level - 84.5%
Buy price (22.02.05) $17.75        $3.36
Sell price (23.02.05) $18.43 $3.96*
Total profit $0.68 $0.60
Return on investment (%)                       3.8% 17.9%

* this price reflects an adjustment for the prepaid interest and the put option cost, given an increase in share price

Main benefits of the strategy

  • Instalments allow you to obtain a leveraged exposure to an underlying share  
  • Risk is limited to the capital invested

Main risks of the strategy

  • The larger the loan the higher the protection costs 
  • Due to the leveraged nature of the instalment, a small negative movement in the underlying share price will lead to a greater percentage loss on the instalment

Disclaimer
The information contained is for educational purposes only and does not constitute financial product advice. ASX does not represent or warrant that the information is complete or accurate. You should consider obtaining independent advice before making any financial decisions. To the extent permitted by law, no responsibility for any loss arising in any way (including by way of negligence) from anyone acting or refraining from acting as a result of this material is accepted by ASX.  Past performance is no indication of future performance