Jun 22, 2013, 02.01 AM | Source: CNBC-TV18

Ability to bear risk key to trade in derivatives: Bhamre

Siddarth Bhamre, head of equity derivatives, Angel Broking, says on CNBC-TV18's The Derivatives Show, an investor's ability to bear risk is key to participation in the derivatives market.

Siddarth Bhamre

Head- Equity Derivatives & Technical

Expertise : F&O

More about the Expert...

Maximum profit with minimum risk — it is the ultimate goal that every investor in every asset class thrives for and the derivatives market is where it is done. Welcome to The Derivatives Show on CNBC-TV18.

Over the next 13 weeks, this new show will empower you with the knowledge that will allow you to trade futures or options in equities, commodities or the currency markets.

In this episode, Siddarth Bhamre, head of equity derivatives, Angel Broking explains the basics that anyone with an interest in derivatives must keep in mind.  Bhamre explains that derivatives can enhance returns while lowering risk. He adds that an investor’s ability to bear risk will determine the return and what one wishes to achieve with his investment portfolio.

Below is the edited transcript of the show on CNBC-TV18

Q: In today's marketplace, why is it important for any investor who has invested,  especially in equities, to take note or have knowledge of derivatives?

A: An investor needs to first understand why one invests in equities and the consequences therein. It is not just a one-sided process where funds are invested and the value keeps growing. It could fall as well and that is the source of the problems in investing. Basically, there are two types of risks in investing. One is the risk of investing in a particular stock and attendant factors that cause the stock price to move up or down.

There is another type of risk which is not related to company, but to the markets in general. All investments are vulnerable to these two kinds of risk. Derivatives are instruments that try to mitigate both these risks while offering reasonable returns.

Q: When the Securities and Exchange Board of India (Sebi) introduced derivatives in June 2000, there was a lot of fear, risk aversion and concerns on it would fare. But now the daily turnover from the futures and options (F&O) segment basis forms a colossal part of market transactions. Give us an idea of how the derivatives market has grown? Has it picked up in popularity?

A: It has become a tremendously popular segment in market and I am sure everybody watching the show is aware of how volumes have significantly moved up. But for a perspective on how this market has shaped up, let us go back a bit in time. In June 2000, the market regulator launched Index Futures and the Stock Options came in November 2001.

Till 2004, the economic growth rate stagnated at around five percent, the market was steadily picking up, but the volumes were not high. The derivatives market kick-started just as growth in the economy and market surged.

Previously, the F&O volume in comparison to the cash volume was lesser. Today, the Options volume is significantly higher. In 2004-2005, the Options volume was five percent of total turnover. Today, the Options volume is 75-80 percent of total turnover. This market has witnessed huge growth and this trend is clearly evident in other asset classes like commodities and currencies.

Q: What about the participants in this market? Are retail investors starting to take interest or is this still the domain of larger investors who either understand the product or who have much bigger portfolios?

A: I believe participants from almost all investor-classes are present in this market. Though retail investors may not be significantly involved, but they are still there. But what differentiates the participants is how much they know about what they are doing.

Retail interest slowly and steadily trickled in. The market caught the retail investor’s attention especially after that crash of 2008, when investors realised that how important it was to play safe in this market rather than just taking a one-way position. From that point, there has been a huge turnaround in Options turnover. There is a huge gap between the knowledge levels of retail and the domestic institutional participants regarding knowledge of the product, the cashflows and repercussions.

Q: Is an investor better off investing in equities than in derivatives?

A: There is a general misconception that that investing in derivatives is speculative in nature. Derivatives reduce risk provided investors use them wisely. So investors not exposed to derivatives are certainly missing out. Investors are mistaken of they think of using derivatives to make money in a very short timeframe. Derivatives not only reduce risk they also enhance returns.

Q: So it can work both for the long-term as well as the short-term investor?

A: Absolutely.

Q: Can you give some examples of how derivatives form an intrinsic part of every transaction that we make in our daily lives?

A: Derivatives are part of daily life. Curd is the simplest and easy example of a derivative. If milk prices go up, definitely curd prices will also go up and vice versa. Curd is made out of milk that is why the prices of curd are dependent on milk.

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