High Beta (Momentum) Stocks Hedging Strategy

What Is A High Beta Stock?

A High beta or momentum stock is one whose rate of change is greater than the index’s.

For example, if Nifty moves up 0.5% and a stock moves up by more than 0.5%, then it is termed as a high beta stock.

Another example, if Nifty moves up 1% and Reliance moves 2%, the beta value of Reliance is 2, which makes it a high beta stock.

Remember that Beta implies risk, not volatility.

So if the stock moves at a rate of change that is higher than the index’s, it is considered risky, and vice versa.

Typically, beta of a stock is measured over a period depending. Beta can be measured weekly. monthly, quarterly, yearly, or by any other period that catches your fancy.

Where do I get a list of High Beta Stocks?

You can download a list of high beta stocks from the NSE website.

Unfortunately, the beta value per stock is not mentioned.

But that is okay, so long you have a list of these stocks.

Also, there’s no site that updates the beta number per stock on a daily basis, and therefore it’s best to rely on NSE.

Click on the text above and choose the appropriate sections (outlined in red) to download a list which is updated daily.

It also is simple to calculate the beta manually.

For example, if Reliance has appreciated by 50% in one year and if the index has appreciated by 10% in that same period, then Reliance has a beta of 5.

You can measure beta per the period of your choice – daily, weekly, monthly, quarterly, yearly, etc.

The Risks of Trading in High Beta Stocks

Aggressive investors and traders who want to ride the momentum, chase high beta stocks.

Many of these traders are short termers who are in to take advantage of the momentum.

They will book profits or losses rather quickly and that could leave an investor in the lurch.

This is the reason why high beta stocks are considered a risky trade, which is why all prudent investors hedge after buying a high beta stock.

High Beta or Momentum Stocks – Investment Theory

Conventional investment theory says

— You buy high beta stocks in a bull market, because these stocks will outperform the market and yield bumper profits

— You buy low beta stocks in a bear market, because these stocks will not drop as much as the indices and therefore your capital will not be at a high risk.

How To Hedge High Beta or Momentum Stocks

When you buy or short a momentum stock, you always run the risk of losing money.

FIIs, Hedge Funds, HNIs, MFs and DIIs are safe players and these institutions always hedge their risk because they deploy other people’s money.

The rough formula for hedging high beta stocks is this:

Say you own this portfolio:

500 Reliance (assume beta of 2) – CMP 1200

1000 Tata Steel (assume beta of 1.5) – CMP 600

The first thing to do is to calculate your portfolio’s beta value, which in this case would be:

Reliance – 500 X 1200 X 2 = 12,00,000

Tata Steel – 1000 X 600 X 1.2 = 7,20,000

The portfolio’s beta value is Rs 19,20,000

The portfolio’s average Beta is 1.6 (12,oo,ooo is actual portfolio value, 19,20,000 is beta value = 1.6)

Therefore you need to hedge Rs 19,20,000 to minimize your risk.

You need to hedge this with Nifty – BECAUSE the rate of change of your stocks will be higher than that of the Nifty’s.

In other words, if Nifty appreciates by 1 your portfolio will appreciate by 2 (Reliance) and 1.20 (Tata Steel).

Therefore it makes sense to BUY NIFTY At-The-Money PUT OPTIONS worth 19,20,000

One lot of Nifty is 75, CMP is 10975.

So hedge value of one lot =  8,23,175

So you will buy 2 lots Nifty Put Options for the next expiry, and you will keep carrying forward puts every expiry depending on prevalent prices.

2 Lots will cover your portfolio’s beta value to the extent of 86% (Option Hedge/PF Beta Value), and that should be sufficient.

Example of Hedge Playing Out:

2 Lots 10975 PEs bought at 200 = 75 per lot X 2 X 200 = Rs 30,000

Assume after 1 month Nifty rose 100 points

Reliance rose 200 points (Beta of 2)

Tata Steel rose  120 points (Beta of 1.2)

So, at the end of the month your portfolio appreciated by:

Reliance Gain: 500 X 200 = 1,00,000

Tata Steel Gain 1000 X 120 = 1,20,000

Total gain = 2,20,000

Less: 2 PEs not exercised Rs 30,000

Net Gain = Rs 1,90,000

Conversely, if you short a high beta stock, you should buy call options, but know that shorting a high beta stock in a bull market is extremely dangerous.

Also know that the situation completely changes when the beta of your stock starts falling.

DO this -calculate the beta of your portfolio and but Nifty PEs on paper to hedge the beta. Check what comes out at the end of the month.

This is how you hedge high beta stocks.