There’re a lot of kinky stuff going around the Indian stock markets.
Low GST collections/compliance, the Trump-Jong Mexican standoff, Fed interest rate hikes, huge bank NPAs, low earning forecasts, uncertainty about when growth will pick up, risk of downgrades — and any one or a combination has the potential to stick a pitchfork right up a bull’s arse.
This can happen suddenly, despite being in a bull market, and end up wiping out solid percentages of portfolio value. The sell-off on Diwali 2017 trading day was a case in point.
Therefore it makes sense to insure your portfolio at a small price instead of riding through the risks.
Let’s take an example. Let’s say your portfolio value is worth Rs 10 lakhs and the market is passing through uncertain times, like it is now.
One important thing to note at this moment is that this strategy must be practiced in times of market uncertainty and not when the trend is clear.
Step 1: Choose the expiration date — today is 23 October 2017, and there would be no point buying put options for October-end expiry. It would make sense to choose Nov- or Dec-end as an expiration date.
Step 2: Choose the index — You must choose an Index that is decidedly weak. For example, as things stand, the Bank Nifty looks weak and in fact, it is the last pillar of support for the Nifty 50. You cannot choose Nifty IT because the dollar is expected to rise against the Rupee. Nifty Mid Cap 50 is not that liquid, so let’s zero in on either the Nifty or the Bank Nifty.
In this example, I chose the Nifty Put Option of 9500 for 30 November 2017. At the time of writing this article it was available at 21.
Step 3: Before You Buy — In this example we have assumed a portfolio of 10 lakhs. One lot of Nifty Options is 75 units.
Therefore, the value of the lot we have chosen is 9500 X 75 = 7,12,500
Therefore, 2 lots will more than cover the value of your entire portfolio.
Now let’s say we buy 2 lots of Nifty 9500PE @ 21.
Our investment will be Rs 3,150 (Rs 21 X 75/lot X 2 lots).
3,150 represents just 0.32% of the portfolio, and if you keep doing this every month, it works out to approximately 4% of your portfolio FOR THE ENTIRE YEAR.
Step 4: After You Buy — Do not consider this put option as a trade. Write off its price just like you would write off an insurance premium. Hold and wait. In case you sell off a part of your portfolio, and wish to square up, you can always sell one lot and hold on to the other.
Buying put options to protect your portfolio in an uncertain market environment is an excellent tactic that helps you sleep peacefully at a small price. In any case, you do expect your portfolio to appreciate by leaps and bounds every year and therefore paying 4% of its value as insurance works out to actually nothing.
This is one tactic I follow and thought I’d share it with all.
Image Courtesy: NY Times