There is both cash and futures strategy, but only HNIs should look at the latter.
With the Shipping Corporation of India’s follow-on public offer (FPO) opening on November 30, investors must be wondering if they should add more shares to their kitty, or use the issue as an exit route.
Typically, FPOs provide a good arbitrage opportunity. If the company’s share price is more than the FPO price, a buyer gets a chance to exit the company at a higher price and enter at a lower level. But the window of opportunity may not last long, because the stock price will return to the FPO price before listing. Things can be completely different if the share price is lower.
What can help a retail investor is the discount offered during FPOs. Usually, retail investors can avail up to 5-10 per cent discount.
Cash market strategy
Let’s understand this with the help of an illustration. Say an investor in Engineers India (EIL) sold 100 shares on July 22, when the stock was at Rs 345 a share. He would have raised Rs 34,500. Considering he held the stock for over a year, he would not have to pay capital gains tax.
Next, he applied in the FPO in the retail category, where shares were being offered at a discount of five per cent at Rs 275.50 (five per cent discount on the price of Rs 290).
Adding Rs 65,500 to the capital raised, he could have applied for shares worth Rs 1 lakh. Since Asba (application supported by blocked amount) is under force, the money will not be deducted from his account till the allotment has been made.
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Based on the stock price, his eligibility was 364 stocks. However, since the subscription was almost three times, he was allotted 120 shares.
On the day of listing (July 27), he would have had 20 more stocks of EIL. And, he would have spent only Rs 33,060 to acquire 120 stocks. It implies a profit of Rs 5,510 in the form of stocks, plus another Rs 1,440 cash profit. In total, he would have made a profit of Rs 6,950 within a week. Additionally, he made listing gains, as EIL listed at Rs 323.50.
But such leveraging may not be possible on every stock. “There is a probability that one is playing on, considering there is a limited amount that a retail investor can apply for. Besides, he cannot be sure of what his allotment will be,” says Ambareesh Baliga, vice-president, Karvy Broking.
Once a company announces its FPO, the stock’s movement also depends on the float. Typically, stocks of companies with a low float (implying that the number of stocks of the company is low) are in demand and command a scarcity premium.
The futures strategy
It is a strategy that is strictly recommended for only high networth individuals (HNIs). Market players say HNIs often sell futures contracts to lock-in profits ahead of listing of new shares issued in FPOs.
Futures contracts may not be necessarily available for all stocks, and are sold in fixed lot sizes. While lot sizes vary from stock to stock, the value typically ranges from Rs 2-2.5 lakh for each lot. The margin money is five per cent or more, depending on the stock.
First is the pricing strategy. The price band of the FPO is at 8-12 per cent discount to the cash market price. However, the price in the futures contract could be higher because the market could be expecting some action. Arun Kejriwal, founder, Kejriwal Research and Investment Services, says, “Investors could take positions on futures contracts on the day the price band is announced. As time lapses, both prices will begin converging.”
Say a listed company whose share is trading at Rs 95 announces an FPO in the price band of Rs 85-90. If the futures market is trading at Rs 100, an investor can get an arbitrage opportunity. Assuming the allotment takes place at the upper end of the price band, or at Rs 90, the gain expected from each share is Rs 10. But then, he will have to wait for the listing.
Another strategy is selling a similar number (the number that he is hoping to get in the allotment) of shares in the futures market. If he thinks he will get 5,000 shares, selling a futures contract of Rs 5 lakh (Rs 100 a stock) will help rake in good profits on the day of listing. If the margin money is five per cent, he will have to invest Rs 25,000 to purchase the contract.
It is important to ensure that he gets 5,000 shares. However, if 5,000 shares were sold and only 2,500 received on allotment, the investor stands to lose a part of the margin money.