Stuff that makes me wanna give up on financial education ~ Thread

OOMF brought a tweet to my attention yesterday. In that tweet, was a highlight of the “mind blowing returns” made in the derivatives market in Q1 this year.
A return, supposedly, of 360%.

Interestingly, that 360% return was touted in some presentation/media by the exchange itself.
I made my points about why I thought that information was misleading (probably harmful) but I was in a huff. I promised to do a proper thread today once I’m settled. So here we go.

The basic premise is that short parties in Jan Futures index expiring at the end of the quarter made a return of 360%.
From the pic, you can see short parties in Saf futures made 203%, KCB futures made 249%, Equity futures 293% and so on.

All the statements made in the screenshots are truthful. But are they responsible?
They can only be responsible if:
1. They were meant for professionals/ HNIs
2. There was much more background context, including the mention that long parties made significant losses.

To distill the information in the images, the assertion is that (and it’s a true assertion):

If you took a Sh.25 Million short position in the index futures, you only needed to deposit an initial margin of Sh.1.5 Million and in the end netted a Sh. 5.4 million profit. Or 360%

The above is of course true. But what’s also true is that if you took a 25M long position, you also needed an initial margin in the environs of 1.5M. But, you’d have netted a loss if about 5.4 mio and in the meantime, had to contend with a series of margin calls. Losing 360%

If you you put 1.5M down to get into a position of 25M, that means you are leveraged 17times. That’s no small leverage. And yes the short party made a holding period levered return of 360% but their unlevered return was barely 22% calculated as 5.4M/25M

Looking at the comments after the initial tweet, I was horrified. I got the sense that folks think that a 360% return in the futures market is not only feasible, it is to be expected. Something you just need to read a little of have a little money to be able to pull off.

There is a general underappreciation for leverage and what it can do to you/for you by the retail investor.
Leverage ties directly with risk.
Many banks will not give you a mortgage if you can’t put 20% down despite perceived safety of real estate in general.

But with only 6% down in this case - and as little as 0% down in many places , retail investors can take massive positions in financial instruments they barely understand.

Just to reiterate, the 360% gain that was made by the short parties is eye popping. What’s also eye popping is the inevitable 360% loss that was made by the long parties who were on the other side of the trade.

Keep in mind that shorting is inherently riskier than going long from the get go. Losses to the short party are potentially unlimited because asset prices can rise infinitely. Losses to the long party are limited because asset prices can only fall to a maximum of zero.

If you were shorting in January, you had other reasons for doing so, other than thinking that coronavirus would spread and affect everybody and assets the way it has. Truth be told, the 360% gain is powered by Covid-19.

If you are so inspired by the “mind blowing returns” that you badly want to short the next time you have some money, fat chance there will be a crisis to benefit from this time around. You will likely lose money.

So a couple of points in summarize:

1. The 360% return is a levered return. Levered 17X.
2. There is an equal and opposite loss for every gain. The loser is not necessarily stupid.
3. These returns are occuring in extraordinary market conditions and definitely not “BAU”

I hope the exchange and all participants can continue educating the public on the merits and demerits of these kinds of investments.
Retail investors should keep their own greed in check when presented with outlandish prospects to profit from markets. For there’s no free lunch.