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Futures are here. Tread with caution. - Views on News from Equitymaster
 
 
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  • Jun 13, 2000

    Futures are here. Tread with caution.

    The Indian stock markets have finally witnessed the reentry of derivatives in the form of index futures. It is a significant move. However caution is required in the manner authorities tread this path.

    Read Equitymaster's four part series on Derivatives

    Futures will benefit the markets in a number of ways. First it will give a sense of direction to the markets/investors. Second, it will enable investors/funds to hedge their long positions in the market, thus reducing the risk associated with such stock holdings. And lastly, it will serve as yet another investment opportunity for investors looking to 'bet' on the markets in general (it is difficult for a person to buy the index). Indeed, the benefits of such a tool makes one wonder why such a tool was not introduced earlier. Well, there are several reasons for this (and let's avoid the incomprehensible arguments put forward by the government at the time of banning such an instrument).

    While the Indian markets were devoid of such a product, two important events (among the many) occurred. These changed the entire risk profile of derivatives. As many investors would have already guessed, the reference is to the financial scams involving Baring's Investment Bank and Sumitomo Corporation, which resulted in billions of dollars of losses. In fact Baring's had to be sold off to ING, as it was unable to meet its liabilities arising from the misadventure. Such scams put the entire investing community at risk of default leading to widespread panic in markets.

    Until these events occurred, derivatives were largely considered to be hedging instruments. However, in these cases, it now seems, that the top-level management may have turned a blind eye as they were making 'good' money from such 'trading' activity. 'Trading' activity implying that traders in these firms carried large uncovered positions in the futures market (no hedging involved here).

    That futures have been introduced in Indian markets is a step in the right direction. However, authorities need to tread cautiously on this path. Not that speculation should be banned. After all it helps in price discovery. Just that excessive speculation should be prevented as it has the potential to put the entire system at risk. Controls are a must. This will protect the interest of the investors.

     

     

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