Hedging your risk

PERSONAL FINANCE

Option-based portfolio is a good way to survive a shaky market.

In volatile markets, most hard core equity investors find themselves in a lurch. They are constantly debating if they should book profits now. But then, there is also the fear of losing money, should the market recover and continue its trip northwards.

Nowadays, however, there are portfolio and wealth managers who offer products that help you to hedge your risk. One such product is option-based portfolio insurance.

Here, you can use the put option, which is a contract between two parties where the put allows the buyer the right, but not the obligation, to sell the instrument to the seller (known as the writer) at a certain time and price (the strike price).

So how does this work? Suppose you have a portfolio of Rs 5 lakh and you are not sure where the market is going. Then, you could buy a put on the same portfolio for one month at a time. You could exercise this option for all the shares individually, that is if they are traded in the derivatives market.

A simpler way of doing it would be putting Nifty or Sensex. If the Nifty today is at 4500 and you want your portfolio to stay intact then buy a put at say Rs 135 (3 per cent of Nifty) of Nifty 4500 for the month of August.

Now if the market goes down by 5 per cent then you stand to gain 2 per cent (5 per cent "" 3 per cent you paid. But your portfolio value goes down by 5 per cent. Therefore, net loss is 3 per cent. On the other hand, if the market goes up by 5 per cent. You tend to lose 3 per cent that you have paid. But your portfolio value goes up by 5 per cent. So your net gain is 2 per cent.

The cost that you would incur is going to Rs 13,500 (135*100 Nifties, where one Nifty contract = 50 Nifties). Since, for a Rs 5 lakh portfolio, you have to buy two Nifty contracts (4500*100 = Rs 4.5 lakh). This amount is closest to your portfolio size.

Sounds simple, isn't it? "" The devil is in the detail. Says Jayant Pai, financial planner, "If one has to do it oneself, it is a tough task."

Adds Mukesh Dedhia, director, Ghalla and Bhansali, "Before getting into the market one should track the movement of their stock prices vis-a-vis the market, then it is easier to apply such strategies and hedge your risk."