You are bullish on a stock say Satyam, which is currently quoting at Rs 280 per share. You believe that in one month it will touch Rs 330.
Question: What do you do?
Answer: You buy Satyam.
Effect: It touches Rs 330 as you predicted – you made a profit of Rs 50 on an investment of Rs 280 i.e. a Return of 18% in one month – Fantastic!!
Wait: Can it get any better?
Yes!!
Question: What should you do?
Answer: Buy Satyam Futures instead.
Effect: On buying Satyam Futures, you get the same position as Satyam in the cash market, but you pay a margin and not the entire amount. For example, if the margin is 20%, you would pay only Rs 56. If Satyam goes upto Rs 330, you will still earn Rs 50 as profit. Now that translates into a fabulous return of 89% in one month.
Unbelievable!! But True nevertheless!!
This is the advantage of ‘leverage’ which Stock Futures provide. By investing a small margin (ranging from 10 to 25%), you can get into the same positions as you would be able to in the cash market. The returns therefore get accordingly multiplied.
Question: What are the risks?
Answer: The risks are that losses will be get leveraged or multiplied in the same manner as profits do. For example, if Satyam drops from Rs 280 to Rs 250, you would make a loss of Rs 30. The Rs 30 loss would translate to an 11% loss in the cash market and a 54% loss in the Futures market.
Question: How can I reduce such losses?
Answer: It is very easy to reduce/minimize such losses if you keep a sharp eye on the market. Suppose, you are bullish and you hence buy Satyam futures. But Satyam futures start moving down after you have bought. You can square up your position at any point of time thereafter. You can buy at 10: 30 in the morning and sell off at 11: 00 on the same day. There is no restriction at all.
Thus, by squaring up early
