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Bovespa Index and mini Index

Bovespa Index and mini Index

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1. What is it?

Bovespa Index (Ibovesp) translates the average performance of the main shares being negotiated in São Paulo stock exchange, and is formed by shares with the larger trading volumes in the next few months. It measures Brazil’s stock market behavior, working as a thermometer of future expectations for the economy and the stock exchange. The index changes in a daily basis, as share prices increase or decrease.

Ibovespa index is just a theoretic reference. However, one can trade with that in futures, with standards set up by the stock exchange itself. Trading Ibovespa futures allows investors to keep a diversified and vast number of different shares. That means the investor doesn’t need to buy every single share individually, in small lots and deals, paying for fees and charges to every single move he takes.

If an investor buys Ibovespa Futures, he expects the stock exchange itself to gain value over time, or the shares that compose the index increase, lifting the points and making him to earn money. If an investor otherwise sell Ibovespa futures, he expect the stock exchange to go down. This way, Ibovespa futures are buying and selling agreements based on the stock exchange’s points to a future date, for a predetermined pricing establish by the counterparts.

The advantage of trading Ibovespa futures is the liquidity (the volume of deals is huge), as well as a low cost and not much money to take positions. It can be used for speculating and also to hedge positions.

Speculation: if an investor expects stock exchanges to go up, but doesn’t know which shares to be buying, he can purchase some contracts of Ibovespa futures, rather than shares. If the stock exchange goes up, he earns the difference.
Also, he can bet on a downfall, selling futures, if he thinks shares in general are showing a downward trend and the economy is not going very well.

Hedge: investors or funds can also use the Ibovespa future to hedge positions. For instance, a fund manager doesn’t have enough resources to buy shares, but expects them to increase. An alternative is to take a position on a possible hike for Ibovespa index, through buying futures. This way he can take advantage of an upward without buying shares individually. Hedging operations on downward trends are also common. An investor can sell Ibovespa futures expecting the stock exchange to go down, but keeping their shares in hands. Or, if the investor or manager has few stocks, but want to minimize systemic risk, may also sell futures contracts Bovespa Index also protecting themselves against the falling market.

Ibovespa quotations are in points, where each point corresponds to BRL1.00. So the reference value can be found just by multiplying the index for BRL1.00. Liquidation is exclusively financial, through daily adjustments until the expiration date or the position closure, and corresponds to the difference between the Ibovespa value by the expiry date minus the starting level agreed by the counterparts.


2. Characteristics

Terminology

Terminology for Ibovespa Futures can be found as follows:

1. Trading code for Ibovespa Futures is “IND”.

2. Each letter corresponds to the expiring month as follows:

Mounth Letter
February G
April J
June M
August Q
Octuber V
December Z

*International Standard

Expirations will always happen in the even months.

3. Expiry year.

Example: for dealing with Ibovespa Futures expiring by February 2014, we have the following code:

IND G 14

Contract

Ibovespa Futures have the following characteristics:

Code IND
Quotation R$ 1.00 per each point
Min Daily Change 5 points (R$ 5.00)
Max Daily Change 10% over the previous quotation
Lot 5 Contracts
Limits 10,000 contratos or 20% of the opened positions to a same expiration date
Trading Timetable 9am – 5h55pm

Day Trade

It is possible to close a day trade (buying and selling futures with same expiry date in a same day) of Bovespa Index and mini Index, giving greater liquidity to this type of contract, in addition to being used as an instrument of speculation.

Daily Settlement

The daily settlement is nothing more than a mechanism used by BMF&Bovespa to balance the investor accounts. As futures change in a daily basis, generating credits or debts, investors are daily updated on their positions, earning or losing as prices change – in other words, they either get their profits or pay for their losses daily. The mechanism is a protection against any noncompliance among investors.

In Bovespa index futures contract, the open positions will be adjusted based on the settlement price of the day at the end of each session. Financial transactions will be the following business day, ie, on D+1, according to the rules of the BM&F.

Guaranty margin

It is a value deposited in cash or notes which will covering any noncompliance of an investor in daily adjustments. Usually to operate options, the investor is forced to deposit a guarantee to mitigate risks. The margin is defined by the stock exchange, according to the analysis of the futures market.

The assets accept as guarantee include cash, gold, government or private bonds, letters of pledge and quotes at funds. To deal with Ibovespa Futures, one must deposit about 15% of the total invested amount in the broker account, as guarantee.

Operational costs

Expenses from investing in Bovespa Index include:

Brokerage – it can change depending on the broker. However, most of them use the basic operational fees, stipulated by Bovespa. In this case, costs reach 0.25% for regular operations and 0.15% for the day trade, based on the theoretical redeem value.

Stock exchange fees – that includes emoluments and registering fees by BM&F, charged as follows.

Emoluments: The fees charged by the BMF values ​​related to trading services. They focus on contract negotiation (opening or closing position before maturity), exercise of options, registration and early settlement and assignment of rights procedure. In Bovespa Index futures contracts, the fees are charged according to the table below:

Number of contracts Range value
From To R$
1 10 0,91
11 50 0,81
51 100 0,78
101 190 0,73
191 2000 0,68
Over 2000 0,64

Liquidation charge: this charge regards to the liquidation of the contracts by the expiry, on top of clearing expenses. Usually, this charge is a fixed value, and has nothing to do with the volume of contracts negotiated. For Ibovespa Futures, fees reach R$ 1.52 per contract.

Clearing fees: include all costs for following positions and receiving reports and filings made by the clearing house, as well as operational costs for holding inactive positions on derivatives. It affects all positions opened in contracts traded in the primary market (except for options and minicontracts) and OTC contracts. The fees are daily updated, and charged in the last work day on each month, by closing the positions or every time an investor transfers all positions to another one.

Fees are based in the number of positions opened by the calculation day, and can vary depending on the volume of contracts traded.

For Ibovespa contracts, it reaches R$ 0.015 per contract and day.

Registry charge: a value charged to register the operation on the clearing house, that only applies to deals that open or close positions before the expiry date, and charged one day after those events.

The table of prices for registration is disclosed by the stock exchange based on average deals for the latest 21 trading sessions. Calculations are made in the last trading session of a week, and define registration charges for the following week.

Currently, registration charges stand as follows:

Number of contracts Range value
From To R$
1 10 1,00
11 50 0,90
51 100 0,85
101 190 0,80
191 2000 0,75
Over 2000 0,69

Also, ISS tax applies to this kind of investment.

Maturity

Ibovespa future contract may expire in any even month in the year -  that includes February, April, June, August, October and December. Expiration always occur in a Wednesday, the closer to the 15th day of the month. If there is a bank holiday, expiration happens in the next work day. All of these possible expiry dates allow investor to design different strategies, selling a short term contract and replace for one with a longer lifecycle, for example.

Liquidation

By the expiration date, all positions that remain opened, after a last adjustment, wil be financially executed by the stock exchange, by registering the inverse operation of the position held. In other words, at maturity, the financial settlement will be where investors will have their contracts bought and sold vice versa.

If the investor wants, he can make a ‘reversed’ operation – if he is ‘bought’ in 10 contracts and wants to liquidate the position, he can just sell them and wait for the final determination of the daily settlements.

Mini Bovespa Index

Rules and features remain the same as Ibovespa traditional future, but the contract’s value change to BRL0.20. In addition to a lower value, which allows small investors to participate, mini indexes have smaller maintenance costs and the same liquidity as the original contracts.

Standard lots for minis comprise 1 single contract which is just R$ 0.20 worth. All other rules follow the standards contracts, like daily updates, guaranty margins, liquidation and expiration rules, etc.

Mini Bovespa Index will have a specific terminology, as follows:

1. Trading code for mini Ibovespa is “WIN”.

2. Each letter corresponds to the expiring month as follows:

Month Letter
February G
April J
June M
August Q
October V
December Z

*International Standard

Expirations will always happen in the even months.

3. Expiry year.

Example: for dealing with ‘mini’ Ibovespa features expiring by August 2014, we have the following code:

WIN Q 14

Trading costs are reduced, though. Brokers use to grant some discounts for mini contracts, and even offer 50% discounts for day trade operations. Mini contracts are also free of registration and clearing fees.

Forward Points – FRP

From a huge demand from investors of Ibovespa, by 2002 BM&F authorized deals with Forward Points. base of the Bovespa index futures contract through a quote, expressed in number of index points, to be increased or decreased the points of the average day’s Bovespa index, calculated on the spot market. Soon, in the end of the trading session, all operations forward points of Bovespa will be transformed into trades in the Bovespa index futures contract, with the same amount and in the same kind of operation to the maturity-base. The maturity-base shall be the first month of the Bovespa index futures contract until the third last business day prior to maturity. Since then, the maturity-base will be the second month open, remaining in that condition until the penultimate before the due date weekday, when it repeats the process.

Ibovespa ‘Roll Over’ – IR1

Roll over operations on Ibovespa index – IR1 – comprise the strategy of dealing with two different expiration dates of  Ibovespa futures at the same time. It’s been authorized by BM&F as of 2008 for meeting the market demand.

Procedures and rules remain the same as regular contracts. However, for IR1 deals, instead of generating new positions in a new contract, it will be automatically transformed in two different operations: the first will have the expiry date set up as being the IND’s original date (short leg), and the second fixed for expiration in the IR1’s set up date (long leg). Thus, the IR1 not have open positions at the end of the day, being distributed on their trades maturities of futures contract Bovespa.


3. Profitability and risks

Profits and risks from investing in Ibovespa Futures are related to floats of the index itself. The main risk for this operation is the market risk properly, in other words, the performance of the various shares involved and present to the Ibovespa index. Ibovespa operations are considered a high risk option, due to the huge daily changes on the index.

Profits will also depend on the index changes. If an investor finds the forecast for the index, he can make huge profits, but if he misses, losses can be also huge. So it’s impossible to precisely determine how the index will behave as it depends on all shares being traded in the market.

Ibovespa futures are widely used as speculating tool, for making fast and huge profits, but they are also used as a hedging tool, to provide an extra protection for large portfolios.


4. Taxation

Taxes over Ibovespa Futures futures follow the same logic of any other variable income investment. Income tax is equal to 15% of the sum of all daily adjustments (if positive) and is charged just when you close a position. Also, income withholding taxes of 0.005% are due over the full amount of gains.

For day trade operations, the income tax reaches 20% of profits, and the withholding tax other 1%.

All costs and fees paid for investing can be deducted from the income tax amount, including those from BMF&Bovespa. In case of losses, a compensation can be applied in any gains in the subsequential months, as long as the operations are similar.

The investor himself is responsible for paying all taxes, except when withholding taxes apply – then taxes must be accounted monthly and paid in every subsequential month.


 5. Example

1. Hedge against a drop in Ibovespa

Let’s assume a certain investment fund holds a large shares portfolio, with over R$ 500,000.00 invested. The “beta” of this portfolio is 1.1, which means it changes regularly almost in the same pace as Ibovespa does. The fund is not willing to sell shares, but he also expects a general drop for the next few days. What could he possibly do with those shares to not loose money? The answer is making a hedge with Ibovespa Futures. Consider the following figures:

Invested amount R$ 500.000,00
Ibovespa Spot 30.800,00
Ibovespa Index Future 32.500,00
Contract size R$ 1,00
Beta 1,1

The first the fund must do is to find the number of contracts to be sold. For such, it uses the following formula:

Fund’s capital / (Cash Index * Contract size) x Beta = Number of contracts

Thus:

R$ 500,000.00 / (30,800 x R$ 1.00) x 1.1 = 17 contracts

So the fund must sell a total of 17 contracts for Ibovespa Futures prices, or for 32,500 points.

By the maturity date, Ibovespa reaches 31,720 points, falling frim selling positions. So the results will be:

(Sold pricing – Closing prices) x Contract value x Number of contracts

(32.500 – 31.720) * R$ 1,00 * 17 = R$ 13.260,00

Income made by the operation reached R$ 13,260.00. However, the shares kept by the fund also dropped. If they drop an average of 2%, it is now a R$ 490,000.00 portfolio. As the income from the operation reached R$ 13,260.00, the hedge worked and the manager still made some profits. Values ​​may vary with fluctuations of stocks and index, indicating that not always it will make a profit to compensate losses in this type of operation.

 2. Mini Index Speculation

Let’s suppose an agressive investor is confident enough that his forecasts point to a market increase, He decides to purchase 10 mini contracts, as follows:

Mini Bovespa Index Price 44.800,00
Contract Size R$ 0,20
Number of contracts 10
Ibovespa at Maturity 47.000

As Ibovespa index increased and by the maturity date it exceeded the contract’s price, the investor made profits. Remind that both Ibovespa futures and mini futures have daily adjustments, as shown within the table below:

Date Previous day prices Adjusted price Contract Size Number of Contracts Daily settlement
D+0 - 44.800,00 R$ 0,20 10 -
D+1 44.800,00 43.950,00 R$ 0,20 10 -1.700,00
D+2 43.950,00 43.523,00 R$ 0,20 10 -854,00
D+3 43.523,00 44.101,00 R$ 0,20 10 1.156,00
D+4 44.101,00 44.968,00 R$ 0,20 10 1.734,00
D+5 44.968,00 45.679,00 R$ 0,20 10 1.422,00
D+6 45.679,00 46.220,00 R$ 0,20 10 1.082,00
D+7 46.220,00 47.000,00 R$ 0,20 10 1.560,00
47.000,00
Total 4.400,00

By the maturity date, he earned R$ 4,400.00, as shown:

 (47.000 – 44.800) * R$ 0,20 * 10 = R$ 4.400,00

If Ibovespa had dropped below 44,800 points, the investor would made losses with the difference being multiplied by the number of contracts and their size.

*Taxes and transaction costs have been disconsidered.


 6. Advantages

  •  The main advantage for Ibovespa futures is to making hedge operations against floats on shares, with more flexibility and a lower amount of money, allowing individuals and funds to better planning their strategies;
  • Another advantage from trading Ibovespa futures is to keep a good portfolio of shares, mitigating risks and in theory mantaining a lot of shares altogether. That means the investor doesn’t need to buy dozens of different shares in different quantities, finding liquidity problems and paying fees to any single operation.
  • Reduced costs;
  • Possibilities of speculating on the index’s ups and downs. If investors think the index will fall, he may sell futures contracts of Bovespa Index. If he think the index will rise, you can buy the index, taking your profit or loss on a daily basis in the daily settlements as the index changes
  • High liquidity.

7. Disadvantages

  • Daily settlements;
  • Guaranty margin;
  • Income taxes;
  • Expiry dates, so you cannot undefinedly carry up positions, needing to postpone to a new expiry date if necessary;
  • High risk as variable income investment.

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