I read in one of the post, a user asking how to generate additional capital to trade in F&O by pledging mutual fund.
What confounded me was the following:-
I always thought that f&O was a higher risk (relatively) product than buying shares in cash segment - This everyone agrees. The higher risk is because there is no delivery and if the trade does not go in your favor, you lose the margin or capital that you paid for the transaction.
Now, the user wants to pledge his Mutual Fund, and generate additional capital so that he can trade in F&o.
Is it double jeopardy!!!. On one hand he must have invested in MF for diversification and safetly and to the contrary, he now wishes to pledge this and trade in F&O.
If the trade goes against him, is the consequences the following:-
Initial capital or margin is lost.
Since he took the margin by way of loan by pledging MF, the broker will now liquidate his Mf to recover the capital/margin. (assuming he does not have cash inflow to pay the broker to offset the margin)
Pay interest cost for the margin.
F&O itself is contribute small and buy larger lots so you get higher profits/losses. This you cannot do in cash segment. When you are getting this benefit why increase the risk two times, by pledging his safety nest i.e MF.
If he was an aggressive investor he would not put his money in MF in the first place, instead use the entire corpus in F&O.
Can someone tell me is my understanding correct or am I missing a point.
I do understand that if the trade goes in his favor he benefits - that is noted. I want to understand the worst case scenario.
You need to read up. All losers donāt lose āentire capitalā if the trade goes wrong.
Hereās the losses scenarios
With futures, you lose to the extent of the mtm loss.
As an Option buyer, the max loss is only the premium paid. Low probability low risk trade.
As an option seller, you lose to the extent of ITM on expiry day. Itās a high probability-high risk trade.
For Option Sellers, max loss can be high if you donāt adjust accordingly. You can limit your loss with adjustments and stop loss. You can keep the profit potential alive with adjustments. You can also take ādefined riskā trades.
Along the way, Option sellers with large capital can keep moving the proverbial āgoal postsā if the trade goes wrong.
Even a person who sold options in March 2020 would have been fine if he rolled out to the next month.
If you trade small, trade often, the probabilities can work in your favor. When you trade small (and use less initial margin), you have additional margin for adjustments.
There are safer strategies too, like Cash secured Put and Covered Calls. You can sell puts at the price you want to buy a stock or sell ATM put (pocket fat premiums) if you want to buy the stock at current market price or sell Covered Calls on the stocks you own.
And yes, F&O can be dangerous. In the hands of the uninformed impulsive trader, Blow Up of Capital is a possibility with Naked Options. But no reason why a conservative and profitable Equity trader shouldnāt do āCash Secured Putsā and āCovered Callsā.
VIj, Thank you for advising me that I need to read - Yes I will and I am in the process of doing it.
So how come after reading your post from a well read person, I am still not able to clarify my doubts. I had asked a query on a simple transaction and wanted to know if my understanding is correct or not and what I get is something which I had not bargained for.
When I quoted capital/margin, I was referring to the margin for each transaction. If my understanding is correct it is simple yes or if my understanding is wrong, what is wrong need to be mentioned and if the query does not interest anyone, leave it blank.
It seems you have not read my query clearly - anyone else would have give a short yes or no answer or just minded their own business as this query from the undersigned was not upto their level and replying is a waste of your valuable time.
I hope I have made it very clear with this follow up post and will be ending it here. Your advise on reading is not appreciated.
Not entirely. Not always. It depends. It is possible.
Yes
Only if thereās debit balance.
Answering yes or no can be misleading, thatās why I tried to explain in my previous post. Reading and learning is a continuous process, my intention isnāt to belittle anyone.
The other thing you are not factoring in is that when people pledge MF to sell F&O, they are usually debt funds and the goal is to get an additional 5 to 7% return on capital.
For them the choice is to between keeping cash with broker which gives 0 return v/s invest in debt MF which will give some return.
They are comfortable with the risk for selling F&O, hence why they look at pledging MF they only look at the 5 to 7% extra return. They would anyway be taking the risk irrespective of MF pledge or not.
Ok Got it - Instead of keeping the money in SB account to generate 3.5%, the money is kept in MF to generate 5 to 7%. Against this, the borrower will take smaller tranches and he will be paying interest for this small tranche say at 9% for a max period of 60 to 90 days (I am assuming the F&O matures in this time at the most) So in the overall scheme of things it is beneficial to the borrower.
Makes sense, did not consider this aspect. Very articulately explained.
Another doubt, when you say, keeping cash with broker - arent all brokerage account linked to bank or is it that for few brokers we need to transfer the money to them to do business. With icci direct, it is linked to my icici bank account. Hence the doubt.
There is no interest payable on collateral margin.
Edit: With ICICI Direct there is, not with discount brokers like Zerodha, Upstox, 5paisa etc
One of the reasons why the top 3 brokers by marketshare are all discount brokers. With predatory tactics, the bank brokers, with their so called āfull serviceā (for whatever thatās worth) literally drove away many retail traders towards Zerodha and Upstox, with a stick.