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Market timing on the Johannesburg Stock Exchange using derivative instruments

Author

Listed:
  • Waksman, G.
  • Sandler, M.
  • Ward, M.
  • Firer, C.

Abstract

This paper investigates to what extent superior returns can be obtained from a market timing investment strategy on the Johannesburg Stock Exchange that makes use of derivative instruments. Traditional timing approaches, where timed switches are made between risky equities and risk-free cash, suffer from various liquidity and cost constraints. Timing using options is proposed as a more practical and efficient alternative. Two timing strategies are considered: bear timing, where put options are purchased in an attempt to protect an equity portfolio from market downturns, and bull timing where call options are purchased to enable a pure cash investor to participate in market upturns. Fair Value Models and Black-Scholes Option Pricing Models are used to price put and call options on the All Share Index and All Share Index Future for the period 1963-1992. Computer simulations are used to simulate the timing decision-making processes of investors with varying abilities in forecasting market movements. The research shows that extraordinary rewards are achievable from timing strategies using options. However, superior accuracy in forecasting market movements is still a critical factor in determining success. Bear timing is preferable to bull timing in efficient and rational markets. Nonetheless, in markets where deviations from the fair value of futures contracts occur, bull timing provides large arbitrage opportunities. A bear timing strategy with a short review period would appear to offer an attractive risk/return trade-off.

Suggested Citation

  • Waksman, G. & Sandler, M. & Ward, M. & Firer, C., 1997. "Market timing on the Johannesburg Stock Exchange using derivative instruments," Omega, Elsevier, vol. 25(1), pages 81-91, February.
  • Handle: RePEc:eee:jomega:v:25:y:1997:i:1:p:81-91
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    References listed on IDEAS

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    1. Black, Fischer & Scholes, Myron S, 1973. "The Pricing of Options and Corporate Liabilities," Journal of Political Economy, University of Chicago Press, vol. 81(3), pages 637-654, May-June.
    2. Cornell, Bradford & French, Kenneth R, 1983. "Taxes and the Pricing of Stock Index Futures," Journal of Finance, American Finance Association, vol. 38(3), pages 675-694, June.
    3. Firer, C & Sandler, M & Ward, M, 1992. "Market timing: A worthwhile strategy?," Omega, Elsevier, vol. 20(3), pages 313-322, May.
    4. Black, Fischer, 1976. "The pricing of commodity contracts," Journal of Financial Economics, Elsevier, vol. 3(1-2), pages 167-179.
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    Cited by:

    1. Dumont de Chassart, Marc & Firer, Colin, 2004. "Risks associated with market timing under different market conditions," Omega, Elsevier, vol. 32(3), pages 201-211, June.
    2. Sven Bouman & Ben Jacobsen, 2002. "The Halloween Indicator, "Sell in May and Go Away": Another Puzzle," American Economic Review, American Economic Association, vol. 92(5), pages 1618-1635, December.
    3. Lim, Terence & Lo, Andrew W. & Merton, Robert C. & Scholes, Myron S., 2006. "The Derivatives Sourcebook," Foundations and Trends(R) in Finance, now publishers, vol. 1(5–6), pages 365-572, April.

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