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 –
- Take no action and let his stock decline with a hope it will eventually bounce back
- Sell the stock and hope to buy it back later at a lower price
- 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 –
- Declining revenue
- Declining profit margins
- Higher financing cost
- High leverage
- 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 –
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 –
- De-growth in GDP
- Interest rate tightening
- Inflation
- Fiscal deficit
- 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 –
- 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?
- 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 –
- If market moves up by 2% tomorrow, what is the likely movement in stock XYZ?
- How risky (or volatile)is stock XYZ compared to market indices (Nifty, Sensex)?
- 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 –
- For every +1.0% increase in market, BPCL is expected to move up by 0.7%
- If market moves up by 1.5%, BPCL is expected to move up by 1.05%
- If market decreases by 1.0%, BPCL is expected to decline by 0.7%
- 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
- One can even say, BPCL relatively carries less systematic risk
- 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.
-
- Download the last 6 months daily close prices of Nifty and TCS. You can get this from the NSE website
- Calculate the daily return of both Nifty and TCS.
- Daily return = [Today Closing price / Previous day closing price]-1
- In a blank cell enter the slope function
- 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.
- 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 –
- 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?
- 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
-
- Hedging allows you to insulate your market position against any adverse movements in the market
- When you hedge your loss in the spot market it is offset by gains in the futures market
- There are two types of risk – systematic and unsystematic risk
- Systematic risk is risk specific to macroeconomic events. Systematic risk can be hedged. Systematic risk is common to all stocks
- Unsystematic risk is the risk associated with the company. This is unique to each company. Unsystematic risk cannot be hedge, but can be diversified
- Research suggests, beyond 21 stocks unsystematic risk cannot be diversified any further
- 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
- Market beta is always +1.0
- Beta measures the sensitivity of stock
- Stock with Beta of less than 1 is called low beta stock
- Stocks with Beta higher than 1 is called a high beta stock
- One can easily estimate the stock beta in MS Excel by employing the ‘Slope’ function
- To hedge a portfolio of stocks we need to follow the following steps
- Calculate individual stock beta
- Calculate individual weightage of each stock in the portfolio
- Estimate the weighted beta of each stock
- Sum up the weighted beta to get the portfolio beta
- Multiply the portfolio beta with Portfolio value to get the hedge value
- Divide the hedge value by Nifty Contract Value to get the number of lots
- Short the required number of lots in the futures market
- Remember a perfect hedge is difficult to construct, for this reason we are forced to either under hedge or over hedge.
Hello Sir,
Neat and clean explanation as always. Thanks for this stuff. I am eagerly waiting for the options module. 🙂
Thanks 🙂 The first chapter on option will be out soon!
Hello Karthik, I had one question how to place a stop loss when trading on indicators of super trend, and which indicator I can use with super trend to filter false signals
You could give MACD a try!
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?
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.
Absolutely, I would agree with you.
Can I not accomplish the same objective more simply by exiting my spot position and getting back in when I think that the volatility is done?
What is the point of hedging – it is again anyway about timing 🙂
Hmm, you can if you know when to initiate and enter back into the position.
Nice Jagdeesh 🙂
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.
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?
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.
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?
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 🙂
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.
Thanks Nilesh 🙂
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?
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.
hi Karthik, how many sucessive candles constitute a down trend or an uptrend in a 5 minute and a daily candle chart
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.
Sir, What should be the min. length of a candle to avoid short candles.
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.
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?
Yup, thats what it means.
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!
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.
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?
Not actually, the money required for hedging can always be parked in Liquidbees, which yields close to about 6.5% returns, in this way you can manage your money more efficiently.
Thanks. What is liquid bees, is it niftybees?
Liquidbees is a debt product traded on the exchange. It is also called a “Liquidbee Exchnage traded fund (ETF)”. In simpler words if you excess money in your trading account you can park that money in an ETF upon which you will get an annualized return of close to 6.5%. Consider this as an alternative to saving bank account with a slightly better return and more efficient tax structure. More details here – http://www.benchmarkfunds.com/gs/Documents/GSLiquidBeESPresntation.pdf
I have 10 shares of TataMotors and I square off my position at price ₹350. Now how do I ensure (using Zerodha PI) that when I square off my tatamotors holdings, the GS Liquid BeES is credited to my demat account ?
Now lets say I want to buy another stock but have money only in GS Liquid BeES but none in my trading account. So do I have to first liquidate my GS Liquid BeES holdings, or will Zerodha PI automatically do that for me.
Thank You.
When you square off Tata Motors you will have to buy liquidbees manually. Similarly you will have to square off liquid bees to buy the stocks that you want. Cant be done automatically.
Hi Karthik,
above mentioned http://www.benchmarkfunds.com/gs/Documents/GSLiquidBeESPresntation.pdf link is not working now. Please can you share any other link if any or do you have that pdf document downloaded?
Thank you.
Regards,
Nishigandha
Will check and get back on this, Nishigandha.
Liquid bees link not working … http://www.benchmarkfunds.com/gs/Documents/GSLiquidBeESPresntation.pdf
Hmmm, I’m not sure if I can help you with domains outside Zerodha!
Please clarify what is niftybees. Same as liquidbees?
Niftybees is an Exchange Traded Fund (ETF), it tracks the Nifty Index.
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.:)
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.
Great simple explaination….
🙂
Can i provide the link to download the last 6 months daily close prices of Nifty and Stocks for Beta calculation?
This should help – http://www.nseindia.com/products/content/equities/indices/cnx_nifty.htm
It is also mentioned in Stock widget in zerodha
We source that info from Smallcase.
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
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.
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.
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.
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.
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.
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.
Yeah, you will be long and short on the same contract hence no position. You can probably initiate a short on Nov series.
Thanks for your detailed explanation on Futures trading,hedging…If you could cover one chapter on PAIR trading also it will very useful.
Pair trading will run through more than a chapter, plan to do a series on this sometime soon.
Can I do Hedging from Equity Cash to Equity Future Or Vice Versa ..
Yes, you can.
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.
For stock quotes, trading, and charting – https://kite.zerodha.com/ . Kite is easily the best in the industry.
For News – http://pulse.zerodha.com/ . This is an aggregator of business news…hence a one stop place for news and information.
Thanks for your prompt reply.
Welcome!
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?
Kenny – how about an insurance cover?
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?
Once both the positions are implemented then you do get margin benefit, but you will need full margin while initiating the positions.
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 ?
Varun, you will have to use the derivative market (either futures or option) to hedge the portfolio in regular equity market.
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
Anil – I’m a little confused, you totally had 20 units, of which you sold 10 @ 855. Next day you again bought 10@844…so you now have 20 units again. Also, you would made a loss since you bought 20@860 and sole 10@855 so about 100 rupee loss.
Varsity is great stuff. Not sure whether capital markets is your first love or writing !
Both I suppose 🙂
sir, can u provide any hedging tips. pl reply me sir
Superb explanation !!! 🙂 Thanks for materializing all concepts …
Thanks!
Why should one not hedge it through options. So that downside is limited and one can have gains too. ?
You can, its just options were not introduced at the point of writing, hence dint discuss the same 🙂
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?
When you hedge your portfolio, the portfolio is completely insulated to market movement. Therefore you will neither make any money or lose any money.
But what about the brokerage charges and all ?
Well, if you are trading with a broker like Zerodha, then you need not worry about brokerage 🙂
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?
One of the ways to directly hedge a futures position would be to buy a counter position the next month. Give it a thought.
Excellent explanation.. Thank you..
Welcome!
Waiting for a module on pair trading. Can you let me know when will that be uploaded ?
Thanks for these amazing notes.
That will take sometime Sourabh 🙂
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)?
Yes, it is possible that you make some profits when you hedge. Some even refer to this as an ‘Alpha Capture’.
what if the weighted beta of my portfolio is negative? ho do we calculate the amount to be hedged and no. of contracts etc.?
Its quite rare to have a -ve negative beta portfolio. But if you do, then you are naturally hedged!
How to hedge futures with options?
If answer is given, then please post the link.
Thanks.
We will discuss this topic sometime soon.
In short here pls if possible.
Only example will do.
Thanks
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.
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
No it does not, as your MIS position will be squared off intra day and NRML will be carried forward.
Sir, how can one hedge a small position of say TATAMOTORS using options on TATAMOTORS?. ( position is smaller than the lot size) Thank you
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.
Pls reply to my queried ablove.
Done.
Loved Your content.Lots of things are getting cleared after reading your contents.A superb effort,simply superb.
Glad you liked it 🙂
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 …
Thanks for the kind words Ramesh. It is Systematic Risk (also called market risk)…check this – http://www.investopedia.com/terms/s/systematicrisk.asp
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
A hedge position is not expected to make a profit or loss, so it really does not matter which direction Nifty moves.
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.
Yes, you can hedge via options. I need to put up a chapter on this soon, will try and do that 🙂
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?
Margin benefit is only for futures position, and not for cash positions.
Also, pls explain if bull(&bear) call spread also has margin benefit
You should, I’d suggest you enter your positions here and check if there are any benefits – https://zerodha.com/margin-calculator/SPAN/
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.
Yes, you can certainly do this. Not a problem at all.
I’m a new trader. Your easy language and example help me a lot to understand the market’s basic.Thanx a lot
Glad to know that, Biplab. Good luck and happy reading.
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 ?
Futures rate.
Could get the settlement of the future in brief. I’m very much confused in it..
Thanks in advance..And thank you for the response too for the earlier one
Welcome, Rupendar. Good luck and happy learning.
When are you going to introduce Hedging with option and in which chapter?
Stay tuned here – http://zerodha.com/varsity/module/trading-psychology-and-risk-management/
Very well explained, very easy to understand. Di you have any excel or software which calculates P&L from hedching a particular stock.i
Thanks Hussain.
No, nothing like that for now.
please tell me about hedging i dont know propperly how to hedg . please write to my mail
No special emails Mr.Singh 🙂
Everything you need to know about hedging is written here. Give it another shot.
Kite provides Beta of a stock.Data provided by small case.Is it same as you mentioned here.
Yup.
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.
Yes, if you do not have sufficient margins, then Mar contract will be squared off. However, since this is a hedged position, you will get a margin benefit. Check this to know how much margin benefit you will get – https://zerodha.com/margin-calculator/SPAN/
Sir, where can find beta of the stock in Zerodha?
You can look up for beta values on the stock widget in Kite. Check the image here
Loved the explanation
Thanks a lot sir. Helpful for my CA exams
Happy to know that, Jaishree. Good luck 🙂
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)?
4. Do we have to calculate Stock beta or we can get BETA info. From anywhere esle?
You get it on Kite’s stock widget.
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.
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?
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.
sir very lucid and useful content for novice like me.Hats off. I have been continuously going through these modules for past 5 days.
Happy learning and good luck, Karan 🙂
sir how can sell a stock in long and short position at once as u have shown
own
You could always use futures and options for this!
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 …
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.
Thank you sir …
Welcome!
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
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.
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
Start with module 1, chapter 1 – https://zerodha.com/varsity/chapter/the-need-to-invest/
Thanks Karthik
simple & lucid …. in a layman’s language
regards
Hari
Cheers! Happy learning!
Hi Karthik
can we do short in intraday or CNC for longer than a day without using future option?
Intraday shorting is possible, not overnight.
Awesome Karthik, was able to learn Beta and Hedging the Portfolio well with your simple way of illustrations! Kudos to you and your team!
Cheers and happy learning!
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
Yes, that’s correct. Your hedge value will be approx for 14L considering your portfolio is skewed towards a larger beta.
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?
This is not really a ‘Zerodha’ call, however you can consider at least 1-year data.
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.
1) In this case, your portfolio will be over-hedged. I’d suggest you think of buying a put instead.
2) I’ve not done that yet, will probably do that soon.
Thanks, I would appreciate doing it , since I am sure many would love to hedge when their portfolio is of lesser value for future hedging.
I agree. Will put it out soon.
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 ??
If you are hedged well, then you are completely insulated to market movement. Your position neither makes a profit or yields a loss.
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?
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 🙂
Pl create a pdf regarding bank nifty
Bank Nifty is a regular futures contract, don’t think it requires a separate PDF.
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 .
No, nothing of that sorts available I guess.
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.
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!
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
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.
Yes Future vs option which is sustainable for long term ,
Neither. These are short-term trading instruments. Use them when you have an active trading strategy.
Well written and in depth information. Much appreciated. I think this is so good, will be sharing with my futures/options broker.
Glad to hear that, Patrick! Happy learning!
Excellent write up, you are a very good teacher. Love to see your blogs.
Happy to note that, Yogesh 🙂 Happy learning!
How we get daily returns of Nifty for calculate Beta value.
You can download the daily closing prices here – https://www.nseindia.com/products/content/equities/indices/historical_index_data.htm from which you can calculate the daily return.
Thanks for the publisher of this article . It’s very useful and understandable with good examples and required links for ease.
Glad you liked the article, Akhila. Happy learning.
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.
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.
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.
What is effect if we hedge via options instead of stock or future
The expense when you hedge via option could be lot lesser.
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
Glad to note that, happy learning 🙂
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
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.
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 .
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.
DEAR SIR ,CAN YOU POST DETAIL INFORMATION ABOUT NIFTY FUTURE CALENDAR SPREAD WITH PROFIT LOSS CHART..AND ENTRY /EXIT POINTS….THANKS IN ADVANCE…
Will discuss the same in this module – https://zerodha.com/varsity/module/trading-systems/
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
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.
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?
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.
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.
.
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.
Hi Karthik,
I have most of investment in smallcap mutual funds. is it advisable to hedge my MF portfolio? if yes then how?
Ah, don’t worry about that. At the most, you may want to diversify by investing in a large-cap fund.
Thank you
Cheers!
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
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.
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
The easiest and efficient way is to go long on the Nifty Index fund or ETF and short the futures, or you could consider buying a put selling a call and buying futures. More on that here – https://zerodha.com/varsity/chapter/synthetic-long-arbitrage/
Thanks sir, in your experience, which of these methods are most widely used by delta neutral traders in the Indian market?
One of the most popular ways is calendar spread and pair trading. Both of them are being discussed here – https://zerodha.com/varsity/module/trading-systems/
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?
Yes, because you are offsetting the long position with a short. This is a calendar spread, which is also a hedged position.
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.
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 🙂
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.”
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.
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.
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.
Yeah that is true! Thanks for your reply.
Cheers!
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.
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.
Sorry future price is in discount than spot price how to do hedging
Gautam, you can borrow stocks from the market and sell while going long on the futures contract. The concept is called Reverse Arbitrage. Selling stocks without holding them can be done through SLB
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.
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.
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) !!
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.
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
Happy learning, Musthafa 🙂
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.
I will include it sometime soon, Pradeep.
One more query sir. Is it possible to hedge small positions of 1 lakh to 5 lakh through shorting nifty etf.
No, not possible. You cannot short Nifty ETFs.
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
The same way, Shubham. Look for the beta of the portfolio and then estimate the hedge value.
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?
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.
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.
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.
Thank You so much. This is great.
Happy learning, Jai!
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
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.
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
Satya, check this – https://zerodha.com/varsity/chapter/synthetic-long-arbitrage/ , this is because of the Put-Call parity.
Lot Size of NIfty Futures???
75.
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
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.
Hello sir,
I have a portfolio a value of 90K rupees with 18 share, how hedge this small portfolio with option ?
Frankly, this may not be wise, because the cost of the hedge will be around 10-15% of your portfolio.
Sir how to delta hedge option strategies?
Hopefully, I should be able to cover this topic soon.
I am waiting sir, meanwhile can u suggest a book for this topic
Mani, unfortunately, I cannot recollect a book on this topic.
Sir have you read Dynamic Hedging by Nassim Taleb, is it a good book?
Yes, long ago. It gets a bit technical, certainly worth a read.
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?
1) It really depends, if your investment objective is long-term, then you may want to figure out if there is a real need to hedge. But anyway, if you really need to hedge, you can do so with Nifty futures
2) You can but this can be slightly tricky.
Thank you for your suggestions.
Good luck!
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.
Arun, I get your point. For this exact reason, you need to measure the risk of your portfolio with respect to the beta.
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
Srikrishna, the idea of hedging is not to make money. The idea is to insulate yourself against any adverse movement from the market.
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?
Yes, you can. Remember, timing matters while hedging.
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)
Yes, futures have M2M and therefore the daily P&L. The profit that you eventually get is upon closing both the positions.
What is the value of portfolio beta when there is perfect hedge?Is it 1
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.
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?
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.
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.
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.
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
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.
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.
That’s right, in fact, you can minimize the cost by options as well.
Exchange Cost’s of hedging isn’t clear from the article. or have I missed something
There are no special charges levied by exchanges for running a hedging strategy, Amit.
I dont use ms excel. Is there any website or software from where i can get directly the beta of a stock.
I’m not sure about this, maybe there are few resources. Need to check again.
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?
Check this – https://zerodha.com/varsity/module/trading-systems/
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?
I’m not sure if I get the context clearly. Can you please elaborate, Vidit? Thanks.
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?
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.
i can trade options in position trading also? and where do i get delta in option trading?
Yes, sir you can do positional options trade. The delta is available on any basic options calculator. I use – https://sensibull.com/
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.
On an intraday basis, maybe you can do this when interportability of exchanges kicks in. Check this – https://support.zerodha.com/category/trading-and-markets/trading-faqs/articles/interoperability-of-exchanges
Hello Sir,
May we know where could we find the other strategies of futures trading you spoke about.
Love the Varsity.
Thanks for it.
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.
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
Kapil, when you have a portfolio, it is best to hedge this with Nifty futures. Individual stock hedge will turn out quite expensive.
Thanks Karthik…this helps.
Thanks
Kapil
Good luck, Kapil!
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
It depends on the strategy, Kapil. If you are looking at hedging, then I’d suggest you look at 1-year data.
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?
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.
Thanks Karthik….
Thanks & Regards
Kapil
Good luck, Kapil.
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 🙂
Still waiting for a reply sir.
Hi
I have a doubt,
if I had bought indigo for example at 1750 , and now it is trading at 1465, and i decide to hedge expecting the price further would fall in the spot market.
i short equivalent amount of futures at a rate of 1467.but even then i will keep losing 283 rs regardless of in which direction the market moves.
what is the point of hedging here, since if i sell my shares also i will lose the same amount, so how am I gaining ( compared to selling off )
Bhavya, when you hedge, you are totally insulated to the market movement. When you are insulated, you neither make a profit or make a loss.
I have open position in bajajfinance dec 19 futures which is expiring today ,how can I roll on Jan 20 contract?
Close the Dec futures position and initiate the position with Jan contract. That’s it 🙂
For one portfolio, after doing portfolio optimization with solver and beta calculation in excel by your methods, I’ve got portfolio beta of 0.5, SD of 11.5% and return of 25.42%. How can a portfolio have beta less than index and still beat the index by such big margin. I mean if index moves up by 10%, it should move up by 5% only. How can it beat it? Is that possible?
It can be a low vol momentum portfolio 🙂
Can you please explain what is this low vol momentum portfolio?
A portfolio which consists of momentum stocks and is also less volatile compared to other stocks.
Hi Karthik,
For someone who has invested the little bit of money he has in equity and quietly watched the value of the portfolio go down and still held on it with conviction that it will bounce back, this article on hedging is tremendously useful. We as a generation have been spoiled with too much information and I’m here asking for more. Would it be too much to expect Zerodha to show a little “Your portfolio beta is x” information in the holding summary page? I think it will be awesome.
Regards,
Gokul
Will check the possibility of this, Gokul. Holdings may have NCDs and bonds, will be a issue to do this in scale I think.But I’ll check.
Sir instead of going short on futures can we go for covered call or protective put on nifty to hedge the portfolio.
Yes, you can. However, if you are hedging against an event, its best to deal with futures.
Hi Karthik,
What do you think is better for hedging,
1. I’m Long Future contract with long put option ( for hedging ).
2. Some sort of Option strategies ( spread strategies ) like Short put ( higher strike price ) and Long put ( lower strike price )
What I want to ask you is that is it better to open a future contract and hedge it with an option or should I follow different options strategies according to my requirements.
Many thanks
Ron
1) Yes, but ensure the delta of futures (1) offsets with the delta of the options
2) I prefer these strategies i.e. any spread positions
Hi Karthik,
Very informative post and your effort to reply all comments is commendable. More knowledge shared in comments section also. Thank you!!
Ex: If i have a portfolio of some 10 stocks worth 5 lakhs . I have shorted nifty futures after calculating beta, anticipating market downfall. Market corrected and I have received same amount of gain in short future that i had lost in portfolio. Should this gained amount in futures to be added back to portfolio by adding more quantities of existing portfolio stocks?. If i dont do it, stocks will still have to climb to original price right? Please explain.
Thanks
Yes, the comment section is a treasure trove 🙂
Ideally, you should plough back the profits to the portfolio in my opinion.
Hi Karthik,
I was looking at the collar strategies and would like to know from you that is it safe and profitable strategies if I’m NOT holding all the contracts till expiration.
For example,
1 long future at Rs. 100
1 long put at Rs 100 ( at the money )
1 short call at Rs 120 ( out of the money )
Let’s say we have 20 days to expirations, so do I have to hold till expiration or can I close my position before that. I know holding till the expiration and if the underlying closes at short call strike i.e. Rs 120, I’ll make the maximum profit but how about if I want to close it before ( will I make any profits )
Also, can I use this strategies for day trading ( does it give any profit ) do u recommend to use this strategies for short term.
Thank you in advance
You certainly can exit the position anytime before the expiry. No need to hold to expiry. The profitability depends on the premium you’ve paid and the intrinsic value of each of the positions. It is best if you can put these numbers in excel or a tool like Sensibull and visualize the P&L. Without this, it is quite difficult to identify the fine print of the strategy.
Thank you so much for your quick response.
Can you recommend any website which offers free Excel sheets for these
Many thanks
That I’m not sure Ron, but I’d prefer to build these myself. It is quite doable…in fact, most of the option strategies chapters have excel sheets associated.
How can I use the formula for the option price ( I know it’s done by delta and gamma ) to figure out at least some approximate price for the option price for the next X days ( before expiry).
But can u think of any basic formula that will help me give some approximate price something like the difference between the strike price +/- debit/credit or any other basic formula
Hmm, there is only one way to figure the option price and that is by using the B&S formula. However, you can get the approximate value by deducting strike from spot for CE and the other way for PE.
Sir ,
Can We also Hedge Options ? or this is a idiotic Question ?
All option spread strategies are sort of hedged positions 🙂
Hi! Karthik, As usual Wonderfully Explained. I have a Question Regarding Calculating Beta of a Porfolio “What is the Reason of Taking 6months Stock Prices and Not a Year or More for Calculating Beta of a Portfolio “?
It is just that the 6-month data is more recent, which matters while calculating the beta of the portfolio.
Can you please explain what does the constant 1 stand for, in the formula
Daily return = [Today Closing price / Previous day closing price]-1.
Thank you for taking the time to write this article as well as the replies.
Ah, its a mathematical simplification of the returns formula.
Good evening Karthikji,
Why do BankNifty get hurt by weakening rupees ?? What’s fundamentals aspects behind that? ? Kindly explain pls
Thanking for your time for same -:)
Weak Rupee hurts the overall economy within which Banking plays a pivotal role. Hence 🙂
Sir
With respect to the concept of beta, is the SENSITIVITY of the stock price is same as VOLATILITY of the stock ?
Also in the example table mentioning beta of different stocks, at last it is mentioned as “SBI Limited”. I think its only SBI and not the SBI Limited. Correct me if I am wrong.
Thanks and regards
The sensitivity of the change in stock price to change in index price = beta
Deviations from the expected annual returns = Volatility
SBI or SBI Limited does not really matter, Aksash 🙂
Sir
Can I have any example of stock with negative beta i.e. as the market moves up, the price of the stock declines ?
Also as beta is referenced to movement of market, please clarify “market moves the stocks” or the “stocks move the market” ?
Regards
I think for the longest time, Airtel had a -ve beta. Not sure if that still exists. The market as a collective force influences individual stocks.
Sir
While calculating beta in MS Excel, you have taken TCS and Nifty closing price of last 6 months on daily basis. I have following queries:
1. Why the duration is 6 months only and NOT any other duration? Won’t it be better if a longer duration is selected say 1 year ?
2. Why the closing price is taken on daily basis? How will beta get affected if closing price is taken on monthly or fortnightly basis?
Thanks and regards
1) Beta changes, so its best to stick to 6-12 months of data
2) Beta is a function of price change, hence daily closing is considered.
Sir
Pardon me for asking too many queries.
The way we have calculated beta of a stock portfolio, in the same manner we can calculate the weighted beta of an equity mutual fund also by going through the portfolio of an equity MF and can compare the weighted beta with Nifty. But different equity MFs have different benchmarks, and in that case what’s the use of weighted beta of a MF since beta is referenced to Nifty and not to any other market indices? Please clarify.
Regards
For MF, it is the same process. Treat the NAV of the fund as the stock price and calculate the beta of the MF vs its benchmark.
Sir
In the above example of hedging a portfolio, you stated that “market declines by 5.5%” . This statement implies that Nifty50 (or Sensex) declines by 5.5%. Nifty50 covers only the large cap companies. What if I am having a portfolio of stocks comprising of mid and small caps also ? In that case, how to correlate the weighted beta of a stock portfolio with the market ups and downs ?
Regards
In that case you’ll have to use a better benchmark – may use the small and mid-cap indices.
Sir,
Hedging, no doubt nullifies the adverse movement in the market but it results in either zero loss or very small loss. Sir, if the market falls and my portfolio valuation is reducing then won’t it be better to add more stocks in my portfolio available at cheaper price. This will give me benefit of RUPEE COST AVERAGING and I will be able to gain more in the long term ? I mean, in long term perspective, which one is better : RUPEE COST AVERAGING or HEDGING ?
Thanks and regards
Of course, it does. The call to hedge or average really depends on your understanding of the market and overall portfolio strategy.
“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.”
These lines are so true in today’s scenario.
Lol 🙂
Hi sir,
First congrats to team varsity……..great job guys.
I would like to know whether we have any different order type for calendar spread order for long and short to execute at a time in order to get margin benefit in or zerodha or any other brokers.
Not at the moment.
Hi Karthik,
I would like to get some pdf or journal where from you took this formula so that I can use it for reference in my project.
Like I mentioned for your previous comment, these are generic formulas used widely in the mkt.
Hi Karthik
Why unsystematic risks can’t be hedged? If I buy stock in the spot market then I am exposed to unsystematic risk, so I can hedge my position by selling the future contract of the same stock. Kindly explain!
Yes, you can hedge by selling futures and with this, you hedge the systematic risk. Unsystematic risk can only be diversified.
Hi Karthik,
I bought LT shares at 852. But after 2 days, the market is down and now it’s trading at 821. If I short sell LT futures at 823, will it prevent my losses to some extent? But the difference between stock price and futures is 31.
Yes, that would hedge the position.
hello karthik,
i have already asked u lot of questions , and u have replied promptly
thanks for the answers.
here is my one more doubt.
i have brought tata power may 20 futures at 30.75, now price is 27.30.
1. tata may 20 – means it expires on 20th right?
2. can i sell now june 20 fut if the price goes still down, so that if i have more loss , ill be insulated.
3. but if price goes up from 27 and stays below 30.75, ill be in loss in both contracts ,, den can i square off my buy position at lower loss and wait for price to fall till next mont and den square off the other , is this possible.?
4. is der any other way to hedge this now ?
5 . and one general question , was usually happens during expiry ? price goes up or down ? can it be generalised ?
1) No, it means expiring in the month of May 2020
2) Yes, you can hedge your position
3) Technically yes, this is possible, but when you have a hedge, you are insulated, but like you mentioned, within the range, you will be in trouble
4) The only way to hedge is by shorting next month futures or by buying puts
5) This cannot be generalized
Hey Karthik
A few doubts at this point again w.r.t portfolio hedging…
1. If I have a portfolio of mixed stocks, small cap, mid cap and large cap, then what type of index should I use to calculate portfolio beta?
2. If we calculate portfolio beta based on annualized beta of stocks say w.r.t Nifty then we can only comment about the annual returns right.. not monthly or daily? Basically then I cannot say that if nifty was to go up by 1% tomorrow my portfolio will go up by Beta(Annual)% right?
3. Can I calculate daily beta by dividing annual beta by sqrt of 365 just like we do for volatility?
4. Is portfolio volatility a weighted average of stock volatility?
5. I still haven’t understood the real value of hedging. . Considering I am a long term investor in stocks, how should i practically use hedging in these volatile times? What I understood from the lesson and some of the comments is that if I hedge my portfolio by finding the portfolio beta and shorting on the right Index future I can reach a situation of zero loss profit. Why is it better than exiting the markets altogether during this period of volatility ?(The only reason that seems logical is if one would want to prevent short term capital gains because of this forced exit).
6. How would this hedging exercise actually be executed. Suppose I short in the nifty futures as per example above and make a profit of 50k while my portfolio runs an equivalent loss. Should I book this profit or both the profit on the futures short and the loss on the long position in the portfolio? If both, then what was the use? Also, when do I roll back the hedge position? How will I know it’s time to book it or end it?
1) Nifty is the only option you have
2) Yes, compare yearly with yearly
3) No, that is not correct
4) Yes
5) A mix of short term gains and applicable charges. Plus you also need to consider the fact that not all stocks in the portfolio may fall. So you may end up buying stocks are really high price and lose the advantage of having bought it a lower price
6) You take the profit from the short futures and plough it back in your portfolio so that it makes up for the loss. Rolling back the hedge is a call that you will have to make, just like the way you would for calling hedge.
Sir it may sound a bit foolish but a basic question if we know the taken position in equity market is gonna fall and it is possible to exit then why just don’t exit it instead of hedging by shorting in futures ?
If it is a single stock that you concerned about, then yes, maybe you can sell and buyback. But if it is a portfolio then maybe hedging is better.
Hello Karthik,
Is there any periodicity with which to check stock beta value, as well as portfolio beta?
Apart from hedging the portfolio at times, we can also use the value for tweaking the portfolio isn’t it?
Thanks,
Vijay
Although BETA changes everyday, it may not make sense to check it daily. Maybe once in 3 months should be ok.
Yes, you can use BETA to tweek the portfolio also.
Hi Karthik,
Sorry to bother you again.
i) I’ve calculated the beta value for ITC as explained by you. The value comes to 0.50.. However, it’s given as 0.78 in tickertape popup.
How can I attach the excel sheet and the image for you to review and correct me if I’m wrong?
ii) How to calculate the beta value of IRCON, which had a stock split in the past 6 months? If I divide the earlier values of the period under consideration by 5,would it be the right method?
Thanks,
Vijay
1) Beta is a function of price, so beta can change
2) You need to take the clean data, adjusted for the corporate action
Hello Karthik,
Thanks for the prompt replies and clarification.
Regarding the IRCON data, can you please elaborate on how to calculate the beta value
It is the same, on EXCEL use the slope function on the returns.
Thanks for the chapter. If you could add ADJusted closing price rather than just closing, Beta calculation will be right. ADJ close is available in the yahoo finance historical data.
For shorting, how to use the Beta ? Because, you have given for only long only portfolio.
thanks again.
What is adjusted close? I’ve not used it. Can you please share more context? Hedging is a long portfolio, short futures.
https://help.yahoo.com/kb/SLN28256.html
for example, https://in.finance.yahoo.com/quote/INFY.NS/history?p=INFY.NS historical data gives adjusted close. This means all splits etc are taken into account.
Hedging can be short futures (many) + Beta adjusted index as well right?
Why would you want to beta adjust when you hedge? When you hedge, you just want to insulate your position completely from the market.
Hi Karthik,
Firstly, I would like to say this is one of the best tutorials I have read anywhere on stock markets. Concise and clear af. Thanks for this!
Question: According to the above single stock hedging strategy and calendar spreads taught in previous chapter it seems there is an arbitrage opportunity always present. I’m sure I’m doing something wrong here, please help.
Ex:
Stock price = 2500
Risk free rate = 5%
Days to future’s expiry = 58 (considering far month future, bought on the date it is underwritten)
Future price = 2500 * ( 1+ 0.05 * (58/365) – 0) = 2519.8 ( since we buy at the time of release, futures price should be very to near to this)
Now I buy stock at 2500 and sell future at 2519.8. Since future and spot converges at expiry, there’s an opportunity of 19.8 (=2519.8 – 2500).
And according to the above calculations, irrespective of the price the spot and future converges at I should be earning 19.8 points out of this trade.
I have cross-checked this at least 5-6 times and have read various articles online but I just can’t seem to find the mistake. Please help.
Thanks!
Thats right, but the thing is that the futures price is always higher compared to spot given the ‘cost of carry’ of the futures. The opportunity arises only when the futures prices increase over and above what is considered a fair price. In your example, maybe 2520 is the fair price, so if you execute the trade, the cost of transactions plus taxes itself will eat away the profit you make. So always check for this costs associated.
Dear Sir
I am regular small time intra day trader in Zerodha. Now I want enter into Futures market for trading. What is minimum margin required to enter into futures trade.
Do check this – https://zerodha.com/z-connect/tradezerodha/margin-requirements/new-margin-framework-for-fo-trades
Hello Everyone. Just one question, what if my Hedge position is going wrong? Is Hedge really proper insurance for my spot position? Next whenever my spot position starts making position then it has to first cover my hedge loss and then my real profit will start? Am I correct?
hi karthik,
does zerodha provide any feature in futures (nifty and bank nifty) for stop loss in overnight position .
1.example i buy nifty futures at 9000 and want to put stop loss 8950 in an overnight position
Yes Ankit, please check this – https://zerodha.com/z-connect/tradezerodha/kite/introducing-gtt-good-till-triggered-orders
Hi Karthik, I just got the doubt that as you said In the topic Beta measures the sensitivity of the stock price with respect to the changes in the market, but today the nifty is up by around 2% and the India cements having a beta of 2.15. should have to increase by 4-5% na, instead it was down by 0.15%. just asking
The beta of 2.15% means that on average when Nifty raises by 1%, India Cement is expected to increase by 2.15%, there is no guarantee though 🙂
Good morning Karthik, as you said they is no guarantee that how the stocks react to indices, but we use beta in hedging our portfolio process so there is a chance that though we have hedged we can loose our money. don’t get me wrong, I’m just clearing my doubts and thanks for the reply. and By the way the way of your teaching style was awesome.
The critical element of hedging is timing, Vinay. If you don’t get the timing right, then yes, what you said is true, you can lose money.
Hey Karthik, hope you are doing well.
Let’s say I am holding 750 units of NiftyBees and I plan to hedge them by shorting one lot of Nifty future at some point in time…now if the market falls, then its fine but if it doesn’t and instead rises, though I wouldn’t lose any money still I would be required to maintain funds to make up for MTM losses from the short futures right? Or will the gains from BEES be considered and margins won’t be blocked?
Any workarounds if the margin will be blocked separately?
Thanks.
~ Abudhar al Hassan.
That’s right, you need to maintain funds to service M2M calls.
Hey Karthik,
Any other alternative other than maintaining funds? Asking bcoz though it would be a neutral position, when the market is rising, we cannot exactly deduct the gains from the holdings and credit into the trading account unless we sell the Bees completely. So in essence, we would be losing cash which we could otherwise use to trade…
No alternatives?
Hmm, not that I can think of. Suggest you create a ticket, someone from RMS will reply to your query with a possible solution (if any).
Hello Karthik,
what would happen if we short 11000 CE and purchase nifty current month futures if it goes upwards of 11000, assuming we hold till expiry and as options and futures would settle based on the spot price , i am thinking by this way atleast we can get to keep the premium,please clarify
Yes, you can. This is a hedged strategy. The only problem is if the market comes down, you will be exposed to unlimited risk. On the higher side, your profits are capped.
Hey Karthik,
So, I queried support and got a very vague response about liquidbees and pledging…which got me thinking…
If I pledge my 750 units of NiftyBees with Zerodha, I should get around 87% collateral margin. Once I do this and then short a Nifty future to hedge my Bees (which was the original idea), and if the market doesn’t fall but rise, then the value of my Bees would also rise, and so would the collateral margin which I got for pledging, right? Will this somehow neutralize the MTM losses made by the short future without eating much of my cash?
Regards,
~ Abudhar al Hassan.
No, that wont offset the M2M loss. You need to bring in cash. I’ll anyway double-check and request a colleague of mine to respond.
Hey Abudhar,
1. If the value of the pledged holdings increases, the collateral margin received for that will also increase.
2. Since MTM losses are debited on your ledger, it will have an immediate impact on the cash available in your account. An increase in the holding value will be nominal until you sell your holdings.
Okay…thank you Karthik & Nakul.
Guess then pledging wouldn’t solve the issue either. The only option left is to sell the Bees then before the market falls as hedging would require extra funds.
Maybe you could implement this in your RMS, where you take into consideration what we are holding and reduce margins when hedging is
Hi,
what is exit strategy after we hedge our positions because irrespective of market movement our position is neutral, how to take the profit out of it?
Initiating and exiting a hedge is based on your market reading, Aman. You need to decide when to do this. Lifting the hedge is simple, you just buy back the futures and you are done.
Hi Karthik,
I was analyzing arbitrage oppourtunity and found that it is impossible to earn profit from there Because as soon as you will come to know the difference. That difference will get filled for the current month futures and cash market. And for far and middle month you will never get a chance to buy or short the shares in given price as No sellers and buyer will get availabe for that price.
Please suggest a good way to take the advantage of price difference between different expiry dates.
Thats right Sarita, eventually wrt to arbitrage, everything boils down to the speed of execution. The sooner you can spot and execute, the better is the chance of you making a profit.
Thank you Karthik for the reply.. But is there a way to spot the price difference quickly.. As you know in different sites we can see the difference but that got updated after 5 mins ..meanwhile we lost that opportunity.. You suggestion will be really helpful for me…
Do retail investor can really earn money with the arbitage opportunity…
The opportunities which is dependent on speed of execution is really tough to crack as institutional algo dont let go of such opportunities. But things like pair trade or anything else which is not dependent on speed is possible.
For 11.6 – Calculating beta in MS Excel section its difficult to find historical index data on the new NSE website. After going through many links found the data @ https://www.niftyindices.com/reports/historical-data.
Plz provide an application in Zerodha for quick computation of the same. Even paid service like sensibull is ok.
Noted.
First of all, Thanks for such a good explanation, i learned lot of things here on varsity, i need a suggestion, i bought some shares of a company 4-5 months back, they performed well but now i feels there price will not move upwards and will go down as they are moving down from many days so how can i overcome that loss, should i sell them? but also i also want to carry them for atleast an year to take advantage of long term profit gain instead of short term capital gain? How can i sustain my profit?
Shubham, you need to be very clear about your intentions, if the idea is to hold for long term, then there is no point worrying about short term performance of the stock. Its not like the stock will well all the time. If it is for the short term, then you should book your profits, move ahead and look for other opportunities.
Dear
I have 2.5 lakh in trading account I short 1 lot banknifty AUG month future and I Buy 1 lot banknifty SEP month future.
now in my traiding account it is showing available margine is 2.35 thousand ( bcoz my position was hedge).
Tomorrow is AUG monthly expiry before expiry can I hedge my banknifty position with banknifty Oct future and then I squre off AUG position.
Is there any penaulty on this ???
No, there is no penalty.
Hello sir
This was a great lesson on futures markets
I have one question, what if there is a price gap between our long and short position? Will that price gab be our fixed profit/loss?
The price gap will remain, and it wont matter much as you are insulated to market movements.
Hey sir.
In the example, the portfolio loss stayed unrealized but the nifty position gave 54k profit. So do we have to pay 30%(or whatever according to slab) on this 54k?
Yes, the taxation bit is different altogether.
Hi
When we hedge using short or long nifty
1. if it is for our long term portfolio, always better to hedge with a a future that is cheaper irrespective of the month is that correct.
2. If my stock is not part of nifty, would then the logic of hedging using a nifty long short be a near perfect hedge or no
1) Yes, in fact you can stick to the near month contract.
2) Thats right.
Hello Karthik,
Thanks for the nice blog.
One question: How could we know whether somebody (smart money) is creating hedging positions or real position in Futures/options?any technique to know that?
It is impossible to figure the intent behind these trades, Rahul.
I am a beginner and trying to understand this.
So if i am an investor and i would want my portfolio for a very long periods of time then does hedging make sense? because in case my portfolio falls by a good % as a long term investor i may want to in fact buy more stocks.. Am i right?
If you are long term investor and you don’t expect too much of a crash, then its ok to leave the portfolio as is.
Nicely explained! Please guide when should we book profit in futures. It may happen that after some fall the market halts or bounces a little. At that time we are not really aware that a big fall is likely to follow, so we close the futures hedge and book profit in it. After that market starts falling again severely and we are caught without hedge. So timing of booking profit in futures is very important, how to get the timing right or nearly right?
Thanks
When you hedge, there is no concept of a profit. You need to look at it from an overall perspective by considering both the portfolio and futures, the gains from one will offset the other. The decision to remove the hedge depends on your outlook on the market, just like the way you’d have got one at the time of initiating the hedge.
We see situations when certain established banks(popular blue chip) do not perform well( all of them) for a long while( 6-8 months or more) & lets say i hold 3 such bank stocks + 2 nbfc ..This is unsystematic risk as maybe banking sector is doing ok but my chosen(holdings) stocks are not performing.
Will Hedging in Banknifty be a good idea mainly done to hedge this ?
Yes, this is assuming you are only exposed to the banking sector.
There is no mention of how long we should hold the hedge position, which would make this chapter more complete.
The tenure of the hedge is dependent on your opinion on markets, just like how you take a call on when to initiate the hedge.
About hedging, Assuming I’m long at X in spot, not to hedge I should go short on Future. What would be the difference if I square off in short only and again buy the shares back when I feel ok.
Also, what would be ~ difference in the charges between Spot vs Future (Asuuming complete cycle at same CV)
Thats also ok, but by doing so, you are losing on your average buying price plus incurring transaction charges.
One more ques. I’ve been reading different chapters in sequence. Should I start puting the learnings so far in some action or first complete all modules then start investing. Also, any dummy trading portal that you’d recommend to practice?
You should start validating, at least by taking paper trades 🙂
sir you say that -“Unsystematic risk cannot be hedge” but i dont think its necessarily true. As in if there’s any turmoil in the company and a person manages to foresee it then why can’t he/she take a short position in the futures market and stave off any temporary losses. isn’t this an example of hedging against unsystematic risk?
many thanks!
Technically yes, you can. But the assumption is that the hedge value and the shares you hold perfectly match.
Sir for profitable hedging we should always buy cheap(whether the spot or futures price) and short the expensive one(remaining of spot or futures price), only then we will have fixed profits, right?
But otherwise hedging(knowing maximum losses) is possible even by buying expensive and shorting cheaper one, is that correct sir?
many thanks as always!
There is nothing like ‘profitable’ hedge. When you hedge, you insulate your position against the market movement, so you neither make a profit nor make a loss.
How frequently do you”ll hedge a stock or a portfolio? Please share your experiences.
I used to do it quite often when I’d take active portfolio positions, but I no longer do as company regulations don’t permit me to trade/take active positions.
Hey Karthik!
1. Is 6 months of past data enough to calculate beta? What would be considered overkill?
2. I calculated beta for my portfolio which comes out to be 0.61. Current Nifty Dec futures price = 13424.8 & currently one lot size Nifty futures = 75. Which makes contract value = 1006860 ~ 10 lakhs. My hedge value is 197854 ~ 2 lakhs Which makes number of lots to be shorted as ~ 0.2. How do I get around this?
3. If options is the answer for 2, how exactly should I optimally do it?
Thanks!
1) It is. 6 months to 1 year is good enough
2) The portfolio beta is 0.6, which is less than the market. So roughly you need to 6L worth of short for every 10L worth of contract value. Tough to hedge this, unless your portfolio is more than 10L. The other alternative is to buy PUT options
3) 2 lots of ATM will be good for this.
Hi karthik sir,
i have one query regarding hedging the portfolio. let suppose my hedge value required is 375000 [(stock value)500000x(beta)0.75]
so i need to short 0.37 number of lots of nifty future 375000/1012000. which is practically not possible
so can i do this hedging with any option which has a delta of .37
if yes ,then what will be the limitations??
please reply.
Regards
sorabh dhiman
Client id- ps5803
Yes, Sorabh. That is the next closest thing that you can do.
How would do the similar example pan out if the beta was negative, instead of positive ? What would the investor do in this case ?
Then it suggests that the portfolio is anyway uncorrelated with the market.
Hi Karthik, I am really impressed with the way Zerodha is educating people about financial markets. I have question for you. You said that the only way to hedge risk is through futures and options, but what about hedging through intraday trade in spot market. In intraday trade (shorting) we may miss to hedge overnight risk, however we can hedge a day to day risk. Am I right. Kindly provide your suggestions on that.
Yes, you can do that, but remember short positions have to be closed by EOD. Which means you can not hedge overnight risk.
As, Headging of portfolio ( 8 lakh ) at 9.784 lakh in future is done ,
suppose that market moves (10 lakh) so we will not get profit too right in future position their would be loss and in spot profit we will be in profit,
i am correct or wrong!!!!!!!.
Tushar, when you hedge your portfolio, the loss in the portfolio is offset by gains in futures or vice versa. So you’ll not make any profit or loss when you hedge.
sir, If we have done headging of portfolio means that if the market moves downward or upward we will be on in loss and not in profit as well, is that correct.
Thats right.
By hedging, if we’re notgaining or loosing, then why all these activities done of trading..?
I am scratching my head..please help..😊
Suni, by hedging you are insulating the portfolio against adverse market reactions, you don’t hedge to lose or gain from the portfolio.
Hedging prevents us from market fluctuation and incurring losses. But we are not making any profit either (in the examples here) as the stocks in the portfolio (long) and the NIFTY FUTURE (short) move in the opposite directions. So, how can we get profit here?
That’s right, you hedge to stay insulated, which means you neither make a profit or loss 🙂
Hello Sir,
Thank you for such a wonderful explanation. Quick question please, so as I understood the crus is that the position in the futures contract should counter the equity position. Or, is there any dependency on the price movement also. For example, if say I expect my portfolio value to increase (expect spot price to increase), then should I buy futures for hedging?
If I may ask it in a different way, what will be the scenario when one will need to buy (go long) the futures contract for hedging?
Saurabh, if you expect the future price to increase, then you can –
1) Continue to stay invested in the portfolio without hedging, or
2) Buy futures, or
3) Have your portfolio plus have a futures position
Thank you, Nilesh!
So if I understand it correctly, if we are long on equities then there’s no ‘hedging’ strategy wherein we buy futures. Please correct me if I am wrong.
Dear Sir,
How is cost of carry calculated?
Could you explain with an example?
Cost of carry is kind of baked into the price of the futures itself, Trace.
Hi Karthik,
Thank you for your reply, not sure why I mentioned name as ‘Nilesh’.
Please correct me if I am wrong, if we are long on equities then there’s no ‘hedging’ strategy wherein we buy futures.
If you are long in equity, and want to hedge, then you should short futures.
best explanation. These chapters are the best to understand the market.Thanks a lot to the team
Happy learning, Mahesh!
Class, excellent outstanding explanation. These chapters are the best to understand the market.Thanks a lot to the team
Glad you liked it, Mahesh 🙂
Sir,
When we hedge our loss in the spot market is offset by gains in the futures market, then what is the rationale behind Hedging?
The rationale is to insulate your position from an adverse market movement. Think of it as protecting your position from a downfall. The flip side is that when mkts move up, you don’t really make a profit (nor a loss).
>>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
Please clarify one doubt about this statement. Does it mean I need to sell my holdings in order to not lose money?
My understanding is, after shorting the future, if the price moves ups, I’d start losing money. So, in order to balance it out, I need to sell my holdings.
No, think about it, on one hand, you have stocks (long position), and on the other hand, you have a short future position, both combined together, you are long + short, so directionally neutral. It does not matter which direction the market moves, it makes no difference to you.
Hi Karthik sir
What if i sell Current month futures contract and buy next month futures contract to collect the premium??? Will i get the premium?? Is there any downside risk?
There is no concept of the premium collection in futures trade.
Sir, I have a doubt about the Duration of Hedging strategy by Futures.
Suppose I have a portfolio of 10 Lac and I want to Hedge it using Nifty Futures for say 1 Yr?
How can I do that?
You will have to keep rolling over the contract every month, Rajdeep.
Sir, so, if I have understood it correctly, to hedge the Portfolio for a 1 yr I have to keep rolling over/squaring off, the contract and offset the Losses and Gains in my Future positions with my Portfolio value (since both will be opposing in nature) and will also incur transaction costs in the process.
That’s absolutely correct, Rajdeep.
And one more question how to calculate the Beta of a Portfolio of Mutual Funds?
The same way as you would for an individual stock, consider the entire MF portfolio as a single stock, take its daily returns and run the slope function against the necessary benchmark’s returns.
One of best explanation for beta stock and future headging
Happy reading 🙂
Hello Sir,
Lets say I have 250 shares reliance for the long term. Market price 1903
To avoid short term volatility I need to sell exactly 1 lot futures (250). So overall more loss would be roughly neutral.
But I were to buy puts instead do I buy ITM/ATM/OTM put? Do i need to purchase multiple lots of puts to make up the same valuation of my stock holding.
It is best to stick to 1 lot of ATM if your purpose is to hedge.
Dear Sir,
Will an atm put option be able to adequately hedge a position?
Lets say I nifty put options to hedge against a stock. Do I have to buy enough atm puts to create the same valuation of the stock I own or would 1 put suffice?
1 ATM PUT option is good enough to hedge roughly 3-5L worth of underlying. YOu can keep this as a thumb rule, not really accurate, but works.
Taking the current pandemic example,
Let’s assume I had 250 (1 lot) shares of Reliance in equity.
Then WHO declared a pandemic.
The market started falling and I took a hedged position by shorting Reliance Futures (1 lot).
The bottom was formed on 23rd March.
At this point, I would be profitable in futures and losing in spot.
So my question is, what is the correct way of hedging?
Booking the profits of futures and let the spot move back to its original position or remaining in both positions( spot and fut ) till the tide passes and close the position at breakeven?
Hope I have placed my question
Thank U sir
Abdul, you hedge neither to make a profit nor to make a loss. You hedge to protect your position. You can choose to remove the hedge when you think its the right time to do so, once you do, your position will be exposed to directional risk.
Hi karthik, once I will create hedge in options. Will it triggers automatically? Or again I need to monitor or stop loss is required to set for both buy and sell. Using zerodha kite how it works in realtime..
Depends on what kind of orders you use to place the hedge. If it’s limit or GTT, then yes, it will trigger.
You gain nothing and loss nothing, whats the purpose of hedge here . .
( Why do we simply trade? To make nothing? )
To protect your position in the market, while you are still invested.
You gain nothing, loss nothing
whats the purpose of hedge here . .
(Why do we simply trade? To make nothing?)
Hello Sir,
One should only hedge with ATM and slightly OTM options correct?
Assuming I hold 300 shares of SBI, and sbi gets some short term bad news. Overall long term position is good. Short term is bad.
This news only affects SBI and not Nifty and bank nifty so I cannot use them to hedge.
How would I hedge adequately since SBI has a lot size of 1500?
Hi Karthik,
From what I understood about hedging after reading the chapter, I feel that hedging the portfolio is kind of waste of money(maybe too harsh). On one side we are putting almost same money as our portfolio value to hedge the portfolio and at the same time we are ensuring that net portfolio value remains same.
This does not seem right because I have invested money to gain profits not to neutralize the portfolio.
So can you explain in detail as to how does hedging benefit oneself?
Piyush, its not a waste of money. Think about it, you have 20L deployed in the market, you don’t want to withdraw this heavy amount because you expect a short term crash in the market, you’d want to stay invest but still protect your capital. What will you do?
I think you have accidentally skipped my previous comment.
Hello Sir,
One should only hedge with ATM and slightly OTM options correct?
Assuming I hold 300 shares of SBI, and sbi gets some short term bad news. Overall long term position is good. Short term is bad.
This news only affects SBI and not Nifty and bank nifty so I cannot use them to hedge.
How would I hedge adequately since SBI has a lot size of 1500?
Yes, if you hold SBI, then hedge with SBI only. No need to use other instruments. As a thumb rule, single stock positions should be hedged with their own contract as long as its available.
Hi Karthik!
A great learning about hedging from you indeed. I have one query. We do hedging when we think that the market is going in reversal mode (I am a long term investor and I expect that market will go down). What if my expectation is wrong and market does not change its direction! Since I have hedged my portfolio, there must be loss to me in this situation?
When you hedge, you will neither have a loss or a profit. But yes, if the market goes up, then you will miss the opportunity to participate in the upmove.
Hello Sir, is the historical data in NSE site adjusted for splits and other actions? If not, where can I find corporate actions details? I searched through nse site, I couldn’t find it, I have the link of old nse providing corporate action details but it not working now.
I dont think they do. Please check, its been a while since I checked.
Thanks sir, I have found the link.
Sir , various types of video available in you tube for future option Hedge. My question is Is Hedging beneficial and could zerodha allowed this Hedging pl.reply with an example.
Yes, you can hedge. For example – long Reliance stock, you can hedge by shorting reliance future.
Hello Sir,
Hedging with a future is good, but it has substantial M2M cost if it goes the other way.
So ATM put provides half a future but there is time and volatility also at play.
Which expiry time frame should one take?
So should one implement a hedge with an ITM option?
Could you explain hedging with options as it is not present in the option strategies module?
You are absolutely right about the M2M with futures and volatility and time decay of options. If M2M is not your cup of tea, then perhaps you should consider ATM Puts as a hedge for your long spot position. I’ve not really put a note on this, will try and do this sometime.
Hello Sir,
I thank you for responding.
An ATM put has a delta of 0.5. Will it be sufficient to hedge against a long position that has a theoretical delta of 1?
You will need 2 ATM (delta = 1), that way the position will be offset and fully hedged.
Hello Sir,
Would it be better to hedge each individual stock in my portfolio or just hedge against Nifty options?
For hedging with futures you have mentioned hedging the portfolio value (adjusted with beta) with the appropriate nifty value.
How does one do this for options?
Its better if you hedge the portfolio as a whole. An individual stock hedge can get very expensive.
Hello Sir,
How does one hedge with options properly?
Long positions can be hedged by buying puts or selling calls.
Short positions can be hedged by buying calls or selling Puts.
Thank you sir for all this amazing knowledge.
I had a question in my mind regarding the expiry of the Future.
When I buy a Futures contract, I am digitally signing a contract that says on a specific date I will be buying the stock at the price I entered the contract.
Que1- Is it really necessary for me to buy the shares in the spot market at the expiry or I can have my profit or loss as it is without buying shares?
Que2- What happens if do nothing on the expiry date after I have bought a future?
Once again thank you sir ji😊
1) If you end up holding till expiry, then yes, you will be obligated. Else you can even square off your trade before expiry, which is also ok
2) It will be settled based on the market prices 🙂
I wonder after I read this chapter because in the middle the Author takes an example of Taking vaccine if u affected virus….(It is like taking vaccine shot against a virus).
Yeah, its like a hedge 🙂
Sir what is the difference between momentum 30 and High Beta 50 stocks? I went through the selection methodology, I couldn’t under momentum 30 selection math. Primarily what I am trying to do is I am looking for stocks for intraday trading. So which list is better sir? or is there any other way to shortlist stocks for intraday?
Mani, where are you looking for the Momentum 30 stocks? My guess is that this will be a better bet.
In NSE site under strategy indices. Basically I am looking for socks that moves faster than nifty sir.
Yup, momentum 30 is a good bet.
Is it possible for you to look at momentum 30 stocks selection criteria and shed some light on the math used.
Will try and do that. I guess it’s based on returns. Have explained the logic here – https://zerodha.com/varsity/chapter/momentum-portfolios/
Yea sir, I guessed the same, does it mean, that high beta stocks are better for intraday.
You want stocks to move so that you can easily trade intrday, so high beta works. But please be aware, risk and return are two sides of the same coin. So be extremely cautious when trading intrday, it is super easy to lose money.
Okay, I understand. I am planning to position size in such a way that my risk of ruin is 15%.
Sure, please back test this before you take the trade.
1) If you want a perfect hedge, you will need to short 2 lots
2) Thats right
Its not a perfect hedge, you can have this if you want it that way. Else, you can create a perfect hedge and let work as a fully insulated solution.
yes sir, is there a website that gives beta value?
Not sure, Mani.
Also, since I learnt everything from you, I should probably let you know that I was able to keep my pnl positive for last three financial years sir, also made sustainable return. I am active in varsity for nearly 4 years and with zerodha for nearly 10 years. What I like the most is you answering every question without judgement or bias to the best of your knowledge. I think this consistency and integrity of yours rubbed on me too sir.
Mani, thanks for the kind words. I’m glad to know that you’ve been profitable. I hope its stays that way! Happy reading and good luck to you 🙂
we hedge porfolic with shorting nifty future of mid month expiry.we have to sqare off future at expiry(or roll over).how hedging work if portfolio (and nifty) goes up and we have to settle future at expiry with loss.In this case we do not want to sell portfolio .
The idea is to insulate the portfolio completely. When you do so, you neither make a profit or loss.
There is a margin to be paid to sell the futures. In your working above you haven’t considered that cost. Shouldn’t that also be calculated while deciding the hedge value?
Hmm, not sure how you can factor in margins here. It may just get very complicated.
Hello sir, all these contents are still deemed as fresh in 2021??
Or it is obsolete now?
Yes sir. These things are core concepts and will remain the same over time.
Hi sir
Thank you for beautiful explaination. I am going thru your option chapters and I must say it’s a well done job(though I still feel futures are easier to understand)
My query is
1) If I am holding a position in future already, can I hedge it with option later( dep on stock performance) or is it advisable to always take a hedge future position.
2) How to hedge future with options?( Always with Itm option?)
1) YOu can hedge it with options, no issues there
2) Not necessary, you can hedge with OTM or ATM options as well. But most prefer ATM)
Sir, While calculation of Hedge value, Do we have to consider initial invested amount only or current value of Portfolio?
Current value, Amoghha.
Dear Zerodha team,
I want to buy a Nifty CE at a price 2.5% higher from where Nifty future is currently trading. But its not reflecting in dashboard.
Please guide.
Regards
Sorry, I dint get that. Do you want a strike that is trading 2.5% higher than Nifty Fut?
Can I have latest video clip how to book buy or sell hedge in zeroda mobile app
There are no video clips 🙂
I’d suggest you speak to a zerodha support executive for this.
Hi Karthik, thanks for building such an informative body of knowledge – I visit Varsity frequently as my “go-to” reference.
I have an observation regarding risk – I feel terming these as systemic would be a better fit than systematic. Systematic and systemic both come from system. Systematic is the more common word; it most often describes something that is done according to a system or method. A systematic approach to learning that involves carefully following the program’s steps. On the other hand, Systemic describes what relates to or affects an entire system. For example, a systemic disease affects the entire body or organism, and systemic changes to an organization have an impact on the entire organization, including its most basic operations.
Please see https://www.merriam-webster.com/dictionary/systemic and https://www.merriam-webster.com/dictionary/systematic
Thanks and please keep adding to this awesome body of knowledge.
Thanks for the detailed explanation, Ashish. I kind of agree with you. But I think the common industry/academic practice is to use Systematic. For example, I was going through this from Columbia University – http://www.columbia.edu/cu/business/courses/download/B7301-XX/glosten/slides21.pdf and here too they use Systematic (slide 9).
When we hedge and try to minimize the risk, aren’t we also dampening our returns? Well, I do appreciate the reasons to hedge, but it is going to impact returns adversely isn’t it? Or am I missing some critical piece that will make hedging more appealing from a return standpoint?
When you hedge, the idea is to insulate the entire basket to both positive and negative returns. Its like you don’t have any positions in the market. So no risk, no return.
I Sir, is cash needed to be there in account to short the nifty futures for portfolio hedging
Yes, but since its a hedged position, the requirement may be lesser.
Hi,
As you mentioned the beta of the market indices ( Sensex and Nifty ) is always +1 .
May I know how to calculate the ‘ beta market indices ‘ in percentage .
You have already mentioned the formula for calculate the beta of the stock but you didn’t mention the formula for market indices.
If you don’t mind would please mention the formula to calculate how much percentage has change in the market
I’ve shared the excel steps. So when you do beta of the market, you essentially run a slope function of Nifty (or Sensex) with Nifty (or Sensex), and hence you get 1 as the answer.
Hi,
Assume I calculated the beta of my portfolio till the date of 24 Aug 2021 . On the next day 25 aug should I calculate the beta of the portfolio again as beta is calculated on the daily return .
If not , so what is the duration or after how long we supposed to calculate the beta of the portfolio again
You can check the beta once in 15 days or so, unless there are really big moves in the stocks.
Can I compare my portfolio ( beta of the all stock ) with daily % change in nifty index .
Like using the formula – current price – previous day close / previous day close *100
To get the result of how much my stock will move for a day .
Is it justified to compare as percentage changes in every second .
Either beta of the stock can only compare with beta of the market indices for better results .
Hmm, not really Shubhika. YOu don’t really have an advantage looking at the change in beta second by second.
Suppose I calculated the beta of my portfolio it is stands at 2.0 % . now to calculate the risk I have to check the market movement and we assume Nifty goes down by 5.5%
Now my question is how do we calculate this 5.5 % change in the market
What is the particular formula to calculate the market
Like – current price – previous day close / previous day close * 100
This formula use for particular time % change in nifty index and it’s changes every second of the day
So I have to keep an eyes on the market and check every second either I bear a lose or book a profit.
Do we have any particular formula to calculate . where market changes can calculate for the entire day .
I hope you get my question
Thats right, the formula you’ve stated works to figure the % change in the market. But there is no need to calculate the change so closely.
Dear Karthik, the Beta value of the stock would vary for different lengths of the period ( say 6 Months, quarterly, annual, etc ) considered for its calculation. Which beta to be considered for hedging a portfolio for an event like annual budget or otherwise?
At least 6 months, Shanshak.
Hi ,
1. I have a stock of Devyani international limited in my portfolio and it has been listed on stock about a month ago . So how can I calculate beta of this stock .
As we need at least 6 month or 1 year report of daily closing price of the particular stock .
2. And some takes a 6 month report and other take 1 year report to calculate beta . I would want to know does it make any major difference in the beta value by taking different time ( 6 month or 1 year ) of report .
1) Yeah, 6 months at least
2) Both values are different, people use them according to trading style. For short term = 6 months, 1 year for long term.
Is it better to square off position before expiry of future contract as you mentioned price at spot market and price of a future contract converge at the date of expiry . Suppose
Spot price – 445
Future price – 450
If I am long on future contract buy at 450 definitely price would come to 445 at the date of expiry .
It’s means I should always square off the position before expire when we are on long .
Not really, futures and the spot always converge. The decision to hold or sell depends on your expectation of the trade, Shubhika, and not on the fact that the futures and spot will converge.
Could you share the excel for the Beta calculation, the link is not working for chrome
I’ve explained the same step by step in the chapter, Nisarg.
Want to ask some questions
1) expiry of options – are they expire at last Thursday of the month or before that Thursday
2)impact of elections on market
1) Last Thursday of the month
2) See what the street expects and the actual outcome is.
Simply Brilliant Karthik !
Happy learning!
thanks @karthik rangappa sir
Good luck!
very nice article
which future contract will you ideally employ to hedge , current or next month contract ?
Current month contract, Shaji.
Thanks
Happy learning!
I am Looking for prefect hedge for nifty ( selling options ). I don’t want let my portfolio to be negative ! I have studied wheres theory but they all saying buying Gold is the only option for me but now a day it is not working .To hedge which is the best instruments USDINR or Gold ,Give some idea to float my position even if stock crash. Buying PUT will also lose time value ! I am waiting for your answer !
Hi Karthik, so basically If I hedge, I am insulated from the market volatility, so ideally let’s say your portfolio is 20% up, and we expect a fed tapering, we should probably hedge always! I didn’t because I hadn’t read this article. 🙁
How do you hedge with options? because there is a premium factor that comes into play?
would you buy a put option, atm?
Or short an OTM call option?
can you point me to a document/blog which deals with such details?
Pankaj, to hedge a portfolio with options, the safest bet is to buy an ATM Put option. Will try and put up an article around this soon.
Hi Mr. Karthik, please clarify me the below
on expiry day, do i have to take or give delivery if any of the below goes CE OR PE GOES ITM.
what happens if futures goes up and down.
i want to know how settlement takes place if i do not exit before epxiry of contract
Position Entry Price Current Price Exit Price P&L
-1x 27JAN2022 FUTURES 1875.55 1876.9 0 -742.5
+1x 27JAN2022 1880CE 52.45 49.4 0 -1677.5
-1x 27JAN2022 1880PE 58.45 54.2 0 2337.5
Total P&L -82.5
Please check this – https://zerodha.com/varsity/chapter/quick-note-on-physical-settlement/
In key takeaway #5, you said “Unsystematic risk cannot be hedge, but can be diversified”, but there is a whole topic on hedging a single stock. I don’t understand how they are different. Please explain.
That chapter on hedging is about hedging a portfolio. That said, single stock can be hedged by its futures or options, but not all stocks have futures and option contracts on them.
What if I have a position in a stock that does not have a futures contract? I dint get this point, if doesnt have future contract how will short it and hedge the position
That won’t be possible at an individual stock level. You will have to hedge it along with the portfolio.
By 9,00,000 hedge value do you mean to say the notional value?
Yes, thats the notional value of the portfolio which needs to be hedged.
Currently (2022) How the beta value is calculated..? and How can i hedge my equity portpolio using Zerodha platform..Pls advise
The technique of calculating beta is the same, and that wont change with time 🙂
Superb…Never had such a simple and detailed explanation of hedging…
One question- we hedge against the loss of portfolio, but what if market is in bull phase and portfolio is rising. In that case, if we have already employed hedge, then we would be at no gain at the end.
Please suggest
Thats right, to hedge a portfolio, you need to have an opinion on the market direction.
Dear Sir,
Then what is the use if there is not profit or no loss ?
Just time pass in Trading Terminal ?
For that we are not here
Regards
Sure.
hy sir
how the beta value of stock is calculated? can you brief it?
I’ve done that in this chapter itself right?
in the continuation of the above question
is beta value changes?
if yes, then in which respect?
Yes, with change in price, so does the beta.
sir high beta stocks are better?
as India is a developing country and definitely the indices will move up and with respect to that stock will do the same, and in respect to this we can gain more profits in high beta stocks.
sir i got the answer of the q. how to calculate the beta value
😊😊
Hello Sir,
Beta Calculation Excel is not Downloding
“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 –
De-growth in GDP
Interest rate tightening
Inflation
Fiscal deficit
Geo political risk”
perfectly playing out in 2022
These things usually unfold in a pack 🙂
Dear Sir
What will be cost / charges, etc of hedging
Regular trading charges are applicable.
Can we place SL for futures trade??
Of course, you can. In fact you should 🙂
Congratulations on your efforts to help learning
Thanks, and happy learning!
Hi Karthik,
Very well explained. Thanks a lot. But this example illustrates hedging when one is in long position at spot market. How can one hedge if one is having short position in future. And how does one square off?
You can buy a call option to offset the short futures position in futures.
Currently (today 27 Sep 2022) I designed one trade on Sensibull.
Here I
1) bought Next month Bank nifty future contract (27 Oct expiry) @38770 and
2) sold current month Bank nifty future contract (29 Sep expiry) @38593.70
And I am getting clear-cut fixed profit of 6% (no matter where I set underlying price or days left to expiry). Also I checked and these contracts are liquid. I can get them at specified price and still payoff is constant 6%
I would like to know what’s happening here. 6% in 2 days 🙄
How’s this possible?
The assumption is that both contracts expire on same day, but its not right?
Ohh! Okay. Thank you!
Sure, good luck.
The excel sheet for beta calculation is not opening. Can you please share the correct link.
Can you please try downloading for another browser?
Hi Karthik, You have put in a wonderful content in Zerodha varsity as a whole so thanks a ton for that. I have a specific query though. 1. Current Reliance spot and futures price for 23 Jan is 2524 and 2542 respectively
2. I want to long Reliance 23 Jan 2540 future 1 lot and hedge it by going long on put
3. The question is – should I go for 2540 put (23 Jan) or 2520 put (23 Jan) here? This question is because – if the price of Reliance goes down then it’s future price too will go down and near to the expiry the spot and future price will converge. So if the expiry happens around 2520 then I will lose entire put premium. We really don’t know at the beginning of three month if the spot price will move more towards future of the other way round. Precisely my questions is – while hedging long future with long put should I use spot price or future price as the strike price for put?
Please share your take on this
Thanks
If you want a perfect hedge, you can think about the delta. Since you are short 1 future, the delta is -1. To offset it, you need +1 delta…so shorting 2 ATM puts (2520), will give you the perfect hedge at the time of initiating the position.
Thanks. Did you mean I should be shorting 2 ATM calls? This is because I am not short 1 future but long 1 future as mentioned in my original query
Ah sorry, so if you are long Futures, you can buy 2 ATM puts.
Hello Sir,
I am investing in Nifty 50 index fund through SIP. How do we hedge this position? Is there a way to find beta value of the mutual fund ? Or is there a way to get beta value of Nifty 50 index? Is it readily available? Kindly help me with this.
I’m guessing Nifty 50 you are investing for the long term. If yes, why do you want to hedge?
Is it permitted to short sell cash settled futures? Post the SEBI notification of phasing out cash settled futures, is it completely phased out?
Yes, of course, its possible.
Hi Karthik,
I have a query related to Nifty futures hedging. Currently Nifty spot is at 17594 and Nifty Mar Fut at 17661. So if I long 1 Nifty Mar futures then to hedge it should I buy Nifty puts with the strike of 17600 (spot ATM) or 17650 (futures ATM)? Precisely what strike should I select here if I want to buy ATM puts? Should it be spot ATM puts or futures ATM puts?
Thanks in advance for clarifying on this
Thanks,
Amit Kale
I’d suggest ATM, Amit.
Do you mean Nifty spot ATM? That’s my exact question. Sorry to bother you again…
Yes, thats right. Nifty Spot is what I’m referring to.
Thanks Karthik
Happy learning, Amit!
Sir, if I hedged SBIN future with put or call, then it shows max loss 18700/- on Sensibul, at expiry. My doubt is that when call or put expires,we have lot size *premium =loss (as above ), then
1) what happens about future, if market goes against?
2) why is max loss of 18700/- only or is there possibility of more than it at expiry?
Plz clarify
You will have to consider the overall P&L. So basically the P&L (Futures position + Options position). So for futures P&L its the difference between the entry price and exit price. If you do it this way, you will know why its 18700.
Ok sir, thank you..
Happy learning 🙂
I just want to thank you for this wonderful course.
Happy learning 🙂
Can I buy 1 lot of future and sell 1 lot of future (next month) for hedge?
Yes, you can.
Hello Sir, I just had a small doubt. Which type of investors usually hedge their portfolio? In the above example you mentioned that selling the stocks and then waiting for the price to decline to buy them back is not practical because of tax and transaction cost purposes, but if the investor wants to be invested for a longer period of time why would he bother with a short term downturn. Wouldn’t it be better for him to just buy more stocks when the prices go down, why would he shell out more money just to hedge this portfolio rather than buy more?
Hedging works when you have a large portfolio where the M2M can be significant. Or it can also help in cases where the portfolio is held for the short term. As a long-term investor, you don’t really have to worry much.
Can we use the same hedging approach for mutual funds as well? If so, where can we find the beta for each mutual fund.
The factsheet of the fund will give you the beta. But my advice, don’t worry about hedging, the fund manager does this for you 🙂
Thanks a lot Karthik. The dhapters on Pricing of future and Hedging were real eye openers.
Question:
Is there any reliable site or tool that can be used for extracting beta value of stocks ?
Raam, glad you liked the chapter. Cant think of any site, but maybe NSE itself provides this somewhere. I remember seeing it long back.
Hi Karthik – Can you help with the excel sheet for Beta, its not opening with the link above currently.
Can you also include a topis on relative strength and how can one use this to our advantage. Also, if you can pass a message to the zerodha team to please include the Relative Strength as an indicator or the spread charts flexibility !
thanks a lot !
Vikkas, can you try downloading the beta excel from another browser? Also, we have already discussed relative strength here – https://zerodha.com/varsity/chapter/indicators-part-1/
If a stock position is hedged, profit in one position will be compensated by loss in another then how is it beneficial? Kindly explain.
Its just that the position itself is insulated to all market directions. You hedge to protect your positions, not to make a profit or suffer a loss.
Loved this chapter. Derivatives are useful for long term investors to protect their portfolio in corrections.
Yup, a point that many have missed 🙂
Dear Karthik,
The stock which i have does not always respond as per its beta value and behaves differently.Is it because of some news related to the particular stock?How to hedge in this case?
Thanks
Maybe on a day to day basis, it wont 🙂
My share portfolio is for long term. So, to hedge it do I have to keep selling and repurchasing nifty on each expiry OR is there a carry-forward mechanism?
If its long term, then maybe just leave it as is?
First off, thank you Zerodha & team for the wonderful educational chapters provided. Always a pleasure to learn from the valuable information given in such a simplified manner here.
My question might be a bit extraordinary. I am wondering, if when a single leg index option’s contract is sold and is moving directionally against me (from OTM to ITM), would it make sense to hedge this losing option position by taking an opposing trade in a futures contract? I have read more about hedging futures positions by options rather than the opposite. Love to hear your thoughts on this.
Yeah, you can hedge it with futures or perhaps another options position, but make sure the overall value of the delta is zero or neutral. I have explained delta in the options module.
If its a non-zero delta position, it will remain unhedged.
Good Morning Karthik Sir i have never seen negative beta on stock screening websites i know negative beta examples are defensive stocks like pharma and FMCG but in real life i have never seen value on any website can you help with this query
For the longest time Airtel had a -ve beta, dont know if that has changed. Maybe you can check once.
Karthik,
It was good explanation of hedging long stock positions with short Nifty futures. Please explain the same example if Nifty goes up by 500 positions. What will be impact of Short Nifty contract vs Portfolio value. It will help me as a beginner.
The position will be insulated, Krishna. The portfolio will not get impacted by either movement as the portfolio is fully hedged.
Hi Karthik,
I need little more clarification to understand. Actually Long position is insulated by short position and vice versa. So will be minimal or no loss. I agree but it will impact returns percentage because one position dilutes the returns of the other position. So my understanding is that hedging minimizes losses and dilutes the returns as well. Please explain with some example if my understanding is wrong.
When you hedged, your position is fully insulated to market movement. You do that only when you feel the market goes down. If the market does go down, then your positions are unaffected, rather you outperform the market. But in the case the market goes up, you are still unaffected but that also means you dont really get the returns that markets have to offer you.
Hi Karthik,
Wish you a very happy new year!
You have made trading easy for us with your simple illustration of concepts and the process. Thank you so much!
I am thinking of exploring Equity Futures to take directional calls on Indices and Stocks. Does Zerodha provide past trading data (daily) of stocks to see the patterns and run some tests? Does Zerodha provide financial data (assets, liabilities, earnings, etc.) like some of the paid websites (Capitaline/Prowess)?
Thanks Pranav. Wishing you the same!
YOu can check kite.trade for the data, hopefully that should help.
for calculating portfolio beat, when you say “sum invested” is it the “total buy value” or “total current value” of the portfolio? assuming its the latter?
You will have the consider investment value.
Hello Karthik Sir could you please suggest me best resource for swaps
Ah, I need to check this myself, not sure 🙂
Hi Karthik,
Can yuu please share the wesites where I can monitor below information. I tried to find but it’s very confusing to me.
1. GDP growth forecasts from the World Bank and RBI.
2. Check inflation and Monetary policies and factors that can drive inflation up.
3. Keep an eye on commodity, crude oil, Dollar, and the USD-INR prices.
4. Track Monsoons and its impact on inflation, CPI and food price inflation.
5. Keep a check on International and domestic political situations
Atleast 1,2,4 which you prefer to visit and check this data.
This would be really helpful if you can respond❤
You can probably check this – https://tradingeconomics.com/
Hi Karthik,
Thank you for sharing this great peice of knowledge,
I have a little doubt, when there is uncertainity,
If the portfolio is in positve MTM, Don’t you think the hedge should be on current value rather than invested value.
Please give your opinion and enlighten us.
Thanks
Aagam
Thats right, you can take in the current market value.
Please check if I am on a right track
To hedge a portfolio of stocks we need to follow the following steps
A) Calculate individual stock beta
Done.
B)Calculate individual weightage of each stock in the portfolio
=Current Value of particular stock investment / Total Portfolio Current Value
C)Estimate the weighted beta of each stock
=Beta*Answer(B)
D)Sum up the weighted beta to get the portfolio beta
Done
E)Multiply the portfolio beta with Portfolio value to get the hedge value
=Weighted Beta*Total Portfolio Current Value
F)Divide the hedge value by Nifty Contract Value to get the number of lots
Done
G)Short the required number of lots in the futures market
Done
Please check my question number B & E
As i have taken current value of all, While calculation instead of investment value.
Please confirm karthik. Am i on a right track?
Yes, the steps listed seems correct.
Hello sir ..my ques is when will you become a billionare? because u r full of knowledge..and if u become one pls send me few bucks ..thanks
You can’t equate the two. Knowledge is gained through experience, money is made by taking risks 🙂
How to hedge with regards to Options? Is it safe to say the strategies like bull spreads are known as hedging?
There is nothing like safe, Prem. It all depends on your risk appetite. But that said, bull spreads are hedged.
which option i should exit first buy or sell in nifty option hedging trading ?
You can exit the sell first so that you free up the margins.
Sir can you also make a course on US fed rates and major global events that play role in volatility but are not easily understood by normal individuals.
I usually find it difficult to grasp what fed rate cuts are usually talked about in the market and how to make a view on market with that info.
And Thank you so much for your valuable lessons.😇
Check this, Roopam – https://zerodha.com/z-connect/varsity/us-fed-rate-cut-how-it-affects-traders-and-investors