Strategy for Hedging against Political Uncertainty 07th May 2014

Portfolio HEDGE Strategy against Political Uncertainty

Current stock market rally is being fuelled due to FII money pou

ring into India and possibilities of a Strong Government coming

in power at the center; any other outcome can lead to a selloff in market.

Two Outcomes possible post election

1) On the expectation of a strong government coming into Power, the rally may continue; upside will surely be limited in the

short term. Market has already considered strong NDA led g

overnment coming in power, therefore the up move if NDA

comes to power will be short lived.

2) Markets is concerned about the emergence of fractured man

date or third front parties putting numbers together, may result

in the selloff.

Since we are entering a Volatile Market Period, Hedging of Exis

ting Portfolio is a very important; like taking an Insurance

policy. Buy a ‘Put Option’ is the simplest way to Hedge. Due to r

ising VIX Premiums, Buying Option are very expensive, so we

recommend following strategy to Hedge Portfolio.

Buy 2 lot of 6700 PE @ 220

Sell 1 lot of 6300 PE @ 81

Sell 1 lot of 6400 PE @ 108

Scenario Analysis

This strategy will reduce the cost of Hedging to 11,500 Rs., for 2 lots, (i.e. 7 lakh value contract), margin requirement to sell options can be given

through Stock portfolio.

How will this help

If strong government comes to power on expected lines NIFTY does moves up, your portfolio growth will only be effected by 1.7% (cost of

Hedging).

On other hand, if any fall in market, strategy will help you maintain your portfolio value higher than the value that should be at that level, as shown in

scenario table, if NIFTY falls to 6300, portfolio without hedging would be 6.3 lakh, whereas with Hedging would be 6520500.

How much to hedge

This question can be answered if you known the beta of your portfolio (i.e. how much your portfolio moves if NIFTY moves by 1%).

Usually high beta stocks have a higher beta, Defensive Portfolio have a lower Beta

For Example,

If you have a portfolio of 1 Cr., which has a mix of Defensive and High Beta stocks, over all we assume Beta of Portfolio is near to 1, that means to

hedge entire portfolio you will have to do 15 lots of above strategy ( NIFTY 2 contract value is 7 lakh).

So a net investment of Rs 12,500 per lot, so for 15 lots 1,87,500 i.e. 1.80% of the total Portfolio will be required to Hedge the entire portfolio.

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