Financial Derivatives -- Identifying the lesser of the two devils..

Hello Readers!! I'm back and hey, the markets have not been too good off late! Good is the last word on your minds for the time being, right?? Heart breaking is more like it! Okay, okay, so I'm being over dramatic but the bitter truth is that events of the last 6 months have left most investors reeling from the awe with which the Sensex rose and then the shock and mouth-gaping horror at the fall it registered.. Now isn't that precisely the reason why I call this space "The SenseXXXational Ride" .. It's a gut-wrenching ride and not for the faint hearted, let me mind you!

Investors entering the market around August 2007 were gingery because the Sensex had crossed the 15,000 mark, the skeptics were crying foul warning anyone who cared to listen that a correction was imminent but with the FIIs pouring in funds like never before, India's growth story was shining brighter than ever. Then came a big blow --- the SEBI banned, or shall I say, limited the investments made by Participatory Notes (PNs). This sent the markets crashing but heck, was anyone using any common sense? No ways dear readers, the markets again resumed their upward climb and then came the final big blow, a below-the-belt blow -- Fears of the U.S. economy going into a recession sent the Sensex on a downfall .. A never ending nadir, it seemed!

Now why this big intro?? Well, these last 6 months can be distinctly divided into 2 phases -- The rise which was then followed by the fall!! Long-term investors and investors owning stocks need not worry, the markets will rediscover the Midas touch, albeit a bit later than what we estimated. It's the investors dealing in futures who were emboldened by the meteoric rise of the Sensex. The lure of doubling the money in a short time was ample to hook -- and suck -- both new and experienced investors into this black hole which not only drained their investments but also saddled them with huge losses!!

Now, those of you who cocked a nose at us simple investors dealing in ONLY shares, where are you people now?? Investing in futtures is risky, so why not hedge or atleast protect your downside? Atleast buy a put option on the futures -- if the markets fall, atleast your loss is defined or limited, to say.

I believe trading in options is safer than dealing in futures. I mean, if you have to dine with the Devil, then why not ensure that you got something to help you digest the food as well? Ok, that sounds like a shit Simili.. I will try to compose a better one next time!! :D

Even options are not without risk; however, I would assume that you will be more cautious after the recent experience with the markets! So, suppose, with the markets poised at the current levels, you expect the markets to rise, i.e, you are bullish on the markets making an up move.. So ideally, one should buy a Call option on Nifty futures (lot size 50) expiring in February, i.e. the current month. This basically gives you an option to buy 50 nifty futures at a predetermined price; but does anything come for free? Ha ha, no readers! You got to pay a small premium, say Rs. 150 for one Nifty future for a strike price of Rs. 5300/- .. So, the maximum loss you can suffer is the premium that you paid for the call option, i.e., Rs. 150 x 50 = Rs. 7500 .. Theoretically, I've assumed that the call option has an ending value of 0, i.e., at the time of expiry. However, in the real market, you will be able to get some value for the call option; hence, your maximum loss is capped at Rs. 7500/- .. The breakeven Nifty level for an investor is Rs. 5450 (strike price Rs. 5300 + the call premium Rs. 150) .. So as long as the Nifty stays above Rs. 5450, your call option will be in the money ..

Gosh I'm tired after writing this post; I hope to come out with a follow-up on this article and more complex derivative strategies in my next post! Hope you enjoy this post!

Reliance power listing date.. Stay invested in RCOM!!

Reliance Power will list on February 11. The IPO price was of Rs 450/share and is expected to list at Rs 610/share. It was the largest IPO ever for India and it raised Rs 11,5000 crore.

Today, Reliance Communications was also in the news as it filed a Draft Red Herring Prospectus (DRHP) for Reliance Telecom Infrastructure, valued at Rs 5,000 to Rs 6,000 crore. Reliance Infratel Ltd. is expected to have 60,000 towers by FY09 and Reliance Communications will hold 95% of the company. Today, Reliance Communications closed at Rs 685, up 12% on the BSE. Shares of Reliance Communication advanced on reports that its subsidiary Reliance Telecom Infrastructure, is planning to hit capital market with Rs 5,000-6,000 crore initial public offer.

Reliance Telecom will sell nearly 10 per cent of its post-issue share capital through the IPO which will put its valuation more than double of what it achieved in July 2007 when it privately placed 5 per cent stake to a group of institutional investors.

RTIL, a 95 per cent subsidiary of Reliance Communications, sold the stake for Rs 1,400 crore to a host of investors including George Soros, HSBC, Fortress Capital, New Silk, Galleon, DA Capital and GLG Capital in a deal which had put its valuation at Rs 27,000 crore.

Going by the IPO size, the equity valuation of RTIL, a company engaged in the business of building, owning and operating communications towers, will be around Rs 50,000-60,000 crore. This will translate into nearly Rs 250-300 per RCOM share.

RCOM demerged its tower assets in RTIL last year in a move which was followed by most telecom companies in India. RTIL has a presence in all 23 telecom circles in the country. It has a 10-year master services agreement to provide passive telecom infrastructure to RCOM

In my post dated December 31, 2007, I'd given the following reasoning for an investment in Reliance Communication (RCOM):

Having established itself as a dominant player in the CDMA segment, RCOM is all set to take the GSM segment by storm when the company will launch its GSM operations in 2008. The company is also planning to introduce a net-enabled phone at only Rs. 480/- per handset. This marks a steep discount to the currently available internet browsing phones at a cost of Rs. 1,400/-! The company intends to place an initial order for 12 million handsets. It will target the 600 million rural population and sell around 1 million pieces a year in the rural and semi-urban areas. The company is also looking at roping in the labour ministry that is looking at digitisation of communication technology and making mobile phones affordable to farmers.

Reliance Communications is looking to expand its tower business to take on the mega tower company created by the big three GSM players of the Indian mobile market. For this purpose Anil Ambani's tower company seems to be targeting an unlikely partner, the state owned telecom giant Bharat Sanchar Nigam Limited (BSNL). The company had earlier invited bids from private players for taking towers on rent but this venture will be different as towers will be shared on a reciprocal basis. Reliance tower infrastructure limited has about 17,000 towers while BSNL has about 36,000 towers putting their total tower strength at 53,000 towers. Both of them are not very far from the 70,000 towers under Indus tower, the joint venture tower company of Bharti Airtel, Vodafone and Idea. All these factors combined should push the share price of RCOM in the Rs. 850 - Rs. 900 range!