In November last year, we listed 11 3x short and leveraged single stock daily Exchange Traded Products (ETPs) on the London Stock Exchange.
For the first time, they enable UK sophisticated traders and investors to take positions on both rising and falling share prices through an exchange-listed instrument. Historically, access to leverage on single companies has been the domain of specialists. The ETPs remove the operational complexity associated with leverage and give sophisticated investors the opportunity to express high conviction views in a transparent, accessible way. The ETPs bring the added benefit of being able to be held in portfolios alongside other investments such as equities, bonds and funds.
The daily ETPs are providing long and short exposure to a selection of major companies listed on the London Stock Exchange
|Underlying stock||+3x Long||-3x Short|
|Lloyds Banking Group||3LLL||3SLL|
|Royal Dutch Shell||3LRD||3SRD|
How they work
These ETPs are designed to give investors 3x leveraged exposure to the daily share price moves, both up and down, of the FTSE 100 companies they track. They utilise leverage to deliver a multiple of the daily underlying share price move, in our case three times. This is referred to as the “Leverage Factor”
Taking the example of the GraniteShares 3x Long Vodafone Daily ETP, if Vodafone Group Plc rises by 1% over a day, then the ETP will rise by 3%, excluding fees and other adjustments. However, if Vodafone’s share price falls by 1%, then the ETP will fall by 3%.
Similarly, looking at the GraniteShares 3x Short Vodafone Daily ETP, if Vodafone Group Plc fell by 1% over a day, then the ETP will rise by 3%, excluding fees and other adjustments. However, if Vodafone’s share price rises by 1%, then the ETP will fall by 3%.
This article focuses on how these ETPs can be used to support high conviction investment strategies, hedge or protect portfolio performance in different scenarios. I focus on four examples, three of which are taken from the first two months of 2020.
1 Coronavirus market correction
Between the market close on Friday 21stst February and Friday 28th February 2020, the FTSE 100 endured a fall of 11.12%, largely due to global concerns around the impact of the Coronavirus. However, our 11 FTSE 100 single stock 3x short ETPs delivered an average return of 39.5%.
|Underlying stock||Share performance|
|-3x Short||Performance GraniteShares Inverse ETPs
|Lloyds Banking Group||-9.30%||3SLL||31.70%|
|Royal Dutch Shell||-11.99%||3SRD||43.17%|
Source: Bloomberg, GraniteShares
The best performing GraniteShares inverse ETP was Barclays, which delivered a return of 52.3% between close of business on 21st and 28th February 2020 against the share price falling by 17.2%. The second best performing GraniteShares inverse ETP was Rio Tinto, which delivered a return of 51.6%, followed by Glencore, with a return of 50.9%. The ETP with the lowest return was Rolls-Royce, which despite the strong bounce on the back of its results announcement on 21 February still delivered 10.5% over the week.
2 Hedging exposure to a company ahead of results
There are times when an investor holds a stock but where they are concerned that upcoming results may be disappointing and have a negative impact on the share price.
If an investor has concerns, they could simply close the position but there may be reasons why this is not possible or desirable:
- The investor does not want to crystallise a gain or is unable to sell because the shares are held in a pension scheme
- The investor is holding the shares for the income and does not want to forego the dividend
- The investor believes that any volatility is short-term, and the company’s outlook remains positive
How would a hedge work? Let’s take a recent example when Royal Dutch Shell’s (RDSA) results on 30 January proved disappointing and caused the share price to fall. Let us assume that an investor held 3000 shares worth £63,930 on 29 January against which a short position was opened in GraniteShares 3x Short Royal Dutch Shell worth £21,308 (notional £63,923) after dealing costs.
The table shows the notional profit and loss of the individual and aggregate positions, excluding any dealing costs, over the next three trading days. It illustrates how a short ETP can potentially provide protection of capital and serve as a hedge when company results fail to meet investor expectations.
The table also illustrates how for holding periods of longer than one day, compound returns will result in over or under hedging of the underlying position. The example here is one of over hedging because of the price trending down.
Source: Bloomberg, GraniteShares
3 Hedging stock specific risks
Companies face risks that are specific to them, so-called idiosyncratic risks, that can come from a variety of factors, e.g. operational issues, business issues, management and governance issues. These may be short-term in nature or may result in fundamental changes in a company’s longer-term prospects. Taking an example of an event that proved detrimental in the short term, consider what happened to the BP share price in the wake of the Deepwater Horizon accident in 2010. It fell by 50% in a month, which is significant. Some investors may have not been able to close positions while others may have wanted to retain exposure for the dividend. For some of those investors with spare cash, it would have been possible to open a short exposure to BP to mitigate part or all of the price risk
4 Hedging broader market risks
Stocks and sectors can serve as a good proxy for broader market risks. Oil and defence stocks, for example, tend to be beneficiaries of any rising tensions in the Middle East/Gulf while prices in the broader market may soften. This was illustrated following the U.S. killing of General Soleimani, the Iranian General, in early 2020, which resulted in prices rises for BP (BP.), Royal Dutch Shell (RDSA), and BAE Systems (BA.)
Stock-exchange listed, single stock ETPs can be used by sophisticated investors to hedge portfolio risk. They offer the benefits of being collateralised and having no margin requirements, as with any investment listed on exchange, an investor commits an amount of capital that they are prepared to lose in a worst-case scenario. They can be held across a range of accounts alongside equities, bonds and fund investments.
Before committing capital to a short ETP, an investor should ensure that they fully understand the risks involved and are comfortable with impact of compound returns on positions held for longer than a day. Capital is at risk.
Will Rhind is chief executive officer of Granite Shares.
Further reading: Companies paying dividends are out there if you look