Why Use Derivatives to Enhance Your Mutual Fund Investments ?

Are you tired of lacklustre returns on your mutual funds ? Want to take your investment strategy to the next level ? - Learn how to use derivatives to boost your earnings and increase your investment potential. So what are derivatives? Derivatives are financial contracts that derive their value from an underlying asset, such as stocks, bonds, currencies, or commodities. These contracts can be used to hedge against potential losses or to speculate on the direction of the underlying asset. When used with traditional investments like stocks, bonds, or mutual funds, derivatives can help increase returns. To enter into a derivative trade, you need to put up a certain amount of money, known as the margin. The margin can be made available by using cash, stocks, bonds, or mutual funds. - Derivative trades give a separate profit or loss, in addition to the profit or loss from the underlying asset. For example, if you buy a stock and enter into a derivative contract, you could earn a profit on both the stock and the derivative. Similarly, if the stock performs poorly, the derivative can help offset some losses. - Now let's take an example of how derivatives can be used with mutual funds to enhance returns. Often, investors get frustrated with mutual funds that don't perform well or give negative returns. To improve returns, you can use the same mutual funds as margin for derivative trades. For instance, let's say you invest Rs 50 lakhs in the ICICI Prudential Nifty Index Fund. This mutual fund tracks the Nifty index and gives a return based on its performance. You can use this mutual fund as a margin and get approximately Rs 35-40 lakhs margin for derivative trading, depending on the prevailing margin rules and exchange guidelines. - Now, you can use derivatives to generate an additional return on top of the return from the mutual fund. Derivative strategies can use futures and options in equity, commodity, currency, or debt. Conservative investors can opt for strategies that give a 5% excess return from derivatives with a risk of a 5% loss on the invested amount in mutual funds. To better understand this concept, let's consider two scenarios: - Scenario 1: You invest Rs 50 lakhs in the ICICI Prudential Nifty Index Fund. Assuming a post-tax return of 15% over 10 years, the ending value would be Rs 2.02 crores. - Scenario 2: You invest Rs 50 lakhs in the same mutual fund, but also enter into derivative trades using the mutual fund as a margin. Assuming a post-tax return of 15% from the Nifty and an additional 5% return from the derivative strategy over 10 years, the ending value would be Rs 3.1 crores. Conclusion Derivatives can also be used with debt mutual funds to generate steady returns. The general rate of interest for bank fixed deposits (FDs) is approximately 5% as of January 2022. However, when invested along with derivative strategies, the expected return can be increased to 9-10% on a conservative basis. Of course, it's important to note that the return from derivative strategies can be further increased depending on the investor's risk appetite. It's always advisable to consult a financial advisor or expert before implementing derivative strategies to enhance your returns.