Previously in this column, we discussed combining short Nifty futures with your existing long position in Nifty ETF to moderate regret when the index declines. This week, we extend this discussion in two ways. One, we discuss the operational efficiency of the strategy and compare this to a popular strategy called shorting the box. And two, we discuss the strategy of adding Nifty futures to your existing ETF position.
Time arbitrage
Shorting the box is a strategy where you short securities against a long position you already hold. During the early days of physical delivery, investors in the US would keep their shares in a safe deposit box. So, when they went short against this long position, they were said to be shorting against the box. Suffice it to know that shorting the box was primarily intended to save taxes. The laws have since changed in the US. Our previous discussion of shorting Nifty futures against your existing Nifty ETF position is a similar strategy with a different intent — to capture short-term price movements on the Nifty without closing your long-term ETF position set-up through an SIP.
While we discussed the behavioural angle previously, there is operational efficiency associated with the strategy. If you sell your ETFs because the Nifty Index pauses its uptrend or starts a temporary downtrend, what will you do with the sale proceeds? Invest lump-sum or set up another SIP later? Either choice could expose you to further regret. What if you invest lumpsum and the market declines thereafter? You could have bought more units of the fund or ETF if you had waited for a while. And if you set up an SIP with the intent to engage in rupee-cost averaging, will you be careful not to spend the sale proceeds till they are invested? Combining Nifty futures with the Long ETF is operationally efficient. Be mindful that ETF units you have in the demat account must fully cover the permitted lot size of Nifty futures.
This brings us to the next discussion. You could also use Nifty futures to add to your existing long ETF position to take advantage of a short-term uptrend in the index. In some ways, you would be engaging in a strategy that institutional money managers do to quickly adjust the beta of their portfolio; they go long on index futures when they expect the market to move up and short on futures when they expect the index to move down.
Optional reading
The above strategy is best used on the Nifty Index and on the Bank Nifty. It is not optimal to use it on individual stocks that you may have in your long-term portfolio. This is because the intention of this strategy is to capture short-term price trends in the market. It is relatively easy to capture the trend on an index than on individual stocks. You could consider covered call strategy on such stocks instead.
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