What are your future options?

A British schoolboy cricketer had once approached Sir Geoff Boycott to learn how to play the hook shot, because he was frequently getting out trying to hit a hook. Boycott told him that the best way to play the hook shot was not to play it! "But how do I score runs?", the boy had asked. Boycott's response was typical: "Don't get out! The runs will come."

Futures and options trading by small investors is akin to a school boy playing the hook shot. The chances of losing money overshadows the probability of scoring big. It is far better to buy quality stocks and wait for your wealth to grow.

Nowadays the lot sizes for F&O trading have been reduced, but the risks have not. Such trading is better left to professional and institutional investors who play for much bigger stakes and usually buy or sell in the cash market and hedge in the futures.

There is no harm in being aware of what F&O trading is all about, and some smart investors can get clues about the market from the difference in spot and future prices and volumes. But I get  confused when I hear talk about 'covered calls',  'strangles' and 'naked futures' and have stayed far away from F&O trading.

Seems like I'm not in a minority of one. The legendary Peter Lynch has made the following comments in his book 'One Up on Wall Street':

"I've never bought a future nor an option in my entire investing career.... Reports out of Chicago and New York, the twin capitals of futures and options, suggest that between 80 and 95% of the amateur players lose. Those odds are worse than the worst odds at the casino or at the race track, and yet the fiction persists that these are 'sensible investment alternatives'.... I know that the large potential return is attractive to small investors who are dissatisfied with getting rich slow. Instead they opt for getting poor quick .... Warren Buffet thinks that stock futures and options ought to be outlawed, and I agree with him."

Is this the time for Tisco?

During the glory days of the Bombay stock market - when there was no NSE, no Internet, no Reliance, no Bharti - the traders used to flock to Dalal Street to make their fortunes by trading Tisco (i.e. Tata Steel) shares.

It was the bellwether of the stock market till new age stocks like Reliance and Bharti pushed it to the background as a 'widows' stock. So it stayed in the background, while continuing to churn out excellent results by curtailing costs and judiciously expanding capacities.

Then Ratan Tata and his team decided enough was enough and it was time to look ahead and become a global player through acquisitions. Tisco made preliminary forays in South East Asia, buying plants in Thailand, China, Singapore, Vietnam. And then came the crowning glory - the Corus acquisition, that catapulted Tisco to the worldwide 6th position in the steel industry.

Historically, acquisitions have known to be value destructive for shareholders, and the jury is still out about the success of integrating Corus with Tisco. Already margins have been affected though turnover has risen manifold. Tisco management is working on that by trying to secure raw material sources globally, mainly for Corus that needs to buy its raw materials (and unlike Tisco which is an integrated plant).

However, the stock that had touched Rs 970 just a few months back, with no dearth of buyers, is now down to Rs 470 odd. That gives Tisco a Trailing Twelve Months (TTM) P/E of 6.7 and a P/BV of 1.6 as per June '08 results.

Technically also, the indicators are heavily oversold and ripe for an upward spurt. That does not mean Tisco can't go down to Rs 400 level. But for those who are trying to build a portfolio, this is a very appropriate time to enter.

An interesting bit of trivia for those who are still not convinced. The June '08 quarter's net profit of Rs 1686 Crores is just about Rs 130 Crores less than the net profit of ALL the listed cement companies (yes, that includes ACC, Ultra Tech, Ambuja, Prism, Birla Corp, JK, Sree, Madras, India, Chettinad, and the rest from north and south India).

So, the short answer to the question is 'yes'. This is a great time for Tisco (I mean Tata Steel - as a long time shareholder I just feel more comfortable with Tisco!).

A Sensex extra

Some interesting patterns happened in the Sensex on Monday, Sept 15, 2008 that prompted this extra edition to my weekly posts.

First, the EMAs. The 20 EMA had kept close contact with the 50 EMA while both averages were below the 200 EMA. Monday's price action has sent both the 20 EMA and 50 EMA downwards signalling the next (and last?) down wave of a 5 wave bear pattern.

Now the interesting part in the price action. The first up-wave of the three-wave bear market rally from the July '08 low of 12500 was resisted at 15100 or so. The second wave came down to 13700 and the third wave went up to about 15600. 

This was a lower top. The first down wave got supported at 14000. The next up-wave tried to cross the 15100 resistance twice and failed - thereby forming not only a double-top but a 'head-and-shoulders' pattern where the left and right shoulders are both near 15100, the head is at 15600 and the neckline is at a slight angle to the horizontal drawn through the 13700 and 14000 support points.

Last Friday, Sept 12 '08 the Sensex was tantalisingly perched near  the neckline at 14000. Monday's price action has decisively broken through the neckline, confirming the head-and-shoulders pattern.

So what happens next? This is where the true beauty of the art of technical analysis lies! The price implication of a head-and-shoulders pattern is that once the neckline is broken the Sensex will retrace at least the amount by which the 'head' is above the neckline.

The difference between the head and the neckline is around:

15600 -14000 = 1600 points.

The Sensex will, therefore, drop atleast 1600 points from the neckline; i.e. to:

14000 - 1600 = 12400.

This is close enough to where the last bottom of 12500 was made in July '08. So we are looking at a bottom testing situation as a first target. If 12500 does not hold, then we might see 10000 level.

A detailed reasoning for these levels were given in an earlier post. There is a possibility that the Sensex may not drop all the way down to 12500 or 10000 right away. Instead it may try to recover around 13100 levels and then meander along sideways for a while before testing or breaking the previous bottom.

The earlier advice of buying in small lots (either in 'A' group stocks or in diversified Equity funds) below the 13000 level is reiterated. In my next post, I plan to discuss if it is the time to Tisco!

How to exercise your rights

Several large rights issues from companies like Tata Motors, Hindalco, Tata Investment will be hitting the market in the near future. Recent entrants to the stock market, like my young friend Bala, may not have a clear idea about what to do with a rights issue.

Once you receive the rights issue application form and the offer booklet from the company, go through the details of the offer. Special attention should be given to the details about how much to pay, when to pay, where to pay and what to write on the cheque. Any mistakes can cause your application to be rejected.

Several options are available to the investor. These are listed below:

1.  Apply for your entire entitlement; e.g. if your entitlement is 42 shares, this figure will be clearly mentioned in the application form; just fill out the form and pay the application money for the 42 shares

2. You may apply for additional shares in the box provided in the form; e.g. apply for 8 additional shares and pay your application money for (42+8=) 50 shares; chances are you will get allotment for the 50 shares because the market is in a bear phase and many investors may not apply for additional shares. Don't get greedy and apply for 52 additional shares. You may then get an allotment of say 17 shares and be left with an odd number of 59 shares (which may be difficult to sell later in one lot)

3. You can apply for less shares than your entitlement; e.g. apply only for 25 shares and let the balance entitlement of 17 shares lapse

4. You may 'renounce' your entire entitlement in some one else's favour, like your broker or your friend. You will usually get a monetary consideration for your renouncement, say Rs 8 per share.

5. You can request the company for split forms, i.e. 25 shares in one and 17 shares in another. That way you can apply for 25 shares and 'renounce' the balance 17 for a consideration of say Rs 8 per share

6. You can decide not to do anything at all and let your entire entitlement lapse.

Why would you choose this last option? In a falling market the difference between the market price and the rights price may not be large enough. After the rights issue is over, the market price may even drop below the rights issue price. So you may be better off to buy the shares at market price after the rights issue is over if you feel the rights price is not leaving a large enough margin of safety.

Investors who participated in the recent rights issues of ICICI Bank and State Bank will know what I'm talking about.

There is a recent move by SEBI to make rights issues paperless, but as on date it remains a proposal only. If readers have any questions on rights issues, please send me an email with your specific query ( or leave a comment on the blog).

Are the media companies 'defensive'?

With the stock markets in a long-term bear phase, experts and analysts have been suggesting that investors look at 'defensive' sectors like FMCG, pharma and IT. The logic behind such suggestions is that whether the market is in a bull or bear phase soaps, toothpastes, medicines and IT services will get consumed.

By the same logic, people will listen to radio, read newspapers and magazines, watch TV and movies regardless of the gyrations of the Sensex.  So media companies should fall under the 'defensive sector' category.

Why aren't the analysts talking about them? Possibly because the different sub-groups of the media sector have different dynamics. Let us have a closer look.

Movies, books and CD/DVD businesses require upfront investments for every new 'product'. Actors, authors and musicians need to be paid beforehand. There are no guarantees that a particular movie or book or CD will sell.  If it sells well, there will be a lot of cash inflow. If not there will be a loss. One hit product may or may not make up for all the losses. Such uncertainty is what investors are wary about.

Radio and TV businesses are largely dependent on advertising. If a particular channel has national recognition - e.g. Radio Mirchi or Star Plus - it can charge a premium rate and advertisers will have no choice but to pay up. But during a downturn, advertising budgets do get cut. The fringe channels get hurt the most and are sometimes wiped out.

The magazine and newspaper businesses are the real 'defensive' ones. Magazines are subscription based and the money is collected in advance and the product is delivered over several months/years. No wonder magazine subscriptions always come with lots of 'free' offers.

The newspaper business is truly recession-proof. No matter what happens in the stock market or in the economy, no body stops reading a newspaper. With the advent of computers and the Internet, a newspaper can be published simultaneously from several locations. However, newspapers tend to have a monopoly in their particular region/location. Think of Times of India in Mumbai, Hindustan Times in Delhi, The Hindu in Chennai, The Telegraph in Kolkata, Deccan Chronicle in Hyderabad.

My favourite among the newspaper companies is Jagran Prakashan. Why? It's circulation is more than the combined circulation of all the well-known English dailies mentioned. Plus it has great cash flows.