Hedging Against Equity portfolio

I prefer to go with future hedging. For options, you have to get both direction and timing right. Otherwise, they go down in value disproportionately. For futures, I only needs to get the direction right by calculation the beta of my portfolio. I generally stay away from option selling as the risk is not capped despite the probability of making money is high. Would like to hear from more investors on how they hedge their portfolio during uncertain times (for eg, during recent budget where market gave no time for 3-4 days if one wishes to sell on pull back).

Two reasons I can think of:

  1. It is done by mistake.
  2. It is done by same person from two different accounts. He is purchasing from account where huge tax is due. So, by purchasing he know he will be entire loss but his lost money will be transferred to some other account where Tax liability is less/negligible. Another loophole where SEBI may need to know who did this.

Portfolio Risk Hedging - Something which we should analyze and discuss in more detail as we come out of this crisis and move towards the next one

Very interesting from below - Portfolio of equity assets with ~97% index position and 3% hedge in this portfolio would have ensured 0% capital loss through this crisis.

https://www.bloombergquint.com/business/taleb-advised-universa-tail-risk-fund-returned-3-600-in-march

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Yes, hedging is the must to do even during normal time. But it need lot of practice. I am practicing it since 3-4 years, and getting slowly hold of it. This crisis I have never though would lead to such corrections, but still able to make positive flow of cash.

If you don’t mind, can you explain your process to hedge your equity positions?

Hi,

The way I do hedging is involving multiple buy and sell PUT positions and then rolling up or down based on Nifty movement. It involves margin, so I pledge my stocks which I do not intend to sell and then use the limit as margin. However, during current crisis, Securities are disabling margins for midcaps now, so I have to arrange a cash in such situations. It involves not just PUT positions but having a good stock list for which you can implement Hedge.

Thanks

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Hi , Can you please provide more details and educate us pls ?

  • Suppose somebody have 1 cr portfolio.To hedge that portfolio, how many lots of PUT he should buy?
  • Will it be ATM,ITM or OTM? What will be the roll over frequency ?
  • Suppose today is 01/01/2020 and Nifty @12000 . So for which expiry should he buy ?
  • How to do the roll over if Nifty move to @11000 on 01/20/2020?
  • How to the roll over if Nifty move to @13000 on 01/20/2020?
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Funny, the exact same subject was tackled in this optionalpha podcast of this week.

Succinctly, buying insurance (as puts) may very well cost you more than any losses you may face. Hence it’s better to buy puts by selling calls (you’ve to sell some more calls than puts cause puts are pricier. Alternatively you can sell calls near to CMP than puts to have same number of calls as puts).

You can get the margin by pledging your portfolio.

As to number of puts to be bought, a quick calculation would be:
[1 crore / 12000 (current value of nifty) ] / 75 (lot size) ~ 11 put contracts. Though it’s a quick calculation, i’m open to be corrected.

You should buy LEAP options (i.e, long term options). Buy puts for as far as you can get. The options in NSE website lists contracts with ask price till December 2023 but since you will be selling calls to buy those puts, it’s better you buy insurance one year hence, cause if NIFTY rockets in the meantime, you will loose value on the calls.

As for managing, if NIFTY comes to 11000 from 12k, then there is nothing to manage, you are not buying insurance for 8% downmove. you’re buying for 50% downmove. The same should be the case if NIFTY move to 13000.

For the above reason, the puts bought (and calls sold) should be 20% farther than CMP cause that much would be normal move for NIFTY in an year.

DO NOT buy near term puts cause you will loose most of your money in theta, without much underlying move.

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Make Sense .Thanks alot. One thing i observed that for longer than 3 months , Nifty options are not liquid enough to get proper price .

So to overcome this situation to hedge PF somebody should buy 3 months long ITM PUT options at 20% below i.e 10000 put options (nifty @12000 on 01/01/2020 ). Now he should wait till march expiry ,2020 and then again buy 7000 put options June contact (because at march end Nifty moved to 9000) . Do you see any risk in this strategy ?

One’s sole focus out of hedging strategy should be on protecting the portfolio against adversity rather than on returns, so it’s basically buying insurance and the objective is protection and not profits.
With that in mind, PUT options must be bought without any prejudices and mechanically every year(at the start) at strikes that are 10% or 20% or 30% down from the market price(NIFTY) depending upon one’s risk appetite.

Now, the good part of this strategy apart from offering some psychological solace is it helps in recovering the short term (paper)losses in core portfolio during market sell-off(although not full), whereas the downside would be the options going worthless(read theta decay) at the end of year in case of no adverse event happens.

So, IMHO, this strategy should be done mechanically and as a yearly ritual without applying any intelligence like trying for adjustments, etc. Buy insurance, exercise the option when it is sufficiently ITM offsetting temporary losses in the portfolio, and repeat the process should be the way forward.

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Looks good in hindsight. Normally buying insurance with expiry 3 months out is gonna kill you with theta decay. You’re gonna loose more in theta decay than any gain you may accrue with the insurance. That was the first line in my succint explanation of the podcast.

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Hi,

Creating positions depends volatility of market (India VIX). When Nifty was stable around year back, there was hardly any movement of 600-700 points in a month, but in last 2 months, we saw movement of 4500 points. When uncertainty is high (VIX toucing 80 in current situation), there is altogether different strategy needs to be deployed. There is no hard fix 1 strategy for every situation, it is based on your experience and improvement.

I generally Buy ATM option and sell some OTM Puts like Buy 12000PE and Sell two lots of 11300 PE. Now this works if Nifty is in stable situation. Then fall of 500-600 points will safe your portfolio loss.

In situation like right now, it is very hard to have 1-2 ration, so now I do Buy 9000PE and sell one 8500PE.

I do all this in multiple lots which helps me in Rollover.

Also, I keep this thing in mind that it is possible some money will be lost in this process as of-course you will have net cash outflow, but that is okay considering what it is protecting.

How I am able to recover the net outflow is by upward rollover based on certain conditions and analysis.

Please note I am still learning and still evolving my strategies. These strategies in the end involves large amount of risks and it has chances of huge capital erosion if not deployed successfully. If not done properly, it can wash out your portfolio.

My purpose of posting here is to present my views and then know where I can get wrong or should Improve. In last 3-4 years, I am able to make some money (not much) but it has also the potential of exponential grow once you are onto something.

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Also In India (Unlike US markets), do not go for any option beyond 2 months expiry. Liquidity is hardly available, and even though you might execute Buy option, it will be significant price difference when you sell if contracts are around 3 month far and are around ATM or ITM.

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LEAP options on indexes are illiquid, but prices are not whacky. Calculate using any options pricing formulae and compare the ratio of the calculator and ask price for near term and far term, they are pretty close.

You just have to put your quote and wait, sometimes a day or two. Buying near term insurance is sure to loose you far more that you hope to gain by the insurance.

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Anyone has an options pricing calculator they use for nifty?
I would be very appreciative if you could share a copy
Thanks

This is the zerodha black scholes option pricing calculator.

That one doesnt work
Nifty volatility is 37%
If I put the figures, I get option price of Rs 2 whereas quoted on exchange is 30. There is a big difference :frowning:
what am i doing wrong ?

Nifty July 7000 Strike is not open.

Here I am showing you the calculation for the Nifty 8000 Strike calculation.

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Thank you Krishna

If I put volatility as 30 it’s slightly cheaper premium

I have a question around that
I am considering Buying puts to protect against sell off
Say I see 2 strike prices
8000 and 9000
I calculate volatility to arrive a price quoted on exchange
If I get a huge difference between 2 volatilities, for instance 8000 quoting at 32 is because of priced volatility of 40 and 9000 quoting at 109 is because of prices in volatility of 30, should I be buying at strike 9000 as the market is pricing a low volatility and eventually when volatility increases the price will be more reflective of real volatility
Is my understanding correct?
Thanks for the help

How are you calculating volatility? Do not calculate by entering the implied volatility - the volatility of underlying would be the same for all strikes.

Refer https://zerodha.com/varsity/chapter/volatility-calculation-historical/ for how to.