| |
| Sandeep Shetty, a middle-class salaried person living in Mumbai with three dependents, had always been averse to the idea of investing in equities.
|
| |
| With interest rate cuts, it had been tough to cope with the increased cost of living. In April 2003, Shetty started observing the markets after hearing optimistic views that a rally was around the corner.
|
| |
| He still did not have the courage to enter the markets then. And as an extra-cautious investor would do, he waited.
|
| |
| He waited for a good four months to check whether at all the markets were in an uptrend and confirmed the call after reading and listening to reports.
|
| |
| Economic growth, market touching all-time highs, fundamentals going strong, restructuring of corporates, sectors looking great, valuations attractive, etc.
|
| |
| 'This is the time,' he thought, 'I must make some money like everyone else.' He then registered with a broker and decided to invest Rs 50,000 in stocks. This was when his broker advised him to consider derivatives as a tool which will enable him to play on a broader spectrum.
|
| |
| So Shetty started his first encounter with the markets. He decided to buy a call option of ITC (the tobacco major has been a favourite) in August (August 1, 2003), around 20 days before expiry (spot - Rs 720, strike - Rs 720, premium - Rs 30). His net outflow was Rs 9,000 (ITC's lot size is 300).
|
| |
| He waited till the expiry and did not square off. At the expiry date, the cash price closed at Rs 817. Net-net, he made a gain of Rs 67 (817 {closing price}-[720 (strike price)+30 (premium)]) i.e. a total gain of Rs 20,100. Meanwhile, ITC's spot price constantly moved up, gaining almost 14 per cent.
|
| |
| This is just one example of how Shetty made money by investing in derivatives, using a simple buy option and not any complicated strategy.
|
| |
| The essential point to note here is that derivative instruments allow you to leverage. So to that extent your profits are exaggerated. In the above case, for example, Shetty could earn Rs 20,100 on an investment of Rs 9,000.
|
| |
| However, if he had decided to deploy the same amount of money in buying ITC shares in the spot (cash) market, he could have bought around 12 shares.
|
| |
| And at the end of the month, his profit would have been only Rs 1,164. The downside in the derivatives, of course, is that if the price does not move favourably, the premium amount paid upfront becomes a dead loss.
|
| |
| Another trade that Shetty did was based on index futures. He bought three Nifty near-month futures (contract size 200) at 1468 (around mid-September this time, there was 15 days to expiry) and sold them when they reached 1492, thus gaining Rs 24.
|
| |
| In all, he made Rs 14,400 on the trade. But Shetty warns on this saying that one should be ready to part with hefty margins to be paid upfront (about 25 per cent) apart from mark-to-market margins since the market tends to be volatile.
|
| |
| Sensex has zoomed past all barriers, and is trading around 4865. Volumes on derivatives are showing new highs and have surpassed the cash volumes long ago.
|
| |
| As on November 5, 2003, volumes on NSE in futures were Rs 10,389.2 crore, volumes in options were Rs 1108 crore and cash volumes were Rs 6139 crore. Some FIIs and high net-worth individuals (HNIs) have made big-bucks.
|
| |
| Enter retail: Somewhere on the streets, stands an average middle-class salaried man looking at the towering rise in the markets wishi ng he was a part of this merry-making but does not have the kind of money to enter the market right now.
|
| |
| Enter derivatives: Even with Rs 1 lakh a retail investor can trade upto around four times the money he has at any given point.
|
| |
| Derivatives also seem to be the right option for a retail investor, since he can explore variety instead of placing all his money in one particular stock.
|
| |
| So, what should your strategy be? Your derivative strategy should basically depend on your objectives. You can make your share holdings work as a means of earning regular income by adopting simple option-writing strategies.
|
| |
| Opposed to this, you can make your profits (and losses, too) multiply if you are willing to bet on the direction of the index or individual stocks by investing in futures and options.
|
| |
| In between, there are also way of combining positions to make your strategy safer. Considering that the market are precariously poised at the point with Sensex making new 52-week highs, here are some strategies various types of investors can follow.
|
| |
| Before that, some important points: Should you trade in an index or individual stocks?
|
| |
| "An index would be preferred over a stock since at the current levels volatility is high, thereby, increasing premiums or stocks. Also, taking a view on the broad market index is considered better than on individual stocks," says Ashok Mittal, head, derivatives, SSKI.
|
| |
| Stocks are exposed to higher volatility than the index where the risk is divided.
|
| |
| Is it more profitable to buy or sell option contracts? "Buying in the options market seems to be the best for a retail investor now," says Mittal.
|
| |
| This is because, buying of options involves the least outflow of money (only premium) and risk (or loss) is limited to the extent of the premium paid if the markets move against the investor. Here are the specific strategies:
|
| |
| * Hedging or covered call strategy
|
| |
Let
|
