Last week, traders witnessed a derivative tracking the SIA shares going to $0. This derivative was 5x Short DLC on SIA (SGX:DSLW).
As SIA is undergoing a complex rights shares and rights MCBs exercise, there was some contention about what the theoretical ex-rights price (TERP) should be.
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Traders felt that the TERP should only consider rights shares conversion while the issuer (SG), considered both rights shares and rights MCBs dilution. SG’s TERP was $3.71, lower than what the traders understood to be at $4.16.
The matter was made worse when SIA share price continued to climb on the ex-rights day and a Short DLC would lose money since it bets on a falling SIA share price.
The Short DLC began with a lower value due to the lower TERP used and hence had less runway to cover the losses. The Short DLC eventually went to $0.
Affected traders voiced their concerns about this issue as they felt the TERP wasn’t correct which resulted in less time for them to react to their trades. They claimed that they could have avoided a total loss if they had more time to liquidate their positions.
The issue was raised to SGX and MAS. SG also met up with a group of traders to discuss the issue.
Not all things must end with a bad taste.
While many would expect this to be a lost case, SG surprised them with a goodwill payment of $0.30 for each SIA 5x Short DLC contract!
They don’t need to do this but they did. I felt this was a good gesture.
SG made it clear that this is a goodwill payment and not a compensation.
Maybe this isn’t enough for some affected traders. I would say that there’s no point arguing further. Let it pass and see what one can do to prevent such situations from happening again. It is always better to rely on yourself than on others’ goodwill.
Here are some precautions which I think traders can take when trading DLCs.
Avoid stock DLCs that are undergoing significant corporate actions
Corporate actions such as rights issues and placements are announced way before the share prices are adjusted. Traders should take note of these company announcements and not merely look at stock charts alone to make decisions.
The best way to prevent another episode of SIA Short DLC is to avoid it. Traders can consider closing their positions whenever such significant corporate actions arise.
If you see the corporate action as an opportunity to trade, you must accept the risk of getting it wrong and having the contract value going to $0. I don’t think SG would make another goodwill payment if it happens again.
DLCs are more suited for day trading
DLCs have compounding effect which means your gains and losses can be amplified when you hold them overnight. Hence, it is better to use it for day trading whereby you open and close a position within the same day. This would also prevent overnight news from affecting your position on the following day. For example, if you have closed the SIA Short DLC position each day, you would have avoided having an open position on the ex-rights day.
Check SG’s adjustment prior to market open
Assume you chose to hold a stock DLC overnight and it is pending a major corporate action. Do yourself a favour and check the adjustment done by SG. Not your own calculation or anyone else’s. SG has also clarified that the adjustment will only be done based on the closing price a day before the corporate action has an effect on the underlying share price. Check and decide fast what you want to do about your position.
Conclusion
It was an unfortunate event that has happened. I think this is the first time that a DLC had encountered a complex rights issue of the underlying stock and hence many traders do not know what to expect. It also happened so quickly that traders had no time to react.
SG was nice to grant a $0.30 goodwill payment per contact to all affected traders. The exact payment procedure has not been established but should be made known soon.
The next best thing to do is to learn from this and take precautions going forward.
PS: Just in case you are wondering, this is NOT a sponsored post.
