Hedging your Portfolio

Markets have been choppy for quite sometime now. The gap up and the gap downs have been happening more than often. The bounce back from the day’s low to the correction from the day’s high is a normal phenomenon these days.

It is becoming really tough for anyone to predict the movements of the markets as the markets have mastered the art of taking everyone by surprise.

Now what to do in these kind of markets? Quite often I hear people saying that investments in equities should be done with a long term horizon and these short term corrections should not be a thing to worry about.

I stand of the same opinion and completely agree to it that one should invest into equities with a long term horizon. But there are times when the markets dip to extremely low levels. The capital gains over more than a year or so is wiped of in less than a week.

The best way to save your money is by keeping your portfolio hedged. The simplest way to hedge your portfolio is by selling index futures. This essentially means that you sell index futures of the amount of the portfolio you have taking into consideration the beta of your portfolio.

Let’s look at an example to understand it better.

Suppose you have a portfolio with a value of Rs. 5 lakhs and the current value of the Nifty is 5000. The lot size for one Nifty future is 50 and the lot size for a mini Nifty is 20. The beta of the portfolio with regards to Nifty Fifty is of 1.2. A beta of 1.2 of your portfolio means that there will be a 1.2% change in the value of your portfolio for every percent change in the value of the Nifty Fifty.

Now you need to sell index futures worth (500000 * 1.2) = Rs. 600000.
The nifty spot is 5000. So you need to sell (600000/5000) = 120 Nifty. Lot size of Nifty Fifty is 50 and lot size of mini Nifty is 20. So you can sell 2 lots of Nifty and one lot of mini nifty.

This will help you to gain in both scenarios – of the market going in either direction. If the markets correct from here and you lose money on your portfolio, you will gain from the index future you have sold. If the markets go up from this point, you gain from the value of increase in your portfolio.

And since the beta of your portfolio is 1.2 then you will stand to gain more as the increase in the value of the portfolio will be more than the increase in the value of the Nifty.

So, on expiry, irrespective of the markets moving in any direction you will tend to gain more if you have hedged your portfolio properly than by keeping you portfolio without hedging.

The author is a Research Analyst working at Apnaloan.com Services (P) Limited.

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