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Why to Choose Mutual Funds Instead of Directly Investing Into Equities?

Why to Choose Mutual Funds Instead of Directly Investing Into Equities?
by Sumit Kati 07/04/2017

Whether to invest in equities or mutual funds is a question that has plagued every investor. As someone who needs the best value for his/her investment should you invest in equity directly or via mutual funds?

Let’s start by first understanding what these two terms ‘equities’ and ‘mutual funds’ stand for-

Equities- Equities generally represent ownership of a company. If you own any equity in a company, you are a part owner of the said company (depending on how much equity you own).

Mutual Funds – It is an investment scheme which is professionally managed by an asset management company. It pools together the resources of a group of people and invests their money in equities, debentures, bonds and other securities.

Why choose mutual funds over equities?

For people who’ve never invested in either stocks or mutual funds, it is hard to know which is better and where to start. Broadly speaking, if you are a novice investor, mutual funds are not only less risky but also way easier to manage. Here are some ways in which investing in mutual funds is beneficial as opposed to investing in equities -

Diversification

Mutual funds provide more diversification as compared to an individual equity stock. When you invest in equity, you are investing in a single company which has its inherent risk. For example, if you invest Rs.20,000 in buying equities of one company, you could face a total loss if that particular company performs poorly in the market. 

If you invest the same amount in mutual funds, it will be invested in different kinds of stocks and financial instruments, high-risk and low-risk both, so you might not face total loss even if one company does poorly.

Scale of Investment and Lower Costs

For an individual investor buying and selling stocks is a difficult task due to its high price. Thus, any gains made from stock appreciation are nullified if the overall trading costs are considered. Comparatively with mutual funds, as the money is pooled from a large number of investors, the cost per individual is lowered. 

Another advantage of mutual funds is that you don’t need to invest large sums of money. Buying equities for a profitable venture needs huge amounts of money, a minimum of few lakhs. With mutual funds, you can start with Rs.1000 and earn profits on that as well.

Convenience

Keeping an eye on the markets everyday is a time-consuming business, especially if you are investing as a side gig. There are people who spend their lives studying the market and still end up sustaining heavy losses. Though investing in mutual funds does not guarantee high returns, it is stress-free and needs less work as compared to investing in equities.

To sum it up

It is important to remember that mutual funds have their own disadvantages as well. Thus, as with any financial decision, educating yourself and understanding the suitability of all the available options is the ideal way to invest.

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How to Read the Mutual Fund Offer Documents?

How to Read the Mutual Fund Offer Documents?
by Nutan Gupta 13/04/2017

It is very difficult to not notice the words of caution after every mutual fund commercial - “Mutual Fund investments are subject to market risks. Please read the offer documents carefully before investing.” How many of us actually read the offer documents? 5 investors in every 100 investors might be going through the documents. Rest 95 either do not know how to read the offer documents or do not consider it important enough to go through the documents.

Here are some important aspects you should consider while reading offer documents:

Investment Objective

This is one of the most important things to look at in an offer document. It gives a fair idea about the thought process of the fund manager and the strategies that he will use in order to achieve the fund’s objectives. An individual can compare these objectives with his own expectations as per his risk appetite.

Past Performance

The past performance of the fund can be looked at to know if the fund has given consistent returns or not. Investors can also look at the launch date if the fund, its total assets under management and compare it with other funds in the similar space. However, this cannot be used to predict future returns, as one cannot determine future returns on the basis of past performance.

Fund Managers

Fund manager is an experienced professional who has an expertise is managing funds. The offer document clearly states who the fund manager to a particular fund is. This gives the investor an insight about the investment style of the fund manager.

Loads and Taxes

The offer document also states all the charges applicable like the entry and exit load, transaction charges and other charges applicable for managing a fund. All mutual funds do not have same charges as the charges vary according to the type of mutual fund.

Expense Ratio

Expense ratio is the ratio which is charged by AMCs to manage an investors’ money. It is charged in percentage terms. Different funds have different expense ratios. However, SEBI has restricted the limit for expense ratios that a fund can charge. Equity funds can charge a maximum of 2.5% and debt funds can charge a maximum of 2.25%.

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Long Iron Butterfly Options Strategy

Long Iron Butterfly Options Strategy
by Nilesh Jain 17/04/2017

A Long Iron Butterfly is implemented when an investor is expecting volatility in the underlying assets. This strategy is initiated to capture the movement outside the wings of options at expiration. It is a limited risk and a limited reward strategy. A Long Iron Butterfly could also be considered as a combination of bull call spread and bear put spread.

When to initiate a Long Iron Butterfly

A Long Iron Butterfly spread is best to use when you expect the underlying assets to move sharply higher or lower but you are uncertain about direction. Also, when the implied volatility of the underlying assets falls unexpectedly and you expect volatility to shoot up, then you can apply Long Iron Butterfly strategy.

How to construct a Long Iron Butterfly?

A Long Iron Butterfly can be created by buying 1 ATM call, Selling 1 OTM call, buying 1 ATM put and selling 1 OTM put of the same underlying security with the same expiry. Strike price can be customized as per the convenience of the trader; however, the upper and lower strike must be equidistant from the middle strike.

Strategy

Buy 1 ATM Call, Sell 1 OTM Call, Buy 1 ATM Put and Sell 1 OTM Put

Market Outlook

Movement above the highest or lowest strike

Motive

Profit from movement in either direction

Upper Breakeven

Long Option (Middle) Strike price + Net Premium Paid

Lower Breakeven

Long Option (Middle) Strike price - Net Premium Paid

Risk

Limited to Net Premium Paid

Reward

Higher strike-middle strike-net premium paid

Margin required

Yes

Let’s try to understand with an example:

Nifty Current spot price (Rs)

9200

Buy 1 ATM call of strike price (Rs)

9200

Premium paid (Rs)

70

Sell 1 OTM call of strike price (Rs)

9300

Premium received (Rs)

30

Buy 1 ATM put of strike price (Rs)

9200

Premium paid (Rs)

105

Sell 1 OTM put of strike price (Rs)

9100

Premium received (Rs)

65

Upper breakeven

9280

Lower breakeven

9120

Lot Size

75

Net Premium Paid (Rs)

80

Suppose Nifty is trading at 9200. An investor Mr A thinks that Nifty will move drastically in either direction, below lower strike or above higher strike by expiration. So he enters a Long Iron Butterfly by buying a 9200 call strike price at Rs 70, selling 9300 call for Rs 30 and simultaneously buying 9200 put for Rs 105, selling 9100 put for Rs 65. The net premium paid to initiate this trade is Rs 80, which is also the maximum possible loss.

This strategy is initiated with a view of movement in the underlying security outside the wings of higher and lower strike price in Nifty. Maximum profit from the above example would be Rs 1500 (20*75). Maximum loss will also be limited up to Rs 6000 (80*75).

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

The Payoff chart:

The Payoff Schedule:

 

On Expiry NIFTY closes at

Net Payoff from 1 ITM Call Bought (Rs) 9200

Net Payoff from 1 OTM Call Sold (Rs) 9300

Net Payoff from 1 ATM Put bought (Rs) 9200

Net Payoff from 1 OTM Put sold (Rs.) 9100

Net Payoff (Rs)

8800

-70

30

295

-235

20

8900

-70

30

195

-135

20

9000

-70

30

95

-35

20

9100

-70

30

-5

65

20

9120

-70

30

-25

65

0

9200

-70

30

-105

65

-80

9280

10

30

-105

65

0

9300

30

30

-105

65

20

9400

130

-70

-105

65

20

9500

230

-170

-105

65

20

9600

330

-270

-105

65

20

 

Impact of Options Greeks before expiry:

Delta: The net Delta of a Long Iron Butterfly spread remains close to zero if underlying assets remain at middle strike. Delta will move towards 1 if underlying expires above higher strike price and Delta will move towards -1 if underlying expires below the lower strike price.

Vega: Long Iron Butterfly has a positive Vega. Therefore, one should buy Long Iron Butterfly spread when the volatility is low and expect to rise.

Theta: With the passage of time, if other factors remain same, Theta will have a negative impact on the strategy.

Gamma: This strategy will have a long Gamma position, so the change in underline assets will have a positive impact on the strategy.

How to manage Risk?

A Long Iron Butterfly is exposed to limited risk but risk involved is higher than the net reward from the strategy, one can keep stop loss to further limit the losses.

Analysis of Long Iron Butterfly strategy:

A Long Iron Butterfly spread is best to use when you are confident that an underlying security will move significantly. Another way by which this strategy can give profit is when there is an increase in implied volatility. However, this strategy should be used by advanced traders as the risk to reward ratio is high.

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5 Things to Know About Asset Allocation in Mutual Funds

5 Things to Know About Asset Allocation in Mutual Funds
by Nutan Gupta 17/04/2017
New Page 1

Asset allocation is putting your money across different asset classes - stocks, bonds, real estate, cash and commodities. Asset allocation ensures that you get the best returns out of your savings. Here are five things that an individual must know about asset allocation.

Asset allocation is not diversification

A lot of times people use the words asset allocation and diversification interchangeably. However, one needs to understand that these are two different terms. Asset allocation is the process of deciding the amount of exposure one needs to have in different asset classes. On the other hand, diversification is what you invest within these asset classes.

Asset allocation could be tactical

An investment strategy is planned to achieve long-term goals. A mutual fund invests in stocks which the fund manager believes will give higher returns in the future. Sometimes, a fund manager thinks that a particular fund will give good returns in the short-term but also has the potential to give superior returns in the long-term. Investment moves are based on what the fund manager thinks and this is known as tactical approach.

Asset allocation is not standard

Asset allocation differs based on the age and risk appetite of an investor. An individual who plans to retire next year will have a different asset allocation than a person who is a young entrepreneur. Asset allocation also differs depending upon the income stream of an individual. An individual with a fixed and regular income stream can have a more aggressive asset allocation than a person whose income is not regular.

Asset allocation could be dynamic

A dynamic asset allocation model is the one when a fund manager makes changes in the portfolio which reflects the most recent changes. These changes should be made keeping the long-term performance of the asset in mind. The riskiness of assets change with time.

Asset allocation needs periodic rebalancing

The asset allocations in our portfolio fluctuate every year depending on market fluctuations. Some assets may have performed extremely well in one year, while some may have underperformed in that period. Periodic rebalancing is required as it reduces volatility in the portfolio.

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Short Call Condor Options Trading Strategy

Short Call Condor Options Trading Strategy
by Nilesh Jain 17/04/2017

A Short Call Condor is similar to Short Butterfly strategy. The only exception is that the difference of two middle strikes bought has different strikes.

When to initiate a Short call condor?

A Short Call Condor is implemented when the investor is expecting movement outside the range of the highest and lowest strike price of the underlying assets. Advance traders can also implement this strategy when the implied volatility of the underlying assets is low and you expect volatility to go up.

How to construct a Short Call Condor?

A Short Call Condor can be created by selling 1 lower ITM call, buying 1 lower middle ITM call, buying 1 higher middle OTM call and selling 1 higher OTM calls of the same underlying security with the same expiry. The ITM and OTM call strikes should be equidistant.

Strategy

Sell 1 ITM Call, Buy 1 ITM Call, Buy 1 OTM Call and Sell 1 OTM Call

Market Outlook

Significant volatility above higher and lower strikes

Motive

Anticipating price movement in the underlying assets

Upper Breakeven

Highest strike price - Net credit

Lower Breakeven

Lowest strike price + Net credit

Risk

Limited (if expires above lower breakeven point and vice versa)

Reward

Limited to Net premium received

Margin required

Yes

Let’s try to understand with an example:

Nifty Current spot price

9100

Sell 1 ITM call of strike price (Rs)

8900

Premium received (Rs)

240

Buy 1 ITM call of strike price (Rs)

9000

Premium paid (Rs)

150

Buy 1 OTM call of strike price (Rs)

9200

Premium paid (Rs)

40

Sell 1 OTM call of strike price (Rs)

9300

Premium received (Rs)

10

Upper breakeven

9240

Lower breakeven

8960

Lot Size

75

Net premium received

60

Suppose Nifty is trading at 9100. An investor Mr. A estimates that Nifty will move significantly by expiration, so he enters a Short Call Condor and sells 8900 call strike price at Rs 240, buys 9000 strike price of Rs 150, buys 9200 strike price for Rs 40 and sells 9300 call for Rs 10. The net premium received to initiate this trade is Rs 60, which is also the maximum possible reward. This strategy is initiated with a view of significant volatility on Nifty hence it will give the maximum profit only when there is movement in the underlying security below 8900 or above 9200. Maximum profit from the above example would be Rs 4500 (60*75). The maximum profit would only occur when underlying assets expires outside the range of upper and lower breakevens. Maximum loss would also be limited to Rs 3000 (40*75), if it stays in the range of higher and lower breakeven.

For the ease of understanding of the payoff schedule, 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 1 Deep ITM Call Sold (Rs) 8900

Net Payoff from 1 ITM Calls Bought (Rs) 9000

Net Payoff from 1

OTM Call bought (Rs) 9200

Net Payoff from 1 deep OTM Call sold (Rs.) 9300

Net Payoff (Rs)

8600

240

-150

-40

10

60

8700

240

-150

-40

10

60

8800

240

-150

-40

10

60

8900

240

-150

-40

10

60

8960

180

-150

-40

10

0

9000

140

-150

-40

10

-40

9100

40

-50

-40

10

-40

9200

-60

-50

-40

10

-40

9240

-100

90

0

10

0

9300

-160

150

60

10

60

9400

-260

250

160

-90

60

9500

-360

350

260

-190

60

9600

-460

450

360

-290

60

The Payoff Graph:

Impact of Options Greeks before expiry:

Delta: If the underlying asset remains between the lowest and highest strike price the net Delta of a Short Call Condor spread remains close to zero.

Vega: Short Call Condor has a positive Vega. Therefore, one should buy Short Call Condor spread when the volatility is low and expect to rise.

Theta: Theta will have a negative impact on the strategy, because option premium will erode as the expiration dates draws nearer.

Gamma: The Gamma of a Short Call Condor strategy goes to lowest if it moves above the highest or below the lowest strike.

Analysis of Short Call Condor spread strategy

A Short Call Condor spread is best to use when you are confident that an underlying security will move outside the range of lowest and highest strikes. Unlike straddle and strangles strategies risk involved in short call condor is limited.

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5 Common Myths about Mutual Fund Investments

5 Common Myths about Mutual Fund Investments
by Priyanka Sharma 17/04/2017

Over the years, investing in Mutual Funds has emerged as a popular option among a vast population of investors with varied incomes and risk appetites. Like any other investment, putting money into Mutual Funds too requires a careful assessment, and study on your part even if you have a professional help. Listed below are some misconceptions related to MF investments:

Mutual Funds demand long-term, huge investments

The fact is that you can get started with a low amount of capital investment’ it could be as low as Rs 1,000. Another misconception is that all Mutual Funds investments are long-term investments and that it is a long wait before one draws benefits from it. The latter too is incorrect. Mutual Funds can be either short term or long term investments, depending upon the underlying assets the mutual funds invest in.

Mutual Fund investment is risk-free

Perhaps, one of the biggest misconceptions about Mutual Funds is that it is a risk-free investment. This is simply not correct. According to one school of thought, the risk of investing in MF is inversely proportion to the diversification of the portfolio. Taking this argument forward, if you hold 2 stocks in your portfolio then the risk is high compared to an investor with 20 stocks. Similarly, MF investments in multiple stocks are less risky compared to direct equity investment.

Also, it is generally advisable that the investment theme should be different to hedge the risk. It doesn’t make sense to invest in 3-4 large cap mutual fund schemes, as these are likely to invest in more or less the same stocks.

Mutual Funds with lower NAV will deliver higher returns

Another common myth related to Mutual Fund investment is that MFs with lower NAV will deliver higher returns. As an investor, we are led to believe that Mutual Fund scheme with NAV of Rs 1,000 will deliver lower returns compared to fund with NAV of Rs 100. The argument behind this is that it is more probable for a stock to climb from Rs 10 to Rs 12 i.e. 20% return compared to the jump from Rs 4,000 to Rs 4,800 for same 20% return. However, the fact is that the underlying theme of Mutual Fund investment decides the future returns irrespective of lower or higher NAV.

All Mutual Funds qualify for tax deduction

This is often sold as one of the biggest USPs for investing in Mutual Funds. However, the fact is that while MF investments do provide tax savings benefits, only the Equity Linked Savings Scheme (ELSS) is eligible for tax deduction under Section 80C of Income Tax Act. The dividends and long term capital gains from these investments are tax free.

Mutual Fund investment does not require regular monitoring

It is generally understood that Mutual Fund investments do not require any regular monitoring. In general, investors take it easy after putting their money in MFs. Well, it is true that MFs do not largely require a constant vigil, but you cannot afford to neglect it completely as it is your investment after all. This is largely because top performing Mutual fund schemes keep changing every year. Therefore, to maximize your returns, it’s a good idea to check the performance of your funds every year. You should keep modifying your portfolio depending on the performance of the funds in previous years. Some of the funds are conservative or invest in defensive stocks, which deliver consistent returns. Such schemes may not be top performers, but are but consistent performers and are best suited for the conservative investor. Such funds are also apt for SIP investment.

Top 5 Mutual Funds

 

Scheme Name

Corpus (Rs cr)

1 M (%)

6 M (%)

1 Y (%)

3 Y (%)

5 Y (%)

HDFC Prudence Fund(G)

17,776

3.1

10.6

30.8

19.7

16.5

SBI BlueChip Fund-Reg(G)

11,629

2.9

4.5

21.5

20.4

19.7

IIFL India Growth Fund-Reg(G)

345

1.0

5.1

33.0

0.0

0.0

Franklin India Smaller Cos Fund(G)

4,860

4.0

8.6

35.6

32.9

30.5

ICICI Pru Infrastructure Fund(G)

1,435

3.0

13.4

34.3

17.7

13.6