Akash Jha
Most traders view futures as a form of short-term market trading or, at most, hedging your risk or arbitraging in the equities markets. Surprisingly, futures can also be viewed as a way to replace your stock assets. Let us examine the benefits and drawbacks of long-term futures holdings. What are the implications and benefits of long-term investment through futures contracts? Above all, what are the greatest long-term investments for novices for traders wishing to enter futures positions? There are three ways to use futures for long-term investing.
1. Substituting cash long position with long futures
Here, let’s look at a rather basic example. One lot of Reliance futures is equal to one thousand shares of Reliance Industries, thus if you’re holding a thousand shares of Reliance Industries in the cash market, you can lower the amount of money locked up by acquiring this lot. You can free up your cash on hand by purchasing futures on a margin basis. However, in the event that the price movement works against you, you must additionally account for MTM margins. For this reason, you can invest the remaining amount by allocating 20% to liquid assets and 80% to debt. We have factored in a 6% yearly return on liquid assets and a 10% yearly return on debt. You will have liquidity when you need it if you do this. First, we’ll compare them under a bullish market scenario.
ParticularsBuy RIL in cash marketBuy RIL in Futures20% balance in liquid fund80% balance in debt fundsBuy DateJan 01st 2018Jan 01st 2018Jan 01st 2018Jan 01st 2018Buy PriceRs.920Rs.920
No. of Shares10001 Lot (1000)
Buy ValueRs.9,20,000Rs.9,20,000
Margin PaidRs.9,20,000Rs.1,20,000
Balance Invest
Rs.1,60,000Rs.6,40,000Sell DateMarch 31st 2018March 31st 2018March 31st 2018March 31st 2018Sell PriceRs.990Rs.990
Sell ValueRs.9,90,000Rs.9,90,000Rs.1,62,400Rs.6,56,000Profit bookedRs.70,000Rs.70,000Rs.2,400Rs.16,000Total ProfitRs.70,000Rs.88,400
3-Month Returns7.61%9.61%
The trader’s 3-month returns would have been 7.61% if he had gone the cash buying approach, as shown in the above chart. In just three months, he could have made 9.61% had he gone with a mix of debt funds and futures. Futures provide that kind of leverage. Here, we’re going to purchase a 3-month future on the off chance that the holding term is only three months. However, what if you plan to keep the stock for a year? In such a situation, the idea of roll-over cost becomes useful. Consider a holding that lasts a year through futures with the roll-over cost factored into the futures price.
2. Investing for the long term by rolling over futures
Is the futures method an option if our investing horizon is one year? One potential stumbling block is that liquid futures are sometimes only accessible for the first two months. Because of this, we will need to roll over the futures every two months. In a year, that amounts to six rollovers. What is the final tally for the aforementioned scenario?
ParticularsAmountParticularsAmountReliance May FuturesRs.938.85Roll cost (4.65/938.85)0.495%Reliance July FuturesRs.943.50Annualized Roll Cost3.01%2-month SpreadRs.4.65
We can compare the futures investment profitability to that of a cash investment with this yearly roll cost of 3.01%.
ParticularsBuy RIL in cash marketBuy RIL in Futures20% balance in liquid fund80% balance in debt fundsBuy DateJan 01st 2018Jan 01st 2018Jan 01st 2018Jan 01st 2018Buy ValueRs.9,20,000Rs.9,20,000
Margin PaidRs.9,20,000Rs.1,20,000
Balance Invest
Rs.1,60,000Rs.6,40,000Sell DateDec 31st 2018Dec 31st 2018Dec 31st 2018Dec 31st 2018Sell PriceRs.1,150Rs.1,150
Sell ValueRs.11,50,000Rs.11,50,000Rs.1,69,600Rs.7,04,000Profit bookedRs.2,30,000Rs.2,30,000Rs.9,600Rs.64,000Total ProfitRs.2,30,000Rs.3,03,600
3-Month Returns25.00%33.00%
Roll Cost
-3.01%
Net Returns25.00%29.99%
If the trader chooses to purchase in the futures market instead of the cash market and keeps the remaining funds in a combination of debt funds and liquid funds, he would still come out ahead by approximately 500 basis points. As an investing tool for the long term, that is the benefit of futures.
Also read :- How to use ratio screeners to shortlist stocks to buy?
Using futures as a tool of reverse arbitrage
This is an intriguing method that you might employ during times of severe volatility. If you are holding a stock and the futures are quoted at a significant discount to the cash market price (without dividend effect), you can profit by selling your cash position and buying futures instead. For example, if you establish a reverse arbitrage at -1.3% and then cancel the reverse arbitrage at +0.6%, you can gain 1.9% in a very short amount of time. These are market-specific opportunities that will only be available for a limited time.
The moral of the story is that futures can be used as an alternative to cash markets for higher yields. Of course, you should consider the tax ramifications of this decision!
