Protect your Portfolio from a sudden market crash

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To sell, or not to sell? Investors are nervous at the current period (Q3, 2018) as Nifty has made its all-time high in this week and given a weekly close (3rd August’18 close 11360) very near to its all-time high of 11390. Since the March 2009 market has witnessed buying pressure in every dips even in the recent medium-full in the first half of 2015 to 2016. At that time, investors have seen almost 15% fall in major indices. Many of them had sold off their entire portfolio at lower prices with a fear of facing 2008 again.

But is it always necessary to sell off the shares which are in profit at pick point? What do you think? Some analysts suggest that sell off the at least half of your investments if market moving near its tops or near to any strong resistance point.

Yes, precaution is always good but I don’t think that there is a need to sell the shares which have strong fundamentals. But I think that we can make hedged position to protect our portfolio. This is just like we buy insurance for car, house, health, etc. Portfolio protection is also required like these different insurance protections  because the long-term stock portfolio is the biggest asset and assurance for retirement for many of us. In this article, I’ll discuss some options strategies which are required to apply at this time frame. These option strategies to protect the portfolio may be the smartest thing to choose for those investors.

Strategy1: Buy Index Put option to protect your portfolio

This portfolio protection strategy is the simplest strategy to use. But you should calculate your portfolio beta before buying index put options. This strategy involves buying at-money-put option as per your portfolio hedge ratio compared to the relevant index to protect your portfolio value.

Calculation of portfolio beta is very important before starting the hedging procedure. Portfolio beta calculates the percentage of the change of portfolio value compared to the relevant index value over the time frame.

If your portfolio beta value is 1.2 compared to Nifty Index, it means that if Nifty has shown 10% return in last 1 year then your portfolio has given 12% return in the same timeframe.

Let us assume that your portfolio value is Rs.50,00,000. Now to calculate hedge ratio we should consider the price of at-the-money put option of 2months or 3 months period Nifty contracts. The closing price of Nifty is 11360.80 today (3rd August’18). Hence the nearby contract strike price is 11400 (I’ve ignored 11350 strike price because the strike price which is multiples of 100 generally shows more liquidity). Your ideal hedge ratio should be:-

Hedge ratio =  ((50,00,000/(75*11400))*1.2= 7 contracts

The ask price of Nifty  put option of strike price 11400 from September monthly option chain is Rs.180, it means You require [(7*75*180)=Rs.94,500] amount to hedge the situation which is almost 1.89% of your total portfolio value but if the market crashes from the pick point then your total portfolio value will be secured to some extent.

Let’s see what will happen in the expiration period if you bought 7 contracts of September put of strike price Rs.11400 by allocating Rs.94,500 from your portfolio value. The below table is showing the changing % of hedged portfolio value under different market situation:-

Nifty portfolio protection

You can easily watch from the table that your position is almost secured even when the market moved below 15%. The largest loss amount is limited to -1.48% or approximately equal to the value of buying put and this will only happen if the market expires at strike price level or the current level.

Strategy2: Collar Options strategy to protect your portfolio

This is another strategy to protect the valuable long-term portfolio. Technically this strategy is nothing but covered call strategy along with buying an additional amount of put. As an effect, this strategy takes away some upside potential.

In this strategy, the investor needs to sell out-of-the-money calls as per the hedge ratio and needs to buy the same quantity of out-of-the-money put options of the same expiry.

Continuing with the above example, the investor needs to sell 7 out-of-the-money call options and needs to buy 7 out-of-the-money put options.

To open the collar strategy, the trader may select a nifty put contract with a strike price of approximately 2-3% below the current aggregate nifty value. In this example, we can take the put of strike price Rs.11000 (3% below the current market value) of September month @Rs.68.70 each. Similarly, we can take Rs.11700 (3% above the current market value strike price call option of September month @Rs.73.80 each.

From the whole transaction of opening the trade, there will be a credit of [(73.80-68.7)*75*7]=Rs.2677.50.

protection strategy for portfolio

You can clearly understand from the above picture that maximum loss is limited to -2.90% of the total Portfolio values even if the nifty goes near 9000 level and of course profit amount is also limited at the upper side. But you can adjust your strategies at any time to earn more profit at the upper level.

The below is the table showing probable profit/loss at the different level at expiry date:-

 

Nifty collar strategy table

But how this strategy is protecting portfolio under different condition of the market:-

Scenario1: Index rises:

Suppose the index crosses the resistance level and moves up then losses from sold call position will be offset by the portfolio return above the level of short call strike price i.e. 11700 level. The puts will expire worthless.

Scenario2: Index moves down:

The portfolio has protection on the lower side. The losses incurred in the portfolio below the strike price of the put will offset by the gains from the long puts. The calls will expire worthless.

Scenario3: Index with no movement condition:

If the index remains stable at the same place then call option and put options both will expire worthless. In this case, the portfolio value will be increased by the amount of premium received i.e. Rs.2677.50.

Conclusion:

Like any other investment decisions, it’s solely on your personal financial goals and risks tolerance ability that whether you will be able to open an options strategy to protect your portfolio or not. To know more on options strategies which are suitable for regular trading in Indian Market, please refer the section “Easy Guide for Indian Option Market” from my book “Best Option Trading Strategies for Indian Market”. I’ve shared my decade experiences and some valuable advice in this book. Anyway! Best of luck with your Investments!

ShawAcademy


About Moonmoon Biswas

Moonmoon Biswas is an Equity research analyst . She has more than 10 years of experience in this field. She has proven track record in the field of Technical analysis and the Fundamental analysis. From the educational background, She is an MBA-Finance with CFA (India). She has work experience in the leading broking houses in India and has also in hand experience in Australian Security Market. She has her own equity research firm and currently also engaged in digital marketing.

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