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Kenya’s investment landscape has faced challenges this year, with dwindling macros impacting the equities market. Year-to-date, the Nairobi All Share Index has declined by 26%, and the NSE20 index by 9.7%. Notably, Safaricom and KCB shares lead the decline, with 39.8% and 49.3% drops, respectively. As a result, analysts and investors are adopting a long-term approach to portfolio management. Despite this, savvy investors are keeping an eye on short-term opportunities, utilizing derivatives for tactical adjustments.
Derivatives, financial instruments deriving value from an underlying asset, index, or rate, are employed for strategic portfolio adjustments. Common types include options and futures contracts. Options provide the right to buy or sell stock at a set price within a specified time, acting as a financial umbrella against market storms. Meanwhile, futures contracts commit the buyer or seller to transact an asset at a predetermined future date and price, offering protection against potential market fluctuations.
Kenya’s Nairobi Securities Exchange Derivatives Market (NEXT) currently hosts two derivative contracts: NEXT Equity Index Futures and NEXT Single Stock Futures. The former provides exposure to price movements on the NSE 25 index, while the latter deals with the underlying security of an equity stock listed on the NSE.
Derivatives offer several benefits for portfolio managers. Firstly, options act as financial umbrellas, providing protection against adverse market movements. Additionally, derivatives allow investors to control larger positions with less capital, offering flexibility and agility in adjusting holdings. This becomes crucial when anticipating sector rotations or capitalizing on perceived undervalued stocks.
Furthermore, derivatives can generate income through option contracts, particularly through option writing. In this strategy, investors sell options and collect premiums from buyers, serving as payment for associated rights.
Ultimately, derivatives are versatile tools for investors seeking tactical adjustments in their portfolios. Strategic use can enhance returns, manage risks, and provide flexibility in dynamic markets. However, understanding and evaluating associated risks are essential for harnessing their full potential.
