Retail investors are usually warned against investing in derivatives, as this is very risky. However, with rising options in terms of foreign indices, the lure to invest in these is significant.
For instance, the Bombay Stock Exchange (BSE) on Friday launched its cross-list derivative indices, with five from emerging markets. Brazil's IBOVESPA futures; Russia's MICEX Index futures; Hong Kong's Hang Seng Index futures; and South Africa's FTSE/JSE Top40 futures got listed on the BSE.
A BSE official said the exchange would soon be launching index futures of the Nasdaq 100 as well. “This gives investors a choice of a different asset class, that they are not exposed to, through the index derivatives that we have launched. It also allows the investor to transfer risk,” he said. He added this instrument was meant for those with proper knowledge of the markets.
| RISK TRANSFER OPTIONS | ||||
| Index | Return % | |||
| 5-year | 3-year | 1-year | 6 mths | |
| Sensex | 30.74 | 59.61 | -11.35 | 4.15 |
| Nifty | 36.26 | 56.90 | -10.24 | 5.30 |
| Hang Seng | 0.73 | 35.73 | -16.18 | 18.54 |
| Brazil IBOVESPA | 32.44 | 37.20 | -9.08 | 17.28 |
| Micex Index | -14.03 | 62.96 | -18.57 | 9.44 |
| FTSE/JSE Top 40 Index USD | 6.40 | 78.17 | -15.70 | 5.82 |
| Source: Bloomberg Compiled by BS Research Bureau | ||||
Price bands for the benchmark equity index derivatives will be the same as those applicable for the existing stock index futures contracts, BSE said. Exchange transaction charges for trades done by members on these futures contracts shall be waived for a period of six months from commencement (till September 30).
The derivatives contracts on these foreign stock indices will be denominated, traded and settled in rupees. Therefore, unlike investing in international feeder funds and the like, you are saved from currency fluctuation risks.
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Alex Mathew, head of research, Geojit BNP Paribas Financial Services, said certain markets are highly correlated with Indian markets. For example, the Hang Seng. He says: “If you have created short positions in the Hang Seng while there is a crisis in Southeast Asia, you can take a long position on your portfolio here.”
One should know the corelation between the various indices and follow these carefully before taking part, says Mathews.
If one is bullish about the growth prospects of the BRICS countries, you can take a position in a country you think is likely to grow the most. The advantage:“The economic growth pace of the BRICS countries will outpace that of the developed countries. Which means returns from the Dow Jones, for example, will not be as high as, maybe, the Russian index,” said the BSE official.
So what are the risks involved in these instruments? First, there is lack of awareness among retail investors regarding trading in not just derivatives but also international markets. “It is becoming more difficult to keep a track of data points with regard to our markets. How will one track what is happening in markets abroad?” asks Jagannadham Thunuguntla, strategist and head of research at SMC Global.
This lack of awareness means less trading. This can be seen in the National Stock Exchange’s (NSE) global indices derivatives (it has both Dow Jones and S&P 500). The volumes traded, compared to the rest of the derivatives segment, is rather low.
Of the four derivatives launched, if an investor were to take a position in, the Hang Seng Index, futures would be his safest bet. This is because it has a wider variety of scrips as its constituents, unlike the Russian and Brazilian markets, which are commodity-driven. The South African market is uncharted territory and an average retail investor will not have much knowledge of this one.
If the Hang Seng were to fall, maybe one per cent, if you had gone long on it, you could end up losing up to four times. But the reverse of this could also happen.
Choose the exchange carefully as well. Most of the action in the derivatives space happens on the National Stock Exchange (NSE). Almost 90-95 per cent of the volumes traded are through the NSE. Which means if you buy positions in one of the newly launched derivative products on the BSE, there is every likelihood that you will face a problem of liquidity, says Thunuguntla.
Options such as international feeder funds and exchange-traded funds are safer, for the time being. Alternatively, if, you have a higher risk appetite, you can take the $200,000 route of investing in direct equity in international markets. These are less risky alternatives and ones a typical individual investor can understand better.