IPO: Initial Public Offering

IPO: Initial Public Offering
IPO
by Priyanka Sharma 08/05/2017

IPO definition
IPO means Initial Public Offering. Initial Public Offering (IPO) is the way an organisation goes public, lists itself on the exchanges and sells share to raise capital. In other words, it is a process by which a privately held company becomes a publicly traded company by offering its shares to the public for the first time. A private company, that has a handful of shareholders, shares the ownership by going public by trading its shares. Through the IPO, the company gets its name listed on the stock exchange.
 
How does a company offer IPO?
A company before it becomes public hires an investment bank to handle the IPO. The investment bank and the company work out the financial details of the IPO in the underwriting agreement. Later, along with the underwriting agreement, they file the registration statement with SEBI. 
SEBI scrutinizes the disclosed information and if found right, it allots a date to announce the IPO.

Why does a company offer an IPO?
1) Offering an IPO is a money-making exercise. Every company needs money, it maybe to expand, to improve their business, to better the infrastructure, to repay loans etc.
Trading stocks in the open market mean increased liquidity. It opens door to employee stock ownership plans like stock options and other compensation plans, which attracts the talents in the cream layer.
2) A company going public means that the brand has gained enough success to get its name flashed in the stock exchanges. It is a matter of credibility and pride to any company.
3) In a demanding market, a public company can always issue more stocks. This will pave the way to acquisitions and mergers as the stocks can be issued as a part of the deal.

Should you invest in an IPO?
Deciding whether to put your money into an IPO of a relatively new company is indeed tricky. Many people say having a cautious approach is a positive attitude to have in the stock market. By participating in an IPO, an investor can buy shares before they are available to the general public in the stock market. However, in case of an IPO, an investor will have to buy shares directly from the companies. 
For any company, IPO launch is one of the biggest events in its history. The company puts in maximum efforts to ensure that the IPO launch is a success. They spend heavily on advertisements in maximum possible available media platforms. A sizeable number of investors get informed about an IPO launch from advertisements or other media formats. Most of the activities are to purely promote the upcoming IPO and do not offer the complete picture. So as an investor before you opt for any IPO, it is imperative that you acquaint yourself with important information regarding company, financials, expansion plans and more. Few things to be considered before investing in an IPO are as follows:

1) Background checks
The Company obviously does not have enough historical data to back your decision, because it is just going public now. The red herring is the data on the IPO details which is provided in the prospectus, you need to scrutinize it. Know about the fund management team and their plans of IPO generated fund utilization. Look at the valuation of the company, is the price offered in the IPO, match with its fair value? This may be the hardest to determine for retail investors, but possibly the most important. Valuation refers to the relative price at which an IPO is offered. So, if the offer price of an IPO is Rs.500 per share, the price is arrived at after valuing the company’s revenues, profits and taking into account cash generation and debt in the balance sheet.
The process can be highly technical but can come with a shot of bias as investment bankers judge the “quality” of management and earnings before arriving at the final offer price.
For investors, these details are too complicated and their best bet is to compare the valuation of an IPO stock with a listed peer in the secondary market. In case, the IPO is that of a new business and there are no comparable listed peers, you have to judge using simple valuation techniques like price to earnings ratio, price to book ratio and return on equity.

2) Who is underwriting
The process of underwriting is raising investments by issuing new securities. Be careful of the underwriting of small investment banks. They may be willing to underwrite any company. Usually, an IPO with a success potential is backed by big brokerages that have the ability to endorse a new issue well. This does not mean that, the big investment banks never bring duds public, but in general, quality brokerages bring quality companies public. Exercise more caution when selecting smaller brokerages, because they may be willing to underwrite any company.

3) Lockup periods
Often IPO takes a deep downtrend after the IPO goes public. The reason behind this fall of the share price is the lockup period. A lockup period is a contractual caveat which refers to a period of time the company’s executives and investors are not supposed to sell their shares. After the lock-up period ends, the share price experiences a drop in its price.     

Once you have decided to participate in a particular IPO, then the question arises how does one go about it?

1) Apply using Application Form
Aspiring investors need to fill up the application form that is available with brokers or agents who sell mutual funds. These application forms are free of cost. When you fill up the form ensure that the details are legible and accurate. Also, attach a cheque for the amount of shares you wish to buy. There is always a minimum number of shares you have to buy, which is as defined by the company. Following the mentioned activities, submit the form with the mentioned time-frame.

2) Apply Online 
You can also apply for an IPO online through ASBA (Applications Supported by Blocked Amount). SEBI developed this process to leverage online option. Through ASBA, investors money doesn’t get debited till shares are allotted. In addition, investor can login to their respective netbanking account and apply for IPOs directly.
 
Do remember, a lot of companies launch its IPO; however, it is not necessary that it will perform well. It is therefore imperative to thoroughly check and evaluate a company, its financials, its future plans before investing in its IPO. If you blindly invest, there is probability that you will end up with losses. 

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How To Save Yourself From Getting Into Overvalued Stocks?

How To Save Yourself From Getting Into Overvalued Stocks?
by Priyanka Sharma 08/05/2017

We often hear people saying, “Don’t jump into the market just because others are getting rich. Invest what you can spare after expenses and stay long-term greedy! 

As the famous quote goes, ‘Precaution Is better than cure’ it’s best that we prepare ourselves by examining all our existing investments. One has to be careful while investing in the market.

What are overvalued stocks?
These stocks have a current price which is not justified by its earnings outlook or price/earnings ratio and is expected to drop in price. This may happen due to emotional buying spurts, which in-turn inflates the market price, or from deterioration in the company's financial strength.

How to prevent it?

1) Ensure diversification
Diversification mitigates the impact of market fluctuations on your portfolio by balancing your performers and underperformers. Diversification may preclude whopping gains, but you'll avoid whopping losses. Diversify among asset classes, sectors and geographic regions.

2) Buy bonds 
Bonds provide stability and capital preservation. During a market low, they also fuel your income stream. Although bonds are less risky than stocks, that doesn't mean they're devoid of risk. You need to gauge several types of risk when evaluating bonds, notably interest rate risk.

Interest rate risk accounts for the chance that interest rates will increase in the future, making your bonds less valuable. Your portfolio needs the safety of bonds, and not all bonds get crushed, when market spirals out of control. 

3) Trim your growth stock allocation. 
Credible research studies have found that asset allocation explains nearly 100% of the level of investor returns. At the heart of asset allocation is the risk/return trade-off. Many investors make the mistake of setting their asset allocation just once and then walking away. It's not a one-time task; it's a life-long process of fine-tuning.

If you have just started your career, you could possibly have more of equity and stocks however, if you are nearing retirement, having debt assets more than stocks would provide better security. Thus, tuning your growth stock allocation according to your life goals would be one way of saving yourself from investing in overvalued stocks.

4) Invest in gold
Gold isn't always about the glitter. It also provides a worthy hedge to inflation. The simplest, safest and most cost-effective way to gain exposure to the yellow metal is through the Gold Shares ETF (GLD). Having it as a part of your portfolio would ensure that you don’t get affected as much from overvalued stocks. 

How to find these?
Comparing the company's earnings to its stock price is the easiest way to know which stocks are overvalued. For instance, a company that's trading at a price 10 times its earnings are considered to be trading at a much higher multiple than a company trading at 2 times its earnings. In fact, the company trading at 10 times its earnings is most likely to be overvalued.

There are a lot of strategies that can be considered while making the decision. Make sure to do your own research or seek help from a consultant or investment advisor.

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Call Ratio Spread Explained

Call Ratio Spread Explained
by Nilesh Jain 26/05/2017

What is Call Ratio Spread?

The Call Ratio Spread is a premium neutral strategy that involves buying options at lower strikes and selling higher number of options at higher strikes of the same underlying stock.

When to initiate the Call Ratio Spread

The Call Ratio Spread is used when an option trader thinks that the underlying asset will rise moderately in the near term only up to the sold strikes. This strategy is basically used to reduce the upfront costs of premium paid and in some cases upfront credit can also be received.

How to construct the Call Ratio Spread?

Buy 1 ITM/ATM Call

Sell 2 OTM Call

The Call Ratio Spread is implemented by buying one In-the-Money (ITM) or At-the-Money (ATM) call option and simultaneously selling two Out-the-Money (OTM) call options of the same underlying asset with the same expiry. Strike price can be customized as per the convenience of the trader.

Strategy

Call Ratio Spread

Market Outlook

Moderately bullish with less volatility

Upper Breakeven

Difference between long and short strikes + short call strikes +/- premium received or paid

Lower Breakeven

Strike price of long call +/- Net premium paid or received

Risk

Unlimited

Reward

Limited (when Underlying price = strike price of short call)

Margin required

Yes

Let’s try to understand with an Example:

NIFTY Current market Price

9300

Buy ATM Call (Strike Price)

9300

Premium Paid (per share)

140

Sell OTM Call (Strike Price)

9400

Premium Received

70

Net Premium Paid/Received

0

Upper BEP

9500

Lower BEP

9300

Lot Size

75

Suppose Nifty is trading at Rs 9300. If Mr. A believes that price will rise to Rs 9400 on expiry, then he enters Call Ratio Spread by buying one lot of 9300 call strike price at Rs 140 and simultaneously selling two lot of 9400 call strike price at Rs 70. The net premium paid/received to initiate this trade is zero. Maximum profit from the above example would be Rs 7500 (100*75). For this strategy to succeed the underlying asset has to expire at 9400. In this case short call option strikes will expire worthless and 9300 strike will have some intrinsic value in it. However, maximum loss would be unlimited if it breaches breakeven point on upside.

For the ease of understanding, we did not take in to account commission charges. Following is the payoff schedule assuming different scenarios of expiry.

The Payoff Schedule:

On Expiry NIFTY closes at

Net Payoff from 9300 Call Bought (Rs)

Net Payoff from 9400 Call Sold (Rs) (2Lots)

Net Payoff (Rs)

8900

-140

140

0

9000

-140

140

0

9100

-140

140

0

9200

-140

140

0

9300

-140

140

0

9350

-90

140

50

9400

-40

140

100

9450

10

40

50

9500

60

-60

0

9600

160

-260

-100

9700

260

-460

-200

9800

360

-660

-300

9900

460

-860

-400

The Payoff Graph:

Impact of Options Greeks:

Delta: If the net premium is received from the Call Ratio Spread, then the Delta would be negative, which means slight upside movement will result into loss and downside movement will result into profit.

If the net premium is paid then the Delta would be positive which means any downside movement will result into premium loss, whereas a big upside movement is required to incur loss.

Vega: The Call Ratio Spread has a negative Vega. An increase in implied volatility will have a negative impact.

Theta: With the passage of time, Theta will have a positive impact on the strategy because option premium will erode as the expiration dates draws nearer.

Gamma: The Call Ratio Spread has short Gamma position, which means any major upside movement will impact the profitability of the strategy.

How to manage risk?

The Call Ratio Spread is exposed to unlimited risk if underlying asset breaks higher breakeven; hence one should follow strict stop loss to limit loses.

Analysis of Call Ratio Spread:

The Call Ratio Spread is best to use when an investor is moderately bullish because investor will make maximum profit only when stock price expires at higher (sold) strike. Although investor profits will be limited if the price does not rise higher than expected sold strike.

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Should you invest in Liquid Funds?

Should you invest in Liquid Funds?
by Prashanth Menon 26/05/2017
New Page 1

Liquid Funds are a popular investment option to park your surplus money for a brief period of time, at a rate of interest which is higher than what a bank generally offers. This is an open-ended debt scheme which invests in treasury bills, money market instruments, commercial paper and certificate of deposits for up to 91 days.

There are a number of factors which make Liquid Funds an attractive option.

Lower risks

To begin with, Liquid Funds are supposed to be least risky as they hold high quality papers. Among the different categories of debt funds, liquid funds have the shortest maturities. They earn returns from the accrual on the instruments and these funds do not involve trading.

Liquid Funds are often compared with Ultra short term funds. However, the two are different on many counts. Firstly, the maturity period for the Ultra short term fund is more than three months and often goes up to a year. Ultra short-term funds are a riskier preposition on the basis of the quality of papers they hold. Furthermore, Liquid Funds do not charge an exit load, whereas Ultra short-term funds put an exit load on the investor.

Better returns

In general, Liquid Funds give returns of over 6-8%. Compare this to the average 4% rate of interest offered by most banks for savings account. The better returns easily make it an obvious choice from an investor’s point of view.

Easy liquidity

There is no exit load charged on liquid funds. In fact, there are now provisions in some funds that allow an investor to redeem their funds within a few hours. Hence, the process that used to take a couple of days earlier is now complete within some hours. Overall, on the basis of the cut-off schedule for redemption, an investor receives money the next day.

Taxation

Liquid funds are taxed like any other debt fund. When profits are realized in less than three years, the same are taxed as per your tax rate, while the profits realized after three years are taxed at 20% with indexation. Investors who come in the 30% tax bracket can opt for a dividend payout if they require cash on a regular basis.

Conclusion

Liquid Funds give an investor the option of investing their capital for a very short duration of time at an attractive rate of interest. The option of redeeming the funds within a span of some hours makes the investment option a very lucrative one.

These funds are best suited as a contingency fund where you can set aside some amount of your investment by a creating a contingency fund.

This route also works well when an investor wants to invest lump sum money and then, in course of time, transfer it systematically it to equity funds. In general, it is not advisable to invest lump sum in equities market at a time when the markets are volatile or are richly valued. Liquid Funds can be a useful tool during such times as money can be parked here with an instruction for STP into an equity fund at regular intervals. By doing so, an investor can protect the investment against the volatility and, at the same time, the money is already invested in an option that gives better returns.

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Bull Put Spread

Bull Put Spread
by Nilesh Jain 26/05/2017

What is Bull Put Spread Option strategy?

A Bull Put Spread involves one short put with higher strike price and one long put with lower strike price of the same expiration date. A Bull Put Spread is initiated with flat to positive view in the underlying assets.

When to initiate Bull Put Spread

Bull Put Spread Option strategy is used when the option trader believes that the underlying assets will rise moderately or hold steady in the near term. It consists of two put options – short and long put. Short put’s main purpose is to generate income, whereas long put is bought to limit the downside risk.

How to Construct the Bull Put Spread?

Bull Put Spread is implemented by selling At-the-Money (ATM) Put option and simultaneously buying Out-the-Money (OTM) Put option of the same underlying security with the same expiry. Strike price can be customized as per the convenience of the trader.

Probability of making money

A Bull Put Spread has a higher probability of making money as compared to Bull Call Spread. The probability of making money is 67% because Bull Put Spread will be profitable even if the underlying assets holds steady or rise. While, Bull Call Spread has probability of only 33% because it will be profitable only when the underlying assets rise.

Strategy

Sell 1 ATM Put and Buy 1 OTM Put

Market Outlook

Neutral to Bullish

Motive

Earn income with limited risk

Breakeven at expiry

Strike Price of Short Put - Net Premium received

Risk

Difference between two strikes - premium received

Reward

Limited to premium received

Margin required

Yes

Let’s try to understand with an example:

Nifty Current spot price (Rs)

9300

Sell 1 ATM Put of strike price (Rs)

9300

Premium received (Rs)

105

Buy 1 OTM Put of strike price (Rs)

9200

Premium paid (Rs)

55

Break Even point (BEP)

9250

Lot Size

75

Net Premium Received (Rs)

50

Suppose Nifty is trading at Rs 9300. If Mr. A believes that price will rise above 9300 or hold steady on or before the expiry, so he enters Bull Put Spread by selling 9300 Put strike price at Rs 105 and simultaneously buying 9200 Put strike price at Rs 55. The net premium received to initiate this trade is Rs 50. Maximum profit from the above example would be Rs 3750 (50*75). It would only occur when the underlying assets expires at or above 9300. In this case, both long and short put options expire worthless and you can keep the net upfront credit received that is Rs 3750 in the above example. Maximum loss would also be limited if it breaches breakeven point on downside. However, loss would be limited to Rs 3750(50*75).

For the ease of understanding, we did not take in to account commission charges. Following is the payoff chart and payoff schedule assuming different scenarios of expiry.

The Payoff Schedule:

On Expiry Nifty closes at

Payoff from Put Sold 9300 (Rs)

Payoff from Put Bought 9200 (Rs)

Net Payoff (Rs)

8800

-395

345

-50

8900

-295

245

-50

9000

-195

145

-50

9100

-95

45

-50

9200

5

-55

-50

9250

55

-55

0

9300

105

-55

50

9400

105

-55

50

9500

105

-55

50

9600

105

-55

50

9700

105

-55

50

 

Payoff diagram

 

 


 

Impact of Options Greeks:

 

Delta: Delta estimates how much the option price will change as the stock price changes. The net Delta of Bull Put Spread would be positive, which indicates any downside movement would result in loss.

Vega: Bull Put Spread has a negative Vega. Therefore, one should initiate this strategy when the volatility is high and is expected to fall.

Theta: Time decay will benefit this strategy as ATM strike has higher Theta as compared to OTM strike.

Gamma: This strategy will have a short Gamma position, so any downside movement in the underline asset will have a negative impact on the strategy.

How to manage Risk?

A Bull Put Spread is exposed to limited risk; hence carrying overnight position is advisable.

Analysis of Bull Put Spread Options strategy:

A Bull Put Spread Options strategy is limited-risk, limited-reward strategy. This strategy is best to use when an investor has neutral to Bullish view on the underlying assets. The key benefit of this strategy is the probability of making money is higher as compared to Bull Call Spread.

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e-KYC Explained

e-KYC Explained
by Prasanth Menon 26/05/2017

How to do e-KYC?

Investors have to provide physical documents as verification of their Proof of Identity and Proof of Address. Submission and verification of these documents are requisite for investors to access financial products. However, with the enablement of Aadhaar based e-KYC service from UIDAI provides investors an instant, electronic, non repudiable proof of identity and proof of address along with date of birth and gender.

What is e-KYC service?

e-KYC that stands for electronic-KYC is only possible for those individual who have Aadhaar numbers. As per RBI, while using e-KYC service, you have to authorise the Unique Identification Authority of India (UIDAI), by explicit consent, to release your identity/address through biometric authentication to the bank branches/business correspondent (BC). The UIDAI then transfers your data comprising your name, age, gender, and photograph electronically to the bank. Information thus provided through e-KYC process is permitted to be treated as an ‘Officially Valid Document’ under PML Rules and is a valid process for KYC verification. The purpose of authentication is to enable investors to provide their identity and for the service providers to supply services and give access to the benefits.

The authentication and e-KYC services are available to different sectors of the industry ranging from Banks, Insurance companies, Government Organizations, Passport Offices, Airports, Depository Participants, Payment Gateway Provider and more.

Advantages of Aadhaar authentication and e-KYC

  • Easy to use process

  • Elimination of paper verification, movement and storage

  • Easy authorization system for investors

  • Real time, faster and instant results

  • Promotes paperless environment

  • Forged documents risk reduces

How to use this facility

  • The investor has to log into the KRA website (always use this service from a SEBI approved company) and enter basic details such as PAN number, email id, AMC name, bank name, date of birth, mode of holding and tax status.

  • Following this activity, the KYC compliance status of the investor will be displayed. If the investor is not KYC compliant, the individual is required to add their Aadhaar number and registered mobile number.

  • Once the user provide required details including Aadhaar number and registered mobile number, then the Aadhaar authentication screen is displayed.

  • Meanwhile, an OTP is sent to the registered mobile number, which has to be entered on the screen along with pin code.

  • Following Aadhaar authentication, the investor is required to upload a self attested copy of e-Aadhaar.

  • After this, the investor will be asked to select consent declaration displayed on the screen for further processing of the request.

  • Final stage of the process commences here wherein the Aadhaar and registered mobile number of the investor is verified with the Aadhaar database of the UIDAI.

  • Post successful confirmation, the screen displays that the investor is e-KYC verified and can carry out transactions in mutual funds.

The above mentioned is an easy and straightforward process to complete e-KYC if instructions are followed to properly and any investor can do it by themselves. A noteworthy pointer to remember is that this facility is currently available only for individual investors with single mode of holding. Also, as per Sebi rules, an individual is currently permitted an investment of Rs 50,000 each financial year per mutual fund for Aadhaar based e-KYC using OTP verification. However, if investor intends to do investment above Rs Rs 50,000 in a financial year, then in-person verification is a requisite.