Index Futures - That's what is coming to India! : (Understanding Derivatives - Part III) - Views on News from Equitymaster

Helping You Build Wealth With Honest Research
Since 1996. Try Now

  • MyStocks


Login Failure
(Please do not use this option on a public machine)
  Sign Up | Forgot Password?  
  • Home
  • Outlook Arena
  • Jun 8, 2000 - Index Futures - That's what is coming to India! : (Understanding Derivatives - Part III)

Index Futures - That's what is coming to India! : (Understanding Derivatives - Part III)

Jun 8, 2000

Mr. Nimish Desai has one a considerable amount of research on some companies and he has selected 12 scrips which he feels will do exceedingly well, even if the market has a whole does not show substantial gain. After having built his portfolio of Rs 1 million he adopts a wait and watch approach. Being an experienced player, he knows that if some adverse news hits the economy, all stocks will decline in value. So he would like to be in a position, that if the market remains steady, he makes profits, and in case the market falls, he should minimize his losses. Nimish therefore does some further exploration and finds that the average volatility of the scrips in his portfolio vis--vis the Nifty is 1.2. That is, if the Nifty increased by 1%, the improvement of the overall sentiment would cause an increase of 1.2% in the value of Nimish's portfolio. Like wise, if the value of the index decreased by 1%, the value of his portfolio decreased by 1.2% purely because of poorer sentiment.

Nimish does not want to bear this uncertainty. All he had to do was to get into a kind of arrangement, that a loss in index would mean an increase in his portfolio value, or the gain in Index mean a loss for him in his portfolio value. This can be achieved by short selling the index in such a quantum that the gain on a unit decrease in the index would offset the losses on the rest of his portfolio. This is achieved by multiplying the relative volatility of the portfolio by the market value of his holdings. Therefore, Nimish would be selling

1.2 * I million = 1.2 million worth Nifty.

Now let us study the gain / loss that accrues to Nimish because of the arrangement

Index up 10% Index down 10%
Gain / (Loss) in Portfolio Rs 120,000 (Rs 120,000)
Gain / (Loss) in Futures (Rs 120,000) Rs 120,000
Net Effect Nil Nil

As we see, that Nimish is completely insulated from any losses arising out of poor sentiment. But as a cost, he has to forego any gains that arise out of improvement in the overall sentiment. One would be justified in asking then why should Nimish invest in equities at all if the gains in cash market will be offset by losses in futures market. The idea is, Nimish is expecting his portfolio to outperform the market. Irrespective of whether the market goes up or not, his portfolio value would increase.

To summarize the chapter on hedging with index futures, we could say,

  • In hedging, you are not looking to make a profit.
  • You have invested in stocks that will outperform the market.
  • The index you have used is a good representative of the entire stock market.
  • You do not want to bear losses that would arise out of adverse events that affect the entire economy.
  • You will not stand to gain from any such news either.
  • Hedging may not always lead to a better outcome. However, it may lead to a more certain outcome.

    One another key derivative that has yet to be discussed by us is the Option, which is tackled in the subsequent article.

  • This article is one of four articles in a series to understanding derivatives. Read Part I, Part II and Part IV of this series

  • Equitymaster requests your view! Post a comment on "Index Futures - That's what is coming to India! : (Understanding Derivatives - Part III)". Click here!


    More Views on News

    BSE Sensex at All Time High; ONGC Among Top Gainers (Market Updates)

    Dec 3, 2020 | Updated on Dec 3, 2020

    The BSE Sensex is trading at its all-time high of 44,785 (up 0.4%). Among the top gainers in the BSE Sensex today are ONGC. In the meantime, the NSE Nifty is trading at 13,162 (up 0.4%).

    Is this the Best Time to Sell Your Equity Mutual Funds? (Outside View)

    Dec 3, 2020

    Amidst the market scaling all-time high, investors are speculating whether to hold on to their position or book profits in equities and move out.

    Here's How You Can Double Your Income Without Slogging for It (Profit Hunter)

    Dec 3, 2020

    It's unfortunate it took event like Covid for people to realise their idea of a 'set' life, centered around their current job, is only as stable as a house of cards.

    Earn More Profits with My Cash Calendar (Fast Profits Daily)

    Dec 2, 2020

    I've used my Calendar to make fast profits and I recommend you do too.

    HDFC Dividend Yield Fund: Will it Yield Steady Returns? (Outside View)

    Dec 2, 2020

    PersonalFN analyses the features of HDFC Dividend Yield Fund and explains the potential this fund has to offer to its investors.

    More Views on News

    Most Popular

    Not Infosys or Wipro. India's Next Wealth Creators Could Be Drone Stocks (Profit Hunter)

    Nov 25, 2020

    India's drones directorate signals the next big defence tech multibaggers.

    It's Time to Book Profits (Fast Profits Daily)

    Nov 27, 2020

    In my first video on Equitymaster, I want to introduce you my proprietary greed and fear index. It's telling us to book some profits in the market.

    How the New Margins Will Impact You (Fast Profits Daily)

    Nov 25, 2020

    The new rules on margins will come into effect from 1st December. Are you ready?

    Create Wealth for Yourself in India's Drone Revolution (Profit Hunter)

    Nov 27, 2020

    The Chinese drone market is 14 times that of India's. Billions may flow into Indian drone companies too. Don't miss out on this wealth creating opportunity.

    The Price of Dying, the Cost of Living (The Honest Truth)

    Nov 20, 2020

    Ajit Dayal presents a cost benefit analysis of the various types of response to covid around the world.


    Covid-19 Proof
    Multibagger Stocks

    Covid19 Proof Multibaggers
    Get this special report, authored by Equitymaster's top analysts now!
    We will never sell or rent your email id.
    Please read our Terms


    Dec 3, 2020 01:14 PM