Hi All,
This might be one of my longest blogs, but trust me, would be very useful for Long term investors. Also, this post, speaks a lot about a very interesting market segment of Derivatives / FNO, which is a bit tricky at first to understand, please feel free to get back to me for any doubts.
In another post today, I have put across possible scenarios and probable market levels pre and post the verdict on 23 May.
And one of the scenarios is, if the Exit polls are completely wrong, and not only BJP, but the NDA is struggling to get a majority...
If this happens, one should be ready for severe price shocks, and even a scenario, close enough or at least similar to 2004 (markets down by almost 20%) can not be ruled out.
Now, in that scenario, the Long term investor, could easily loose more than that in their equity / mutual funds portfolio.
In order to be safe in this situation, a Portfolio Insurance is a must
What it means is, we buy some out of the money puts in order to safeguard our portfolio for the unexpected price shocks. The premium you would pay for this, should be treated like a mediclaim / term insurance policy premium, which we pay for financially safeguarding ourselves and not for earning returns like the endowment plans or ULIPs.
(Endowment plans are the ones where you get life cover along with maturity benefit, unlike the term / mediclaim plans, where if nothing happens the entire premium is lost.)
Now, how do you do it ?
Knowledge about Options - Two basic things, Buy Call option when you are bullish, and Put options when bearish and most importantly,what ever you put in while buying an option can theoretically might become Zero. But it's highly advisable, if not in detail, you should know about the basics of Options trading.
Portfolio size - I am not getting in to deeper details of calculating portfolio beta and all, however, basically, if your portfolio is close to Rs. 8-9 lacs (Total Equity exposure stocks + Eq Mutual Funds), unfortunately
How many lots / Put contracts - For a portfolio value up to Rs. 10 lacs, one lot of Put can be taken as insurance, which means if you have a portfolio of Rs. 25-30 Lacs, you should go with 2 to 3 lots.
Which strike price to select - Now this aspects has 3 sides.
Expected downfall - If you expect a 5% fall, select a round figure strike price for Puts, close to current Index level - 5%. So which means a 5% drop is around 11100, and hence you should buy Nifty PE 11000. for a 10% drop the same approximately works out to PE 10500, and so on... Also, remember round figure strike prices would have better liquidity and hence should be selected over the odd ones. And especially for a once in a 5 year event like this strike price of half a thousand difference should be proffered, like 11000, 10500, 10000, etc, and the strikes in between should be omitted.
Amount of premium - Though different school of thoughts and expects might give you % figures like 3 to 5%, let me tell you what I personally look at. Given the risk of entire premium becoming zero in option on the expiry, you should not pay more than what you are comfortable loosing, can be a very small amount as less as Rs. 5 - 10 k
Which Expiry - We are playing for an event based scenario and ideally the expiry should be closest to the date of the event, in the current scenario, the same is on 23rd and coincidently, that's the weekly expiry. However, if there is a complete fragmented verdict, the quantum of the negative impact can be prolonged in time and hence one can even go with monthly expiry for May with the expiry date of 30 May. This will even have a slight extra time value which would limit the loss of premium if nothing negative happens, you would be able to sell the put at something more than zero.
When to purchase - There is a crucial factor of time value when it comes to option, which means the early you buy any option, higher would be the time till expiry and hence higher would be the premium. so buying it just before the actual verdict makes sense. Even higher the volatility costlier would be the premium. 20, 21 and 22 May would be a best time to buy as its just before the verdict day and importantly, as the exit polls have already been announced the volatility has also cooled down a lot today and is currently ~ 23%
How does it safeguard -
Let's take a scenario of NDA not getting majority on its own and markets plummet by more than 5% from the levels a day before the verdict, let's assume it to be 11600. Which means 5% drop would be closer to 11000.
Now lets say you bought Nifty 30 May PE 11000, trading approx at Rs.60 (So you pay Rs. 4500, i.e. Rs.60 x Nifty lot size 75). This will start making money when the markets starts falling down from the 11600 levels and would give guaranteed positive cash flow when Nifty goes down below 11000.
Now, lets assume markets go down till 10700, on the last day of expiry, 30 May, this option would trade near Rs. 300 (11000 - 10700), you purchased it @ 60, so your net profit would be Rs. 18000 (300-60) x 75.
Which means by doing this, when markets have fallen by around 7%, you have at least recovered 2% (Rs. 18000 / Rs. 10 lacs portfolio) of it , and thereby reduced your financial loss.
Now, what happens, if NDA retains the power and markets do not fall or go up from the 10600 levels... In that case the premium of Rs. 6o would start to decay and will become zero on the date of expiry, after the verdict on 23 May, there would still be a week left for the expiry and you might be able to recover something out of the Rs. 4500 paid.
Just remember, this is done with a sole intention of reducing loss and not making profits.
People might think, why do you do this after the exit polls showing a clear majority for NDA and hence markets may not even fall, my answer is simple...
Markets have a weird way of proving everyone wrong...
Hope this was helpful...
Cheers ! ! !
This might be one of my longest blogs, but trust me, would be very useful for Long term investors. Also, this post, speaks a lot about a very interesting market segment of Derivatives / FNO, which is a bit tricky at first to understand, please feel free to get back to me for any doubts.
In another post today, I have put across possible scenarios and probable market levels pre and post the verdict on 23 May.
And one of the scenarios is, if the Exit polls are completely wrong, and not only BJP, but the NDA is struggling to get a majority...
If this happens, one should be ready for severe price shocks, and even a scenario, close enough or at least similar to 2004 (markets down by almost 20%) can not be ruled out.
Now, in that scenario, the Long term investor, could easily loose more than that in their equity / mutual funds portfolio.
In order to be safe in this situation, a Portfolio Insurance is a must
What it means is, we buy some out of the money puts in order to safeguard our portfolio for the unexpected price shocks. The premium you would pay for this, should be treated like a mediclaim / term insurance policy premium, which we pay for financially safeguarding ourselves and not for earning returns like the endowment plans or ULIPs.
(Endowment plans are the ones where you get life cover along with maturity benefit, unlike the term / mediclaim plans, where if nothing happens the entire premium is lost.)
Now, how do you do it ?
Knowledge about Options - Two basic things, Buy Call option when you are bullish, and Put options when bearish and most importantly,what ever you put in while buying an option can theoretically might become Zero. But it's highly advisable, if not in detail, you should know about the basics of Options trading.
Portfolio size - I am not getting in to deeper details of calculating portfolio beta and all, however, basically, if your portfolio is close to Rs. 8-9 lacs (Total Equity exposure stocks + Eq Mutual Funds), unfortunately
How many lots / Put contracts - For a portfolio value up to Rs. 10 lacs, one lot of Put can be taken as insurance, which means if you have a portfolio of Rs. 25-30 Lacs, you should go with 2 to 3 lots.
Which strike price to select - Now this aspects has 3 sides.
Expected downfall - If you expect a 5% fall, select a round figure strike price for Puts, close to current Index level - 5%. So which means a 5% drop is around 11100, and hence you should buy Nifty PE 11000. for a 10% drop the same approximately works out to PE 10500, and so on... Also, remember round figure strike prices would have better liquidity and hence should be selected over the odd ones. And especially for a once in a 5 year event like this strike price of half a thousand difference should be proffered, like 11000, 10500, 10000, etc, and the strikes in between should be omitted.
Amount of premium - Though different school of thoughts and expects might give you % figures like 3 to 5%, let me tell you what I personally look at. Given the risk of entire premium becoming zero in option on the expiry, you should not pay more than what you are comfortable loosing, can be a very small amount as less as Rs. 5 - 10 k
Which Expiry - We are playing for an event based scenario and ideally the expiry should be closest to the date of the event, in the current scenario, the same is on 23rd and coincidently, that's the weekly expiry. However, if there is a complete fragmented verdict, the quantum of the negative impact can be prolonged in time and hence one can even go with monthly expiry for May with the expiry date of 30 May. This will even have a slight extra time value which would limit the loss of premium if nothing negative happens, you would be able to sell the put at something more than zero.
When to purchase - There is a crucial factor of time value when it comes to option, which means the early you buy any option, higher would be the time till expiry and hence higher would be the premium. so buying it just before the actual verdict makes sense. Even higher the volatility costlier would be the premium. 20, 21 and 22 May would be a best time to buy as its just before the verdict day and importantly, as the exit polls have already been announced the volatility has also cooled down a lot today and is currently ~ 23%
How does it safeguard -
Let's take a scenario of NDA not getting majority on its own and markets plummet by more than 5% from the levels a day before the verdict, let's assume it to be 11600. Which means 5% drop would be closer to 11000.
Now lets say you bought Nifty 30 May PE 11000, trading approx at Rs.60 (So you pay Rs. 4500, i.e. Rs.60 x Nifty lot size 75). This will start making money when the markets starts falling down from the 11600 levels and would give guaranteed positive cash flow when Nifty goes down below 11000.
Now, lets assume markets go down till 10700, on the last day of expiry, 30 May, this option would trade near Rs. 300 (11000 - 10700), you purchased it @ 60, so your net profit would be Rs. 18000 (300-60) x 75.
Which means by doing this, when markets have fallen by around 7%, you have at least recovered 2% (Rs. 18000 / Rs. 10 lacs portfolio) of it , and thereby reduced your financial loss.
Now, what happens, if NDA retains the power and markets do not fall or go up from the 10600 levels... In that case the premium of Rs. 6o would start to decay and will become zero on the date of expiry, after the verdict on 23 May, there would still be a week left for the expiry and you might be able to recover something out of the Rs. 4500 paid.
Just remember, this is done with a sole intention of reducing loss and not making profits.
People might think, why do you do this after the exit polls showing a clear majority for NDA and hence markets may not even fall, my answer is simple...
Markets have a weird way of proving everyone wrong...
Hope this was helpful...
Cheers ! ! !
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