Skip to main content
texts

Can mutual funds invest in futures and options? A detailed guide

#
Share :

When reading about stock markets and investing, you may come across the term futures and options (F&O) and wondered if mutual funds use them. The short answer is yes, but only for specific purposes and under strict regulations.

Futures and options are derivative contracts that derive their value from an underlying asset, like a stock or an index. Let’s take a closer look and explore how mutual funds trade, the role of futures and options, and the rules surrounding their use.

  • Table of contents
  1. Types of mutual funds
  2. Why should you choose mutual funds?
  3. What are futures and options?
  4. Role of futures and options in a mutual fund
  5. Guidelines around the use of futures and options

Types of mutual funds

To understand how mutual funds trade and their use of F&O, it’s important to know the types of mutual funds. Here are some categories:

  • Equity mutual funds: These funds invest in stocks and aim for long-term growth. They are suitable for investors looking to potentially build wealth over time and willing to take risks. Subtypes include large-cap, mid-cap, and small-cap funds, catering to different risk appetites.
  • Debt mutual funds: These focus on bonds, treasury bills, and other fixed-income securities. They are less risky and provide relatively stable return potential, making them suitable for conservative investors or short-term goals.
  • Balanced or hybrid funds: These combine stocks and bonds to balance risk and reward potential and can provide both growth potential and relative stability.
  • Index funds: These passively track a stock market index like Nifty or BSE Sensex. They are simple, low-cost funds ideal for beginners and those who prefer a hands-off approach.

Knowing the differences between these types helps you choose a suitable fund based on your risk tolerance, time horizon, and financial goals. Each fund type serves a specific purpose, giving you flexibility in your investment journey.

Why should you choose mutual funds?

Mutual funds can be a beneficial investment choice for many reasons:

  • Professional management: Investment experts make informed decisions based on market research and analysis, saving you time and effort.
  • Diversification: By spreading your money across various assets like stocks, bonds, and other instruments, mutual funds reduce the risk of losses tied to any single investment.
  • Affordability: With many SIP options starting at Rs. 500 a month, mutual funds make investing accessible to a wide spectrum of people.
  • Liquidity: Most mutual fund schemes are open-ended and therefore, easy to buy and sell, providing you convenient access to your money.
  • Transparency: Regular reports and disclosures keep you informed about the fund’s performance and where your money is invested.

Additionally, mutual funds can cater to investors with varying goals and risk appetites, making them a flexible investment option.

What are futures and options?

Futures and options are financial contracts that allow people to buy or sell something at a future date, often used to hedge risks or speculate in financial markets. Both fall under the category of ‘derivatives’, which are financial instruments whose value depends on (or is “derived” from) the value of an underlying asset.

Futures

A futures contract is an agreement to buy or sell an asset (like stocks, gold, or oil) at a specific price on a specific future date. It’s like pre-booking something for later but locking in today’s price. For example, if you think the price of oil will go up, you can agree to buy it at today’s price using a futures contract. When the price goes up, you can sell it at the higher market price, earning a profit. However, you must buy or sell when the contract ends, regardless of whether it benefits you.

Options

An options contract gives you the choice (but not the obligation) to buy or sell something at a certain price by a certain date. There are two types:

  1. Call Option: Gives you the right to buy at a set price.
  2. Put Option: Gives you the right to sell at a set price.

For example, if you buy a call option for a stock, and its price rises, you can buy the stock at the lower set price and profit.

Both involve risk, and their value depends on the asset’s price, time, and market factors. They’re widely used by traders and businesses to manage financial risks or aim for higher returns.

Role of futures and options in a mutual fund

Futures and options (F&O) are advanced tools that mutual funds use for specific purposes, such as:

  • Risk management: F&O help mutual funds protect their portfolios from market volatility. For example, if the market is expected to decline, a fund can use F&O contracts to hedge its investments and minimise potential losses.
  • Efficient portfolio management: Fund managers use F&O to rebalance or adjust their portfolios swiftly without needing to trade individual securities, ensuring alignment with investment strategies.
  • Arbitrage strategies: Some funds employ derivatives to exploit price differences between the cash and derivatives markets, aiming for risk-free profits.

Mutual funds do not use F&O for speculative purposes. Instead, these tools are employed thoughtfully to make the fund more adaptable to changing market conditions, providing added value to investors.

Guidelines around the use of futures and options

Mutual funds trade in options and futures under strict rules to ensure investor protection:

  • Limited exposure: Regulatory bodies cap the proportion of assets a mutual fund can allocate to F&O, ensuring the fund remains diversified and does not depend heavily on derivatives.
  • No speculation: Mutual funds cannot use these instruments to speculate or gamble on market outcomes.
  • Clear objectives: The use of F&O must align with the mutual fund’s stated goals, ensuring that investors' expectations and the fund’s actions are consistent.
  • Transparency: Fund houses are required to disclose all F&O transactions in regular reports, giving investors a clear view of how these tools are utilised.
  • Regulatory compliance: All F&O activities must adhere to guidelines set by regulatory authorities like SEBI, ensuring accountability.

These rules ensure that mutual funds use F&O responsibly, safeguarding investor confidence and maintaining the fund’s integrity.

Conclusion

Mutual funds can trade in options and futures, but only under strict guidelines. These tools are used to manage risks, improve portfolio efficiency, and ensure liquidity—not for speculation. This makes mutual funds a reliable choice for investors seeking professional management and diversification.

Whether you’re new to investing or a seasoned investor, mutual funds offer a range of options to meet your needs. With tools like futures and options, fund managers can seek to address market challenges. Start small, stay consistent, and watch your money potentially grow with mutual funds.

FAQs

Can I trade in mutual funds?

Yes, you can buy or sell mutual funds, but they aren’t traded like stocks. Instead, they are purchased and redeemed through fund houses or platforms based on their Net Asset Value (NAV).

Is mutual fund trading profitable?

Investing in mutual funds has the potential to be profitable over time if you choose funds wisely and remain patient. However, they come with risk and returns are not guaranteed.

Can I invest Rs. 100 daily in mutual funds?

It depends upon the asset management company’s policies. Some companies may allow investments of Rs. 100 daily through a Systematic Investment Plan (SIP).

How do I start trading in mutual funds?

The use of the term ‘trading’ in mutual funds has a different connotation than in stocks. Rather than frequent buying or selling, in mutual funds, trading simply refers to the purchase or sale of mutual fund units.
To start trading mutual funds, you can follow these steps.

  1. Open an account with a mutual fund platform.
  2. Choose a fund that matches your goals and risk level.
  3. Start investing through a lump sum or SIP.
  4. Monitor your investments regularly to stay on track.

You can also invest or redeem units through a mutual fund distributor, investment advisor or aggregator platform.

Mutual Fund Investments are subject to market risks, read all scheme related documents carefully. This document should not be treated as endorsement of the views / opinions or as an investment advice. This document should not be construed as a research report or a recommendation to buy or sell any security. This document is for information purpose only and should not be construed as a promise on minimum returns or safeguard of capital. This document alone is not sufficient and should not be used for the development or implementation of an investment strategy. The recipient should note and understand that the information provided above may not contain all the material aspects relevant for making an investment decision. Investors are advised to consult their own investment advisor before making any investment decision in light of their risk appetite, investment goals and horizon. This information is subject to change without any prior notice.

texts