Parag Parikh Long Term Equity fund will be introducing 'covered call strategy' in the fund. This can be a game changer for the fund in a market that does not steeply go up or moves up gradually or stays sideways or even falls (1/n)
Options is slightly difficult to explain over twitter, so here’s my video on ‘basics of options’, do subscribe to my channel ☺ (2/n)
How does a cover call work?
When a fund buys a stock, they expect it to go up. But they don’t make returns if the stock stays sideways or falls and is exactly where cover call comes into picture. Let me explain, (3/n)
Lets say PPFAS has invested in RIL @ the current market price of 2315. PPFAS will sell a call option of RIL at 2600 & receive a premium of 10 rupees. Selling a call option @ 2600 means the fund is nt expecting RIL 2 move above 2600 in that month (last Thursday of the month)”(4/n)
Lets see how much profit/loss does the fund make in various possible situations
Situation 1 – RIL closes the month @ 2315
Return – As the stock dint close above 2600, PPFAS will make 10 rupees of profit where as other funds holding RIL will make nothing. PPFAS at advantage(5/n)
(2)-RIL closes @ 2200
Return–The stock dint close above 2600, PPFAS will make 10 rupees of profit. While any other fund holding RIL will make a loss of 2315 – 2200 = 115, PPFAS will loss 115 – 10 = 105 as it has received 10 as premium from the call option. PPFAS at advantage(6/n)
(3)–RIL closes the month @ 2600
Return–As the stock dint close ABOVE 2600, PPFAS will make 10 rupees of profit. While any other fund holding RIL will make a profit of 2600–2315=285, PPFAS will gain 285+10=295 as it has received 10 as premium 4m d call option. PPFAS advantage(7/n)
(4)–RIL closes the month at 2640
Returns-As the stock closed above 2600, PPFAS will loose 30 rupees (2640 – 2600 = 40 but has received 10 as premium so net loss 30), as it was not expecting it to close above 2600. (8/n)
While other fund holding RIL will make a profit of 2640 – 2315 = 325, PPFAS will gain less 325 - 30 = 295. PPFAS at Disadvantage (9/n)
While theoretically people may argue saying writing a call is a risk strategy, covered call (buy the share and then selling the call) has its own advantages. 3 out of 4 probability in favor of PPFAS as explained above. (10/n)
Negatives – 1. NAV may become volatile due to market-to-market impact
2. There can be some opportunity cost loss, if after selling the call option in the interim the fund decides to sell the stock
3. If the fund size increases drastically, options may have an impact cost(11/12)
Overall it’s a win – win in my opinion. (END)
Just to clarify, it is not necessary that the fund will always and at all times use it. They might use it only when they think it is prudent. They are currently only adding this as a provision.

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More from @kirtan0810

16 Jul
While there is some confusion around MFD & RIA, below is what i gather from the @fpstudycircle meeting today

(1) MF distributors cant charge fees and can only make monies through commissions (1/4)
(2) Individual RIAs (clients less than 150) cant make commission income and can only charge fees. Individual RIAs has to advice direct where ever there is available and commission products are allowed where ever direct not available like corporate FDs etc. (2/4)
(3) Corporate RIA entity can run both fee based & distribution. Depending on the clients requirements the entity can segregate the client 2 fee based or distribution services but cant make money through fees & distribution both 4m the same client. This is client level segregation
Read 4 tweets
2 Jun
There seems to be a fair bit of confusion amongst investors on what’s happening in arbitrage funds. Let me explain the arbitrage space and how it works with MFs. Not sure if it is simple enough but have tried (1/n)
Mutual Funds do cash future arbitrage. Assume a stock to be at 100 in cash market and 101 in futures market at the start of the month. Mutual Funds will buy stock in cash market at 100 and sell futures at 101 thereby locking a 1 Re profit. (2/n)
Last Thursday which is the expiry, the cash and future prices merge (that’s how it works), so irrespective of whatever the cash price is, the fund still makes 1 Re. (3/n)
Read 12 tweets
14 May
What was the NBFC package all about and will it help MFs?

(1) 30,000 cr will be infused. So any bank who wants to buy NBFC/HFC/MFIs debt paper from the secondary market (mainly from MFs) can buy it and the guarantee will be given by the government (1/n)
so if after having bought the paper if the institution defaults, government will pay. This is only for Investment grade paper (BBB- and above). This is definitely a big plus for MF. The FT schemes that got shut have 40% exposure to the above sector. (2/n)
(2) The same 30,000 cr above can also be used to subscribe for primary (new) issues/fund raising by the financial institutions. (3/n)
Read 5 tweets
26 Apr
I am afraid that some section of the media reporting that investors will receive money around the average maturity of the fund may not really work that way. Reports say, if FT Ultra short is 0.62 years Average Maturity, pay back will be roughly 7-8 months, I doubt! (1/n)
How are investors going to be paid back?
(1) Interest on the debt
(2) Maturities proceedings
(3) Selling debt in the secondary market (2/n)
(1) Interest income – This is very difficult to calculate & FT should issue this soon but assuming the 10k cr portfolio is earning 10%, interest income will be 1000 cr., roughly. This may have deviation from the actual. (continue)
Read 11 tweets
27 Aug 19
Let me explain the 1.76 lakh cr transfer 4m RBI to government

Its split into 2,

(A) 1.23L cr of dividends paid out from the profit of this year.

(B) 52K cr of capital paid out (Older profits accumulated n have become a large reserve of which 52,600 was paid out)
(A) Let’s first try and understand the 1.23 lakh cr dividend which is higher than the average dividend paid (60-65k cr.) over the last 5 years. How could the RBI afford to pay so much divided? (2/n)
So this year RBI made huge profits, how?
(a) Higher OMOs - RBI bought a lot of bonds from the markets to infuse liquidity in the system. When RBI owns more bonds, it received higher interest as income. (3/n)
Read 9 tweets

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