DERIVATIVES AS AN INVESTMENT
Can we use derivatives as an investment material? Are you joking?
As of basic concepts of the derivatives market, we learned it was a speculative material.
Isn’t it only a trading component, but we can also still invest in it?
We should understand the different types of applications and advantages. There are four strategies involved in the investment module.
Here we will discuss the investment strategies in the future & options market.
What are the common type of derivatives available in the markets are
CASH MARKET VS DERIVATIVES MARKET INVESTMENT:
We have discussed these types in our previous topic. Traditional investors only know about the cash market investment, it’s like a buy and holds method to accumulate wealth over a period of time.
This required lot of patience in the market, for example, Reliance shares traded around 800 to 1600 range in almost five years but the last six month price was increased exponentially due to the recent investments in the company.
If you bought 200 shares of reliance at the price of 1200, the amount of investment is 240000. What is the current profit of your investment?
It is 220000 within six months your capital is almost doubled.
Derivative players have different ideas, they invest in the future market instead of the cash market. Just recap, how the futures market works.
INVESTMENT STRATEGY IN THE DERIVATIVE MARKET:
Before going to the answer, let us explain a few types of investment strategy in the market are
· Long future
· Married Put
· Cash secured put
· Covered call
A long position means simply buying stock, commodity, or currency with the expectation of increasing price in the future.
Come to the example of reliance share.
If you buy the futures market instead of the cash market is called a long future. Let us come to question what the lot size of reliance is and how much profit would be made in reliance on future trade
After the announcement of the right issue, the reliance lot size was changed to 505 which means one rupee movement gives 505 Rs as a profit. Just check the amount of profit earned by the derivative players in the market.
The price was moved from 1200 to 2300. That is an 1100 Rs price movement so what’s the profit 1100* 505= 555,500. It’s a lot of investment in the market.
In the future market, we don’t give the full amount of money like the cash market, only paid the initial margin of the contract that is 250000 in reliance trade.
If the market reverse, how to manage your position. Let us go to another strategy of investment.
As long as the market is in our direction we would make a huge return but some time any global cues occur market fall suddenly.
We have a long position in the future, at the same time we should be careful at the downside risk.
To minimize the risk simply buy the put option. You can apply this strategy in the cash market also.
If you have 505 shares in reliance and want to protect the downside risk, simply buy the one lot put option.
In this case, you need to carefully select the put option strike. However, a married put is typically used when an investor is still bullish on a stock but ready to hedge against potential losses and uncertainty.
CASH SECURED PUT:
Intelligent investors waits for the correct price to enter the cash market but derivative players don’t wait they simply sell the out of the money put in every month and simultaneously setting aside enough cash to buy the stock.
THE TRADE SETUP
· Selling the put obligates you to buy the stock at a specified strike price if the option is assigned
· Keep enough cash to buy the stock
· Generally, the stock price will be above the strike price
A covered call is a familiar option the strategy used to generate income in the form of collecting option premiums.
To execute the cover call, an investor holding a long position in the cash market that should be equal to the futures lot size.
It is generally called rental income because investors sells out of the money call in every month to collect the premium.
Let us look at the investment cycle of the derivative investment below.
· These are the advanced investment strategies used by the derivative traders.
· Use these four strategies in the derivatives market as an investment option.
· It needs a huge capital to execute the trades without capital don’t go for the derivative investment strategies.
· A Lot of risks involved in this type of investment.
· Consult your financial adviser before taking any position.