Nifty PE crosses 24|A statistically informed entry-exit model!

Investing Strategies
379

Hi

Have been following this thread for sometime and liked the tussle in viewpoints :slight_smile:

Just a query/viewpoint.

Assume that nifty falls to a great extent by 28 Dec 2017 when your options expire and so does your portfolio but if you are so steady to hold onto your stocks for a 5-8 year period why not use this opportunity to add onto these positions rather than put money on the table for paying premiums today which are ~2% of the portfolio value?

Trying to create a protective put hedging strategy for a long term investment horizon is not worthwhile in my humble opinion. That too for small time retail investors it could seriously go wrong. For such a strategy almost on a daily basis one needs to calculate beta of the portfolio, delta of the puts and readjust basis the portfolio and contract value. Its not only a costly affair but a time consuming activity. Yes one can simply buy puts and think that his or her portfolio is hedged but the Greeks will create havoc as time passes.

Such hedging requires to be ‘optimally’ hedged as there are too many variables at play mathematically speaking and it is for those who have the number pressure to show to their investors quarter on quarter. When the same person is the investor, analyst and the trader all rolled into one I don’t think one should be bothered.

Personally I would not mind to have a drawdown and use that phase to bet heavy/add on to my favorite horses.

Regards
Deepak

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380

Just to clarify Deepak, if for example, my portfolio is worth Rs. 100 today, and falls to Rs. 80 by December end (Rs. 78 after hedge cost), while Nifty falls from 10k to 9k (assuming my portfolio gets hit higher to the downside due to smallcap/value bias). If hedge the same nominal amount ignoring beta and without any rebalancing, then my puts will be worth Rs. 10. Hence my hedged portfolio does not fall much (Rs. 100 -> Rs. 88), even without rebalancing. However, I have Rs. 10 in cash, which I can use to purchase securities at a heavy discount.

Especially given that I am not adding to my portfolio, this is a valuable strategy as it allows me to add to my PF in a fall while sacrificing some of the gains I would have had if there is no fall, a type of an insurance contract. You are right in pointing out that a perfect hedge required daily calibration, but a good hedge can be made with buy and holding options 3-4 months out.

Like I said earlier, I don’t expect this to be a perfect hedge - only to hedge out major market moves, like a 2015 china like crash, DeMo, or even a 2008 like meltdown since I believe that market valuations are rich, and thus more prone to sudden reversals.

EDIT: Its also important to note I am only hedged from current levels, i.e. if NIFTY goes up 10% and then falls 20%, I am only going to get paid for the last 10% of the move. This is the drawback to passive hedgeing (and thus why I am comfortable not rebalancing my hedges and adjusting strikes/calculating greeks)

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381

That too for small time retail investors it could seriously go wrong.
For such a strategy almost on a daily basis one needs to calculate beta
of the portfolio, delta of the puts and readjust basis the portfolio and
contract value. Its not only a costly affair but a time consuming
activity. Yes one can simply buy puts and think that his or her
portfolio is hedged but the Greeks will create havoc as time passes.

There is no need to manage the greeks if one buys an option. It is an insurance premium for your (vehicle) portfolio; the seller/writer (insurer) has manage greeks especially if the option is ATM and may be exercised.

From what I have read of the options market in India, for option buyers it is best to settle in cash (square-off) rather than let the option expire ITM and then pay extra tax.

382

Hi

The point is that there is nothing like passive hedging, rather it should be called ineffective hedging. Either its optimal or non optimal, ie almost a binary function actually. And if a protective put is looked at from an insurance perspective then one needs to be in the money management business as a profession worrying about QoQ returns and not a long term individual investor.

So it means either of the two things:
a) one is not confident of the businesses he has invested in that he can’t add when they are on sale (assuming one considers himself to be a long term investor)
b) there is a mental revulsion that he does not want the portfolio to drawdown (usually for money managers who are allowed to use derivatives to hedge owing to the numbers pressure from their investors)

Coming to portfolio hedging. I am not going to explain why the Greeks are so important to manage but rather I would recommend the chapter on Greeks in John C Hull’s book 'Options, Futures & other Derivatives as an introduction. This chapter is 101 on hedging of portfolios. And I hope we know the consequences we expose ourselves when we try to make use of a really dynamic product such as options to hedge our beloved portfolios. Pasting a picture from the chapter to this post. Also recommend to read Natenberg’s book on options and volatility. One final thing is the protective put equation below. This simplifies the number of puts one needs to hedge in this strategy and it does require monitoring.


WhatsApp Image 2017-09-13 at 11.45.24 AM.jpeg960×1280 297 KB

Be fearful when others are greedy and greedy when others are fearful - Mr WB

All the best. Nice thread though.

Regards
Deepak

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383

Mate, I’m not sure what you mean by “The point is that there is nothing like passive hedging, rather it should be called ineffective hedging. Either its optimal or non optimal, ie almost a binary function actually”

If you shift from a 100% equity portfolio to a 20% cash one, you’ll have a lower drawdown in crisis, thus averting some of your downside. Is this an “in effective hedge”. Or, if you add 5-6% of gold to your portfolio, as Ray Dalio says, expecting it to increase in times of crisis, is it an ineffective hedge because its unable to cover your entire drawdown? or by your definition, not a hedge at all since hedging is “binary”. Maybe there is no point holding anything other than 100% cash, since its “binary”.

This is a very quick and dirty hedge, so only do it if you understand its limitations. This is not going to stop you from making bad picks in your portfolio - they’ll go down regardless of market conditions. This only reduces your drawdown in case of a market wide (idiosnycratic) risk event. (remember I said reduce, not completely eliminate)

As far your knowledge of options goes, please try to get a deeper understanding of how options work, before talking about option greeks (and hopefully drop your condescension). I understand that options are complicated, but they are actually simple when you are hedging an equity portfolio (so called delta only exposure). In fact, in this case there is only partial delta hedging, because the direction of gamma works in your favour. It increases the delta as the index decreases, i.e. is more sensitive to falls than to rises. One is not really concerned with the value of other greeks, other than theta (time decay, which is built in when you say I’ve already paid for this option) or sensitivity to volatility.

There are no “consequences we expose ourselves when we try to make use of a really dynamic product” because its a simple pay off - you buy an option, mentally mark the value of the option down to zero, however in case of any significant decline from the point in time where you buy an option to expiry, you receive a cash payout equal to (Strike - Nifty at Expiry). With this, you go buy cheap stocks. It’s as simple as that.

And the distinction between a long term term investor and one that uses puts is quite arbitrary - would you consider Seth Klarman, or Prem Watsa speculators because try to hedge their positions? WB doesn’t engage in this because it is not logistically feasible for him to buy them in such quantities. Besides, the duration of his portfolio is much lesser than ours, as his investments are directly controlled and hence yield significant cash.

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384

Hi

The strategy of ‘protective put’ is optimal or non optimal. It is not a broad statement that all hedges are binary.

Thanks for the advice on getting more knowledge on options. Working towards it.

Please do not mistake my straightforwardness as condescension. Apologies if it sounded so.

Wont carry on the discussion as you have ‘mentally marked the value of the options to zero’. Seriously recommend the two books as starters in my last post though.

p.s. my final thesis in my formal studies of finance was called “Measuring the efficiency of portfolio construction”

Regards
Deepak

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386

All I’ll say is, difference of opinion does a market make :wink:

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387

Hedging using options and other derivative instruments seems to be a topic that needs a separate thread and a discussion which if expressed in simple easy to understand words could add a lot of value to the overall forum and the individual knowledge base of our fellow members.

If possible, i request the appropriate person with enough knowledge on this subject and an ability to express it in a way all of us can understand - to start a new thread so all of us learn and become better & more informed.

Best
Bheeshma

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388

Hi,
I have done certain studies and have posted previously. But I think all the studies regarding the valuation has only got academic interest , till liquidity is there. Once liquidity dries up market will fall regardless being expensive, fair of even cheap. Off course a fall from a high valuation level will be always devastating. But since markets will be giving opportunities all time it may be wise to have some cash in portfolio as the market nears historic high valuations. But even in this high valuation periods a lot of stocks are there at inflection points. Also with new entrants come to nifty in place of so many laggards, this may increase the EPS of nifty there by cooling off the valuations. Any way i plan to shift to certain % age of cash once nifty gets over valued in terms of both PE multiple and Price to Book.

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389

Hi
can anybody help me in finding the nifty 50 volume data prior to 1997. In nse website its available only from 1997 onwards.
I had done a Williams Accumulation /Distribution analysis for Nifty.As the volume data from the inception of nifty april1996 is not available the charts are little distorted but still can catch the trend. Its has been seen that when the long term trend in Accumulation /Distribution is brocken, it can be taken as a indication of possible trend changes. Also if index is climbing without accumulation extreme caution is needed. This is what is happening now. Nifty accumulation levels reached the max lvl at 2016 august , when nifty was hardly 9000. But now nifty at 10000, the acc lvls is far below the 2016 august lvls. Nifty distribution was too heavy during the demonetization fall of 9000 to 7900 lvls. The accumulation during the present rally of 2000 odd points hadnt covered the distribution during 1000 pts fall during demonetization. But in nifty 500 we have a different picture. It is obvious from the broader market outperformance.
From the charts it is seen that during the rally 1997-2000, the accumulation level was falling indicating weakness of the rally. Towards the end of the rally there is a sharp decline in acc lvls despite sharp increase in nifty. And exatcly when nifty fell from the top at 2000, the acc lvls also have brocken the prior trend line leading to a sharp bear market for allmost 3 years. Same thing happened in 2008 also. Both time nifty had reached 28 PE multiples.
So what i infer from these is when nifty gets overvalued ( say above 26 PE), if further rally is not supported by accumulation, it is better to be cautious. But right now accumulation is building. I plan to keep a close watch on this during the further movement of nifty. If accumulation fails to reach a new high, and falls despite rally in nifty, OR If the prevailing trend line in accumulation is breached, I may have to rethink about my investment strategy. And i think even if market crashes, it may be simillar to the 2000 crash, rather than 1991 and 2008 crash which occured after huge rallies.
Presently 100% invested and will remain till this theory holds.

william accdis.xls (815.5 KB)

williams accdis 2.xls (1.2 MB)

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390

@diffsoft Could I request you to look at the above request from @josephseby. On this forum I think you are the one who might be able to assist him with this. In turn, we would all be able to learn something new, if Joseph has more historical data to work with. Best Regards.

391

Hi

S&P 500 hits 2500 for the first time.

And yesterday BofaML said the bull run in emerging equities is just getting started.

Most of us are anyways keeping dry gunpowder handy.

Regards
Deepak

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392

Hi,
thank you for showing interest. I like to do same analysis on sensex also. But for sensex I didnt got any volume data for the full index. If the data is available then we can do the same analysis and try to find what happened in the accumulation / distribution lvls during the bull market of 1990-1991, and the subsequent crash.In such case we will be able to study the acc/dis behaviour during 1990-91 major bulll market and subsequent crash, 1999-2000 minor bull market and subsequent crash, 2005-2008 major bull market and subsequent crash. These three are the major bull and bear mkts in indian markets till date. If we are able to get a clear analysis we may be better prepared for any such events in future.

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393

Sure, glad to help.

@josephseby , attached is I think what you requested, the Nifty data for CY 1996. I picked this up from my ProwessIQ data subscription.

Data requested.xlsx (20.8 KB)

Cheers,

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394

Hi,
Thank you very much for a spontaneous help. Actually in my analysis i used the total no of shares traded as the volume, not the value. I feel using total value of the shares traded will give erroneous results as the value will be rising as the individual stock prices rises. So a cumulative acc/dis data to generate the Acc/Dis line will not represent the real situation if we are using value instead of number of shares. Anyway thank you very much for responding. Looking forward for further positive interactions and knowledge sharing

395

I am sorry I do not have that information on me.

396

Another interesting hedge for downturns without selling your pf of stocks is selling short (can be done with F&O in the Indian market). It’s extremely risky, and you need to have decent cash reserves along with conservative position sizing in order to whether volatility, so its only recommend for pros/stupid enough to think they are a pro. At the same time, if a good short thesis is found, its a money spinner, especially given how few professional short sellers there are in the Indian market, since that causes valuations to touch ridiculous heights.

Many value oriented hedge fund managers (Ackman, Einhorn, Icahn etc.) use this to maintain a hedged portfolio with a <50-60% net long. In fact, Icahn has lost a decent amount of money being net short since 2015. I probably fall into the “stupid enough to think they are a pro” category, so I’ve adopted a short position to help hedge some more risk.

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398

Hi

Article on zerohedge sent by a friend. Related to the US markets though.

Goldman’s is downright apocalyptic because as the bank’s global equities strategist Peter Oppenheimer writes in his recent “Bear Necessities” report, Goldman’s Bear Market Risk Indicator has recently shot up to 67%, prompting Goldman to ask, rhetorically, “should we be worried now?”

GS uses 5 parameters to conclude on the bear market indicator - valuation, momentum, unemployment, inflation & yield curve.

image.jpg1181×849 178 KB

image.jpg1143×323 111 KB

Regards

399

I have been seeing these for years now on ZH. These guys are permabears and everyday is doomsday on ZH.

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