Derivatives Losses – Rs. 111,800 in a day on a lot – Suzlon crash

Today’s Suzlon crash is a good example of why derivatives are particularly risky. You can have large profits or be left with  big derivatives losses if you are unaware of what you are getting into.

Suzlon stock intra-day price chart


Source: Google Finance

Suzlon crashed by around 29% in one day. The stock closed yesterday at Rs. 24.25. Today it closed at Rs. 16.00 on the NSE. Intra-day, it went as low as Rs. 13.35.

Suzlon in CDR – background story

Suzlon, the wind-turbine manufacturer, is currently facing severe business pressure. They had taken on too much debt when they went on an acquisition spree in the last 6-7 years. The financial crisis of 2008-09 hit them hard. They are going through a Corporate Debt Restructuring (CDR) process right now.

Today, promoters sold 10.995 crore shares which amounts to 6.19% of the paid-up capital or the company. The amount generated by this share sale is to be utilized towards the CDR process.

This is standard. Promoters are supposed to put in their own money in parallel with the restructuring of loans by the banks. This ensures that the promoters also take some risk or “have skin in the game”.

After noon the company shared this announcement with the Exchanges. It seems market participants did not take the announcement too well as the stock price chart show.

Though, personally, I do not see anything wrong in the stake sale if the promoters are serious about reviving the company and getting out of CDR.

 

If you held a Suzlon futures lot

A futures transaction enables you to play on margin. A futures market lot in the case of Suzlon involves 13,000 underlying Suzlon shares. So when Suzlon futures closing price yesterday was Rs. 24.50, a one lot holder had exposure to,

13,000 underlying shares * Rs. 24.50 = Rs. 318,500 notional amount

That is a lot of money! To take a position in the futures market, one does not have to put up the entire amount. You put up a margin amount that is determined by the exchanges. It is typically much lesser.

A futures trader uses leverage. You commit less money and trade on a far bigger notional amount.

In Suzlon’s case, one rupee of price decrease means that your notional amount shrinks by Rs. 13,000. The reverse holds too. If the price increases by Rs. 1, the notional amount increases by Rs. 13,000.

Today, the futures price closed at Rs. 15.90.

Assuming Rs. 24.50 (yesterday’s future’s closing price) – Rs. 15.90 = Rs. 8.60, that gives you a loss of,

13,000 underlying shares * Rs. 8.60 price movement = Rs. 111,800 loss

This humongous amount is today’s loss if a futures holder closed out the futures transaction at the day’s closing price.

Conclusion

Derivatives on stocks including futures and options, and derivatives on interest rates and commodities are particularly risky. A trader can make huge profits. But you can have huge derivatives losses too.

Many people are lured to derivatives by the hope of making a quick buck. Unfortunately, there are many horror stories that I personally have heard of retail investors routinely having large derivative losses. If you missed reading the Are you an investor or a speculator – Benjamin Graham article, I recommend that you read it carefully.

Be aware of what you are getting into – both the possible profits and the possible losses. Don’t bite more than you can chew. Stay safe!

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Comments

  1. Dalip Singh says

    Point taken.And likewise I have stopped taking wild Tips as I did earlier and lost money in the bargain.I have stopped futures trading altogether where I feel the big fish operators and pools sway the scale in their favour.Mostly meeting with Stop Loss in the bargain.

    • says

      Dalip, I agree, stop losses are essential and strong discipline is needed to stick to stop losses.

      Do you invest for a 3+ year period? What stocks do you find interesting?

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