Inter-exchange hedging - III

INVESTMENT IDEAS

Crude short @ 2850

Crude payoff

BPCL long at 415

BPCL payoff

2950

-100

400

-15

2900

-50

410

-5

2850

0

420

5

2800

50

430

15

2750

100

440

25

 To any novice trader, it is clear that one of the two trades must result in profits - even if notional. In the happy event of both the trades resulting in profit, no one is likely to complain.  In the event of one of the trades going against us, the real purpose of the inter-exchange hedge comes to the fore. Suppose the short sale in crude is yielding a profit of Rs 50 per barrel. Since we know the contract size of crude is 100 barrels, the profit is Rs 5,000.  If BPCL starts to fall after we buy at Rs 415, we have the envious situation of crude shorts sustaining the loss in BPCL of up to Rs 5,000. The minute we see the price of BPCL falling below a level where the loss exceeds Rs 5,000, we exit both trades and walk away with no profit/no loss.  The above modus operandi is to minimise risks and maximise returns.  Your stop-loss levels are pre-determined by the profit available in any one trade, and thereafter you know you are playing a zero-loss, infinite profit game. Qualitatively speaking, this type of strategy should attract the maximum percentage of your capital as the degree of safety is the highest.  Rather than initiate naked positions, traders would do well to cultivate the "safety first" habit not just in their driving, but also in their trading regimen.  The author is CEO of BSPLindia.com and a Mumbai-based investment consultant. He has exposure to the MCX crude futures mentioned above, the exact quantum may vary from day to day.