Case Study: Derivative Debacle and Future Fortune – A Kerala Story

Background
Rahul, a 35-year-old investor from Kochi, Kerala, had been actively trading in the derivatives market for years. He owned a small business in the spices sector and had invested his surplus funds in the stock market. In 2020, Rahul entered into a forward contract to sell 1,000 shares of Federal Bank Ltd. at ₹100 per share, with the contract expiring in six months. Rahul expected the stock price to drop due to the COVID-19 pandemic’s impact on the banking sector, allowing him to buy the shares at a lower price and sell them at ₹100.

The Downfall
However, contrary to Rahul’s expectations, the stock price surged to ₹140 per share due to the government’s stimulus packages and the bank’s strong quarterly performance. When the contract expired, Rahul was obligated to sell the shares at ₹100, incurring a loss of ₹40 per share (₹140 – ₹100). His total loss amounted to ₹40,000 (1,000 shares x ₹40).

Rahul was devastated by the loss, which was a significant setback for his business. He had to dip into his working capital to cover the losses, affecting his spice trading operations.

The Turnaround
Undeterred, Rahul decided to invest in futures contracts, predicting that the stock price of Infosys Ltd. would continue to rise due to the growing demand for IT services in Kerala. He bought 1,000 futures contracts of Infosys Ltd. at ₹1,500 per share, with the contract expiring in three months. As expected, the stock price skyrocketed to ₹1,800 per share due to the company’s strong quarterly performance and the Kerala government’s initiatives to promote IT investments in the state. Rahul sold the futures contracts at ₹1,800, earning a profit of ₹300 per share (₹1,800 – ₹1,500). His total profit amounted to ₹300,000 (1,000 shares x ₹300).

Rahul’s profits from the futures contracts helped him recover from the losses incurred in the forward contract. He was able to replenish his working capital and expand his spice trading business.

Questions for Discussion
1. What are the risks associated with trading in derivatives, and how can they be mitigated?
2. How did Rahul’s expectations influence his investment decisions, and what were the consequences?
3. What role did market volatility play in Rahul’s losses and gains?
4. How can investors balance their risk tolerance with potential returns when trading in derivatives?
5. What lessons can be learned from Rahul’s experiences, and how can they be applied to real-world investment scenarios in Kerala?

Learning Objectives
1. Understand the basics of derivatives, including forwards and futures contracts.
2. Analyze the risks and rewards associated with trading in derivatives.
3. Evaluate the impact of market volatility on investment decisions.
4. Develop critical thinking skills to balance risk tolerance with potential returns.
5. Apply lessons learned from case studies to real-world investment scenarios in Kerala.

References
1. Hull, J. C. (2020). Options, Futures, and Other Derivatives. Pearson Education.
2. Kolb, R. W., & Overdahl, J. A. (2020). Financial Derivatives: Pricing and Risk Management. John Wiley & Sons.
3. Kerala Stock Exchange (2020). Derivatives Market in Kerala: An Overview.

Note: This case study is fictional and for educational purposes only.