Small deposit, big return, large risk

Taking a large exposure by paying a small margin may not work in your favour with many investment products.

Invest just Rs 20,000, take exposure up to Rs 2 lakh — a sales pitch that might make many investors feel they are getting a great deal. But before jumping in, look at the product carefully.

We list some such offers, starting with a futures and options (F&O) product. According to data from the National Stock Exchange, daily turnover in index options rose from Rs 28,372 crore on April 1 to Rs 40,533 crore on April 26. “A lot of young people are willing to take risk that comes with investing in the F&O segment. Many enter and exit the market within hours, not the right way to approach investments,” said Mukesh Dedhia, director, Ghalla Bhansali Stock Brokers.

Margin money is a minimum prescribed amount (as a percentage of the stock, index, commodity, currency price) paid as security to the broker. Higher the volatility, higher the margin money. The risk is much higher as well.

INDEX F&O: Say you purchase a Nifty futures contract at 5,200, with a lot size of 50 (one contract = 50 lots). The total value of the contract is Rs 2.6 lakh. However, you may have to pay Rs 26,000-65,000 (10 to 25 per cent of the exposure) to purchase one contract. And, if the call goes wrong, the difference has to be paid. Suppose the Nifty contract falls to 5,000 points. The investor will have to pay Rs 10,000 (200 points times 50).

INVESTMENT ADVICE: While index futures are the safest among the F&O products, only an investor with spare money should look at these, because it involves predicting or timing the market. “At best, it can be used for hedging in case the market is falling fast and your portfolio comprises shares bought at higher prices,” said Dedhia.

Stock f&o: This is riskier, and more complicated. Since individual stocks are much more volatile than indices, they are more difficult to predict. The minimum trading amount required for trading is Rs 2 lakh. The margin money is also higher, upwards of 10 per cent, depending on the stock and the broker.

Investment advice: “I do not recommend trading in stock futures because it is mostly based on speculation. One may use it for hedging, but in a very rare case,” said Gaurav Mashruwala, a certified financial planner.

Commodity F&Os: Most commodity exchanges have a standard margin money requirement, depending on the underlying commodity. “For instance, the margin is five per cent for gold and up to 15 per cent for many agricultural commodities,” said Viral Shah, senior vice-president, Geojit Commtrade.

The margin money for commodities is based on the commodity and the tenure of the contract.

Investment advice: Commodity movements are driven by global demand and supply situations. For a retail investor, it is quite difficult to keep track of this. At best, it can a portfolio diversifier.

Currency futures: The margin required for a dollar-rupee future is three per cent. Recently, the Reserve Bank of India (RBI) decided to permit stock exchanges to trade options on the spot dollar/rupee exchange rate. Sebi guidelines are awaited on this.

Investors have been recently moving to currency trading because it requites little margin money. “The minimum amount required to buy one dollar-rupee contract is around Rs 45,000 ($1,000) — much lesser than equities,” said Shah.

Investment advice: It is mostly importers and exporters who will benefit from it. But, high net worth individuals, who are looking to take advantage of the Reserve Bank’s $2,00,000 window (per person) to invest abroad, can use currency futures to hedge against fluctuations.

Interest rate futures: The underlying asset is the 10-year notional bond. RBI recently allowed interest rate futures for five-year and two-year bonds and 91-day treasury bills. The margin required is 3-3.5 per cent.

Investment advice: Not much retail participation is seen in this segment. “The main reason is the physical delivery of the underlying bond. For other asset classes, the delivery happens in cash,” said S Rajendran, general manager, treasury, Union Bank of India.