Futures and options are financial derivatives that allow investors to hedge against market risks and speculate on the future movements of the underlying assets, such as stocks, commodities, or currencies. Let us discuss what Futures and options are and the difference between futures and options. In recent years, the use of futures and options has been gaining popularity in the mutual fund industry, as fund managers seek to protect their portfolio’s value and generate additional returns.
Futures
Futures are contracts that obligate the buyer to purchase or the seller to sell an underlying asset at a predetermined price and date in the future. The price of the underlying asset is known as the futures price, and it is determined by the market forces of supply and demand. Futures are used to hedge against price fluctuations, as investors can lock in a price for a future purchase or sale of an asset. In the mutual fund industry, fund managers use futures to hedge against market risks and to generate additional returns by speculating on the future movements of the underlying assets in the portfolio.
Options
Options, on the other hand, are contracts that give the buyer the right, but not the obligation, to purchase or sell an underlying asset at a predetermined price and date in the future. The price at which the buyer can exercise the option is known as the strike price. Options are used to speculate on the future movements of the underlying assets, as investors can buy call options to bet on a price increase or put options to bet on a price decrease. In the mutual fund industry, fund managers use options to speculate on the future movements of the underlying assets in the portfolio and to generate additional returns.
The use of futures and options in mutual funds can provide several benefits to investors, such as:
Benefits:
- Risk management: By using futures and options, fund managers can hedge against market risks and protect the value of the portfolio. For example, if a fund manager expects the price of a stock in the portfolio to decrease, he can sell a futures contract at the current price, thus locking in a price for a future sale of the stock.
- Increased returns: Fund managers can use futures and options to speculate on the future movements of the underlying assets in the portfolio, which can generate additional returns for investors. For example, if a fund manager expects the price of a stock to increase, he can buy a call option at a lower strike price, thus betting on a price increase.
- Diversification: By using futures and options, fund managers can diversify the portfolio and reduce the dependence on a single asset class or sector. For example, a fund manager can use futures and options to bet on the price movements of commodities, currencies, or interest rates, which can provide additional returns and reduce the dependence on stocks or bonds.
However, there are also some risks associated with the use of futures and options in mutual funds, such as:
Risks:
Leverage: Futures and options are leveraged products, which means that a small movement in the price of the underlying asset can result in a large profit or loss. This can amplify the risk of the portfolio and increase the volatility of the returns.
Liquidity: Futures and options are traded on exchanges, and the liquidity of the market can be affected by the volume of trading and the open interest of the contracts. This can affect the ability of the fund manager to enter or exit a position and increase the risk of slippage.
Complexity: Futures and options are complex financial derivatives that require specialized knowledge and expertise to use effectively. This can increase the risk of mispricing or mismanagement of the portfolio.
In conclusion, the use of futures and options in mutual funds is becoming increasingly popular as a way to hedge against market risks and generate additional returns. The use of these derivatives can provide several benefits such as risk management, increased returns