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 IPO money refunded!!

With the Reliance Power IPO money being refunded to QIBs (Qualified Institutional Buyers) and non-institutional buyers on February 1, I expect the markets to rise in the coming week due to increased liquidity and the cheap levels the markets are at the moment. Additionally, global sentiments seem positive at the moment and with the U.S. markets closing in the green in yet another session on Friday, chances of the Indian market opening higher are pretty high on Monday!

I would like to advise those investors with a bit of a risk appetite to buy a Call option (Strike price 5500, expiry 28 Feb 2008) on Nifty (lot size: 50 Nifty). The call option was trading at a price of Rs. 170 - Rs. 180 on Friday, towards the close of trading. It is likely to go higher on monday on the back of psoitive global sentiments. Still, I expect the market to move higher because 1) Refund of the Reliance power IPO money has provided investors with a lot of cash, 2) FII buying could provide a boost to the market. Historically, the FIIs have made 20% of their annual investment in Feb and FIIs were back in the thick of action on Friday. 3) Global sentiments coupled with average to positive Q3 results should help the markets stage a rally now, and finally, 4) Sentiments remain positive ahead of the 2008 Budget and with the Fed cutting rates by another 50 bps, I strongly believe that RBI too will have to follow suit, albeit with a lower rate cut.

So while you are busy reading this latest entry and analysing/digesting what I've said, I'll sneak across and warm myself with a hot cup of coffee!! Anyone interested in 1??

N.B.; Take whatever profits you get, the market may surprise negatively in the near-term and a lot of these so-called support levels will be tested if the markets face a down-turn.. Every rally is a time to book profits; currently not the ideal time to buy! Hey, also invest in the Reliance Natural Resources Fund. I apologise for the delay in bringing across this mutual fund to your attention! Risk-avoiding people should look to invest in Mutual fund schemes!