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Tag: hedging

  • The Benefits Of Futures Trading In India

    An index future is a futures contract on a market-wide or sectoral index. For example, the NSE has futures on the market-wide Nifty index and liquid futures on the Bank Nifty index (which is a sectoral index of liquid banks). Both of these indices are very liquid, which means that they are traded a lot by both individual and institutional investors. Why are index futures becoming very popular in India? What are the pros of trading in index futures? The once-famous Badla system on the BSE, which involved trading in stock futures, led to the growth of index futures trading in India. Let’s talk about how to trade index futures, but let’s also think about how trading index futures might help traders.

    1. Stock risk can be avoided by taking a broad view of things.

    Let’s say you’ve decided to invest in banking stocks, but it’s hard to know which ones to buy. Private banks are having trouble with valuation, and PSU banks may be worried about nonperforming assets (NPA). A better plan would be to look at the banking industry as a whole, which will naturally diversify your portfolio. You can do that by buying Bank Nifty Futures and joining the trend of banks going up. The benefit is that you can keep this position open for as long as you want by rolling it over every month for a marginal cost of about 0.50%.

    2. You can trade both long positions and short positions.

    If you are long, which means you are buying, it is fine. What if you don’t like banks? You can sell short banking stocks on the stock market, or you can sell the stocks you already own. But because rolling settlements are used on Indian markets, you can only short stocks during the day. The other option is to sell stock futures of specific banks, but this time you run the risk of losing money on a specific bank. All of these problems might be solved if you just sold the Bank Nifty index futures. If you think the Indian market as a whole will go down, you can just sell Nifty futures.

    3. You can trade index futures with less money

    When you trade futures, keep in mind that you need to trade on margin. But margins on indices like the Nifty and the Bank Nifty are usually lower than margins on individual stocks. This is because an index is made up of several stocks, which gives it a natural way to spread out risk. Because there is less risk, you need less margin to buy an index futures position. By doing this, it will be made sure that less money will be locked up.

    4. You can lower your risk with index futures.

    This is a very important part of how you manage your portfolio. As a private or institutional investor, you can hold a large number of stocks in your portfolio. You think that the market will correct by 10% to 12% once the US Fed raises interest rates. You are also sure that the drop in the value of your stocks will only last a short time and that they will go back up in value in a few months. You could keep your money, but selling Nifty futures would be the best way to lower your risk. When the market goes down, you can make money by selling Nifty futures contracts. This will lower the average cost of the stocks you own. You will be in a better place in three months, for sure.

    5. The risk of not being able to sell these index futures is low

    We frequently observe liquidity problems in particular equities or stock futures. Index futures, on the other hand, almost never have liquidity risk because institutional investors like them. Because of this, the bid-ask spreads are also not very big. Because of this, it’s usually safe to trade in these index futures because you won’t run out of cash. This is one of the main reasons why people trade index futures all over the world.

    6. Index futures can help you spread out your investments.

    Even though this point is more about taking advantage of opportunities, it is related to the one about minimising risks. You have a portfolio that is mostly made up of financial assets right now. You think the RBI rate hikes pose some risk, so you want to make your money safer by investing in industries that don’t change as much, like FMCG and IT. Even though it is possible to buy these stocks, it will cost money and tie up money if this is a short-term opportunity. A better plan is to use FMCG index and IT index index futures to spread out your portfolio. You can structure your portfolio to be more diverse in this way with little risk and cost.

    7. Trading in index futures costs a lot less.

    This doesn’t need to be said again. The commission and STT rates for index futures are much lower than those for stocks or even stock futures. In fact, most brokers also offer fixed brokerage packages for indices, which makes them cheaper than stock futures. Take full advantage of the fact that index futures cost less.

    You might do well trading index futures because they have less risk and could give you a bigger return. But index futures are useful for more than just trading!

  • A Beginner’s Guide To Hedging

    Hedging is a beneficial investment strategy that every investor should know about. Hedging in the stock market provides portfolio safety, which is often as important as portfolio growth. Hedging is commonly discussed but not explained. But it’s not a mystical term. Even a novice investor can benefit from learning about hedging.

    Before hedging

    When it comes to trading and investment, you need to choose the right one from a plethora of brokerage firms . One of the important factors you need to look for while executing hedging strategies is the lowest brokerage and someone with a fast-growing online brokerage background.

    Hedging

    Consider hedging as a type of insurance. By hedging, people protect themselves from the financial consequences of an unfavourable event. This does not stop all bad things from happening. However, if a negative event occurs, properly hedged, the damage is lessened.

    Hedging happens very universally. For example, buying a homeowner’s insurance protects you against fires, burglaries, and other unanticipated events. Portfolio managers, investors, and organisations employ hedging to decrease risk. In the financial markets, hedging is not as straightforward as paying an annual insurance premium.

    Hedging investment risk involves strategically using financial instruments or market tactics to offset price risk. Traders hedge one investment by trading in another. To hedge, you must conduct counter-trades in securities having negative correlations. Of course, you must still pay for this type of insurance. For example, if you own XYZ stock, you can buy a put option to protect your investment from large declines. However, to buy an option, you must pay a premium.

    Less risk means less possible profit. So, hedging is a practice used to decrease prospective losses (and not maximise potential gain). If the investment you’re hedging against is profitable, you’ve usually lowered your prospective profit. If the investment fails, your hedging will have decreased your loss.

    Hedging Explained

    Derivatives are commonly used in hedging strategies. One of the most common derivatives is options. In trading techniques involving derivatives, a loss in one investment is compensated by a gain in another.

    Assume you hold Tata motors stock. You believe in the company’s long-term success, but you are concerned about recent losses. Put options let you protect yourself against a decline in CTC by selling it at a predetermined strike price. This is called a married put. If your stock price falls below the strike price, the gains from the put option reduce your losses.

    Hedging Drawbacks

    Every hedging approach has a cost. So, before you utilise hedging, consider whether the possible benefits outweigh the costs. Hedging is used to safeguard against losses, not to create money. The cost of hedging, whether it’s an option or lost earnings from a futures contract, is unavoidable.

    While hedging is similar to insurance, insurance is more precise. With insurance, you are fully paid. Portfolio hedging isn’t exact. Things can get unpredictable. The perfect hedge is a goal that risk managers strive for but rarely accomplish.

    Hedging and You

    Most investors will never trade a derivative. In fact, most long-term investors overlook short-term volatility. Hedging has little value for these investors because they let their investments expand with the market. So why hedge?

    In order to understand how it works, you should hedge your own portfolio. Many large corporations and financial funds will hedge their protfolio. Examples of hedges include oil companies. For example, an international mutual fund may protect against currency swings. Understand and assess these investments with a rudimentary understanding of hedging.

    Forward Hedge Example

    A wheat farmer and the wheat futures market are two examples of hedging. The farmer sows in the spring and harvests in the fall. In the interim, the farmer faces the danger of decreased wheat prices in the fall. While the farmer wants to maximise his harvest’s profit, he does not want to bet on wheat’s price. At the present price of $40 per bushel, he can sell a three-month futures contract. It’s called a forward hedge.

    After three months, the farmer is ready to harvest and sell his wheat at market price. It is now only $32 per bushel. They buy wheat for that price. Simultaneously, he buys back his short futures contract for $32, netting $8. His wheat sells for $32 + $8 hedging profit = $40. When he planted his crop, he locked in the $40 price.

    Assume now that wheat is $44 a bushel. Sells his wheat at market price and buys back his short futures for $4. His net profit is $40 ($44 – $4). Both his losses and gains are reduced.

    The Verdict

    Investing involves a certain amount of risk. A fundamental understanding of hedging methods can help any investor understand how corporations and investors protect themselves.

    Whether or not you decide to start using complex derivatives, learning about hedging will improve your market knowledge and make you a better investor.

    At Zebu, we are one of the best brokerage firms in the country. We provide one of the lowest brokerages and are becoming one of the most sought-after online brokerages in India. Please get in touch with us to know more about our services and products.