How can derivatives be used to manage a portfolio

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Are you an Investor Advisor. What are derivatives? What are Futures and Options? Derivatives for Hedging Investors, who have invested in stocks and mutual funds over the last 10 to 15 years, know that, the one certainty of equity markets is volatility. Derivatives for Arbitrage What is Arbitrage? Arbitrage funds have multiple benefits:- Arbitrage Funds offer the investors to earn short term returns by taking minimal or no risks.

In volatile market conditions arbitrage funds can provide comparable or even higher returns than low risk liquid funds. The biggest advantage of Arbitrage Funds compared to liquid or debt funds is related to taxation. Arbitrage funds are equity oriented funds. Equity funds enjoy substantial tax benefits compared to debt funds, as explained earlier. Conclusion We have seen that, many investors are mystified when they hear about derivatives.

Previous Next. Back to Mirae Asset Mutual Fund. You haven't found the answer for your queries? Do post your queries to Mirae Assets MF. Send yourself a copy. Dwaipayan Bose Dwaipayan leads content production and mutual fund research in Advisorkhoj.

He is actively involved in business development strategy, driving revenue growth and profitability, delivering superior customer satisfaction and talent development in Advisorkhoj. An alumnus of IIM Ahmedabad, Dwaipayan is a Finance and Consulting professional, with nearly 17 years of management and consulting experience in financial services domain across several geographies. Dwaipayan has a strong track record of driving superior financial performance and developing talent in the organizations he has been involved with.

He can be followed on his Twitter handle DBadvisorkhoj. Would you like to continue with some arbitrary task? Do you want to register as an Financial Distributor? That was easy! Isn't it? Unlike others we dont spam or share your email without your concern. Verify your email address. Enter the code we just Emailed you. Log In with Email. Login Forgot Password? New Password. Change Password. Existing User? Section 1. Should this be interpreted to mean that a Fund will be prohibited from using margin a Fund wishing to purchase certain assets forward will be obligated to settle the full contract price at conclusion of the agreement.

A strong case can be made that where assets are purchased on margin the leverage arising there from will not be caused by the derivative instrument but the relationship between the broker and Fund.

A Fund will thus be exposed to the possibility of losing more than its initial investment should the asset be purchased on margin and provided the price of the reference asset falls below a certain level. In this regard the use of margin will be responsible for causing the risk and not the derivative instrument.

In addition; where a fund settles the entire purchase price in respect of a futures contract, any losses that the Fund will be exposed to will not be caused by the derivative instrument but by market forces outside of the derivative instrument and in relation to the relevant reference asset.

In deciding on whether to use a futures contract the following question would need to be asked: Is it the intention of the legislature to mean that a derivative instrument will be responsible for any losses suffered by a Fund by virtue of the nature and structure of the futures contract in allowing its value to fluctuate as a result of market forces in relation to the reference asset?

If this question is to be answered in the affirmative a Fund may wish to refrain from using futures to enhance the portfolio management of a Fund inasmuch as fluctuations in the values of the reference assets could cause large price swings in that of the derivative instrument and thereby cause dramatic losses for a Fund.

OPTIONS: in terms of an option a party will be responsible for the payment of an initial premium for the right to buy or sell the relevant reference asset at the contractually agreed strike price.

The strike price will be enforceable regardless of any adverse market values. Such prices will however inform the decision of the option holder as to its decision in exercising the option. Should the option holder decide not to exercise the option, it will only lose the premium paid for the privileges granted thereby. In such a situation, the option holder will not be exposed to the risk of losing more than its initial investment in the particular derivative instrument, being only the premium that is subject to loss where the option remains unexercised.

At first glance, this seems to be what has been intended in terms of the wording of section 1. The position however changes when the concept of margin is introduced into the matrix.

Where options are purchased on margin the initial investment will consist of the margin payment which will provide the Fund with full exposure to the reference asset irrespective of the fact that the Fund would only have paid part of its entire purchase price. Provided the price of the reference asset does not fall below a certain level, the Fund will not be exposed to the risk of losing more than the amount initially invested. Should the Fund however decide to divest itself of the instrument purchased on margin during the life of its existence, or should the price of the asset fall below a certain level, the Fund will face the risk of losing more than the amount initially invested.

As stated earlier, the cause of these risks lies in the use of margin and not the derivative instrument. To reiterate, even if margin were to be disallowed any losses that a Fund stands to face would be caused by market forces in relation to the relevant reference asset and the derivative instrument would thus not be responsible for any risks so posed. The current wording of the section would therefore necessitate the conclusion that a derivative instrument would never be responsible for posing the Fund with the risk of losing more than the amount initially invested; this could not have been the intention of the legislature and careful consideration should thus be paid to the structure and nature of derivatives and the various causes of price fluctuations in relation to them.

Some solutions can be provided to the problems alluded to thus far. With regard to margin; the legislature could not have intended to prohibit its use seeing as the optimal management of the Fund depends on the strategic implementation of practices such as margin. This ambiguity can be resolved by defining the concept of "leverage" as used in the Notice so as to exclude the prohibition on the use of margin.

As for fact that the derivative instrument must be responsible for posing the Fund with the risk of losing more than the amount initially invested; clarity is be required in order to ascertain whether price fluctuations of the reference assets over which the derivatives are issued are included within the ambit of section 1.

In addition, attention should be paid to activities that may be performed in respect of derivative instruments.