Hedging in terms of Future and options in Stock Market
Introduction- Futures and Options
What is Stock Market Hedging- Using Future/Options
Hedging Pre-requisites
Strategies-
Benefits of Hedging
Content
Derivative Market Structure
3
Stock Futures
Stock options
Call Options
Put Option
4
Direction/ view/Trend of Market. (Up,Down,Sideways)
Up Trend
Down Trend
Sideways Trend
Four kind of Market Situation
Bullish Market
Bearish Market
Volatile Market
Sideways/Non volatile Market
Take stock delivery
Buy stock future
Buy Call option
Sell put option
Bull call spread
Ratio call spread
Buy Put and buy future
Basic Strategies - Bullish Market Trading Strategy-HEDGING
Sell stock future
Buy Put option
Sell Call option
Bear Put spread
Ratio Put spread
Sell stock and buy Call
Basic Strategies - Bearish Market Trading Strategy
Volatile Market
Straddle
Strangle
Sideways Market
Sell straddle
Sell Strangle
Basic Strategies- Volatile & Sideways
Introduction-Hedging
Portfolio protection :-
Sell stock future
Buy puts
Buy Index puts
Sell Nifty Futures
Introduction-Hedging
Hedging reduces risk.
Hedging involves establishing other position whose price behavior will
likely offset the price behavior of the original portfolio.
The objective of portfolio protection is the temporary removal of some or
all the market risk associated with a portfolio.
Using Options
Equity options with a stock future
Index options ( Nifty)
Importance of delta Protective puts Writing covered calls
Importance of Delta/Beta
Delta is a measure of the sensitivity of the price of an option to changes in
the price of the underlying asset:
Importance of Delta
Delta enables the to figure out the number of option contracts
necessary to mimic the returns of the underlying security. Beta measures how much a stock would rise or fall if the market rises /
falls. The market is indicated by the index, say Nifty 50.
Example- Hedging using index
Investor Buy 1000 shares of Reliance @ 800(approximate portfolio value of Rs. 8,00,000. However, the investor fears that the market will fall and thus needs to hedge.
January Nifty futures is trading 6150 The beta of Reliance is 1.25 To hedge, the investor needs to sell [Rs. 8,00,000 *1.25] = Rs. 10,00,000
worth of Nifty futures (10,00,000/6150 = 162 Nifty Futures) 3 lots
Warning: Hedging involves costs and the outcome may not always be favorable if prices move in the reverse direction.
Example- Hedging by Selling Stock Futures and Buying in Spot market
Investor Buy 1000 shares of Reliance @ 800(approximate portfolio value of Rs. 8,00,000. However, the investor fears that the market will fall and thus needs to hedge.
The Reliance futures (near month) trades at Rs. 806. To hedge, the investor will have to sell 1000 Reliance futures.
Warning: Hedging involves costs and the outcome may not always be favorable if prices move in the reverse direction.
Example- Hedging by buying Put option
Investor Buy 1000 shares of Reliance @ 800(approximate portfolio value of Rs. 8,00,000. However, the investor fears that the market will fall and thus needs to hedge.
Stock delta is always 1 ATM put delta is always 0.50 To hedge, the investor will have to buy 2000 Reliance 800 strike put
option.
Warning: Hedging involves costs and the outcome may not always be favorable if prices move in the reverse direction.
Protective Puts
A protective put is a long stock position combined with a long put position
Protective puts are useful if someone:
Owns stock and does not want to sell it
Expects a decline in the value of the stock
Writing Covered Calls
Appropriate when an investor owns the stock, does not want to sell it, and
expects a decline in the stock price
An imperfect form of portfolio protection
The premium received means no cash loss occurs until the stock price falls
below the current price minus the premium received
Index Options
Investors buying index put options:
Want to protect themselves against an overall decline in the market
Want to protect a long position in the stock
If an investor has a long position in stock:
The number of puts needed to hedge is determined via delta.
Differences
Protective puts provide protection against large price declines, whereas
covered calls provide only limited downside protection. Covered calls
bring in the option premium, while the protective put requires a cash
outlay.
Identify the risks
Distinguish between hedging and speculating
Evaluate the costs of hedging in light of the costs of not hedging
What is our objective?
Should we hedge at all?
If so, how much should we hedge?
What hedging instruments should we use (Futures, Options)
What tenor should we hedge (1 months, 3 months, etc.)?
Hedging Pre-requisites
EXECUTION MONITORING REPORTINGOBJECTIVE STRATEGY
1. Which instrument to hedge?
1. Further adjustment
1. Should we hedge?
2. When to hedge?
1. How a hedge would perform under different market conditions?
1. What is the actual MTM for accounting purposes?
Mitigate - price risk
Safeguard - Profit Margins
Helps in making forecasting decisions, which are well supported by
rational statistical analysis
Provide confidence that the company has a well disciplined process to
manage market uncertainties
Benefits of Hedging
• “McMillan on Options” by Lawrence G. McMillan• “Bible of Option Strategy” by Guy Cohen• “Technical Analysis” by Charles D. Kirkpatrick II• “Technical Analysis Of The Financial Markets” by John
Murphy
• www.theoptionsguide.com• www.stockcharts.com/education/
Recommended Books on Options/Technical Analysis
Thank You….
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