Bullish Security



Take the case of a speculator who has a view on the direction of the market. He would like to trade based on this view. He believes that a particular security that trades at Rs. 1000 is undervalued and expect its price to go up in the next two to three months. How can he trade based on this belief? In the absence of a deferral product, he would have to buy the security and hold on to it. Assume he buys a 100 shares which cost him one lakh rupees. His hunch proves correct and two months later security is less than the arbitrage profit possible, it makes sense for you the security closes at Rs.1010. He makes a profit of Rs. 1000 on an investment of Rs. 1,00,000 for a period of two months. This works out to an annual return of 6%.

Today a speculator can take exactly the on the security by using futures contracts. So Let us see how this works. The security trades at Rs. 1000 and the two month futures trades at 1006. Just for the sake of comparison, assume that the minimum contract value is 1,00,000. He buys 100 security futures for which he pays a margin of Rs.20,000. This works out to an annual return of 12 percent. Because of the leverage they provide, security futures form an attractive option for speculators.


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