Derivatives are a commonly discussed topic in the investment and economic community. They are financial instruments whose worthiness is calculated by the value of the underlying assets. The assets meant here include bonds, equities, commodities, and currency among others. Futures & Options are the two types of derivatives and these are used by mutual funds to manage the risk, speculate future profits and settle for risk free profits. Derivatives can be used by the mutual funds in their portfolios in a better and more effective way by the various strategies which could be utilised to have good advantages.
Uncertainty, doubt, speculation, risk are terms which relate to stock market. There are so much of unpredictable changes in the market that it has affected the investors badly. Here the investors are left with very few options that are:
- Do distress selling of stocks, but if it the mutual funds or other stocks were purchased on a higher rate than what they are selling this day, it could be harmful and detrimental to the investors and them.
- Try to be immune to the changes and take the risk. One could be in losses but ultimately the stock market would recover.
- The best alternative is to make use of the index futures to eliminate and reduce the fluctuations.
Different investors may react differently. Some may want to sell the stock, while some may want to wait. The fund manager or managers will have to use their portfolio to counter the trend by doing the opposite in the futures market. This way though the profits could reduce, the risk of losing money also is lessened.
When a position is taken or has been decided to be taken on the future movement of the stock market, it is called speculation. The manager has the confidence that the market price would rise in future and then he would definitely be in profits. He then buys the NIFTY futures and waits.
The fund would be in profit if the manager’s guess about the rise is correct. But if the views were wrong, the fund would be in a loss. In case the manager feels there is a bearish trend in the market, he could sell the nifty future and hold on till trend changes. He could also speculate about the individual stocks by buying or selling the derivatives. Speculation in the options and futures can result in either profits or losses. It all depends a lot on the manager’s call.
Buy low sell high is the commonly used strategy in the futures market. This approach can be used in the futures market successfully but one must be able to anticipate the movements. Traders have the option to use two types to predict the future prices which are:
- Fundamental Analysis: One should study the demand for a commodity and accordingly ensure supply so that demand and supply is neither less nor more as this would affect the future prices.
- Technical Analysis: It studies the price behavior and tries to find models that could help forecast price. The price behavior can be analysed by different types of charts.
Traders usually combine the best points of both types.
This is a strategy where a particular instrument or a few instruments are purchased and sold in two or three different markets. Since usually the prices differ in each market, there is a possibility of one benefiting from the fluctuations in the market.
Here you could buy certain commodity from one market and sell in another market making a short term profit. The difference between the cash price and future price during a transaction gives us the net returns during a transaction. The returns here are lesser than those from equity funds hence these are compared in the CRISIL fund index. The fund is not affected by the market fluctuations due to this arbitrage strategy.
There are a few more strategies which could be used by the mutual funds but they again would depend upon the market conditions existing at that time.
You should be able to move along with the trend i.e. enter in the fray at the right moment and exit from the fray at the right time. It is this which could dictate the profit or loss margin and a good trader knows his timings very well.