MARKET TIMING ON THE JOHANNESBURG STOCK-EXCHANGE USING DERIVATIVE INSTRUMENTS

This paper investigates to what extent superior returns can be obtaine d from a market timing investment strategy on the Johannesburg Stock E xchange that makes use of derivative instruments. Traditional timing a pproaches, where timed switches are made between risky equities and ri sk-free cash, suffer from various liquidity and cost constraints. Timi ng using options is proposed as a more practical and efficient alterna tive. Two timing strategies are considered: bear timing, where put opt ions are purchased in an attempt to protect an equity portfolio from m arket downturns, and bull timing where call options are purchased to e nable a pure cash investor to participate in market upturns. Fair Valu e 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 fo r the period 1963-1992. Computer simulations are used to simulate the timing decision-making processes of investors with varying abilities i n 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 timin g in efficient and rational markets. Nonetheless, in markets where dev iations from the fair value of futures contracts occur, bull timing pr ovides large arbitrage opportunities. A bear timing strategy with a sh ort review period would appear to offer an attractive risk/return trad e-off. (C) 1997 Elsevier Science Ltd.