How Mutual Funds Use Futures and Options in Investing

What are Futures and Options in Mutual Funds

Mutual funds make use of financial derivatives in the form of futures and options to manage risks and control portfolio volatility, subject to limits and guidelines prescribed by SEBI. These are linked with securities such as stocks or market index. Fund managers use them carefully to avoid losing investments and controlling market fluctuations within the regulatory limits.

• Futures: Futures are contracts to buy or sell a stock or market index at a predetermined price on a future date. They are mainly used to hedge and retain market exposure.
• Options: Contracts giving the right, while not creating an obligation, to buy (call option) or sell (put option) an asset at an agreed price within a certain duration. They support in limiting losses during uncertain market conditions.

Types of Mutual Fund Schemes

The Securities and Exchange Board of India (SEBI) classifies mutual funds into five broad categories based on asset class and investment objective. These are tailored to various investment objectives, risk, and investment periods.

• Equity Schemes: It is a type of fund that invests primarily in equity and equity-related transactions. These investment schemes can offer good long-term gains but remain subject to market risks.
• Debt Schemes: Debt funds invest in fixed-income instruments, like bonds, treasury bills, and corporate debt. Their goal is to offer steady returns at a comparatively lower risk.
• Hybrid Schemes: Hybrid funds are investments in a combination of both equity and debt securities. They aim to balance growth and risk, and therefore would be suited to moderate risk investors.
• Solution-Oriented Schemes: These plans focus on a defined financial aim such as retirement or child education. They normally come with an extended lock-in period.
• Other Schemes: This category includes funds that do not fit into the above groups, such as exchange-traded funds (ETFs), index funds and funds of funds.

Key Takeaways

Stocks and debt instruments are the main investments in mutual funds. Futures and options are also used in some schemes to deal with risk. These tools help manage portfolio risk and support better asset allocation. When used within regulatory limits, derivatives can enhance portfolio stability and risk management.