Friday, 25 January 2019

A Quick Understanding About Forward Contracts & Option Contracts

A Quick Understanding About Forward Contracts & Option Contracts

So in the previous posts we have discussed what derivative contracts are and some important terms related to derivatives. In this post we will discuss about the types of derivative contracts.

Basically there are two types of derivative contracts.
1.Forward Contract  
2.Option Contract

Also Read
5 Things That Will Decide The Future Of Market 
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1.Forward contract

A forward or future contract is the simplest form of derivative transaction. Normally in this type of transaction there is an agreement to buy or sell certain quantity of underlying asset at a certain price on a specific date. No cash is exchanged while entering into the contract. Interestingly there is a difference between “no cash” and “margin money”. You have to understand that in forward contracts you must have required margin money in your account. But at the same time you don’t have to pay any cash out of your pocket for the contract. It is only the decrease of the price of the asset which will be debited from your ledger account.
Let’s understand this with an example.

John enters into a contract to buy 1 lot of Asian Paints January Future contract @ ₹1400 on 1st January 2019. Here asset underlying is the shares of Asian Paint, quantity is 600 shares, and future date is the last Thursday of this month. Now as per stock exchange the minimum margin money for 1 lot of Asian Paint shares is ₹800000. So you are only eligible to enter into the transaction only if your ledger account has a balance of ₹800000 or more than that. But at the same time you are not paying anything to enter into this contract.

Now, if next day the future price of the share decreases by 10 then John will bear loss of ₹6000 and this will be deducted from his account.

Similarly, if the price of the share increases by ₹20 then you will gain a profit of ₹12000 and that will be credited to your ledger account. If the price of the share remains unchanged then you will gain nothing. This is the simple math.

Now let’s take another example in which we will see a different application of forward contracts. Maya wants to purchase gold after three month but she is worried about the fluctuation of price in gold market. Hence she will buy 1 lot of gold today but the future date will be after three months. So if the gold price increases then she will gain a profit. But if the gold price decreases then she will bear loss.

2.Option Contract

The very simple meaning of option is the process of choosing between alternatives. So what are the alternatives in stock market? Answer is “to buy or not to buy, to sell or not to sell”. So option is a contract where the buyer of the option contract acquires a right to buy or sell a specific quantity of asset underlying on a specific date at a specific price. One major difference between forward contract and option contract is the premium paid. 

As we have already discussed that there is no need of cash in forward contracts but in option contracts you have to pay cash which is known as “premium” in stock market. This is the price you are paying to acquire a right. After acquiring this, you have the option to invoke the contract or just ignore it and it will lapse. Let’s understand it by an example.

Sania bought 1 call option at the strike price of ₹1400 for January series. She also paid premium of ₹10 to acquire this contract.Now three outcomes may come.

First if the share of Asian Paint went up to ₹1450, then Sania will exercise her contract and buy the shares @₹1400. In this case let’s understand the cash flow from Sania’s point of view.
Purchase shares @1400 = -₹840000
Premium paid @10= -₹6000
Sell shares at market price @1450 =₹870000
So net profit = ₹870000-₹840000-₹6000= ₹24000

Now let’s come to the second outcome where the price of the share is decreased to ₹1350. In this case Sania will not exercise her option to buy the shares. So cash flow will be as under.
Premium Paid = -6000
Purchase shares = Nil, Sell shares = Nil
So net loss of Sania = ₹6000

And the third outcome where price of the share remain unchanged then it is upto Sania, whether to exercise or not exercise the option.
So in this way option contracts work. 

Basically option contracts are used for hedging purposes. In simple terms big companies use this like insurance. We will discuss it in our coming blog posts. Till then stay invested, stay happy.

Friday, 18 January 2019

What are Derivatives and some important terminologies in Derivatives?

What are Derivatives and some important terminologies in Derivatives?

Many people wonder what is derivative, what is futures and options, how much risky they are and can we make profit from them. The one answer is “Yes” but terms and conditions applied. You need education, patience, practice to get this yes. If you are doing these three things then I believe you can earn from stock market. For education I’m starting a series of posts where I’m going to discuss some basic knowledge about stock market and today our topic is “Derivatives”.

Also Read,

A derivative is a security which value is normally derived from the value of another underlying asset. This asset could be equity, commodity, forex or any other asset. In now-a-days more complex and hybrid derivatives are coming to the focus in which asset underlying are loan, weather, monsoon, mortgages, crops, insurances etc. Many people don’t know the proper meaning of derivatives. I’ve come across many peoples who believe that derivatives are different thing from stock market. But no, derivatives are completely dependent upon stock markets. Let’s understand it through a simple example.

Take the example of cheese which is made from milk. The price of cheese is directly related to milk i.e. the value of cheese is derived from the value of milk. If milk price will go up then the cheese price will definitely go up, there’s no other questions in this. Similarly if milk price is going low then cheese price will go low. For an example I have a lot of TATA Steel share. Here the underlying asset is the share of TATA steel. If in cash market price of TATA steel is increasing then definitely TATA steel’s future’s price will also increase.

One major misconception about Derivatives are, People think Derivatives decide the cash market’s price where as in reality cash market fixes the price of derivatives or futures and options of shares. 

Derivatives are two types.
1.Forward Contract
We will discuss about them in details in our upcoming blog posts. Before that let’s know some basic terminologies used in Derivatives.

Lot Size You can buy even a single share from equity market in cash segment. But in derivative segments there is different lot size for different shares. For an example Asian Paints has a lot size of 600 shares. That means one contract of Asian paints required 600 shares in a lot. If you are willing to buy or sell then you have to buy in 600 or multiple of 600 in derivatives market which is lot wise. Example –
1 lot = 600 shares
2 lot = 1200 share
10 lot = 6000 shares

Open positions – In equity market if you are doing intraday trading then you have to complete your trade within that day. You can’t wait for the next day. You can’t sell shares today and buy tomorrow or after 10 days. This is one of the limitations in equity market. But Derivatives gives you the freedom to sell and buy after few days before the contract’s period ends. So if you have bought one lot of Asian paint’s share then your position will be called as open position.

Closing Position –When you square off your position in stock market in derivatives segment then it will be called as closing position. In India you can square off you r position on or before last Thursday of the month. If you are not closing your position then stock exchanges will automatically square off your position. This is like the opposite of open position.

Mark to Market Settlement ( MTM ) – In India exchanges run a daily MTM with regard to all future positions and therefore your profit or loss of one day will be credited or debited to your account in that same day. So if you are having a profit of 6000 then it will be credited to your ledger in your brokerage. Similarly if you are facing a loss of 10000 then it will be deducted from your account on the same day without even considering your financial position. That’s why futures trading are risky.

Margin Money- This is the money which brokerages keep with themselves to protect and save themselves from any loss incurred by client. For an example John has 100000 in his account. He has taken position in the market of 500000. When his position start losing 1% then his value will decrease by 5000 and the same will be deducted from his 100000. Now he has 95000 in his ledger. Similarly if after two days the shares went 15% downwards then John will bear 75000 losses. Now he has 20000 in his ledger. This is the time where brokerage will ask for margin money because John has not sufficient money to compensate further loss of 15%. There are different types of margin money. We will discuss them in some other blog posts.

So if you are trading in futures and options then you must know these terms and understand how much risk you are bearing. In our next blog posts we will discuss about forwards contracts and option contracts which comes under derivative segments.

Stay Happy, Stay Blessed

Saturday, 12 January 2019

5 Things Which Will Decide The Future Of Stock Market Of India in 2019

5 Things Which Will Decide The Future Of Stock Market Of India in 2019

It is well said, “Without a plan, you can’t win a war.” Similarly, if you are a participant in the stock market then you’ve to be prepared for all kind of situations. Sometimes the opportunity will come to tap whereas sometimes threat will come which must be avoided. In 2018most of the stock markets in the world remain in sideways for the first half of the year and a correction had happened in the second half of the year. So in this post, I’m going to discuss 5 most important things to watch in the stock market which will decide its future in this year and in coming years.

Also Read

5. Economic Survey and Interim Budget of 2019

We all know a country’s economy has a major role to play the direction of the stock market. It may be the macro-economic activity or micro-economic activities, the players of the stock market watch all the statistics very carefully to invest in any business. That’s the sole reason that economic survey and interim budget which will come in 1st February 2019 has a significant role to play in stock markets of India.

4. General Election

As we know one of the most important factors in fundamental analysis is the certainty in markets. If there will too many changes in legal formalities if new acts are coming or acts are facing amendments regularly then it becomes hard for the market to understand the environment and thus the markets underperform in comparison to any other markets. That’s why certainty in government is a crucial role to play. In 2019 general elections are going to start. If the current government of Mr., Narendra Modi continues then it will be a good sign for stock markets and the next few years are going to be good for investors. But if any contrary thing happens, then the market may take time to find a direction.

3. Monetary Policy Of RBI

Reserve Bank of India (RBI) is the central bank of India. It regulates all banks and it decides the monetary policy of the country. This policy has again greater importance from the point of view of stock markets. This policy indicates the interest rate and inflation rate. By this policy, RBI try to keep the inflation in control. If in the coming quarter interest rates started to rise then that will be a bad signal for the economy and market will start to go in a downward direction.

2.Crude Oil Price & Exchange Rates

As India imports crude oil, it becomes a significant thing which creates impact. From the history of the stock market we can easily see that whenever there’s a rise in crude oil price, stock market starts to underperform and vice versa. Similarly, exchange rates also have their own importance. If US Dollar will gain strength in 2019 then rupee will weaken and the stock market will go to a correction zone. So if you’re going to invest in the stock market then you must keep your eye in crude oil momentum and exchange rates.

1. Results Of Domestic Companies

Many times we have witnessed stock specific reaction. It happens when any stock shows any exceptional news or bagged big orders or post extra ordinary results. This will happen when companies started growth and post good results. So the results of all the four quarters in 2019 of domestic companies are also going to give a direction to the Indian Stock Markets. But normally it is very hard to go opposite of economy.

So, these are the 5 things which I think of greater importance. If you have anything in mind you can share that in the comment box. Constructive suggestions are always welcomed. 

Thank You.
Stay happy, Stay Blessed.

Friday, 4 January 2019

Why SIP is Better Than Traditional Investments like Fixed Deposits Or Recurring Deposits?

Why SIP is Better Than Traditional Investments like Fixed Deposits Or Recurring Deposits?

Hello friends, wish you all and your family a very very happy new year. I hope this year will fill your life with happiness and wealth. Make sure to take care of your health, that's something more important than anything else in this world. So friends this year first post will be related to the reasons why SIP are a better option than traditional investments like fixed deposits, recurring deposits, national saving certificates or any kind of term deposits plan. Let's start.
What is SIP?

SIP is acronym of systematic installment purchase. It is nothing but a kind of indirect investment in a stock market with a pre-defined order which is given on a specific date and time each month. SIP is better than direct investment in the stock market because of few genuine reasons. First, it invests your money in a portfolio of stocks which reduces your risk. Second, this portfolio is managed by an expert who has years of experience in the stock market and its industries. Thirdly, people don't have time to track everything in the market, so they should opt for this option for a handsome return over a long time.

Why it is better than Traditional investment options?

Honestly speaking SIP is better than any traditional plan because of its ability to offer a higher return in comparison to traditional investments.

Let's take an example of Axis Long Term Fund which is equity linked saving scheme. If you had invested 5000 per month from Feb 2013 to December 2018 then this would be the calculation.

Monthly Investment - 5000
Total Installment- 73
Total Investment- 365000
Value as on 1st January 2019 - 588857
Net Profit- 223857
Absolute Profit - 61.33%
Internal Rate Of Return- 15.95%

Now let's check the return of a midcap fund. We will take the example of L&T Midcap Fund(Growth). If you had invested 5000 per month from Feb 2013 to December 2018 then this would be the calculation.

Monthly Investment - 5000
Total Installment- 73
Total Investment- 365000
Value as on 1st January 2019 - 657558
Net Profit- 292558
Absolute Profit - 80.15%
Internal Rate Of Return- 19.67%

So you can easily see that if you're investing in mutual fund through SIP then you can expect a return between 12-22% depending upon the fund and its performance. Even if you invest in index fund then also you can expect at least a 10% return which is better than any traditional investments plans.

SBI, the largest PSU bank of India is giving interest at the rate between 6%-7% for both fixed deposits, term deposits, and recurring deposits whereas in post office you will get interested at the rate of 7%-8%. If you are investing in NSC then you will get 8% interest per annum. Each employee invests in provident fund regularly. It is giving 8.55% interest which is best in traditional investment category but still less than mutual funds return. That's why it is advisable to invest in mutual funds through SIP mode for a longer period to get the maximum benefit.

The difference of 1% seems to be very less but if we take a bigger corpus then it really matters. If we had invested 1 crore rupees then 1% of 1 crore will amount 1lakh which is a significant amount for a middle-class family in a country like India.

Things to remember before investing

Please, it's a humble request to all of you to increase your time horizon. If you truly want to get maximum benefit then make sure you have set a target for 20-25 years. Why I'm saying this, because the famous quote of the mutual fund, "Mutual funds are subjected to market risks, read all scheme related document carefully." When it comes to market risk you can't escape from this. If your time horizon is 5-10 years then it may possible that the market will stay sideways and you won't get the return as you expect. But when your time horizon is longer then the market will definitely reward you with a handsome return. Take the example of investment guru Warren Buffet. He doesn't sell once he buys. I really like his concept of investing. So the major take away from this discussion is, "Invest for at least 20-25 years and you won't regret your rest of the life."

So this was today's discussion. if you've any doubt then you can write in the comment box. Same applied in case of suggestions.

Stay Happy, Stay Blessed.