close

December 2021

Finance

HOW TO SELECT THE RIGHT ELSS FUND AND CREATE WEALTH

When you begin your investment journey, you are often bombarded with several questions pertaining to the different investment options that can be suitable for your investment portfolio. One of the best investment options could be ELSS mutual funds as these mutual funds offer investors with dual benefits of wealth creation opportunities and tax benefits. In this article, we will understand how you can select the right ELSS mutual funds for your investment portfolio and create wealth. Let’s quickly recall what ELSS mutual funds are.

What are ELSS funds?

SEBI (Securities and Exchange Board of India) defines ELSS mutual funds as a type of mutual funds that invest a majority of their investible corpus ,at least 80% of their assets in equity and equity-related instruments. A tax deduction of up to Rs 1.5 lac per annum are eligible on these tax-saving investments under Section 80C of the Income Tax Act. An investor can save up to Rs 46,800 every year by investing in these tax-saving investments.

How to select the right type of ELSS funds for your investment portfolio?

Here are a few tips that can help you choose the right ELSS tax saving mutual funds for your investment portfolio:

  1. Stop chasing A-star mutual funds

Investors often find themselves being drawn towards top-performing mutual fund schemes. An investor often ends up making such impulsive investment decisions based on the yearly returns of the ELSS mutual fund scheme they wish to invest in. However, one must understand that the past returns of a scheme does not guarantee the future returns of that particular mutual fund scheme. Instead of considering the recent returns of the scheme, an investor must take into account the performance of the ELSS fund across different investment.

  1. Always check the risk-return ratio

As per the risk-return principle of investments, a higher degree of risk must be settled by a higher potential of substantial returns. Hence, before you decide to invest in ELSS, you should look for their risk-return potential. You can do this with the help of a financial metric known as Sharpe Ratio. It demonstrates the capability of returns provided for every additional degree of risk taken.

  1. Look at the structure of the fund

A composition of a particular fund portrays the type of investments or assets a particular mutual fund scheme is composed of. A fund manager is mandated to invest at least 80% of the securities across equity securities. The remaining composition of the fund can be invested across a mix of money market instruments or fixed-income securities depending on the risk profile of the investor. So, an investor with a high risk-appetite might look for ELSS funds that invest majorly in small-cap equity funds rather than large-cap equity funds or mid-cap equity funds.

Now that you are aware of how you can choose the right ELSS funds for your investment portfolio, hope it motivates you to invest in ELSS funds and enjoy the several benefits offered by these mutual funds. Happy investing!

read more
Finance

Common derivatives market terms you need to be aware of

Derivatives are contracts that derive their price or value from an underlying asset. The underlying asset may be a bond, stock, currency, debt instrument, interest rate, commodity, or market index. There may be two or more parties to a derivative contract.

While different types of financial derivatives exist in the market, you can broadly classify them into four major categories – forwards, swaps, futures & options.

Standard derivative market terms you must know

  • Futures contract: This is an agreement between two entities to buy or sell an underlying asset. The sale/purchase is undertaken at a specified price, however, on a future date. Both the parties to a futures contract are obligated to execute the contract on the stipulated date. Like any other transaction involving financial instruments, the buyer holds a long position while the seller holds a short position. Futures contracts are generalised exchange-traded contracts. As the futures exchange is the counterparty to every transaction, default risk is eliminated. Futures on interest rates, forex, and stock indices are primarily popular.
  • Forwards contracts: It is a promise to deliver an underlying asset at a predetermined price at a stipulated date in the future. These tailor-made contracts are executed in the OTC (Over-The-Counter) market and not via an exchange. Hence, they suffer from counterparty risk, as an exchange’s rules and regulations do not govern them.
  • Options: These are derivative finance contracts wherein the option holder/buyer has the right, but not the obligation, to purchase or sell the underlying asset at a prescribed price on a future date. If the buyer exercises the option, the seller must fulfil the contract.
  • Call option: It is an option contract wherein the buyer has the option to buy the underlying asset at a stipulated price on the exercise date.
  • Put option: It is an option contract wherein the holder has the option to sell the underlying asset at a predetermined price on the exercise date.
  • Exercise date: The date on which the option holder exercises the option contract is known as the exercise date. American options can be exercised on or before the option expiry date, while European options can be executed only on the option expiry date.
  • Exercise/Strike price: The exercise price is the price at which the underlying asset can be bought or sold by the option holder on the exercise date.
  • Option premium: It is the present market value of an option contract. It is incurred by the option buyer and is an income for the seller.
  • Equity derivatives:  They derive their value partly or wholly from underlying equities or stocks. Equity futures and options are the most sought-after derivatives in the stock market.
  • Swaps: It is an agreement between two entities to exchange predetermined cash flows for a given period. Popular swaps are interest rate and currency swaps.

Conclusion

These are some derivative market terms you should know before you engage in derivative trading. Derivative trading is a suitable hedging mechanism as you can take simultaneous positions in the spot and derivative markets and mitigate your losses. You can consider taking expert assistance to master derivative trading.

read more
Finance

How do listed options differ from OTC options?

Listed Options

Many companies will not admit to using listed options because of the extra administrative overhead. Companies like Saxo that use listed options generally have a large number of shareholders and a relatively high volume of shares changing hands daily. Visit their website.

In this case, it is usually advantageous for the company to employ listed options rather than over-the-counter (OTC) options. This is because OTC options face greater counterparty risk and legal costs in addition to increased administration costs.

Listing an option contract also provides investors with specific legal remedies that OTC options do not provide.

OTC Options

Over-the-counter (OTC) options are negotiated directly between two parties and usually take place on the phone. There is no centralised counterparty to either party like there would be in a listed options contract.

Additionally, most OTC contracts involve higher transaction costs because each party’s broker charges separately for the transaction – whereas listed options charge a flat fee per contract traded.

Because of these disadvantages, many brokers have stopped offering OTC option facilities altogether since it is more profitable for them to deal in listed options.

Despite the negative connotation associated with OTC options, they are not inherently wrong. Some types of OTC options can be even more advantageous than their listed counterparts depending on the situation that companies find themselves in.

For example, control transactions by controlling shareholders are usually conducted using OTC options because it saves costs and maximize flexibility.

OTC options are traded through a dealer network in an unregulated market, and they do not have standardised terms.

On the other hand, Listed options trade in a regulated environment and offer standardised contract terms and features.

One of the most glaring differences between listed and OTC is that listed has standardised contracts with defined specifications that you can view easily online.

 A key reason for this difference is that listed options attract more institutional investors than over-the-counter (OTC) contracts because of their accessibility to retail traders.

This means there is less room for misrepresentation by brokers when dealing with such large numbers of investors who employ different types of strategies.

Listing requirements vary depending on the market; however, listing requirements typically require having at least one market maker willing to make a two-sided marketplace.

Requirements for Hong Kong

  • The contract size cannot be less than HK$100,000 or more than HK$12,000,000
  • Each transaction must involve at least two months tenure OR an average of 21 days per month.
  • An issuer must have more than 12 months trading history on its securities and earnings before interest taxes, depreciation and amortisation (EBITDA) of at least HK$10 million for the last 12 months before filing for listing application formalities.

OTC options lack this standardisation of terms which makes it difficult for retail traders to trade due to the lack of clarity on what kind of options are being bought and sold

The terms also need to be agreed upon between buyer and seller, which means every trade is unique, resulting in some losses for traders unfamiliar with OTC markets.

Another disadvantage of OTC options trading is that the buyer’s broker needs to have a certain amount of money on hand to ensure they can pay if their client decides to exercise their option when it expires.

This arrangement usually requires only major players such as large banks or financial institutions because they have deep pockets and many clients, giving them an edge over other brokers. It also limits the available market pool because individual investors cannot buy these options due to limited funding capabilities.

OTC options are usually not listed on any public exchange, which means you can trade them at any time between the party who is buying and selling.

An alternative to buying OTC options would be to buy a listed put or call option from another much easier company. Still, it will typically have a much larger premium than if trading exclusively in OTC markets.

read more