Use futures and options only as a hedge, and if you have surplus.
Since the stock market has been highly volatile in the last few months, retail investors are quite confused about their investment strategy. So, Shailesh Raja’s friend suggested that he opt for futures contracts.
His advice: Futures & options (F&O) are a good way to ensure there is some hedge against direct equity holdings. “These give high returns as well,” says the 35-year-old resident of Kolkata, explaining his recent penchant for the market’s F&O segment.
The problem with Raja’s strategy is that he is not using the F&O segment to hedge but as an investing strategy. This can hurt him bad.
Mukesh Dedhia of Ghalla Bhansali Stock Brokers says, “Ideally, retail investors should not get into the F&O segment, and definitely, not be aggressively involved. High networth individuals can still have an exposure because they have huge investments and are constantly watching the markets.”
F&Os are a lure due to the low-fund requirement, which is a certain per cent of the price of the stock or the index. Called margin money, it is the minimum prescribed amount paid as a security to the broker.
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For instance, a Nifty futures contract at 5,200 with a lot size of 50 (one contract = 50 lots) would cost Rs 2.6 lakh. But, you will have to pay Rs 26,000-65,000 as margin (10-25 per cent of the exposure for index futures).
“If the call goes wrong, the difference has to be paid immediately, and it can be huge,” says Kiran Chheda, an equity analyst. Say the Nifty contract falls to 5,000 points. You will have to pay Rs 10,000 (200 x 50). The margin increases with increase in volatility and quality of stock.
But if you have spare cash and want to experiment, index futures are the safest as a hedge when the markets are sliding and your own shares are bought at a high price, say experts. It should form less than five per cent of the portfolio. Remember, this entails the risk of predicting the markets. “If you are bullish on the index, exchange-traded funds and index funds are better options,” says Chheda.
Stock futures are riskier and complicated, as individual stocks are much more volatile than indices. The minimum trading amount required is also higher at Rs 2 lakh, and so is the margin (anything above 10 per cent). But if you still buy these, stick to largecap stocks (again, less than five per cent).
“Say you are holding a stock for 10-11 months and fear the price will fall. Selling it will attract short-term capital gains tax (15 per cent). You can sell the stock in the futures market provided the lot size is the same,” advises Dedhia.
Viral Shah, senior vice-president, Geojit Commtrade, favours currency futures as hedge instruments, especially when volatility in the currency market is as high as it is today. The margin required is lower than equities at three per cent (dollar-rupee contract) and so is the minimum amount ($1,000). But, both commodity (margin 5-15 per cent depending on the commodity) and currency markets are driven by global events, and thus, can be difficult to predict.
For a typical retail investor, financial planners say a well-diversified portfolio (equity + debt) is good enough. Debt is the best known portfolio-diversifier. Although it gives low returns, it provides balance to the portfolio. When the equity market is southward-bound, debt instruments ensure the total value of the portfolio does not go for a free fall.
Even the choice of debt instrument could differ according to your risk appetite. For instance, conservative investors may opt for bank fixed deposits and risk-taking ones may go for debt-oriented hybrid funds (aggressive, returns = 8.79 per cent in one year).
The other option for hedging is gold. Gold and stock markets are inversely co-related.
So, when markets are sliding, traditionally gold gives good returns. Gold’s intrinsic value makes it a safe and liquid option in volatile markets. Typically, extra cash can be kept in the form of gold, preferably through gold exchange-traded funds (returns = 15.03 per cent in last one year).