Speculation
We have seen earlier that trading in index futures helps in taking a view of the market, hedging, speculation and arbitrage. In this module we will see one can trade in index futures and use forward contracts in each of these instances.
Taking a view of the market
Have you ever felt that the market would go down on a particular day and feared that your portfolio value would erode?
There are two options available
Option 1: Sell liquid stocks such as Reliance
Option 2: Sell the entire index portfolio
The problem in both the above cases is that it would be very cumbersome and costly to sell all the stocks in the index. And in the process one could be vulnerable to company specific risk. So what is the option? The best thing to do is to sell index futures.
Illustration:
Scenario 1:
On July 13, 2001, ‘X’ feels that the market will rise so he buys 200 Nifties with an expiry date of July 26 at an index price of 1442 costing Rs 2,88,400 (200*1442).
On July 21 the Nifty futures have risen to 1520 so he squares off his position at 1520.
‘X’ makes a profit of Rs 15,600 (200*78)
Scenario 2:
On July 20, 2001, ‘X’ feels that the market will fall so he sells 200 Nifties with an expiry date of July 26 at an index price of 1523 costing Rs 3,04,600 (200*1523).
On July 21 the Nifty futures falls to 1456 so he squares off his position at 1456.
‘X’ makes a profit of Rs 13,400 (200*67).
In the above cases ‘X’ has profited from speculation i.e. he has wagered in the hope of profiting from an anticipated price change.
