FTSE reshuffle offers traders tight spreads and volatility

THE quarterly reshuffle of the FTSE 100 is due this Wednesday after the market close. Companies will be thrown into or out of the financial first division and spread betters should be ready. The changes can spark both immediate volatility and longer-term opportunities upon which traders can capitalise.

The review ensures that the UK’s leading blue-chip index is updated to reflect the changing market capitalisation and liquidity of Britain’s listed companies. Firms outside the FTSE 100 that grow to rank among the 90 largest by market capitalisation are automatically promoted, while FTSE 100 firms with the lowest values, or any that have fallen to the 111th spot or below, drop into the FTSE 250.

Traders are anticipating that engineering firms Tomkins and Weir Group will enter the top flight of the FTSE next week while insurance group Resolution, which dropped down to the FTSE 250 back in March, will rejoin the top flight.

Other stocks will have to drop out, and there are rumours of TUI Travel being shuffled into the FTSE 250 after June’s review saw Thomas Cook exit the blue-chip index, says Oliver Hughes, head of equity trading at Cantor Index. But Hughes thinks Home Retail is a more likely contender for demotion – “they’ve been struggling with a sluggish improvement in consumer confidence and increased competition from supermarkets”. Also on the cards to join the ranks of the FTSE 250 are Cable & Wireless and engineering firm Invensys, which is groaning under the weight of its pension liabilities.

While the process is transparent and well publicised to minimise any dramatic share movements, pension funds and investment trusts with FTSE 100 tracker products need to reweight their portfolios to reflect the reshuffle.

This enhances volume in the relevant stocks in the run-up to the announcement and the next day. Spread betters can take advantage of this extra volume and anticipated volatility to make some short-term profits. When Essar Energy joined the FTSE 100 back in June, the volume of trading jumped on the day of the announcement and its price also rose. (See chart.)

The rule of thumb would typically be to buy rumoured entrants and sell likely leavers. But spread betters should be wary of shares being pushed to artificially high or low levels and might consider a contrarian sell of entrants and buy of leavers.

Traders also point out that the share prices of both Invensys and Cable & Wireless have actually risen in the last week or so on the back of takeover speculation. This should be a reminder to all that market rules of thumb do not equate to a consistently successful strategy.

Even if the volatility of the reshuffle doesn’t tempt you, stocks that have moved into the blue-chip index may be worth a fresh look. They could gain tighter spreads and more attractive terms when it comes to funding or margin requirements.

Spreadex’s Andy Mackenzie explains: “The change in daily rolling spread width at Spreadex for stocks which jump from FTSE 250 rating to FTSE 100 rating falls from 25 basis points either side of the spot rate to just 10 basis points. The margin rate requirement falls from typically 20 per cent to just 5 per cent for blue-chip stocks. This potentially frees up a large amount of your trading cash.” Check with your provider, since not all providers differentiate in their spreads.

Traders should ensure they are placed to anticipate the reshuffle’s winners and the losers and to take advantage of the extra volatility and liquidity on Wednesday.