Most would be thinking that a plunging market will be a breeding ground for bankrupts and bunch of losers, but had we not heard of stories where millionaires emerge from a plunging market?
Here we will show you 2 instruments that you can possibly use to earn from a crashing market.
1. Trading/Buying Put Warrants
Put Warrant is a kind of special instrument that will enable the trader to profit from a plunging prices/value of the underlying product. When a market plunge, we will talk about the index dropping. The index for KLSE will be KLCI (Kuala Lumpur Composite Index), which is made up from 30 largest listed company in terms of market capital.
If you are anticipating that the KLCI will fall to 1300 by the end of 2015, how can Put Warrant benefit you now?
Let’s study 1 Put Warrant (FBMKLCI-H1) which is listed in the KLSE
The real value of the Put Warrant will need to take into consideration on the exercise level, the value of the underlying product (KLCI) and the conversion rate.
For example, FBMKLCI-H1, which is issued by Kenanga carries an exercise level of 1720 and a conversion of 398:1. Based on the current KLCI as of last Friday (5th Sep 2015) closing of 1589, what is the true value of FBMKLCI-H1 ?
The calculation will be (Exercise Level  – KLCI Value ) / Conversion Rate  = Real Value [RM 0.329]. However, Put Warrant usually trade/swing along with the FKLI value (FKLI as of last Friday is 1560), hence that will value FBMKLCI-H1 at 0.40. As of last Friday, the closing price of FBMKLCI-H1 is RM 0.51, putting up a 27.5% premium based on the FKLI value of 1560.
Now if you are looking at KLCI dropping to 1300 by year end due to the negative outlook, where will be for FBMKLCI-H1 ?
( Exercise Level 1720 – KLCI value 1300) / Conversion rate 398
= RM 1.055 (Real value of FBMKLCI-H1 when KLCI at 1300)
With just RM 5,100 to purchase 100 lots of FBMKLCI-H1 at RM 0.51, when KLCI drop to 1300, FBMKLCI-H1 could be trading at the range of RM 1.05. Your 100 lots of FBMKLCI-H1 will then worth RM 10,500, translating to a gross gain of RM 5,400 or 105%
However, trader should be caution that Put/Call Warrant always trade near to 0% premium when nearing expiry date, this will put an outright higher risk when buying warrant which carries a high level of premium.
2. Trading/Shorting the FKLI
The FKLI (FTSE Bursa Malaysia Kuala Lumpur Composite Index Futures) is also known as FBM KLCI Futures and KLCI Index Futures. Basically, the FKLI Contract Months are spot month, the next month, and the next 2 calender quarterly months (March, June, September, December).
FKLI minimal fluctuation is 0.5 index point, which is valued at RM 25. The current initial margin requirement per contract is RM 4,500, however will be subject to changes from time to time.
If you are anticipating KLCI to drop to 1300 by end of the year due to the negative sentiment, you can short a December contract (current level at 1514) and wait. Should the FKLI-December2015 drop to 1300, your gross profit will be RM 10,700. With an initial investment of RM 4,500, that will be a 137% return in 3 months.
Well, that is the opportunity on a plunging market. However, should one had a different view, then he/she should act the accordingly to his/her own view.