First introduced in July 2017, I felt that DLC hasn’t been well understood by the market for its use and purpose other than being perceived as yet another leveraged product to stay away from. Leveraged products need not be risky when controlled properly and used appropriately. It’s actually an opportunity for retail investors to act and benefit like a hedge fund.
What is DLC and How It Works?
DLCs are listed on SGX like a stock, and they are also traded like a stock. If you have a stock broker account that can trade say any single stock share, you can use the same broker account to trade DLC too. Unlike some other leveraged investment products, there are no margin requirement for DLCs.
The idea of hedging by retail investor is almost unheard of, and some people don’t want to go through the hassle of setting up a CFD trading account to take short positions in the market. While DLCs can be used for speculative purposes, I primarily want to explore the idea of using DLCs to hedge a long-only portfolio which I feel is more applicable to retail investors.
Long-only retail investors are now given the unique opportunity to at a fraction of the cost, leverage up and hedge their positions in times of short-term market downturn. It comes in different leverage levels (3x,5x,7x), both short and long.
For the purpose of discussion, I will address only a short DLC and how it can be used for hedging to protect one’s portfolio in times of market uncertainty when there’s a downside bias.
For detailed DLC mechanism, refer here
There are a total of 64 DLCs available in the market at the time of writing. Keeping to the focus of hedging a long-only portfolio, I’m only interested at DLCs concerning MSCI Singapore Index which I take to be hedging away market risk. For simplicity sake, I’ll assume that it’s a Singapore-only portfolio.
For example, you own a portfolio of shares worth $70,000. To mitigate market downside from shocks, you may consider buying a DLC SG7xShortMSGxxxxxx worth $10,000 to give your portfolio a net exposure of zero. In a market downturn, if you want to keep your positions without having to sell them out, hedging with a product like DLC can be a very useful tool to ride out short-term volatilities in the market.
While the long positions of individual stocks in the portfolio may experience loss in a market selldown, the DLC would offset the losses with a gain that should somewhat match the size of your long positions, hedging away the market risks in your portfolio. With a fully-hedged and well-diversified portfolio, theoretically, any outperformance is a result of company-specific reasons which generated excess returns (‘alpha’).
With DLC introduced, we no longer have to sit and ride out the market volatility, watching our portfolio taking a beating each day. Instead, we can now take ownership of protecting our portfolio with tools like DLCs.
Some examples I could think of to consider hedging with a short DLC:
- Taking a 3-5 day vacation, wanting to put your mind away from the markets
- Black swan event happening elsewhere that you expect it to spread to Asia markets
- In anticipation of big news happening in the US when Asia markets are closed
There are many more ways to use DLCs to protect and enhance portfolio returns that have not been discussed. Alternative strategies could involve partial hedging or using them like modified options (straddle/collar/etc.).
Overall, I think that the introduction of DLCs is a good thing for investors. It reduces the hassle of having to set-up a separate CFD account to go short and opens up the option for investors to hedge their portfolio or take speculative positions other than for the purpose of hedging.
Thanks for reading.
Once again, this article is a guest post and was originally posted on Kenny‘s profile on InvestingNote.
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