Use derivative strategies to insure portfolio now

Experts predict medium-term targets based on how much the market has fallen. “After a deep cut, the ensuing rally usually will be double of the cut. Investors should be careful now because the Nifty has already rallied 10,000 points from the recent bottom—double the 5,000 points cut,” says Hasit Pandya, Director, HPMG Shares & Securities. High market valuation, due to the relentless liquidity-driven rally, is another worry. Though the PE multiples of Sensex and Nifty have started correcting due to improvements in earnings, they are still very high compared to the historical average of around 18 times. In other words, the market is now over discounting future earnings.What should investors do? Since equity investors have made good money, it makes sense to shift a part of the profit to debt. Though this rebalancing will result in lower gains if the market continues to move up, there is no harm. “The purpose of financial planning is to meet goals and not to beat the best fund manager or benchmark,” says Melvin Joseph, Managing Partner, Finvin Financial Planners.Have the cake and eat it tooPortfolio insurance is the best strategy to adopt if you want to remain invested in the market and at the same want to reduce the portfolio risk. While rebalancing works for passive investors, portfolio insurance works for only active investors; because these strategies are implemented using the futures and options (F&O) segment of the market.Buying out of the money put options and writing covered call options are the most commonly used portfolio strategy tools. Buying put option gives you the right to sell the underlying stock or index at a pre-determined strike price on or before specified expiry date. The price you have to pay for buying them is known as premium. If the strike price of a put option is below the current market price, it is known as out of the money put options.Continuous Nifty rally a worryPE multiples also still high compared to historical average. 86315857Cost of Nifty options expiring on 30 Sep 86315859Premiums come down with lower strike prices. For instance, the premium of 17,200 Nifty is significantly lower compared to 17,500 Nifty. Since the insurance you seek is from major crashes and not from minor blips, taking out of the money puts is the best option. However, the fall is not big when the strike price goes down further to 16,900 and therefore, there would be no need to buy deep out of the money puts. You can also use the technical support levels for selecting the put option strike price.“Since 17,200 is a good support and investors need to worry only if the same is broken, buying put option there can be good hedging strategy,” says Pandya.Know what you are hedgingTo get full protection, the hedge should be based on your exact portfolio. However, it is not possible to hedge all stocks in the portfolio. That is because all stocks would not be there in the F&O segment. So using actively traded contracts, like Nifty, is one option. However, investors should note that hedging is opportunity-based and should be carried out judiciously. “Buying Nifty put option works effectively if your portfolio is large-cap heavy or your investment is in large-cap funds,” says Sahaj Agrawal, Head of Research - Derivatives, Kotak Securities. Several investors realised this mistake after they hedged using Nifty to protect their gains from the 2018 mid-cap rally. As mid-caps continued to fall, they lost their capital and their hedging did not work because Nifty continue to climb up.Covered callSince the market has rallied significantly in recent months and is expected to get into a consolidation phase before the next decisive move, it makes sense to extract some premium using the covered call option writing strategy. While call option buyers will have the right to buy a stock or an index at a pre-determined price on or before specified expiry date, the liability to honour them will be on call option writers. Option sellers are called options writers in F&O jargon. Always write covered call options —only against your actual holding— because it can be risky otherwise. The premium call option writers collect will bring down their cost of holding. Let’s assume that you bought Nifty ETF at 17,560 and wrote a 17,600 Nifty at Rs 127.45. If Nifty remains below 17,600 on 30 September, you can keep the entire premium and this will bring down your cost of Nifty ETF to Rs 17,432. Only issue here – you are restricting the potential upside with this strategy. You will not be able to participate in gains if the Nifty goes beyond 17,727.45—strike price + premium.

Use derivative strategies to insure portfolio now
Experts predict medium-term targets based on how much the market has fallen. “After a deep cut, the ensuing rally usually will be double of the cut. Investors should be careful now because the Nifty has already rallied 10,000 points from the recent bottom—double the 5,000 points cut,” says Hasit Pandya, Director, HPMG Shares & Securities. High market valuation, due to the relentless liquidity-driven rally, is another worry. Though the PE multiples of Sensex and Nifty have started correcting due to improvements in earnings, they are still very high compared to the historical average of around 18 times. In other words, the market is now over discounting future earnings.What should investors do? Since equity investors have made good money, it makes sense to shift a part of the profit to debt. Though this rebalancing will result in lower gains if the market continues to move up, there is no harm. “The purpose of financial planning is to meet goals and not to beat the best fund manager or benchmark,” says Melvin Joseph, Managing Partner, Finvin Financial Planners.Have the cake and eat it tooPortfolio insurance is the best strategy to adopt if you want to remain invested in the market and at the same want to reduce the portfolio risk. While rebalancing works for passive investors, portfolio insurance works for only active investors; because these strategies are implemented using the futures and options (F&O) segment of the market.Buying out of the money put options and writing covered call options are the most commonly used portfolio strategy tools. Buying put option gives you the right to sell the underlying stock or index at a pre-determined strike price on or before specified expiry date. The price you have to pay for buying them is known as premium. If the strike price of a put option is below the current market price, it is known as out of the money put options.Continuous Nifty rally a worryPE multiples also still high compared to historical average. 86315857Cost of Nifty options expiring on 30 Sep 86315859Premiums come down with lower strike prices. For instance, the premium of 17,200 Nifty is significantly lower compared to 17,500 Nifty. Since the insurance you seek is from major crashes and not from minor blips, taking out of the money puts is the best option. However, the fall is not big when the strike price goes down further to 16,900 and therefore, there would be no need to buy deep out of the money puts. You can also use the technical support levels for selecting the put option strike price.“Since 17,200 is a good support and investors need to worry only if the same is broken, buying put option there can be good hedging strategy,” says Pandya.Know what you are hedgingTo get full protection, the hedge should be based on your exact portfolio. However, it is not possible to hedge all stocks in the portfolio. That is because all stocks would not be there in the F&O segment. So using actively traded contracts, like Nifty, is one option. However, investors should note that hedging is opportunity-based and should be carried out judiciously. “Buying Nifty put option works effectively if your portfolio is large-cap heavy or your investment is in large-cap funds,” says Sahaj Agrawal, Head of Research - Derivatives, Kotak Securities. Several investors realised this mistake after they hedged using Nifty to protect their gains from the 2018 mid-cap rally. As mid-caps continued to fall, they lost their capital and their hedging did not work because Nifty continue to climb up.Covered callSince the market has rallied significantly in recent months and is expected to get into a consolidation phase before the next decisive move, it makes sense to extract some premium using the covered call option writing strategy. While call option buyers will have the right to buy a stock or an index at a pre-determined price on or before specified expiry date, the liability to honour them will be on call option writers. Option sellers are called options writers in F&O jargon. Always write covered call options —only against your actual holding— because it can be risky otherwise. The premium call option writers collect will bring down their cost of holding. Let’s assume that you bought Nifty ETF at 17,560 and wrote a 17,600 Nifty at Rs 127.45. If Nifty remains below 17,600 on 30 September, you can keep the entire premium and this will bring down your cost of Nifty ETF to Rs 17,432. Only issue here – you are restricting the potential upside with this strategy. You will not be able to participate in gains if the Nifty goes beyond 17,727.45—strike price + premium.