Investing 2.0: Where to Invest Derivatives

Posted by Mehul Kothari | Published on 13 Mar 2019
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Investing 2.0: Where to Invest Derivatives

Derivatives or financial derivatives, as the name suggests, are financial contracts that “derive” their value from an underlying asset. Simply put, derivatives help you make profits by taking a call on the future value of its underlying asset. There are many types of financial derivatives of many assets such as commodities, currency, indices and stocks. For the sake of simplicity however, we will delve into equity financial derivatives for better understanding.


How does an equity derivative work?

Suppose you buy a derivatives contract on stock A that is trading at Rs 2,000 in the spot market. The expiry date of the contract is a month later. At this time the stock trades at Rs 2,500 in the spot market, but you can still purchase it at Rs 2,000, thereby making a profit of Rs 500 per share. The same holds true if the stock price were to fall by Rs 500. In that case you would incur a loss of Rs 500 per share.


What are derivatives used for?

To know the uses of financial derivatives let’s look into the below terms:

Hedging

Derivatives offer you the opportunity to protect yourself against price fluctuations. You can use a derivative strategy to protect yourself against a price rise or a price fall. This is called hedging.

Risk transfer

Every investor in the market has a different risk appetite or tolerance to bear losses. Derivatives can be used effectively to transfer risks from risk-averse investors who want to protect themselves against price fluctuations to risk-tolerant investors such as speculators who take contrarian trade positions to enhance profits.

Different types of derivatives contracts

Futures and forwards:

As explained earlier, future contracts are agreements coined to buy or sell a specified number of shares at a pre-stipulated time in the future. Forwards can be called a variant of futures but ones that can be customised to a certain extent. Unlike futures, these are non-standardised in nature and cannot be traded on the exchange.

Options:

Options are similar agreements like futures, but one in which you can exercise a choice or an option to meet the obligation. For example, if you have an option contract to buy 50 shares on the expiry date, you can choose whether or not you wish to do so. Options too can be traded on the stock exchange.


What do you need to invest in derivatives?

To understand how to trade derivatives here are the following factors you need to consider:

A demat account- Just like trading in shares, a demat account is a pre-requisite for dealing in derivatives.

Trading account- A trading account is linked to your demat account and serves as your unique identity in the market.

Margin maintenance-
Initial margin- When you decide to deal in derivatives, you need to deposit an initial margin, that is decided by the stock exchange. It is a risk containment measure on behalf of the exchange, and depends upon the total value of your outstanding position as well as the average volatility of the stock and interest cost over a stipulated time period. This margin is adjusted daily depending upon the market value of the open positions you hold.
Exposure margin- This margin is also levied by the exchange and is used to control excessive speculation and volatility.
Mark to market margin- Apart from the two margins mentioned above, you also need to maintain a Mark to Market (MTM) margin. This margin covers the difference between the cost and the closing price of the contract on a day to day basis.


Derivatives trading must do’s

Research- This is the most important aspect of derivatives trading. Derivatives trading is far more complex than stock trading, so do not make a trade unless you are completely sure of the position you are taking, the purpose of the same and the possible consequences.

Maintaining the margin amount- Margin maintenance plays a big role in derivatives trading. It is always prudent to maintain some extra amount in your account as the margin amount changes with the rise and fall in the underlying stocks.
 

 

 

Disclaimer: Investments in the securities market are subject to market risks. Read all the related documents carefully before investing.

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Investing 2.0: Where to Invest: What type of an investor are you?

Posted by Mehul Kothari | Published on 13 Mar 2019

Characteristics of the Types of Investor in Stock Market The key to successful investing is chalking out an investment strategy that is in sync with your risk appetite. Simply put, your risk appetite is your tolerance to bear losses. Your risk appetite may be low, medium or high. Therefore, to begin investing, you need to understand your risk appetite first to understand what type of an investor you are. This is what will determine your investment profile and help you achieve your financial goals.There are different types of investor profiles hence, while each individual has a different investment profile and investment preferences, it is easy to classify investors into three broad categories based on the amount of risk they are willing to take. Here are the three types of investors based on their risk tolerance: The conservative investorThe first and foremost concern of this type of investor is the protection of his capital. He is unable to bear any erosion of the principal amount he has invested. This makes him a low-risk investor who will probably get sleepless nights during a volatile period in the markets. What he prefersA low-risk investor is therefore likely to be happy investing in debt instruments. Since he is not aggressive in his expectations, he does not mind the likelihood of moderate capital growth with steady returns.The balanced investorThis is someone who is willing to take a little more risk to enhance the value of his portfolio. He will thus have more tolerance for volatility than a conservative investor, but will not be willing to invest in high-risk instruments for greater returns. What he prefersA medium-risk investor seeks a balance between stability and growth. His portfolio will consist a mix of debt for stability and equity-oriented instruments that invest in stable companies. The aggressive investorAs the name suggests, this is an investor who can take the market’s short-term volatility in his stride. He is not afraid to expose his portfolio to high risk in pursuit of higher growth. The essential difference between an aggressive investor and low and medium risk investors is that he is willing to take greater risk. What he prefersAn aggressive investor is willing to expose his portfolio to high risk instruments in the equity markets and may even bet on unknown companies to further enhance the value of his portfolio. Such investors with a competitive investor profile are also willing to opt for leveraged products such as derivatives of equities and other asset classes. ConclusionTo identify your investor profile it is important to determine what kind of an investor you are before you embark on your investment journey. It is important to bear in mind that wealth creation is a time-consuming process and staying invested will bear fruit if you have time on your side. Thus, it is wise to invest according to your own risk profile. This is what will take you closer to your financial goals. The best part about different investor types is that every individual begins as a novice and gradually progresses to the next consecutive level of investment accomplishment through training and knowledge. Irrespective of the type of investor you are currently, moving on to the next level is not too far, and can be easily done with a little practice and education.What is the key to being an experienced investor? As can be seen from various examples around us, the most successful investors have excellent temperament that has helped them consistently outperform the market. They can do this not because of perfect timing or hordes of cash. They do it by distinguishing their instinctive tendencies, established methods, doctrines, and laying down a disciplined plan of action.Taking a cue from Warren Buffett, he says, "Success in investing is not associated with one's I.Q." At the end of the day, what one needs is the temperament to restrain impulses that usually get most people into trouble.   Disclaimer: Investments in the securities market are subject to market risks. Read all the related documents carefully before investing.

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Investing 2.0 Where to Invest : Commodities

Posted by Mehul Kothari | Published on 14 Mar 2019

When it comes to investing, a key ingredient to success is diversification. Simply put, it is the act of reducing risk by distributing resources among various financial instruments. Diversification can happen not only within a single asset class such as equity, but can also be achieved among various asset classes. For instance, retail investors may consider investing commodity besides equity and debt. Unlike popular perception, investing commodity is not as complicated or risky and offer immense potential for market-savvy investors. Basics of investing commodity To understand what are commodities investments, let’s look at how commodities are classified into five broad sectors: ● Agriculture● Metals and materials● Energy ● Services● Precious metals Each of these categories have different commodities under their heads as explained below: Where does trading happen? Now that you know what are commodities investments, it is a good idea to know there are three main exchanges where you can trade in commodities. These are the National Commodity and Derivatives Exchange (NCDEX), Multi Commodity Exchange of India (MCX) and the National Multi Commodity Exchange of India. All the three exchanges have a national presence and electronic trading and settlement systems and can offer benefits of investing in commodities. Investing in commodities made easyThere are a host of equity traders who have a well established presence in commodities as well, and offer trading facilities through the internet platform. If you are new to trading, you can also check the list of brokers registered with the above exchanges to make a final choice. You can begin trade by entering into an agreement with the broker and undergo the normal Know Your Customer (KYC) procedure. Besides a bank account, you will need a commodity demat account from National Securities Depository Ltd. You will need to pay your broker a percentage of the contract value. For different commodities there will be different brokerages. It will also differ on the basis of transaction type meaning trading or delivery. However, it cannot exceed the maximum limit as specified by the commodity exchanges. Pricing and contracts in commodity trading There are two types of prices in commodity trading: spot and future. ● Spot price is the price in which one buys and sells a commodity on the spot ● Future price is the price of the same commodity at a future date. A futures contract is thus an agreement to buy or sell a stipulated amount of a commodity of your choice at a certain price on a future date. On this date, the commodity being traded (type and quantity) must be delivered at the contracted price, irrespective of a rise of fall in the market price. Trading in commodity futures is done on margin. This means, as an investor you have deposit only a fraction of the futures contract with the broker. This provides higher leverage and the option to reap higher returns. Cash or delivery settlement mechanism A contract may be settled through a cash or a delivery mechanism. If you want a cash settlement, you must indicate so at the time of placing an order. Else, if you wish to make a delivery, you need to have the required warehouse receipts. You have the option of changing this mechanism as many times till the expiry of the contract date. How does a transaction take place? A transaction is made electronically between the brokers of both the buyer and seller of a commodity. Both parties enter into respective obligations. While one party decides to purchase, the other decides to sell. The buyer is obliged to take delivery and pay for the commodity for the ascertained price, while the seller has the obligation to deliver the commodity on the said date. Both the buyer and seller can however absolve themselves can absolve themselves of this obligation by offsetting their trade before contract expiry. This is what most speculators do to make gains by speculating on the direction of the price of the commodity. How is commodity trading advantageous? The right mix of commodities in your portfolio can help your portfolio as they are an excellent means of diversification. For instance, gold has a low co-relation to equities and will typically provide gains when equities are down. You could also consider mutual funds investing in commodities to add to your portfolio. Further, as commodity prices determine inflation, investing in commodity futures may be used as a hedge against inflation. However, it is imperative to understand the risks involved in commodity trading before taking a leap.   Disclaimer: Investments in the securities market are subject to market risks. Read all the related documents carefully before investing.

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  • Cost Inflation Index - Meaning, Calculation & Benefits
    Posted by Rushabh H. Mehta | Published on 06 Mar 2020

    Inflation is an economic term and referred to the continuous rise in the price of goods and services, thereby reducing the purchasing power of the money. The pinch of inflation is felt by all sections of the economy, be it, the consumers, investors, and the government.  And, even though it increases the cost of living, inflation is a necessary evil and desirable for the growth and development of the economy. For the reason of inflation, it is only fair to pay more for your goods like comb and brush over the years due to an increase in the price. For the same reason, it is unfair to pay capital gains tax on your assets without taking into account the impact of inflation on the value of the asset. Cost Inflation Index(CII) is the index to calculate the increase in the price of assets year-on-year due to the impact of inflation. What is the Cost Inflation Index? Cost Inflation Index or CII is an essential tool for determining the increase in the price of an asset on account of inflation and is useful at the time of calculating the long-term capital gains on the sale of capital assets. It is fixed by the central government and released in its gazetted offices by the Ministry of Finance every year. Capital gains are the profits arising from the sale of assets like real estate, financial investment, jewellery, etc. The cost price of the asset is adjusted taking into account the Cost Inflation Index of the year of purchase and the year in which the asset is sold, and the entire process is known as Indexation. Cost Inflation Index Calculation The cost inflation index calculation is done by the government to match the inflation rate for the year and calculated using the Consumer Price Index (CPI). Cost Inflation Index India for the financial year 2019-20 has been set at 289. Change of the base year for the Cost Inflation Index The cost inflation index base year was changed in the Union Budget 2017 from 1881 to 2001. The base year was changed by the government to enable accurate and faster calculations of the properties purchased before April 1, 1981, as taxpayers started to face problems with valuations of older properties. The base year has an index value of 100, and the index of the following years is compared to the index value in the base year to determine the increase in inflation. With the change in the base year, the capital gains and tax burden has reduced significantly for the taxpayers as it now reflects the inflated price of the asset realistically. The current Cost Inflation Index Chart for each year is as under- How is the Cost Inflation Index (CII) used in calculating capital gains To calculate the capital gains on your assets the purchase price of the asset is indexed by the cost Inflation Index using the formula below- Indexed cost of the asset at the time of acquisition = (CII for the year of sale/ CII for the year of purchase or base year (whichever is later))*actual cost of acquisition If suppose you purchased a flat in December 2010 for Rs 42 lacs and sold in Jan 2019 for Rs 85 lacs. Your capital gain from the sale of the flat is Rs 43 lacs. The CII in the year in which the flat was purchased is 148, and the CII in the year the flat was sold in is 280. The purchase price of the flat after taking into account the Cost Inflation Index is = (280/148)*Rs42 lacs= Rs 79. 46 lacs  This is the indexed cost of acquisition. Your long-term capital gain after taking indexation into account is Rs 85,00,000- Rs 79,45,946 = Rs.5,54,054. Long-term capital gains on the sale of property are taxed at 20% with indexation benefit. So, your tax liability, in this case, would be- 20% of Rs 5, 54, 054= Rs 1,10,810 Without indexation benefit, the capital gains are taxed at 10%. In this case, the capital gains would be- Sale price of the flat - purchase price of the flat = Rs 85,00,000 – Rs42,00,000 = Rs.43,00,000.  The capital gains tax without indexation benefit will be 10% X Rs 43,00,000 = Rs.4,30,000. Thus, indexation helps reduce the long-term capital gains and reduce the overall tax burden for the taxpayer considerably. Indexation benefit can be used for investments in mutual funds, real estate, gold, FMPs, etc. but is not applied for fixed income instruments like FDs, recurring deposits, NSC, etc. Few important tips to remember about the Cost Inflation Index- If you receive an asset as a part of the will, then in such the CCI for the year in which it was transferred will be considered and not the CCI of the purchase of the asset Indexation benefit for the cost of improvement of the asset is the same as the cost of improvement of the asset. Cost of improvement incurred before 1981 to be ignored. CONCLUSION Cost Inflation Index is an important parameter to be considered at the time of selling long-term assets as it is beneficial for the investors. Reach out to our experts at IndiaNivesh for any queries about capital gains arising from the sale of assets for correct guidance.   Disclaimer: Investment in securities market / Mutual Funds are subject to market risks, read all the related documents carefully before investing. 

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  • Dematerialisation of Shares – Meaning, Process & Benefits
    Posted by Rushabh H. Mehta | Published on 06 Mar 2020

    The online platform has revolutionised the way we live. Whether it is transacting, connecting with a loved one, getting updated about the happenings in the world, everything can be done online. When it comes to investments, the online platform provides ease and convenience. Investment in shares and share trading is a prevalent activity undertaken by many investors. They invest their money in the stock of a company with a view to earn profits when the stock value rises. When shares are purchased, share certificates are issued in physical form containing the details of the investor and the investor. However, these physical share certificates are inconvenient, and so the concept of dematerialisation has been introduced. Do you know what it is? What is dematerialisation? Dematerialisation of shares means converting physical shares and securities into an electronic format. The dematerialised shares and securities are, then, held in a demat account which acts as a storage for such shares. Dematerialised securities can then be freely traded on the stock exchange from the demat account. How does dematerialisation work? For the dematerialisation of securities, you need to open a demat account with a depository participant. A depository is tasked with holding shares and securities in a dematerialised format. As such, the depository appoints agents, called, Depository Participants, who act on behalf of the depository and provide services to investors. There are two licensed depositories in India which are NSDL (National Securities Depository Limited) and CDSL (Central Depository Services (India) Limited). Need for dematerialisation of shares Dematerialisation of securities was needed because it became difficult for depository participants to manage the increasing volume of paperwork in the form of share certificates. Not only were there chances of errors and mishaps on the part of the depository participant, but physical certificates were also becoming difficult to be updated. Converting such certificates into electronic format frees up space and makes it easy for depository participants to track and update their investor's stockholding. Benefits of dematerialisation for investors As an investor, you can get the following benefits from dematerialisation – You don’t have to handle the physical safekeeping of share certificates. Since your investments are converted in electronic format, you can easily store them without the risk of theft, loss or damage You can access your online demat account and manage your investments from anywhere and at anytime The charges associated with the demat account are low. Depository participants change holding charges which are minimal and you don't have to pay any stamp duty on dematerialised securities Since no paperwork is required to be done, the transaction time is considerably reduced Given these benefits, dematerialisation proves advantageous. Nowadays, the practice of holding physical securities has become almost obsolete and buying through a demat account has become the prevailing norm for investors. How to convert physical shares to demat? To convert physical shares to demat, the following steps should be followed – You should open a demat account with a depository participant. A depository participant can be a bank, financial institution or a stockbroker who is registered as a depository participant with the two licensed depositories of India You would then have to avail a Dematerialisation Request Form (DRF) from the depository participant and fill the form Submit the form along with your share certificates. The share certificates should be defaced by writing ‘Surrendered for Dematerialisation’ written across them. The depository participant would, then, forward the dematerialisation request to the company whose share certificates have been surrendered for dematerialisation. The request should also be sent to Registrar and Transfer (R & T) agents along with the company The company and the R & T agents would approve the request for dematerialisation if everything is found in order. The share certificates would also be destroyed. This approval would then be forwarded to the depository participant The depository would confirm the dematerialisation of shares and inform the depository participant of the same Once the approval and confirmation is complete, the shares would be electronically listed in the demat account of the investor Buying securities in a dematerialised form If you are looking to buy stock in a dematerialized form, here the simple steps that you can take for the same – Choose your broker for buying the securities and pay the broker the Fair Market Value of the securities that you want to buy The payment would be forwarded by the broker to the clearing corporation. This would be done on the pay-in day The clearing corporation would, then, credit the securities to the broker’s clearing account on the pay-out day The broker would then inform the depository participant to debit its clearing account and transfer the shares to the credit of your demat account The depository would also send a confirmation to your depository participant for the dematerialisation of shares in your account. The dematerialised shares would then be reflected in your demat account You would have to give ‘Receipt Instructions’ to your depository participant for availing the credit of shares in your demat account. This is needed if you hadn’t already placed a Standing Instruction for your depository participant when you opened your demat account. Similarly, for sale of dematerialised shares, the process is opposite. Trading in stocks in a dematerialised format is simple, quick and convenient. It has also become the practice of the current market. So, if you want to buy or sell securities, open a demat account and start trading in dematerialised securities. Should you have any doubts, get in touch with the team at IndiaNivesh who will look into your requirement and lead you towards a quick resolution.    Disclaimer: Investment in securities market / Mutual Funds are subject to market risks, read all the related documents carefully before investing. 

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  • High Dividend Mutual Funds
    Posted by Rushabh H. Mehta | Published on 02 Mar 2020

    Dividend mutual funds are a type of mutual fund that pays a regular dividend to the unitholders of the mutual fund scheme, thereby creating a regular source of income for them. The investment strategy of the fund manager is to invest in a basket of companies that have a steady flow of income and promise to pay periodic payment to the investors. Some investors prefer a regular source of passive income from their investments. Mutual fund schemes that offer a high dividend are a popular choice for such investors. The frequency of payment of dividends is decided by the fund manager and is usually fixed. Dividends can be paid daily, monthly, quarterly, six-monthly, or yearly, and the frequency of payment is mentioned beforehand. However, there is no guarantee on the rate and amount of the dividend to the investors and the payment of dividend is subject to the performance of the fund. There are 2 types of dividend mutual funds based upon the asset class that they invest in. 1. Dividend Yielding Mutual Fund (Equity) • Mutual fund schemes which invest more than 65% of their corpus in equity shares of companies • Like any other equity scheme, they have the potential for higher returns, but also carry a higher risk • Investors should invest in these schemes with an investment horizon of medium to long term 2. Dividend Yielding Mutual Fund (Debt) • Mutual fund schemes which invest more than 65% of their corpus in debt instruments of government and corporations like treasury bonds, commercial papers, etc. • These funds carry low risk and provide average returns to investors • Interest received from the various instruments is paid as a dividend to the investors• Investors should invest in these schemes with an investment horizon of short to medium term Tax treatment for dividend mutual funds Till now, dividend income received by the investor used to be recorded under the income head of “Income from other sources” and such income was tax-free in the hands of the investor. However, as per the Union Budget 2020, the DDT is now abolished for companies and mutual funds. From April’20 onwards, any dividend received above Rs 5000 will be taxed in the hands of the investor. It will be taxed as per the individual tax slabs for both equity and debt schemes. Only debt investors who fall in the lower slabs of 10% and 20% will pay lesser taxes on dividends. For all the others, the taxation would be higher going forward. Why should investors invest in high dividend mutual funds? Dividend mutual funds offer unique advantages to the investors, especially when the macroeconomic condition of the country is weak; these investments provide the reliability of income to investors. The benefits of dividend mutual funds which should be kept in mind while investing in such funds• Fund managers of dividend mutual funds invest in companies which can pay steady dividends and even if there is a slowdown in the economy, as companies do not want to send any negative signals, they avoid curtailing payment of dividends, thus making them less volatile than other funds.• Overall returns from these funds are less affected as compared to other funds as the dividends provide a hedge against market volatility.• In a low-interest rate regime, investors looking for a higher consistent income can opt for dividend mutual funds. Disadvantages of a dividend mutual fund scheme • Returns generated by dividend mutual fund schemes are lower as compared to growth schemes in case of rising markets• These funds are not suited for aggressive investors looking for higher returns from their investment• Moreover, with the abolition of Dividend Distribution Tax (DDT), investors in the higher tax-bracket will have to pay higher taxes on the dividend income. Role of dividend mutual funds in a portfolio Invest in dividend mutual funds with an investment horizon of 7 to 10 years for optimal returns. Investment in such funds should be a part of your strategic asset allocation and to lower the volatility of the overall portfolio. Aggressive investors can allocate less than 10% of their portfolio in such funds. Conservative investors, on the other hand, can allocate a higher percentage to these funds. Essential things to keep in mind while investing in dividend mutual funds • Conservative investors looking to invest in dividend funds should invest in large-cap funds, preferably of blue-chip companies that pay a higher dividend. Investing in companies with a higher proportion in mid & small-cap companies will increase the risk of the investment, thereby defeating the purpose of investment• Invest in a fund which has been in existence for some time and witnessed a few market cycles• Avoid investing in a fund with a small corpus to minimize risk as few wrong investment calls can significantly hamper returns• The expense ratio plays a vital role in determining the overall returns from a scheme. Choose funds with a lower expense ratio   CONCLUSION Investing in high dividend mutual funds is a good option if you are looking for a regular income through dividends. Consult our experts at IndiaNivesh to help you guide through the allocation of funds in these schemes as per your investment horizon and risk profile.   Disclaimer: Investment in securities market / Mutual Funds are subject to market risks, read all the related documents carefully before investing. 

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