Classes can hardly ever be refreshing. 9 AM ones even less so. This one was just another such early morning class when I had dragged myself to the classroom.What more, it was a Sunday morning - a time when the majority of the sane world is hours away from getting off the bed. And then if you have taken an elective which only a few others have, then all of you put together are just too few in number to take the liberty to doze off in class.
Nevertheless, amidst strings of naps that lasted a few seconds (usually the times when the Professor is busy writing on the board), what struck me sometime in the middle of the lecture was this amazing concept that the Professor talked about. It was an "Options and Futures" class (scary stuff - isn't it! Nice way to brag on one's own blog!)- and the Professor was talking about the various ways one can use Stock Index Futures (I can easily imagine a big chunk of readers who have got until this point stopping right here! However, if you have ever invested in stocks / plan to do so in future, its worth continuing reading - trust me!)
Most of the times, when we are investing in the stock of a company, we are betting on the company to do well. What we tend to forget is that as we bought the stock, we not only took up the risk that the company may or may not do well, but also the risk that the market-in-general may or may not do well. Even if we do have that in mind, we usually do nothing about it. (Frankly, the "we" here means novice investors - which includes me!).
So, for example, if you invest in Company A purely because you think it will do well, and say some event occurs which brings the whole market down (Government toppled - War with Pakistan - etc), pulling down our dear Company A with it, then you make a loss even when your view on the company was probably correct. (The market-in-general say went down by 20%, while Company A went down by 5%. Hence the Company A has outperformed the market - but you still make a loss - you would have been much better off parking that money in a Savings Bank account!)
One way to ensure that your money is precisely where you want it to be is to go long on the stock and short on the index futures.(For the benefit of those who could not get head or tail of the last sentence - it simply means that you bet on the stock to do well and so you buy it now, and at the same time you also bet on the market-in-general to not do well and so you get into a contract saying - "I will make money if the market does not do well after 3 months, and lose if it does").
What this ensures is that the gains (or losses) you make in the stock purely because of the market 's performance in general are cancelled out by the losses (or gains) you make in the the contract. Thus you are left with the gains (or losses) which can be purely attributed to the stock! So, the investment is as good as your view on the company (and the company alone - not the market-in-general) with which you wanted to invest in the first place.
And I was awake for the rest of the class!
