Looking to re-balance your portfolio?

Derivatives in India, were launched in June 2000 starting with Nifty Futures. Followed by it were Nifty Options and Stock Options in 2001. However, it was in November 2001 when Stock futures were introduced which changed the game. Indian participants were already used to the badla system, so they quickly adopted to stock futures segment.

Among the institutional players, Mutual Funds were allowed access to derivatives. Initially, it was restricted to hedging, but slowly they were put in line in with all the other participants. Mutual funds were allowed to trade in all the four sub segments. There were well prescribed limits for each of these so risk management was well in place. This made the equity derivative market extremely vibrant. The quality of data for research was also were good. The price discovery was very efficient.

However, eventually SEBI took a few steps back. They decided to disallow Mutual Funds from selling options. So, a Mutual Fund could buy option and then sell it but vice versa was not allowed. This turned out to be a big deterrent for the options market. Eventually, Mutual Funds stopped participating in the options segment. This made stock options market extremely illiquid. The cues from stock options market reduced. Though they were good in quality, the frequency reduced quite drastically.

Recently, a change has come by. Now, SEBI has allowed Mutual Funds to sell Call options against their underlying holdings. Though, they have kept some strict regulation around it, like:

• The MFs will only be able to write call options of stocks that are part of the benchmark indices.
• The total notional value (taking into account strike price as well as premium value) of call options written by a scheme shall not exceed 15 per cent of the total market value of equity shares held in that scheme.
• In addition, the underlying shares shall not exceed 30 per cent of the unencumbered shares of a firm held in the scheme.

The fact that Mutual Fund portfolios have grown significantly in size, it is imperative that they have some avenue to manage cost, which also works partly as hedge. Clearly, if the regulator thinks that it is important that large institutions should be allowed the use of derivatives, the same is applicable to individuals as well. As individuals one needs to harness derivatives well for portfolio rebalancing.

For people holding cash positions, covered call writing works well as a tool to reduce cost. The only important point out here is that just the way there specialized people to do that in Mutual funds, as individuals one needs to get trained by experts.

Happy Trading.

Cheers!!!