Module 4 Futures Trading

Chapter 11

Hedging with Futures

317

M4-Ch11-title

11.1 – Hedging, what is it?

One of the most important and practical applications of Futures is ‘Hedging’. In the event of any adverse market movements, hedging is a simple work around to protect your trading positions from making a loss. Let me to attempt giving you an analogy to help you understand what hedging really is.

Imagine you have a small bit of vacant barren land just outside your house, instead of seeing it lie vacant and barren you decide to lawn the entire plot and plant few nice flowering plants. You nurture the little garden, water it regularly, and watch it grow. Eventually your efforts are paid off and the lawn grows lush green and the flowers finally start to blossom. As the plants grow and flowers start to bloom it starts to attract attention of the wrong kind. Soon you realize your little garden has become a hot destination for a few stray cows. You notice these stray cows merrily gazing away the grass and spoiling the nice flowers. You are really annoyed with this and decide to protect your little garden? A simple work around is what you have in mind – you erect a fence (maybe a wooden hedge) around the garden to prevent the cows from entering your garden. This little work around ensures your garden stays protected and also lets your garden flourish.

Let us now correlate this analogy to the markets –

  • Imagine you nurture a portfolio by picking each stock after careful analysis. Slowly you invest a sizable corpus in your portfolio. This is equivalent to the garden you grow
  • At some point after your money is invested in the markets you realize that the markets may soon enter a turbulent phase which would result in portfolio losses. This is equivalent to the stray cow grazing your lawn and spoiling your flower plants
  • To prevent your market positions from losing money you construct a portfolio hedge by employing futures. This is equivalent to erecting a fence (wooden hedge) around your garden

I hope the above analogy gave you got a fair sense of what ‘hedging’ is all about. Like I had mentioned earlier, hedging is a technique to ensure your position in the market is not affected by any adverse movements. Please don’t be under the impression that hedging is done only to protect a portfolio of stocks, in fact you can employ a hedge to protect individual stock positions, albeit with some restrictions.

11.2 – Hedge – But why?

A common question that gets asked frequently when one discusses about hedging is why really hedge a position? Imagine this – A trader or an investor has a stock which he has purchased at Rs.100. Now he feels the market is likely to decline and so would his stock. Given this, he can choose to do one of the following –

  1. Take no action and let his stock decline with a hope it will eventually bounce back
  2. Sell the stock and hope to buy it back later at a lower price
  3. Hedge the position

Firstly let us understand what really happens when the trader decides not to hedge. Imagine the stock you invested declines from Rs.100 to let us say Rs.75. We will also assume eventually as time passes by the stock will bounce back to Rs.100. So the point here is when the stock eventually moves back to its original price, why should one really hedge?

Well, you would agree the drop from Rs.100/- to Rs.75/- is a 25% drop. However when the stock has to move back from Rs.75/- to Rs.100/- it is no longer a scale back of 25% instead it works out to that the stock has to move by 33.33% to reach the original investment value! This means when the stock drops it takes less effort do to so, but it requires extra efforts to scale back to the original value. Also, from my experience I can tell you stocks do not really go up that easily unless it is a raging bull market. Hence for this reason, whenever one anticipates a reasonably massive adverse movement in the market, it is always prudent to hedge the positions.

But what about the 2nd option ? Well, the 2nd option where the investor sells the position and buys back the same at a later stage requires one to time the market, which is not something easy to do. Besides when the trader transacts frequently, he will also not get the benefit of Long term capital tax. Needless to say, frequent transaction also incurs additional transactional fees.

For all these reasons, hedging makes sense as he is virtually insulates the position in the market and is therefore becomes indifferent to what really happens in the market. It is like taking vaccine shot against a virus. Hence when the trader hedges he can be rest assured the adverse movement in the market will not affect his position.

11.3 – Risk

Before we proceed to understand how we could hedge our positions in the market, I guess it is important to understand what is that we are trying to hedge. Quite obviously as you can imagine, we are hedging the risk, but what kind of risk?

When you buy the stock of a company you are essentially exposed to risk. In fact there are two types of risk – Systematic Risk and Unsystematic Risk. When you buy a stock or a stock future, you are automatically exposed to both these risks.

The stock can decline (resulting in losses for you) for many reasons. Reasons such as –

  1. Declining revenue
  2. Declining profit margins
  3. Higher financing cost
  4. High leverage
  5. Management misconduct

All these reasons represent a form of risk, in fact there could be many other similar reasons and this list can go on. However if you notice, there is one thing common to all these risks – they are all company specific risk. For example imagine you have an investable capital of Rs.100,000/-. You decide to invest this money in HCL Technologies Limited. Few months later HCL makes a statement that their revenues have declined. Quite obviously HCL stock price will decline. Which means you will lose money on your investment. However this news will not impact HCL’s competitor’s (Tech Mahindra or Mindtree) stock price. Likewise if the management is guilty of any misconduct, then Tech Mahindra’s stock price will go down and not its competitors. Clearly these risks which are specific to the company affect only the company in question and not others. Such risks are often called the “Unsystematic Risk”.

Unsystematic risk can be diversified, meaning instead of investing all the money in one company, you can choose to diversify and invest in 2-3 different companies (preferably from different sectors). When you do so, unsystematic risk is drastically reduced. Going back to the above example imagine instead of buying HCL for the entire capital, you decide to buy HCL for Rs.50,000/- and maybe Karnataka Bank Limited for the other Rs.50,000/-. Under such a circumstance, even if HCL stock price declines (owing to the unsystematic risk) the damage is only on half of the investment as the other half is invested in a different company. In fact instead of just two stocks you can have a 5 stock or 10 or maybe 20 stock portfolio. The higher the number of stocks in your portfolio, higher the diversification and therefore lesser the unsystematic risk.

This leads us to a very important question – how many stocks should a good portfolio have so that the unsystematic risk is completely diversified. Research has it that up to 21 stocks in the portfolio will have the required necessary diversification effect and anything beyond 21 stocks may not help much in diversification.

The graph below should give you a fair sense of how diversification works –

graph-m4-ch11

As you can notice from the graph above, the unsystematic risk drastically reduces when you diversify and add more stocks. However after about 20 stocks the unsystematic risk is not really diversifiable, this is evident as the graph starts to flatten out after 20 stocks.  In fact the risk that remains even after diversification is called the “Systematic Risk”.

Systematic risk is the risk that is common to all stocks. These are usually the macroeconomic risks which tend to affect the whole market. Example of systematic risk include –

  1. De-growth in GDP
  2. Interest rate tightening
  3. Inflation
  4. Fiscal deficit
  5. Geo political risk

Of course the list can go on but I suppose you got a fair idea of what constitutes systematic risk. Systematic risk affects all stocks. So assuming you have a well diversified 20 stocks portfolio, a de-growth in GDP will certainly affect all 20 stocks and hence they are all likely to decline. Systematic risk is inherent in the system and it cannot really be diversified. However systematic risk can be ‘hedged’. So when we are talking about hedging, do bear in mind that it is not the same as diversification.

Remember, we diversify to minimize unsystematic risk and we hedge to minimize systematic risk.

11.4 – Hedging a single stock position

We will first talk about hedging a single stock future as it is relatively simple and straight forward to implement. We will also understand its limitation and then proceed to understand how to hedge a portfolio of stocks.

Imagine you have bought 250 shares of Infosys at Rs.2,284/- per share. This works out to an investment of Rs.571,000/-. Clearly you are ‘Long’ on Infosys in the spot market. After you initiated this position, you realize the quarterly results are expected soon. You are worried Infosys may announce a not so favorable set of numbers, as a result of which the stock price may decline considerably. To avoid making a loss in the spot market you decide to hedge the position.

In order to hedge the position in spot, we simply have to enter a counter position in the futures market. Since the position in the spot is ‘long’, we have to ‘short’ in the futures market.

Here are the short futures trade details –

Short Futures @ 2285/-

Lot size = 250

Contract Value = Rs.571,250/-

Now on one hand you are long on Infosys (in spot market) and on the other hand we are short on Infosys (in futures price), although at different prices. However the variation in price is not of concern as directionally we are ‘neutral’. You will shortly understand what this means.

After initiating this trade, let us arbitrarily imagine different price points for Infosys and see what will be the overall impact on the positions.

Arbitrary Price Long Spot P&L Short Futures P&L Net P&L
2200 2200 – 2284 = – 84 2285 – 2200 = +85 -84 + 85 = +1
2290 2290 – 2284 = +6 2285 – 2290 = -5 +6 – 5 = +1
2500 2500 – 2284 = +216 2285 – 2500 = -215 +216 – 215 = +1

The point to note here is – irrespective of where the price is headed (whether it increases or decreases) the position will neither make money nor lose money. It is as if the overall position is frozen. In fact the position becomes indifferent to the market, which is why we say when a position is hedged it stays ‘neutral’ to the overall market condition. As I had mentioned earlier, hedging single stock positions is very straight forward with no complications. We can use the stock’s futures contract to hedge the position. But to use the stocks futures position one must have the same number of shares as that of the lot size. If they vary, the P&L will vary and position will no longer be perfectly hedged. This leads to a few important questions –

  1. What if I have a position in a stock that does not have a futures contract? For example South Indian Bank does not have a futures contract, does that mean I cannot hedge a spot position in South Indian Bank?
  2. The example considered the spot position value was Rs.570,000/-, but what if I have relatively small positions – say Rs.50,000/- or Rs.100,000/- is it possible to hedge such positions?

In fact the answer to both these questions is not really straight forward. We will understand how and why shortly. For now we will proceed to understand how we can hedge multiple spot positions (usually a portfolio). In order to do so, we first need to understand something called as “Beta” of a stock.

11.5 – Understanding Beta (β)

Beta, denoted by the Greek symbol β, plays a very crucial concept in market finance as it finds its application in multiple aspects of market finance. I guess we are at a good stage to introduce beta, as it also finds its application in hedging portfolio of stocks.

In plain words Beta measures the sensitivity of the stock price with respect to the changes in the market, which means it helps us answer these kinds of questions –

  1. If market moves up by 2% tomorrow, what is the likely movement in stock XYZ?
  2. How risky (or volatile)is stock XYZ compared to market indices (Nifty, Sensex)?
  3. How risky is stock XYZ compared to stock ABC?

The beta of a stock can take any value greater or lower than zero. However, the beta of the  market indices (Sensex and Nifty) is always +1. Now for example assume beta of BPCL is +0.7, the following things are implied –

  1. For every +1.0% increase in market, BPCL is expected to move up by 0.7%
    1. If market moves up by 1.5%, BPCL is expected to move up by 1.05%
    2. If market decreases by 1.0%, BPCL is expected to decline by 0.7%
  2. Because BPCL’s beta is less than the market beta (0.7% versus 1.0%) by 0.3%, it is believed that BPCL is 30% less risky than markets
    1. One can even say, BPCL relatively carries less systematic risk
  3. Assuming HPCL’s beta is 0.85%, then BPCL is believed to be less volatile compared HPCL, therefore less risky

The following table should help you get a perspective on how to interpret beta value for stock –

If Beta of a stock is Interpretation
Less than 0, Ex : -0.4 A -ve sign indicates the stock price and markets move in the
opposite direction. If market moves up by 1%, then –ve beta stock
of -0.4 is expected to decline by 0.4%
Equal to 0 It means the stock is independent of the market movement.
The variation in the market is not likely to affect the movement in the
stock. However, stocks with 0 beta is hard to find
Higher than 0 lesser than 1,
Ex : 0.6
It means the stock and the market move in the same direction;
however the stock is relatively less risky. A move of 1% in the market
influences the stock to move up by 0.6%. These are generally called the low beta stocks.
Higher than 1, Ex : 1.2 It means the stock moves in the same direction as the markets;
however the stock tends to move 20% more than the market.
Meaning, if the market increases by 1.0%, the stock is expected
to go up by 1.2%. Likewise if the market declines by 1% the stock
is expected to decline by 1.2%. These are generally called the high beta stocks.

As of January 2015, here is the Beta value for a few blue chip stocks –

Stock Name Beta Value
ACC Limited 1.22
Axis Bank Limited 1.40
BPCL 1.42
Cipla 0.59
DLF 1.86
Infosys 0.43
LT 1.43
Maruti Suzuki 0.95
Reliance 1.27
SBI Limited 1.58

11.6 – Calculating beta in MS Excel

You can easily calculate the beta value of any stock in excel by using a function called ‘=SLOPE’. Here is a step by step method to calculate the same; I have taken the example of TCS.

    1. Download the last 6 months daily close prices of Nifty and TCS. You can get this from the NSE website
    2. Calculate the daily return of both Nifty and TCS.
      1. Daily return = [Today Closing price / Previous day closing price]-1
    3. In a blank cell enter the slope function
      1. Format for the slope function is =SLOPE(known_y’s,known_x’s), where known_y’s is the array of daily return of TCS, and known_x’s is the array of daily returns of Nifty.
    4. TCS 6 month beta (3rd September 2014 to 3rd March 2015) works out to 0.62

You can refer to this excel sheet for the above calculation.

11.7 – Hedging a stock Portfolio

Let us now focus back to hedging a portfolio of stocks by employing Nifty futures. However before we proceed with this, you may have this question – why should we use Nifty Futures to hedge a portfolio? Why not something else?

Do recall there are 2 types of risk – systematic and unsystematic risk. When we have a diversified portfolio we are naturally minimizing the unsystematic risk. What is left after this is the systematic risk. As we know systematic risk is the risk associated with the markets, hence the best way to insulate against market risk is by employing an index which represents the market. Hence the Nifty futures come as a natural choice to hedge the systematic risk.

Assume I have Rs.800,000/- invested across the following stocks –

Sl No Stock Name Stock Beta Investment Amount
01 ACC Limited 1.22 Rs.30,000/-
02 Axis Bank Limited 1.40 Rs.125,000/-
03 BPCL 1.42 Rs.180,000/-
04 Cipla 0.59 Rs.65,000/-
05 DLF 1.86 Rs.100,000/-
06 Infosys 0.43 Rs.75,000/-
07 LT 1.43 Rs.85,000/-
08 Maruti Suzuki 0.95 Rs.140,000/-
Total Rs.800,000/-

Step 1 – Portfolio Beta

There are a few steps involved in hedging a stock portfolio. As the first step we need to calculate the overall “Portfolio Beta”.

      • Portfolio beta is the sum of the “weighted beta of each stock”.
      • Weighted beta is calculated by multiplying the individual stock beta with its respective weightage in the portfolio
      • Weightage of each stock in the portfolio is calculated by dividing the sum invested in each stock by the total portfolio value
      • For example, weightage of Axis Bank is 125,000/800,000 = 15.6%
        • Hence the weighted beta of Axis Bank on the portfolio would be 15.6% * 1.4 = 0.21

The following table calculates the weighted beta of each stock in the portfolio –

Sl No Stock Name Beta Investment Weight in Portfolio Weighted Beta
01 ACC Limited 1.22 Rs.30,000/- 3.8% 0.046
02 Axis Bank Limited 1.40 Rs.125,000/- 15.6% 0.219
03 BPCL 1.42 Rs.180,000/- 22.5% 0.320
04 Cipla 0.59 Rs.65,000/- 8.1% 0.048
05 DLF 1.86 Rs.100,000/- 12.5% 0.233
06 Infosys 0.43 Rs.75,000/- 9.4% 0.040
07 LT 1.43 Rs.85,000/- 10.6% 0.152
08 Maruti Suzuki 0.95 Rs.140,000/- 17.5% 0.166
Total Rs.800,000/- 100% 1.223

The sum of the weighted beta is the overall Portfolio Beta. For the portfolio above the beta happens to be 1.223. This means, if Nifty goes up by 1%, the portfolio as a whole is expected to go up by 1.223%. Likewise if Nifty goes down, the portfolio is expected to go down by 1.223%.

Step 2 – Calculate the hedge value

Hedge value is simply the product of the Portfolio Beta and the total portfolio investment

= 1.223 * 800,000

= 978,400/-

Remember this is a long only portfolio, where we have purchased these stocks in the spot market. We know in order to hedge we need to take a counter position in the futures markets. The hedge value suggests, to hedge a portfolio of Rs.800,000/- we need to short futures worth Rs.978,400/-. This should be quite intuitive as the portfolio is a ‘high beta portfolio’.

Step 3 – Calculate the number of lots required

At present Nifty futures is trading at 9025, and with the current lot size of 25, the contract value per lot works out to –

= 9025 * 25

= Rs.225,625/-

Hence the number of lots required to short Nifty Futures would be

= Hedge Value / Contract Value

= 978,400 / 225625

= 4.33

The calculation above suggests that, in order to perfectly hedge a portfolio of Rs.800,000/- with a beta of 1.223, one needs to short 4.33 lots of Nifty futures. Clearly we cannot short 4.33 lots as we can short either 4 or 5 lots, fractional lot sizes are not available.

If we choose to short 4 lots, we would be slightly under hedged. Likewise if we short 5 units we would be over hedged. In fact for this reason, we cannot always perfectly hedge a portfolio.

Now, let as assume after employing the hedge, Nifty in fact goes down by 500 points (or about 5.5%). With this we will calculate the effectiveness of the portfolio hedge. Just for the purpose of illustration, I will assume we can short 4.33 lots.

Nifty Position

Short initiated at – 9025

Decline in Value – 500 points

Nifty value – 8525

Number of lots – 4.33

P & L = 4.33 * 25 * 500 = Rs.54,125

The short position has gained Rs.54,125/-. We will look into what could have happened on the portfolio.

Portfolio Position

Portfolio Value = Rs.800,000/-

Portfolio Beta = 1.223

Decline in Market = 5.5%

Expected Decline in Portfolio = 5.5% * 1.233 = 6.78%

= 6.78% * 800000

= Rs. 54,240

Hence as you can see, one hand the Nifty short position has gained Rs.54,125 and on the other hand the long portfolio has lost Rs.54,240/-. As a net result, there is no loss or gain (please ignore the minor difference) in the net position in the market. The loss in portfolio is offset by the gain in the Nifty futures position.

With this, I hope you are now in a position to understand how you could hedge a portfolio of stocks. I would encourage you to replace 4.33 lots by either 4 or 5 lots and run the same exercise.

Finally before we wrap up this chapter, let us revisit two unanswered questions that we posted when we discussed hedging single stock positions. I will repost the same here for your convenience –

  1. What if I have a position in a stock that does not have a futures contract? For example South Indian Bank does not have a futures contract, does that mean I cannot hedge a spot position in South Indian Bank?
  2. The example considered, the spot position value was Rs.570,000/-, but what if I have relatively small positions – say Rs.50,000/- or Rs.100,000/- is it possible to hedge such positions?

Well, you can hedge stocks that do not have stock futures. For example assume you have Rs.500,000/- worth of South Indian Bank. All you need to do is multiply the stocks beta with the investment value to identify the hedge value. Assuming the stock has a beta of 0.75, the hedge value would be

500000*0.75

= 375,000/-

Once you arrive at this, directly divide the hedge value by the Nifty’s contract value to estimate the number of lots required (to short) in the futures market, and hence with this you can hedge the spot position safely.

As far as the 2nd question goes – no, you cannot hedge small positions whose value is relatively lower than the contract value of Nifty. However you can hedge such positions by employing options. We will discuss the same when we take up options.


Key takeaways from this chapter

    1. Hedging allows you to insulate your market position against any adverse movements in the market
    2. When you hedge your loss in the spot market it is offset by gains in the futures market
    3. There are two types of risk – systematic and unsystematic risk
    4. Systematic risk is risk specific to macroeconomic events. Systematic risk can be hedged. Systematic risk is common to all stocks
    5. Unsystematic risk is the risk associated with the company. This is unique to each company. Unsystematic risk cannot be hedge, but can be diversified
    6. Research suggests, beyond 21 stocks unsystematic risk cannot be diversified any further
    7. To hedge a single stock position in spot we simply have to take a counter position in the futures market. But the extent of spot value and futures value have to be same
    8. Market beta is always +1.0
    9. Beta measures the sensitivity of stock
      1. Stock with Beta of less than 1 is called low beta stock
      2. Stocks with Beta higher than 1 is called a high beta stock
    10. One can easily estimate the stock beta in MS Excel by employing the ‘Slope’ function
    11. To hedge a portfolio of stocks we need to follow the following steps
      1. Calculate individual stock beta
      2. Calculate individual weightage of each stock in the portfolio
      3. Estimate the weighted beta of each stock
      4. Sum up the weighted beta to get the portfolio beta
      5. Multiply the portfolio beta with Portfolio value to get the hedge value
      6. Divide the hedge value by Nifty Contract Value to get the number of lots
      7. Short the required number of lots in the futures market
    12. Remember a perfect hedge is difficult to construct, for this reason we are forced to either under hedge or over hedge.

317 comments

  1. jagadeesh says:

    Hello Sir,
    Neat and clean explanation as always. Thanks for this stuff. I am eagerly waiting for the options module. 🙂

  2. Vidhyalakshmi says:

    Hi Karthik. I have a few questions. Here’s the first one: With the single stock situation…when the stock price declines, shorting the stock futures makes sense, because of the (a) long-term capital tax benefit, (b) difficulty in timing the market and (c) savings on unnecessary transaction costs. But, when the stock price rises (which is how we’re hoping to make a profit), taking a contrary position in futures will neutralize the gains. So, at which points, should we enter and exit the contrary futures position to lock in the profits?

    • jagadeesh says:

      Hi Vidhyalakshmi,
      Generally, Hedging is done when you expect news driven volatility in the market. eg. Before the union budget release, Before the annual reports etc. Once you sense that the volatility is done and news is discounted in the price, you can unhedge them again.

    • Karthik Rangappa says:

      For the hedge to be effective you need to ensure your view on markets is reasonable. If you initiate a hedge and the market falls then the hedge works in your favor…else if the market goes up you obviously will not lose money but you will certainly not benefit from the market raise. For this reason, before you hedge make sure you are ready for this trade off. For example we are now looking at a possibility of a US fed rate increase. If that happens markets may react and tank a bit further. So at this stage you need to decide your stance – do you want to take the risk or insulate yourself. Do remember this is a event based hedge so as Jagadesh mentioned remove the hedge once the event is through.

  3. Vidhyalakshmi says:

    Thank you very much, Jagdeesh, Karthik! I just have a couple of more questions. (1.) You mentioned earlier that the Nifty sort of eliminates unsystematic risk; so rather than go through the trouble of picking a diversified portfolio of individual stocks, is it okay to just buy NiftyBees…which would also make calculations for the hedge value a lot simpler? (2.) I’ve started trading index futures recently (with decent success thanks to you!) and I was wondering if my calculation of support and resistance levels should be based on the particular Nifty future (usually far month) or the current Nifty index?

    • Karthik Rangappa says:

      Glad to know about the success bit 🙂

      Anyway, it does make sense to pick up Niftybees…it automatically represents a diversified portfolio. However do remember the performance of the Niftybees will be just as much as the market (obviously). Also for S&R calculation, I would advice you so that on the Nifty Index as opposed to far month contract.

  4. Vidhyalakshmi says:

    Okay, last two questions 🙂 (1) The predictive analysis (PA) column in Pi…can we use it as a confirmation of our directional view of a future…how often does it predict the price on the right side? (2) The site says that the predictive analysis column is only activated in the last 30 mins. But that’s not the case. In fact, the PA price is adjusted as the day progresses. Has there been a change in the way the feature was originally designed to be used?

    • Karthik Rangappa says:

      The PA column on Pi just tries to predict the closing prices for the day (which is the weighted average of the last 30 mins)….even though the PA columns is functional, it makes sense to look at it for the last 30 mins…so dont use this as a confirmation for your directional. Regarding the accuracy bit, I dont think I can comment as I don’t use this feature myself…but I’m certain it gives out a good ballpark on the closing values. Also, please feel free to ask as many questions as you want, there is no restriction on that 🙂

  5. Nilesh says:

    Dear Sir,
    Just wish to thank you and team Zerodha for making such a wonderful platform where everyone can learn stock market in simple/easy to understand manner.

  6. Ganesh says:

    First I would like to thank you to make it wonderful notes.

    In order to have hedge 10L worth of my PP, I need to have another 10L additionl capital in my account. So managing this money and keepig this for such trading are a bit complicated I believe, right?

    • Karthik Rangappa says:

      Well, for 10 L worth of short you need about 16% margin…which is about 1.6L. So I guess it is worth to set aside this money for hedging.

  7. madhu nair says:

    hi Karthik, how many sucessive candles constitute a down trend or an uptrend in a 5 minute and a daily candle chart

    • Karthik Rangappa says:

      Usual look back period is about 5-7 candles…so if you are looking at EOD then look at at least last 7 trading sessions. Same holds true for 5 mins candles.

  8. t rama says:

    Sir, What should be the min. length of a candle to avoid short candles.

    • Karthik Rangappa says:

      Make sure that today’s range is at least the average of the last 10 trading sessions. In this way you could avoid taking trades based on short candles.

  9. madhu nair says:

    hi Karthik, If i use average true range and change the period to 5 on a 5 minute chart, does it mean a look back of 5 five minute candles? and 14 would signify a look back of 14 five minute candles on the same chart?

  10. Karthik Rangappa says:

    Yup, thats what it means.

  11. J S Pundir says:

    Hello there! At the end of assumed market volatility hedging positions are to be squared off without any P & L from the point of entering the hedge! So rather exiting positions whenever anticipating volatility( both decisions- to hedge or exit- are to be taken on same assumption) seem better then unnecessary hedging by taking a contra position in same stock / index futures( the cost of additional two trades, locked positions, delayed margin availability thus denying entry or trade in the volatility weigh against…) . Surely there must be other options!

    • Karthik Rangappa says:

      But what if the draw down in market is much more severe than what you have expected? I’ve tried to explain the logic in section 11.2 as to why hedging a better option when you anticipate a fairly large correction. Also, you can hedge using options rather than futures which incurs a much lesser costs.

  12. R.P. Hans says:

    In the case of future and hedging by future, we shall have unused money also for MTM. How to manage it.What % shall be kept for that purpose? Will it not reduce the value of portfolio? This amount will be idle in the account?

  13. Ashwin Datre says:

    hello Karthik sir,
    Thanks a ton for this great job of making the markets understanding so easy especially for a novice like me.
    just had a question…to hedge a long position, be it in a single stock or in a portfolio, which future contract we should be looking at to assume a short position on.. near month,mid month or far month?
    please excuse me if this sounds a silly question.:)

    • Karthik Rangappa says:

      Thanks Ashwin, I’m glad you liked our content. I would suggest you use the current(near) month contract to hedge…but if you are very close to the series expiry then you could buy the mid month directly as it would save you from the rollover efforts.

  14. Rupesh says:

    Great simple explaination….

  15. vasanth says:

    Can i provide the link to download the last 6 months daily close prices of Nifty and Stocks for Beta calculation?

  16. Daevee says:

    Dear Karthik
    Thanks for in detail hedging view on Stock market.
    But Commodity hedging is different than stock market share.Still my question is unanswered. kindly enlighten me if m wrong.
    Daevee

    • Karthik Rangappa says:

      Not really – think about it both stock and commodities are future contracts. The characteristics on the instrument is the same, hence the methodology is also the same. Anyway, we will include an entire module on Commodities and Interest Rate Futures shortly…I’m sure you will appreciate this in greater detail then.

  17. R P HANS says:

    Sir,
    How to and when to come out from the hedged position to get some profit. Because after all, we r trading to make profit. Time comes when we choose to hedge our position or a trade but I usually not able to decide about the which position to close first which one to close later.

    • Karthik Rangappa says:

      Hedging is a part of the game and is not really done to make a profit. In fact its done to protect your profits. You would need to do this as and when you deem appropriate.

  18. lakshmi says:

    Is span margin and exposure margin required to write an option when i have the underlying security in my account? Can I pledge the underlying security and write an ATM put option? I read that it requires 16% of the value to hedge in one of your replies to another questioner. If there is no movement or little movement against my thinking in the underlying, I will be making a small but sure profit. If it goes completely against my assumption, I stand to loose just the brokerage. Please let me know as much in detail as possible.

    • Karthik Rangappa says:

      Yes, option writing requires a margin deposit even if you have the underlying in the account. Yes, you can pledge shares and short options (but cant buy options with pledge shares). The P&L depends on the the movement in the underlying. If you short ATM put and market goes down you will lose money but if market goes up then you will not.

  19. pavan says:

    Dear Karthik,
    In the example that you have mentioned, you had taken a long position in stocks and a short in futures contract for that stock. Now suppose that I have gone long on CRUDEOILM15OCTFUT and decide to hedge this position, how can I do this? If I take a short position in CRUDEOILM15OCTFUT at the same price, my initial long position will get squared off.
    Thank You.

    • Karthik Rangappa says:

      Yeah, you will be long and short on the same contract hence no position. You can probably initiate a short on Nov series.

  20. varadharajan says:

    Thanks for your detailed explanation on Futures trading,hedging…If you could cover one chapter on PAIR trading also it will very useful.

  21. Master Shaikh says:

    Can I do Hedging from Equity Cash to Equity Future Or Vice Versa ..

  22. Rajesh says:

    Thank you for writing the lucid article.
    I am new to the market.
    please give some site which gives stock quotes and news and data.

  23. kenny says:

    thanks Karthik Rangappa. i have really learnt what hedging is all about. i have some questions. i have some risks and uncertainties facing some oil fields. i can only use them in real option valuation if they can be hedged. those uncertainties include, oil price, amount of recoverable reserves, Operational hazards including blowouts, spills and personal injury, operating costs. I am aware that only the oil price is market risk and can be hedged. how can i hedge other unsystematic risks?

  24. Karan Samal says:

    If I want to take one Calendar Spread Position in Nifty Futures, do I need to have full margin for 2 Nifty Futures (1 Buy + 1 Sell) before I get the margin benefit? According to Margin calculator, the Margin for 1 hedged position in Nifty Future is approx Rs 12,000. So how much cash should I have to take this position?

    • Karthik Rangappa says:

      Once both the positions are implemented then you do get margin benefit, but you will need full margin while initiating the positions.

  25. varun says:

    Very well explained. Thanks for the information. One doubt,
    Can we use hedging technique in the normal market ? If yes, what is the difference between hedging in the normal market and in the futures market ?

    • Karthik Rangappa says:

      Varun, you will have to use the derivative market (either futures or option) to hedge the portfolio in regular equity market.

  26. anil bhasein says:

    i purchased 10units of aditya birla nuvo @ 873 and 10 units of the same at 850 , so total i have 20units @ 860.15
    now one day the price came to 855.10and i sold 10 units . did not cover it the same day
    but again purchased it the next day at 844 . did i make a profit or a loss in this trade /
    PL LET ME KNOW IF THIS STRATEGY IS RIGHT OR A BETTER ONE COULD HAVE BEEN USED

  27. Naresh says:

    Varsity is great stuff. Not sure whether capital markets is your first love or writing !

  28. padmanathan says:

    sir, can u provide any hedging tips. pl reply me sir

  29. Omkar says:

    Superb explanation !!! 🙂 Thanks for materializing all concepts …

  30. Tanmay Garg says:

    Why should one not hedge it through options. So that downside is limited and one can have gains too. ?

    • Karthik Rangappa says:

      You can, its just options were not introduced at the point of writing, hence dint discuss the same 🙂

  31. Akash Jatwala says:

    If i hedge my portfolio with Nifty Future and i short it , and if the market move upwards then i will incur a profit on my portfolio and a loss on Nifty Future. Is this a short come of hedging?

  32. Rajesh says:

    Hello Karthik, I am more comfortable in futures rather than options. Can you pls suggest me some hedging strategies for the future itself (Long and Short both?

    • Karthik Rangappa says:

      One of the ways to directly hedge a futures position would be to buy a counter position the next month. Give it a thought.

  33. Malini says:

    Excellent explanation.. Thank you..

  34. Sourabh Sisodiya says:

    Waiting for a module on pair trading. Can you let me know when will that be uploaded ?
    Thanks for these amazing notes.

  35. Sai Sreedhar says:

    You have mentioned that we cannot hedge the portfolio exactly (so we end up Over Hedging or Under Hedging). Is it wise enough to say that Over Hedge works more in our favour, supposing the market falls, and I am not only hedging my portfolio but also making profit buy the additional amount of hedge (in the future contract)?

    • Karthik Rangappa says:

      Yes, it is possible that you make some profits when you hedge. Some even refer to this as an ‘Alpha Capture’.

  36. vedant manore says:

    what if the weighted beta of my portfolio is negative? ho do we calculate the amount to be hedged and no. of contracts etc.?

    • Karthik Rangappa says:

      Its quite rare to have a -ve negative beta portfolio. But if you do, then you are naturally hedged!

  37. amit mishra says:

    How to hedge futures with options?
    If answer is given, then please post the link.
    Thanks.

    • Karthik Rangappa says:

      We will discuss this topic sometime soon.

      • amit says:

        In short here pls if possible.
        Only example will do.
        Thanks

        • Karthik Rangappa says:

          Ex – Assume you have two lots of Nifty Futures long, we know delta of a futures contract is 1, so since you have 2, delta adds up to +2. You need to offset this delta with options…maybe by buying 4 ATM PE, since each ATM PE would be -0.5, 4 PEs would add up to -2. So you kind of hedge your futures position.

  38. Khraw says:

    Sir
    I have a question. Suppose I bought 1 lot of Nifty Future as NRLM and next day I expect the market to decline in order to protect and make some profit I want to short or sell Nifty future with 4 lots as intraday or MIS and vice versa (I.e buy 4 lots as intraday when expect market to rise). Does it affect my NRML 1 lot Mifty future?

    Thanks

  39. Harjinder Singh says:

    Sir, how can one hedge a small position of say TATAMOTORS using options on TATAMOTORS?. ( position is smaller than the lot size) Thank you

    • Karthik Rangappa says:

      In this case you cannot have a perfect hedge, in fact you will be over hedged when you buy 1 lot of Tata Motors puts.

  40. khraw says:

    Pls reply to my queried ablove.

  41. JAJU says:

    Loved Your content.Lots of things are getting cleared after reading your contents.A superb effort,simply superb.

  42. Ramesh Patwardhan says:

    Sir,
    At the outset, let me congratulate you for the marathon effort you have put in while developing this VARSITY.
    It has really become the ‘seat of learning’ on the topic.
    However, at some places in the text, I find the words “Systematic risk” whereas it should be “Systemic risk” …
    Is that right? Or have I gotten the meaning wrong?
    Please throw some light.
    Thanks …

  43. Suresha.ks says:

    Hi,
    I have a position in spot market for long term percpective but this stock is not in future. My question is if this stock starts to fall due to some fundamental reason,according to Beta calculation we can hedge a position in Nifty but that time if nifty is in sideways what to do

  44. Benny says:

    Dear Karthik,

    Thank you for the effort you are taking.
    Can we use the hedging in options also? Please explain how to do it with an example.

  45. Subbu says:

    Sir,
    You said that for calendar spreads, margin requirement reduces owing to reduction in risk. Does this apply to cash- future hedging also? Suppose I sell 1 lot of any stock future and buy equal number of shares and hold both till expiry. In this case also the risk is reduced. Will there be any margin benefit for the cash transaction?

  46. Subbu says:

    Also, pls explain if bull(&bear) call spread also has margin benefit

  47. Vishal says:

    For hedging future will it make more sense buying a put option for same stocks, if option series has just started, though it will limit profit but it will also reduce the risk.

  48. Biplab goswami says:

    I’m a new trader. Your easy language and example help me a lot to understand the market’s basic.Thanx a lot

  49. Rupendar Singh Rathore says:

    Hi experts,
    I just want to clear my basic in futures contracts..
    Suppose I enter into short position on a future on ABC commodity at 50 for 3 months and after 3 months spot rate of ABC commodity is 52 and future rate after 3 months is 54 … Which rate should I use to calculate my loss ?

  50. Sujay Roy says:

    When are you going to introduce Hedging with option and in which chapter?

  51. Hussain says:

    Very well explained, very easy to understand. Di you have any excel or software which calculates P&L from hedching a particular stock.i

  52. ranjodh singh says:

    please tell me about hedging i dont know propperly how to hedg . please write to my mail

    • Karthik Rangappa says:

      No special emails Mr.Singh 🙂

      Everything you need to know about hedging is written here. Give it another shot.

  53. SANDEEP REDDY says:

    Kite provides Beta of a stock.Data provided by small case.Is it same as you mentioned here.

  54. Pradeep says:

    Hi,
    I have a doubt in hedged position.
    For Ex:
    Long Adani Power Mar -Fut Cont
    Short Adani Power Apr – Fut Cont

    If market goes down, March Contract will be in loss and April contract will be in gain. In this scenario, will march contract alone will be squared off if it reaches below margin.

    Please explain me elaborately.

  55. Raghav says:

    Sir, where can find beta of the stock in Zerodha?

  56. Jaishree says:

    Loved the explanation
    Thanks a lot sir. Helpful for my CA exams

  57. Ayush says:

    Few questions, sir?
    1. In hedging, one is protecting himself from systemmatic risk but he/she is also not gaining much then, why would one would like to hedge?
    2.Beta is the calculation on the basis of how market and stock price reacted to each other in previous days or months, Am i right?
    3. If i have to calculate the stock beta daily, then i will have to change the closing price on daily basis(closing price of previous day)?

    • Ayush says:

      4. Do we have to calculate Stock beta or we can get BETA info. From anywhere esle?

    • Karthik Rangappa says:

      1) A fall from 100 to 80 is 20% decline, the move from 80 to 100 is 25%, so your money has to work harder when going up. So you are better off hedging.
      2) Yes
      3) Yes, its best of you can calculate beta on a closing basis.

  58. sidharth says:

    Hello,
    Suzlon Futures price was 21.30. I gave a sell order at 21.20 when the LTP was 21.30 but kite short sold at 21.30 immediately (basically the LTP at the time of placing the trade)? Is this correct?
    I have traded futures on Kite but never had this issue for either buying or selling.
    Seems like a bug? Can you explain?

    • Karthik Rangappa says:

      Exchange tries to get you the best possible execution price. You wanted to sell at 21.20, but there was matching order at 21.30, so you got that price.

  59. karan says:

    sir very lucid and useful content for novice like me.Hats off. I have been continuously going through these modules for past 5 days.

  60. jagadish says:

    sir how can sell a stock in long and short position at once as u have shown
    own

  61. Abhilash says:

    Excellent Explanation … I cannot see any Smileys here to post like Whats app… anyway I need to clarify something …

    1. Can we calculate Stock Beta for every stock or only the Stocks from NIFTY or SENSEX index ?

    2. I saw a video to calculate Beta , they are using WEEKLY Closing price of 10 years instead of DAILY. So what about the big difference by using Historical Weekly and Daily and how it impact Beta values of Weekly and Daily ?

    3. From your example, As of 2015 Beta value of ACC Limited is 1.22 [we have used historical 6 months Daily Closing price ] . So this 1.22 will be valid for the next 6 months and again we have to calculate the Beta or it will be a Constant for ever ?

    Thanks in advance …

    • Karthik Rangappa says:

      1) You can calculate the beta for every stock
      2) They would have used weekly since they were considering 10 year data
      3) Beta changes – 1.22 is as of now. Having said so, beta does not change drastically. So its kind of safe to assume that the beta you’ve calculated today will be valid for over the next few weeks.

  62. Gurpreet says:

    Hi Karthik,

    I am a regular reader of all your blogs and am a huge fan of yours 🙂 . I had bought Coal India stock 200 shares @ 295. Now it is somewhere around 250 and is continuously descending. After reading your hedging concept, i checked the future contract of Coal India but in that, minimum qty mentioned is 1700. I am in doubt and don’t know how to apply hedging here.
    Could you please suggest what will be best hedging option here?
    Thanks
    Gurpreet

    • Karthik Rangappa says:

      Happy to note that, Gurpreet 🙂

      I’m afraid you will not be able to hedge 200 shares as the lot size will not match your holding quantity.

  63. jagdish says:

    Hi sir,
    im beginer in this field.will you suggest me to enter in this trade.if you please guide me from where to start and how
    With regards

  64. Hari says:

    Thanks Karthik

    simple & lucid …. in a layman’s language

    regards
    Hari

  65. Ash says:

    Awesome Karthik, was able to learn Beta and Hedging the Portfolio well with your simple way of illustrations! Kudos to you and your team!

  66. Girish says:

    Dear Karthik,

    Very nicely laid out explanation on Hedging a long stock portfolio. Let me see if I got it right 🙂
    Say my portfolio of Rs. 10 Lakh has a Beta is 1.40 Given all time high stock markets, and an expected correction, what is a bare minimum Hedge Value? I guess, hedging 100% of my portfolio by shorting NIFTY would mean that I am also shutting myself out from any potential gains from underlying Long positions?

    Please clarify.
    Best Regards,
    Girish

    • Karthik Rangappa says:

      Yes, that’s correct. Your hedge value will be approx for 14L considering your portfolio is skewed towards a larger beta.

  67. Krishnakant says:

    How much period Zerodha considers to calculate beta of a stock ? i mean basis past 6 months or 1 year or 5 years or 10 years data?

  68. Ash says:

    1. If my portfolio value is 3 lakhs say, then one lot of nifty future will come to 7.3 lakhs at current market price(=9750*75). So I cant hedge in futures is what you are saying right?
    2. So which part of options have you discusses the hedging topic? I couldn’t find when I look into the titles.

  69. Strydon says:

    What happens if the hedged futures goes north (contrary to the position favourable for us) and we are forced to square off ? Obviously our spots are going north for good but wouldn’t the hedged futures be dragging our profits down ??

    • Karthik Rangappa says:

      If you are hedged well, then you are completely insulated to market movement. Your position neither makes a profit or yields a loss.

  70. Nancy says:

    The Nifty PE is above 26.41 as on Oct 13, 2017. I read that in the last 17 years Nifty PE has reached this level thrice and all the three occasions there was a market crash. So can we anticipate a market crash soon? Is it not a good time to buy stock for people who don’t know hedging strategies? Should I sell my stock and book profits?

    • Karthik Rangappa says:

      Well, if you believe history tends to repeat itself then you have a reason to sell. If you believe that its ‘different this time’, then you can forget about selling 🙂

  71. Abhishek c says:

    Pl create a pdf regarding bank nifty

  72. Shripad Malap says:

    Hello Sir,
    Do we have any report in NSE or BSE weekly to show positions of traders ? Like Chicago Mercantile publish report weekly called COT (Commitment of Traders) report .

  73. SHANTARAM PATIL says:

    Dear Sir,
    I have gone thru hedging Future Chapter.

    I understood hedging to be done for protecting your portfolio for minimising loss and hence buy future.

    Sir, I purchased 1 Maruti future on 3rd of Oct. @ rs. 7912/- from 3 rd of Oct till 20 th Oct a loss is 27925/-. The expiry is on 26 th Oct . Now i am still in bullish way that Maruti stock may go up and i can manage my loss. As u r experienced person , I would like to know your view on the same since 2/3 days are left.

    Also please let me understand what exactly is the Hedging with an example.

    Please reply.

    Thanks & regards.

    • Karthik Rangappa says:

      Ah, I’m really not sure about the direction, Shantaram. I’m afraid I won’t be able to help you much here. Good luck!

  74. SHANTARAM PATIL says:

    Dear Sir,
    Really one has to take his own decision and learn in better way.

    But still…… What is exactly hedging? and can u pl provide 1 simple example.

    Sorry to bother.

    Thanks & Regards

    Shantaram : 9987889301

    • Karthik Rangappa says:

      Hedging is a technique where you insulate your positions against market movements. So irrespective of where the market moves, your positions will stay intact. Think of it this way – Outside your house, there are riots happening, you have locked yourself in your room and staying safe inside, completely isolating yourself to the riots outside.

  75. Yash says:

    Yes Future vs option which is sustainable for long term ,

  76. Patrick Jones says:

    Well written and in depth information. Much appreciated. I think this is so good, will be sharing with my futures/options broker.

  77. YOGESH BORSE says:

    Excellent write up, you are a very good teacher. Love to see your blogs.

  78. mayur says:

    How we get daily returns of Nifty for calculate Beta value.

  79. Akhila Reddy says:

    Thanks for the publisher of this article . It’s very useful and understandable with good examples and required links for ease.

  80. Barjinder Singh says:

    Hello Sir,

    The articles are all wonderful with the exact knowledge that one requires to trade effectively. Beautifully explained by touching upon the most crucial points, which otherwise would require years of hardwork and practical experience.

    Thank you.

  81. jyotshna says:

    1.) Stocks beta we compare with index, for crude, gold and also currency how to find beta and compare ( with which index or data ) ?
    2.) In explanation it is mentioned that if beta is -ve then stocks movement is different, is it completely opposite means when market goes up then stock down and vice versa ?
    3.) For trading we should look for high beta shares and for investing beta nearly 1 ?
    4.) How farmers can hedge their crop and also how Govt. hedge fund ( if earth quack, geo political tension or anything happened ) ?
    Varsity is helping students also so asking.

    • Karthik Rangappa says:

      1) You can do this with the commodity index
      2) That’s what the math suggests i.e the stock and index moves in opposite direction
      3) If you like trading volatile stocks, then I’d suggest you trade the high beta stocks
      4) Farmers can hedge with futures, not sure about the Govt.

  82. Kishan says:

    What is effect if we hedge via options instead of stock or future

  83. Narasimmamurthy says:

    I salute Zerodha for a lucid presentation with illustration ; just when I was looking to hedge my newly formed portfolio 4 months old. I respect the value of investor service done . With regards

  84. Aniruddha Kumthekar says:

    Hello Karthik,

    Thanks for very nice explanation!

    I have couple of questions:

    1: If everyone if shorting futures to hedge cash portfolio & if mutual funds are not allowed to use F&O other than hedging, who is buying them to offer other side of the trade? Is it only retail trader? I wonder if they can offer so much of volume
    2: Future volumes seem to always be in synch with cash volumes. Portfolios can’t be hedged at every stage right?

    Thanks,
    Aniruddha

    • Karthik Rangappa says:

      1) Everyone has a different agenda in markets and not everyone hedges. Also, to hedge or not is a call dependent on your view on markets. You could feel bullish while I feel bearish. Different opinions is what really makes the market
      2) Not true.

  85. Gurjeet says:

    I just calculate HPCL beta from july is 1.20 but my question is as per beta stock should move higher as nifty moved but it fell by -15.74% compared to nifty 14.46%.. I think it was because of split so how share split effect beta and how to calculate accurate beta in case of share split .

    • Karthik Rangappa says:

      Ah, the beta does not work like this – at least not on a day to day basis. It gives you an over sense of the risk. Also, these % moves that you mentioned could be as a result of some corporate action.

  86. suresh brahmbhatt says:

    DEAR SIR ,CAN YOU POST DETAIL INFORMATION ABOUT NIFTY FUTURE CALENDAR SPREAD WITH PROFIT LOSS CHART..AND ENTRY /EXIT POINTS….THANKS IN ADVANCE…

  87. Yusuf Rampurawala says:

    what is the difference between cash and carry arbitrage (difference between spot and futures prices) and hedging positions in spot market by taking counter positions in futures? In both cases, C&C and hedging, counter positions are taken in the two markets. kindly explain with one example

    • Karthik Rangappa says:

      When you hedge, you are completely insulated against the market movements, you are expected to neither make a profit or loss. But in arb, you are extracting a value.

  88. trader says:

    Hi Karthik,

    1) is it possible to do reverse futures arbitrage in India in any segment (commodity/equity/currency)?
    2) how does one do cash and futures arbitrage strategy on Nifty and BankNifty?

    • Karthik Rangappa says:

      1) That is not easy as you’d be required to short spot and continue to hold it overnight
      2) Not possible as the underlying does not trade.

  89. vivek says:

    Hi Karthik,
    I have taken long position in future on a stock when month was started but recent turbulence after budget has brought me in loss.
    Expiry is near on 22nd Feb .
    Wanted advice —
    1)-Can you explain any strategy so that I can minimise my losses .
    2)Is carrying contract for next month is advisable in bearish market.
    .

    • Karthik Rangappa says:

      1) It is hard to intervene now, but if I were you’ve I’d have written few Call options
      2) Only if you have a strong conviction that the market will bounce back.

      Good luck.

  90. paresh says:

    Hi Karthik,

    I have most of investment in smallcap mutual funds. is it advisable to hedge my MF portfolio? if yes then how?

  91. Keshav kunal says:

    Hi ,

    If I hedge i am neutralising all my gain condition…right??
    Hence hedging is right only when one is sure of the price going down when one has invested in spot market?? It is not a good option when all stocks are moving in right directions???
    Pl correct if m wrong

    • Karthik Rangappa says:

      Yes, when you hedge you neutralize yourself to the markets, hence you won’t be affected by P&L. Also, you hedge, only if you feel the markets are moving against you.

  92. Delta 1 trader says:

    Hi Sir

    Is it possible for you to advise of an easy way to execute a long stocks vs short futures trade on Nifty or Bank Nifty (i.e. to capture the basis)? Is there an automated script/order type available in zerodha which will replicate the stock holdings of 1 bank nifty/nifty contract? Also is there going to be a margin benefit available for this kind of delta neutral trade?

    Thanks
    Labeeb

  93. Mangala A S says:

    Mr. Karthik,

    Does buying the current month future and selling mid month future of the same underlying in the adverse market called as Hedging? Or calendar spread?

    • Karthik Rangappa says:

      Yes, because you are offsetting the long position with a short. This is a calendar spread, which is also a hedged position.

  94. Adishwar says:

    Hi Karthik! You have mention here that if we hedge our portfolio we will end up saving our money on Long term Capital gains tax and other transaction cost.
    Given now Profit of more than 1 lakh will be taxed 10℅ is it still good option to hedge our portfolio?
    Also according to Taxation module by Nithin he mentioned Income earned from Future and option (Non-speculative income) cannot of offset from Long term Capital losses.We have pay tax on gains from Futures and options according to tax slabs we are in. Whats your view on this?

    Apart from futures trading module. I just Drawn Fibonacci retracement according your guidelines in technical analysis module on nifty 50 and I WAS AMAZED it just bounce back after coming near 38.2%. It would be helpful to me me if you can check and let me know.

    • Karthik Rangappa says:

      I’m really not sure about this, can you please let me know the context in which I’ve stated this? Thanks.
      About Fib – yeah, sometimes it works like a charm 🙂

      • Adishwar says:

        11.2 5TH paragraph you have mentioned

        “But what about the 2nd option ? Well, the 2nd option where the investor sells the position and buys back the same at a later stage requires one to time the market, which is not something easy to do. Besides when the trader transacts frequently, he will also not get the benefit of Long term capital tax. Needless to say, frequent transaction also incurs additional transactional fees.”

        • Karthik Rangappa says:

          Ah, basically if you hold the equity position for more than 365 days then you pay only 10% LTCG, else you pay 15% as short-term capital gains tax.

          • Adishwar says:

            Yes I know that. But one will also end up paying taxes on income earned from futures. For ex. If I come in 30%tax slab then I have to pay 30% of my gain in futures as tax right?☺️
            Wouldnt it be nice to just cut your portfolio when you sense nifty will fall. Also just using smallcase market mood index you can time the market not perfectly but close I guess.

          • Karthik Rangappa says:

            Yes, none of the market timing tools are accurate.
            About the futures, yes, that makes sense, but do check with your CA once. I’m guessing Futures used purely to hedge may be argued for in true spirit. But of you are trading futures regularly then I guess you have no options.

          • Adishwar says:

            Yeah that is true! Thanks for your reply.

          • Karthik Rangappa says:

            Cheers!

  95. Gautam bhardwaj says:

    Hi
    I have a question kindly answer i have googled it a lot but cannot get answer
    If the price of future is more and price of spot is less suppose price of any share is 1000 and future price is 990 how to benefit from this situation suppose we dont hold the stock and it is only for trading.

    • Karthik Rangappa says:

      Gautam, its common for Futures to trade in premium/discount to spot. However, if the premium/discount is more than expected, you can set up a cash and carry arbitrage. Have explained more in detail in this module.

  96. Gautam bhardwaj says:

    Sorry future price is in discount than spot price how to do hedging

  97. Krunal Shah says:

    Hello Sir,

    Can you please publish the chapter on option hedging and also suggest what is to be done if market moves beyond what we have hedged.

    Example: Bank Nifty is at 26500 and now I have sold 27000 CE and 26000 CE assuming that it will not go beyond 27000 and same for 26000 for downside. Now what is to be done if market starts moving 27000 side or making down to reach 26000, Could you please suggest.

    • Karthik Rangappa says:

      Hedging with options can be a bit tricky, Krunal. When you hedge, the idea is to protect from adverse directional movement. However, options is not just about directional movement, but also other variables come into play. So its best to hedge with futures as opposed to options.

  98. CHIDAMBARAM V says:

    Hi Sir,
    1.Can’t Hedging a portfolio be done as a 1 single stock hedging with stock future for all the stocks in our portfolio?If so then what is the benefit in hedging with NIFTY future rather than multiple single stock futures?
    2.If hedging to be done only when we assume market is going to move in opposite direction to our position in market,then isn’t it also similar to timing the market?If so then why can’t we exit our portfolio and get back to it once correction is over (since long term capital gain tax is also introduced now,hence no much difference in tax benefits too)
    3.If we are hedged and market moves in opposite direction to out view on hedging ,then our future position will makes a loss and portfolio will be in gain,hence both offset each other.Means we are not going to make any money from our investment idea if the hedging is wrongly done.
    4.More gains in market are made only during news and major announcements and if we insulate our-self from them with a fear of market moving down, with hedging then how are we going to make money in the market (since hedging insulate us from market move in either direction) !!

    • Karthik Rangappa says:

      1) You can hedge a single stock if you think that particular stock can drag the entire portfolio down. To do this, you need to ensure that the stock have a futures contract and you also need to ensure that the quantity you hold matches the lot size.

      2) Hedging is an expense and you need to do that only if you think the market is going down, yes this involves a certain degree of timing. Also, you have to explain to your CA that the trading in F&O is for hedging to avoid any tax-related situations

      3) Yes, you the objective when you hedge is to insulate your portfolio. You neither make money or lose any.

      4) Hence you hedge your portfolio only when you anticipate serious trouble in the market and not really against corporate announcement.

      Good luck.

  99. Musthafa says:

    Sir, Great indeed. Neat and clear. Fantastic. The most beautiful presentation I ever read of the topic.
    Looking forward eagerly to see the module 4

    Thanks a lot

  100. Pardeep Kumar says:

    Sir you have not covered hedging using options in the options chapter. Please cover it at the earliest. I suspect that a sharp correction can happen any time now.

  101. Pardeep Kumar says:

    One more query sir. Is it possible to hedge small positions of 1 lakh to 5 lakh through shorting nifty etf.

  102. SHUBHAM RAJKUMAR SHETI says:

    Sir I have a doubt regarding hedging. How can we hedge a small cap stock with Nifty as you can see from past 2-3 months they are mostly moving in opposite direction

  103. JAI DESAI says:

    Hi,

    I had one question. How to put stop loss in a hedged position. Because one contract we have shorted and the other position for same contract is long.

    So the margins required are less in this case. But can we put stop loss for both positions? And then just square off one position and continue with other position which is in our favour?

    • Karthik Rangappa says:

      By definition, a hedged position is insulated against market directions. So there is no need to place a stop loss. Of course, you can square off on leg whenever you want.

      • JAI DESAI says:

        Sqaure off on leg means sqaure off one of the positions? Either short or long?

        I understand that there is no need to put stop loss in hedging, but by putting stop loss on both sides I get to confirm which side the stock is moving if the other stop loss gets hit automatically and I do not have to monitor the trade.

        • Karthik Rangappa says:

          Yes, SQ off means to close one position completely.

          I got your point, you can do this by manually tracking both the sides of the trade.

          • JAI DESAI says:

            Thank You so much. This is great.

          • Karthik Rangappa says:

            Happy learning, Jai!

          • JAI DESAI says:

            One last question

            I’m trying to hedge COLPAL Futures by buying OCT contract and selling Nov contract at the same time. Taking spot price here and not future price for this example.
            So CMP is 1175.
            For Sell position i’ll put stop loss at 1275
            For buy position i’ll put stop loss at 1075.

            Margin required is around 22k as per the calculator

            Lets say price moves up so the Stop loss for sell contract will get triggered at 1275 and the buy contract will continue unless I square off. After the stop loss for sell position gets triggered, Will I have to add more margin to keep my buy position? Since buy position is something I would like to continue with as I have a target price in mind

          • Karthik Rangappa says:

            At the time of taking the position, you will need to have enough margin for both the position. You will get the margin benefit once the position is taken.

  104. SATYA KONETI says:

    Hi Karthik,

    Today NIFTY was at 11700, the call option premium (11700 CE) was at 160 and 11700 PE premium was at 110, I have not seen such huge difference in the premiums (At the Money). Please tell me what could be the reason for this.

    And NIFTY futures also at 11760 current month contract when NIFTY was at 11700. Why such huge difference between spot and Futures price.

    Thanks in advance
    Satya

  105. SNEHA MAHESHWARI says:

    Lot Size of NIfty Futures???

  106. Prakash Joshi says:

    Sir,
    I want to get my doubt cleared regarding hedging of port folio.
    Suppose I have a port folio which needs hedging for a value of say 10 lac rupees. then I need to have a nifty futures short position contract in place. As I want to hedge my portfolio for all the time, do you suggest that the short contract has to be in place all the time or only when we expect that the market may go down. This is difficult to predict.
    Prakash Joshi
    Thane. MAHARASHTRA

    • Karthik Rangappa says:

      Yes, Prakash, you need to short Nifty worth 10L to hedge your portfolio. By the way, it is not really required to keep a hedge all the time. You need to time this based on your opinion on the market direction.

  107. kuldeep says:

    Hello sir,
    I have a portfolio a value of 90K rupees with 18 share, how hedge this small portfolio with option ?

  108. Mani says:

    Sir how to delta hedge option strategies?

  109. karthikjayasimha says:

    Dear Sir,

    You have explained how to hedge the portfolio using Nifty Futures. I have two doubts here:
    1. As an investor, if we are regularly investing (through SIP) in a product like NV20, how to hedge such a portfolio?
    2. As a trader, if we take up long or short Futures positions in Index or individual stock, can we hedge them using options?

  110. Arun says:

    Dear Karthik,

    Isn’t there one scenario in which hedging can actually result in loss as below:
    Suppose, today I am long on portfolio and I predict market to fall tomorrow so I hedge my portfolio by shorting Nifty futures, but somehow my prediction went wrong and Nifty didn’t fall rather portfolio stocks fell down.

    we did book a loss. Falling stock may be a natural course of stock but unnecessarily additional loss occured due to our poisition on Nifty. correct me if I m wrong plz.

    • Karthik Rangappa says:

      Arun, I get your point. For this exact reason, you need to measure the risk of your portfolio with respect to the beta.

  111. Srikrishna says:

    Hi Karthik,

    I think I am confused a bit on this topic. I want to put a example here and plz help me in solving this , so that I can clearly understand the concept.

    Ex: Suppose a stock is worth 100 (in Spot Market) and I bought 500 of them. So, total worth of 50,000.
    Obviously my view is long on the stock and expecting it to increase. However, due to recent events, stock has fallen down to 95.
    Now, at this point, my loss is 5*500 = 2500.
    The market events still suggest that there might be more volatility even for sometime more. So, instead of trying to sell and buy them at lower price, I would go for hedging, by doing the below:
    Assume ,when the pice of the stock in Spot Market is 95, the price in Future Market is 100. Also assume , market lot is 500.
    Now, I will hedge my position by selling 1 lot of stock i.e 100*500 = 50,000 (Contract Value).

    Assume, the stock came to 90 after few days, at this point, the money lost from 95 to 90 in Spot Market is covered in Future Market.
    Hence, there is no much loss or profit.
    My question here is,
    1)if I think that the stock price might go against me and there is no money I can make out after hedging, why not I should close my position. That is, when the stock is at 95.

    Please explain. Thanks in advance.

    Thanks
    Srikrishna

    • Karthik Rangappa says:

      Srikrishna, the idea of hedging is not to make money. The idea is to insulate yourself against any adverse movement from the market.

      • Srikrishna says:

        Now, I think it in a different way. Let me know if this is the right way?
        In my case of example, think that the stock reached 90. Now, there is no profit nor loss because of the counter positions you have in Spot Market and in Future Market.
        Assume the market is improving and the stock reaches 95 within a day or so. Now, I can buy back in Future Market to close my position here and just hold on to Spot Market shares. By this way, I can minimize my losses by hedging and when market is going in favor of me, I can hold on to Spot Market shares and look for profit?

        Is this the right understanding? Please let me know?

  112. Kiran says:

    Hi Karthik,
    My doubt is what is profit lock?
    Suppose i bought a 700 share of ubl in equity at rs 700 and sold ubl futures for one lot at 710.
    Now for converging both the shares to either 705 or 695, i have to wait for 10 days suppose.
    Here will the profit or loss will be calculated on daily basis for futures or because of profit lock there wont be any loss or profit on daily basis until unless i complete these two transactions(i.e sold ubl equity and bought ubl future)

    • Karthik Rangappa says:

      Yes, futures have M2M and therefore the daily P&L. The profit that you eventually get is upon closing both the positions.

  113. Alpy says:

    What is the value of portfolio beta when there is perfect hedge?Is it 1

    • Karthik Rangappa says:

      The portfolio beta remains the same. However, with a perfect hedge, the systematic risk is reduced and therefore the portfolio is insulated against any adverse market movement.

  114. trader says:

    How do traders hedge their Futures positions in stocks like kajariaceramics?? The options trading volume is pretty low..for example if I try to do a protective call strategy.. in other words how do traders hedge futures positions of stocks whose options are illiquid? is there anyway other than taking an opposite futures position of next month contracts?

    • Karthik Rangappa says:

      There are 2 alternatives –

      1) Buy the stock in spot ( this is assuming you have a short in future)
      2) Set up an opposite position in the next month’s contract.

  115. Aditya says:

    Hi Karthik, Thanks for the detailed explanation of hedging. Pardon me for my naive question. I do get it that when i anticipate a downturn in the market i can look to hedge my portfolio. What if i hedge and the downturn doesn’t come, instead the market moves up. I understand that hedging will cut into my profits since it is a 0 sum game. Now my question is why to hedge? If anticipating a downturn, we can very well square off all our positions and take new positions once we can confidently rule out the possibility of a downturn because though the hedge will not allow the losses in portfolio it will also not allow profits in case our anticipation of downturn was not correct.

    • Karthik Rangappa says:

      When you hedge your portfolio, you are completely insulating your portfolio from the market. If the market goes down as expected, then you lose nothing. However, if the market goes up, you won’t make anything as well. Yes, you can sell off your portfolio and reinitiate, but you need to time the market perfectly well here – both at the top and bottom, which if you ask me is really tough.

      • Anuragh says:

        Hello Karthik,
        In regards to the question asked by Aditya ,
        Hedging is used only when you are planning for Investment and not for Day trading/ Intraday I guess. Is my understanding correct ?
        If it can be used for Intraday then how do I remove the shorting done just cancel the order made is that all ?
        Thanks in Advance

        • Karthik Rangappa says:

          only when you are planning for Investment and not for Day trading/ Intraday I guess —-> not really, technically you can hedge your intraday positions as well. However, I’m not sure if that is a very useful thing to do.

          • Anuragh says:

            Okay , In that case I am just thinking if I can hedge my Intraday/ Overnight position so that if in case price starts going in the opposite direction then I would not be losing much right ?
            Also I know I can use Trailing stop loss to minimize my Loss but still hedging will have less loss than Trailing SL
            Is my understanding correct ?
            Thankyou in advance.

          • Karthik Rangappa says:

            That’s right, in fact, you can minimize the cost by options as well.

  116. Amit says:

    Exchange Cost’s of hedging isn’t clear from the article. or have I missed something

  117. prakhar says:

    I dont use ms excel. Is there any website or software from where i can get directly the beta of a stock.

  118. vidit d says:

    You mentioned about the trading strategies of future. I only found calendar spread strategy and rest are option strategies. Pls guide me where can i find them in Varsity?

      • vidit d says:

        Like you mentioned,in one of the previous strategy that buy future and sell at spot. If i go for position trading,In future we need only margin money but in spot buying we would need that much amount of cash? Hence if doesnt meet that level,we can apply this strategy?

        • Karthik Rangappa says:

          I’m not sure if I get the context clearly. Can you please elaborate, Vidit? Thanks.

          • vidit d says:

            I do position trading and not intraday,then if i need to apply strategy,do i need to infuse that much amount in order to buy at spot? And how would i sell at spot in position as its not allowed in position trading? Thereby can we say that this strategy will work on intraday only?

          • Karthik Rangappa says:

            Yes, spot requires a larger outflow of money than futures. You are essentially trying to swing trade, where you can buy and sell easily, no restrictions as such.

  119. vidit d says:

    i can trade options in position trading also? and where do i get delta in option trading?

  120. krishna says:

    Instead of taking an opposite trade in the futures for hedging can’t we take the same trade in another exchange ? for example I want to hedge 100 sbin stocks bought in nse and want to hedge them in bse.
    I wanna know the drawbacks of this or pros if any.

  121. Purushotham says:

    Hello Sir,
    May we know where could we find the other strategies of futures trading you spoke about.
    Love the Varsity.
    Thanks for it.

    • Karthik Rangappa says:

      Thanks for all the love for Varsity 🙂
      Most of the strategy notes are scattered on the net. It is better to identify a strategy and then try to read up more on it.

  122. Kapil says:

    Hi Karthik,

    Apologies upfront, if this question is silly or is already answered. I have a portfolio which has 5 stocks and all of them are F&O stocks.

    Now what is the best approach for hedging, is it individual stocks or hedging at portfolio level?

    Thanks
    Kapil

    • Karthik Rangappa says:

      Kapil, when you have a portfolio, it is best to hedge this with Nifty futures. Individual stock hedge will turn out quite expensive.

  123. Kapil says:

    Thanks Karthik…this helps.

    Thanks
    Kapil

  124. Kapil says:

    Hi Karthik,

    Sorry…one more follow up question. What should be time period for the Beta? You have mentioned 6 months. But Beta ranges are available for 1 month, 3 months, 6 months, 1 year etc.

    Is 1 month or 3 month more closer to the true reflection of the Beta instead of 6 months or 1 year?

    Thanks in Advance!

    Kapil

    • Karthik Rangappa says:

      It depends on the strategy, Kapil. If you are looking at hedging, then I’d suggest you look at 1-year data.

  125. Yashvanth says:

    Hi Karthik, while hedging the portfolio, what if the Beta value come very less than 1? In the example that you have taken, the overall Beta for the portfolio was 1.2. What if it was something like 0.4 or less? Any other way for hedging or should I not hedge that portfolio?

    • Karthik Rangappa says:

      A beta of less than 1 just indicates that the overall portfolio is less volatility compared to the Index. Hence to hedge this portfolio, you’d have to short fewer quantities of Nifty.

  126. Kapil says:

    Thanks Karthik….

    Thanks & Regards
    Kapil

  127. Mo says:

    Having a diversified portfolio reduces risk, and I agree with that.

    But why is it that in terms of beta, the portfolio carries greater risk?

    If you look at it from a mathematical point of view, the risk is lower if you buy one particular stock, from a particular sector (Let’s say Infosys from IT sector having beta 0.43), which contradicts the entire point of diversification, and in fact encourages us to put all our eggs in one basket.

    Help me out here please, a bit confused 🙂

  128. Mo says:

    Still waiting for a reply sir.

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