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How To Trade with Interest Rate Futures

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indian rupees new 300x197 How To Trade with Interest Rate Futures

Knowing the future and taking advantage from it, is a dream come true for every one. Those that possess the skills are able to reap the benefits from it. On Dalal Street, investors and speculators alike will forecast the market movement of the index and commodities by trading in the derivatives. The NSE launched trading in Interest Rate Futures (IRF) recently on 31st Aug after a gap of 6 years.

Interest rate futures will enable to investors to take a position on the interest rates. It will also them to hedge their cash flows that they have. Hedging of the cash flows would be required since they may have exposures to a number of mortgage loans or even on long term fixed deposits.

When you buy an IRF, you are entering into an agreement to trade (buy or sell) a debt instrument. This is usually a government bond that carries an interest rate of 7% that is payable half yearly. The price of this instrument is fixed and this protects the investors against any risk from changes in the interest rates. Since the delivery of the instrument has to be done through stock market, it ensures that that instrument is delivered.

Experts and analysts believe that you should take position in the interest rate futures only if you have any exposure to the fixed income instruments. This will let you hedge the risk by using these fixed income instruments.

Retail investors will usually start with equities, debts, mutual funds, and currencies and finally when they are more confident, they will slowly graduate to IRF’s. Since IRF’s as a trading instrument is more complex and requires more understanding of the financial markets than the other instruments.

If you really want to gain expertise, then you should monitor and understand how the inflation rate works. This will help you in attaining the goal of minimizing your risks and safeguarding the investments that you may have made. Being well versed on how the market operates for interest rate futures is the key in booking profits and keeping the investments safe. The basic knowledge of the historical values of the interest rates is a must. Know the risks of trading the interest rate futures before you actually start trading in the product.

Globally IRFs are traded the most and in fact 80% of the derivative trading volume can be attributed to this class of futures.

Mechanism of the instrument

Quite simply when the interest rates are 8%, then an IRF would trade at 92, if the interest rate goes down (unlikely in the near future as of now) to say 7%, then you would buy the IRF now. In the reverse scenario, if the interest rates were to head north say 9%, and then you would sell the IRF. In this way you would be booking the profits on the IRF instruments.

All future based trading instruments do well, when they move according to the anticipated situations. In those cases the pay offs and return on investments are really good. The same is the case with IRF. The returns are of course dependent on the kind of leverage that you have and the kind of investments that you have made.

Of course then if the market moved contradictory to your estimation, then there would be huge losses and you would have to honour your margin requirements. This is a high stakes game where the losses can be equally big.

How to deal in IRF

Dealing in IRF is a bit complicated. But if your fundamentals are clear, then you will stand to gain immensely. You would need to have a  “Subsidiary general ledger account” with an exchange. This will help you to get the timely delivery of the instruments (securities) at the time of the settlement.  All resident Indians can trade in the IRF’s in much the same way that they can invest in stocks and debts through the stock exchanges. The National Stock Exchange (NSE) has even waived off the transaction fee for IRFs till the end of the year. This means that you would only need to pay the brokerage commissions for trading in the IRF’s.

The minimum contract size for the IRF is 2,00,000 and this can be purchased with a margin amount of just 2.5%. Now you can trade and purchase the funds with just Rs. 5000. When investors anticipate that there may be a fall in the bond prices, then they can make up for the depreciation losses. With IRF instruments, they are in a better position to do so. Retail investors can easily sell short if they anticipate a fall.

Analysts feel that this platform is an extremely efficient platform to hedge the risks whether they are investors or speculators in the market. As of now, many experts believe that the delivery mechanism can be improved, as it’s quite complex at the moment.