Derivatives: The Gambling Connection

With the launch of the derivatives market in Kenya fast approaching, I would like to highlight or rather discuss briefly on a feature of interest to me and that is the derivative contract size.

A contract size is the quantity that can be delivered on a futures and options contract that is exchange traded. This contract size is standardized and varies depending on the commodity or instrument that is traded. The contract size also determines the KES value of a unit move in the underlying commodity or instrument

The contract size governs the minimum ticket size of a futures trade. Increasing it would mean that only ‘richer’ traders participate while decreasing it would mean that it makes it more affordable for ‘regular’ traders (like myself) to trade.

Expected derivatives contract size in the Kenyan market:

  1. Index – index points times 100
  2. Single Stock Future – 1 contract = 500 shares
  3. Forex – 1 contract = 1000

Minimum order value:

  1. Index Value = 3900 points * 100 = KES 390,000
  2. Single Stock Future Value = KES 17 (stock price) * 500 = KES 8,500
  3. Forex = USD/KES 101 * 1,000 = KES 101,000

Increasing the contract size:

This would limit trading to only those that can afford to trade in large amounts and that’s why it would effectively  target the ‘richer’ traders. However, this does not necessarily mean that these ‘richer’ traders are better at making money. What it does mean is that they are better ‘placed’ to handle a much larger loss of money in the market while majority of us ‘regular’ traders cannot.

For brokers and stock exchanges, this would be a red flag. Their reasoning is that it would be terrible for market liquidity. Well, there is evidence of this. Last year, the SEBI increased the equity derivative contract size from Rs 2 lakh to Rs 5 lakh which hit volumes hard. This is because 20%-30% of the turnover came from retail investors (which makes sense because the contract size was so low and thus attractive and affordable to them)

Why I think this is important to consider in future

I believe increasing the contract size makes sense especially for the Kenyan economy which is driven (more or less) by the spending power of the ‘regular’ folk. So when the ‘regular’ folk go crazy on speculating on this derivatives market our losses (and as such reduced spending power) hurt the economy. Currently, the middle class population in Kenya constitutes 44.49% of the total population and they form a powerful purchasing block.

Majority of those in the middle class income group rely heavily on their salaries yet the economy is not creating enough jobs to absorb the ever increasing young population.

The derivatives market does serve a useful purpose by providing risk management tools against various financial risks. However globally, this only accounts for approximately 5% of the traded derivatives.

Over 85% of derivative volumes are either speculative in nature (read: GAMBLING) or from dealers hedging speculative trades.

The gambling connection

Quick money has become the norm in Kenya and this is why there is a booming betting industry (read: GAMBLING) that has formed that makes billions of shillings from the misfortunes of many.

I once went to a casino to experience this world of quick money. I walked around the tables and since I had no idea what was going on – I just watched. First up, the Roulette game. The minimum entry to a game is a mere KES 1,000 and you can receive chips (what you use to play with) worth a minimum of KES 25 (40 chips).

Mind you 40 chips look a lot when you have them on the table (just picture it) and it creates some sort of confidence of having more thus making you believe you can win big. This boosts the gamblers ego (especially if they are on a winning streak – irrespective of how small. A win is a win)

Now, when the chips start to end the gambler thinks to themselves, “It’s only KES 1,000 (or less since you are already in the game) let me ‘buy’ more chips because I know I will win it back and win so much more”. And thus, the cycle continues. The intoxicating pull of a possible win is hypnotic and it doesn’t help that the ‘house’  treats them extremely well providing free food and drinks throughout the day and night.

Parting note…

That’s my concern. Most times derivatives trades aren’t handled in the most ethical way. So it is highly likely there will be vultures in the market. All I am saying is, an increase in the contract size may be welcome as it may help keep the ‘regular’ traders away from unnecessary risks that will eventually be socially amplified.