Migrating from iShares MSCI Japan ETF (EWJ) to TOPIX Futures
Over the past 25 years, both stock index futures and ETFs have enjoyed great success. But while both have seen significant growth in volume and the number of products, the primary futures contracts far out trade their ETF counterpart (see Futures vs. ETF Average daily dollar volume below). When choosing to trade between futures and ETFs, one should be aware of why futures are so much more active on a dollar basis.
Advantages of Futures over ETFs:
Execution costs: In general, futures are cheaper instruments to trade when you consider all in costs such as bid offer spread, market impact, roll costs and annual management fees.
Around the clock trading: Futures trade nearly 24 hours a day (except on weekends). ETFs cannot be traded around the clock. So, when events in Asian and European Time zone move markets, futures traders can initiate or offset positions. The 2016 elections, the BREXIT vote and Swiss National bank action on the Franc several years ago were all examples where futures were open for business and traded massive amounts of contracts.
Capital Efficiencies: Stock index futures require only an upfront performance bond margin—about 5% of notional amount of the contract. ETFs at a minimum require 50% margin (and borrowing the other 50% at broker loan rates). Capital is precious and futures have a great advantage here.
Currency Exposure: There is less currency exposure in TOPIX futures than in EWJ. When Japanese market does not change but USD/JPY exchange rate changes, the USD-value of the EWJ will change accordingly. Not so for the futures – the TOPIX futures will not move and so there is no gain/losses. This is a more “pure play” on the Japanese stock market.
Clearing House Mitigates Counterparty risk. Over the last 150 years, CME Group’s Clearing House has been a robust and stable entity that has effectively dealt with counterparty risk issues even when the world financial system has undergone significant stress.
Tax efficiencies: (for retail and high net worth traders only) Short term gains from futures contracts are taxed at a much more favorable rate than short term gains from stocks and ETFs.
Comparing the EWJ with TOPIX futures
| Broker | Investor | |
|---|---|---|
| 1) Starting Position | Flat | Long 135,200 EWJ* |
| 2) EFP is privately negotiated | Investor buys/broker sells 100 TOPIX futures at 1800.00 Broker buys/investor sells 135,200 EWJ at $59.00 | |
| 3) Reports trades | Long 135,200 EWJ Short 100 TOPIX |
- 135,200 EWJ Long 100 TOPIX futures |
| 4) EFP reported | EFP reported to CME via CME Clearport, Front end clearing or contacting GCC within 5 minutes. Futures price and EWJ price confirmed | |
| 5) Final Positions | Broker short 100 TOPIX (¥900,000,000 notional) Broker long 135,200 EWJ ($7.98 million or ¥900,000,000) Flat market exposure |
Long 100 TOPIX futures |
* 135,200 EWJ = $7.98 million USD or about ¥900 million notional amount
¥5000 x 1800 x 100 TOPIX futures contracts = ¥900 million notional amount
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