Black Monday

The ghosts of black Monday of May 17, 2004 still haunts most of the investors of the Dalal street. The prospects of a Left-supported government was greeted by the Sensex crashing 842 points on that very day-the worst stock market collapse in history.

There are many conspiracy theories on why this happened and the jury is still out there to give the verdict. The left party’s anti reforms stand and their rejection of divestment of the public enterprises in most strident manner were some of the main reasons for the market crash that the critics agreed upon.

The verdict of investors was so strong against the left parties, as if the investors have already foreseen the turbulent relationship between congress and left for the next 5 years.

Were the investors right in their verdict?

The market and it’s participants behave in accordance to the various factors . It is the behavioral pattern of the investors, which intrigues me the most.

Were the investors right in their verdict when they totally discarded the Left?

Let’s separate the emotions away from the pragmatism, it’s not as if a kiranawallah will close his shop if Mayawati becomes Prime Minister or the major parties of India are tangled up in coalition government.

If we analyze the sensex from 17-18 May 2004, we will see a peculiar pattern. The sensex nose dipped by 842 points on May 17 and gained 372 points on May 18. The S.E.B.I ( Securities Exchange Board of India) and the finance ministry wanted a more accurate picture of the crash and subsequently a hunt was launched to find out if there was foul play involved: a deliberate attempt to create selling pressure and bring down share prices.

This signifies that the real reason was not “the Left factor” but something else.

During the subsequent years Left rejected every pro reform bill in the parliament still the market had an unprecedented bull run for the next couple of years. The Left withdrawal didn’t result in upward movement for the share market.

The politics have a very small role to play in the market.

I had always assumed that the politics and the government is not of much importance for the investor community but what happened exactly 5 years later made me eat my words.

Golden Monday

There are certain incidents in history which attain the status of a “Classic”, some of them are India beating Australia in 2001 home series, the fall of Berlin wall and the rise of the share market on May 18 2009. Everyone in the market was euphoric, the trading was halted after market hit 20% circuit for the first time ever.

The overwhelmingly verdict in favor of a strong stable government proved that it’s wrong to underestimate the voters.

The correlation between politics and share market.

I was wrong in my analysis of May 17 2004, market crash . The politics do matter a lot to the share market and it’s investors.The election verdict itself is turning out to be a game changer for the economy and the share market. The market would have been more than happy , if the Third front didn’t have any role to play in the election mandate.

Uday kotak , Vice Chairman and Managing Director, Kotak Mahindra Bank said that “The Indian markets saw their bottom in March. The decision by the Indian voter in terms of the new government and the stability of the new government is a structural change in India. Markets and the real economy will need to reflect this structural change. The bottoms have significantly moved up from the 8,000 levels. On a global basis, we are past midnight, but it’s still too early to call a global dawn.”

The euphoria in the market is only because of a stable government in New Delhi.I am very happy to say that I have been proved wrong, when I said that politics have a very small role to play in the share market.The overall mood of gloom in economy changed overnight, after the election mandate.

If UPA (United Progressive Alliance) performs on it’s promise of better governance, reforms and social schemes then there is no stopping us from achieving a GDP target of around 7%-8% .

History has uncanny ability of repeating itself. The markets were extremely bullish from 1985-86, when Rajiv Gandhi was elected with record majority.We are not yet out of the woods on the pure fundamentals but we have got a huge chance of getting out of the woods. We have got a huge shot in the arm.The election has provided a right stimuli, which was wanted in this kind of economy(recession).

The pundits have always said that it’s always difficult to predict or analyze the market and I have learnt that now.The curious case of two different Mondays has provided us with contradicting views on the correlation of politics and the share market.

Whether bear or bull, in stock markets people have strategies to make money. . One of the traditional strategies in the Bear market many of us have heard is of “Doubling down Strategy” i.e. whenever there is a decline in stock prices - . buy stocks which already are in loss due to decline is prices and reduce the average costs of this purchase. Can derivatives help to beat this strategy?

There is a strategy in derivatives known as “Stock Repair Strategy” to overcome the losses suffered due to wrong timing of purchase.

Here the basic concept needs to be understood before we move on to explain the Stock Repair Strategy:

Option Spread: It is created by the simultaneous purchase and sale of options of the same class on the same underlying security but with different strike prices and/or expiration dates.

Call Spread: A spread that is constructed using calls which can be referred to as a call spread.

At-the-money call: A call option is at the money when the common stock price is equal to the strike price.

Out-of-the-money call: A call option is out of the money when the strike price is greater than the market price of the underlying interest.

How does Stock Repair Strategy work?

In Stock Repair Strategy one has to buy one At-the-Money (ATM) call simultaneously selling two Out-of-the-Money (OTM) call options on the same stock, in the same month. One must make sure to purchase exactly equivalent amount of at-the-money call options as shares of stock they are holding in their demat accounts.

Lets take an example to understand this in detail:

Mr. X bought 200 shares of ABC Company at Rs.2500 each so total cost is Rs.500000 and it declined to Rs.2000 each, losing Rs.100000 for example. Mr. X wants to recover this loss using through the strategy then Mr. X will have to buy 2 ATM call contracts (100 shares each) of ABC Co. at Rs.2000 as strike price valued at Rs.200.

Then Mr. X would sell 4 OTM call contracts (100 shares each) of ABC Co. at Rs.2250 as strike price valued at Rs.100.

What is cost for this trade?

(Premium of OTM x number of shares in contract) - (Premium of ATM x number of shares in contract)

i.e. (Rs.100 x 400) - (Rs.200 x 200) = Rs.0

The nearest OTM options normally cost half the price of the ATM options. So, in the above example Rs.100 is taken for OTM.

What is the Computing break-even point in this strategy?

Lets assume Stock of ABC Company rises to Rs.2250 from Rs.2000 by the expiry of contract period. The 4 OTM contracts of Rs.2250 strike call options would expire valueless while the 2 ATM call options of Rs.2000 will expire in the money of Rs.250 each contract. Exercising ATM call will give the options trader a profit of Rs.50000 (Rs.250 x 200). Investors stock position has also regained from Rs.2000 to Rs.2250 therefore this value will be again Rs.50000. Adding both this amounts will give a total gain of Rs.100000 which is equivalent to total loss of Rs.100000. So, it can be observed by mere movement i.e. achieving break-even at reduced price in this strategy have ‘repaired’ investors stock.

Considering a scenario if stock price rise strongly, then what will happen?

Lets assume stock price of ABC Company bounced strongly and is now trading at Rs.3000 on expiration. Here, all the call options will expire in the money but Mr. X has sold more call options than purchased, investor requires buy-back of the written calls at a loss. Investors 4 OTM call written is now worth Rs.750 each i.e. Rs.300000 (Rs.750 x 400) but investors 2 ATM call is only worth Rs.1000 each i.e. Rs.200000 (Rs.1000 x 200). So, it seems investor has suffered a loss of Rs.100000 from this strategy but this loss can be offset by the gain from his stock position. The stock price has moved from Rs.2000 to Rs.3000 i.e. a gain of Rs.200000 (Rs.1000 x 200 stocks). So, offsetting loss of Rs.100000 on this strategy investor remains with a net profit of Rs.100000, which can be considered as recovery of initial loss for an investor for this stock before applying this strategy.

Two main reasons for considering stock repair strategy as better alternative to follow:-

1) Investor buy one option and sell two options, so that investors do not have to put up additional capital as would have been in the case of doubling down strategy. Investor just needs to put out a small amount of money if the 1 by 2 spread produces a debit which will be much lower compare to another bulk of stocks purchased from secondary stock markets.

2) In this strategy investor will recover from losses with less of an upward move in stock prices. For example, if investor had purchased stocks, which are now down by 10% since its purchase investor with the help of this strategy can recover 10% loss as long as that company stock rises by about 5%.

When an investor should implement this strategy?

To recover losses in stock would be the trigger when this stock market is expected to rise moderately due to events of global economic improvisation / stability, political stability of new government, expecting rise in our GDP numbers, rise in profit numbers of companies, etc.

To conclude, there is no downside risk by applying this strategy. When the stock price moved up strongly investor still achieved the break-even. If the stock price had gone down at expiration, then all the options involved would expire worthless and so there will be no further loss by executing this strategy.

Imagine buying a stock at Rs 100, probably on the suggestion of a friend, neighbor, aunt, girlfriend, hoping to double, triple your money, touching the lunar surface in no time…

And then,

80,70,50,25,10,5 …..What the hell is happening? You question all deities you pray to as to why this is happening to you. And the final stage: investor and advisor resort to desperate measures as panic sets in quick and fast.

Sitting in front of their computer screens pressing that F5 key again and again believing against hope, hoping against hope, investors dig for some divine intervention that will move their stocks price up. The friend’s stock is up; the aunt’s stock is up, while our pal is still pressing that Refresh button hoping to make a killing. Let’s put him out of his misery, what?

It’s not going to happen.

It’s never going to happen

Unless you realize that you have made a wrong stock pick without knowing if that company makes pajamas or refines crude oil.

In times like these, when 15000 levels on the BSE Sensex seems folklore, your broker is pressing you to put money in a new rising star company, which might be a shooting star very soon. You don’t know. Fact is, nobody does. In markets like these, you don’t know what stock to buy at what levels because the benchmark index is at 9-10 PE on FY09 earning (PE is prices to earning ratio, which gauges how expensive it is to buy index stocks in comparison to other markets in the world, on the basis of earning). The best option is to be sold and stay put. The advisories and advocates of the stock markets burp out levels at which you should buy, hold, go long, go short,  specific stocks,… They are as clueless as you are as soon as one variable changes, be it interest rates, earnings of the company, and so on.

The Indian economy is not running away anywhere. Neither is the stock market. Having grown by near 9% average for the last 5 years in a row to reach $1 trillion in GDP (It’s about $700 billion now, due to FII money exit and rupee devaluation), the economy cannot and will not sink like the Titanic. It has a mass of over 1.3 billion people and with 240 million households, demand surely exists - for consumer durable and FMCG companies, for roads, bridges, dams, power, and what not. So consumption spending is surely there. What is missing is investment spending; this will take sometime from an individual’s point of view as the current interest regime is too high.

All the above-mentioned demand areas requires $100 billion of investments annually for the next 5 years. Let’s say FIIs might be able to pullout about $20 billion ($12 billion has already been pulled out this year so far). The numbers are still more than sufficiently optimistic to drive our economic growth.

To fuel all this government will surely relax investment norms in key critical sectors like railways, telecom, banking, airlines. So our growth story is still visible and we will surely see a ray of light at the end of the tunnel.

So all investors, new or old! Stop pressing that Refresh button and dig in a little deeper when you invest.

The author is working as Research Associate at Padmakshi Financial Services Ltd.

Personal loans are gaining popularity among loan seekers in a big way. Be it planning a vacation or getting you daughter married, down payment of your new house or medical obligations, a personal loan may be used for any purpose. A personal loan may be a secured or an unsecured loan where the end use of the money is not supposed to be declared while taking the loan. The rate for unsecured personal loans ranges from about 15 % to 25 % per annum depending up on the credit history and the income of the loan seeker. This type of personal loan is more popular among the public.

The problem begins when people take these kinds of loans for investments into various instruments including equities. Markets have been pretty volatile for last few months and are expected to behave the same for quite some time. So if you planning to take a personal loan and invest in to equities of mutual funds thinking that the markets are at low then think again. The inflation rate has been moving up. The last numbers posted was well above 12%. With the growth in the Gross Domestic Product (GDP) around 8% to 9% the economy may see a negative growth in the current fiscal. The Reserve Bank of India has tried to tighten the liquidity situation by increasing the Cash Reserve Ratio (CRR) by 50 basis points. They may increase it by another 50 to 100 basis points if needed to keep a check on the inflation numbers. The condition worsens if the loan you have taken is on a floating interest rate. You end up losing money in the equity markets and pay more towards the loan at the same time. This is like being the rope in a tug of-war match where both sides are trying to pull you towards themselves to the fullest.

A better way to invest into equity market is by the way of arbitrage. It is buying in the cash market using the loan amount taken and selling it in derivative market by way of futures at a price which is more than the price bought added with the interest amount. On the day of maturity you reverse your position on both the markets and difference of the amount over and above the cash market price added with interest on the loan and the price sold in the futures market is your profit.

To explain arbitrage lets take the following example.

One lot of Reliance Industries Limited (RIL) is of 75 shares. Suppose the price of one RIL share is Rs. 2200 on 1st July, 2008. The maturity is on 31st July, 2008. The total amount of loan of 75 shares is (2200*75) = Rs. 165000. If the interest rate is 18% per annum then for one month the amount of interest is (165000*1.5%) = Rs. 2475 which is (2475/75) = Rs. 33 per share. Thus you need to short one lot of Reliance at any price which is more than (2200+33) = Rs. 2233. If you manage to short at a price say Rs. 2250, then you make a profit of (17*75) = Rs. 1275 on one lot which is almost 9.3% per annum. Now no matter what the price is on the expiry, you will manage to earn the amount stated above as you have already squared off your position.

The main thing over here is to find the right price to buy in the cash market and sell in the futures market. If you manage to hit the right price over the screen, then bingo! You have made money where everyone is losing it.