Hedging a Trade

General
1

Have a query regarding how best to manage a hedge position… for example…

I bought ONGC after it tanked by 6% (STOCKFUT JUL Contract) and I held the position overnight, expecting a recovery tomorrow.Now the next day, even though I am hopeful of a bounce back… there is a chance that the stock will open with a spike down, if it does…

  1. Will it be a good hedging strategy to sell ONGC (STOCKFUT AUG Contract) and later choose the direction I want to go in?

  2. Is this a good way to hedge & how best to manage it?

1 Like
2

You can do that Salman. But if the idea is to wait and watch then you are better off setting up a straddle or a strangle.

3

This would not be a good way to hedge and manage the position. Best way to hedge is to open it along with position or immediately afterwards as soon as possible to minimize any adverse price gap between the two…

Lets go through various scenarios and analyze them assuming you have bought ONGC July Contracts at 410 and are now thinking of shorting Aug Contract at 400.

  1. ONGC continues going down and reaches around 380. Aug is in 20 profit while July is 30 loss. Which one will you close? Normal human tendency is to book profits and keep losing trade open and hoping for recovery. Lets assume you will not do this but close the July trade at loss of 30. Now what if ONGC starts moving up without going to 370 (which would have been break even point to get 30 profit on Aug Trade)?

  2. ONGC turns around and starts going up. Exactly opposite of 1st scenario where July will start becoming profitable while Aug will be loser. Again question will be which one to close and which one to hold and what happens if market again turns around after you book the loss.

  3. Finally what if ONGC just moves slightly up and remains between 400 to 410 for some period of time. Both Aug and Jul will be losing. Also due to volatility cool off and time value erosion value of futures will decrease adding to losses.

Bottom line no matter what there could always be some loss. Sorry don’t mean to confuse you. Here is what I suggest -

  1. Look at your July trade and decide a SL where you would exit no matter what. Also you can decide a target where you would exit in case the trade is profitable. Usually it is best to decide this before entering the trade. Emotions interfere with our judgement once in trade and it becomes difficult to decide these.

  2. Short Aug Fut only if your research and analysis suggest so. Not to hedge Jul future. Infact it would automatically suggest closing of July contract.

  3. Treat Jul and Aug as separate trades and treat them so with their own SL and targets.

8 Likes
4

Thanks Ajay :slight_smile:

5

You are welcome Salman.

6

I have 250 TCS shares and avg buying price is @ 2000. CMP is around 2200 and I want to hedge my portfolio.

  • if I buy a put of 2200 to hedge, I’ve to pay 43 rs which is almost 2% of my investment.
    Is there any other way/strategy to hedge this?
7

Short 1 Lot of TCS Futures, Then it will be No profit No Loss deal (Apart from margin required in the intermediate period plus taxes).
However if you want to gain from the rise of shares, then the solution you have mentioned is appropriate, though you would lose a huge amount in premium.

8

Sell call option?

1 Like
9

You can additionally sell the 2260 call option to reduce the hedging cost by 50%. But keep in mind that if stock goes above 2260 then the gains from there on won’t be captured.

10

I don’t understand …you are already in profit of 200 points , then what is there to hedge?

In case you want more profits , why not use a trailing SL?

I’m sorry if I missed something , but when you are in profits , no need to take extra positions and undercut your profits by extra brokerages and taxes

11

@Chandan_Sabarwal Google ‘Covered Call’

12

Thanks, everyone for precious suggestions.
What If I sell future which generally trades at 0.5-1% premium. In any case, I’ll be having a 0.5-1% return per month on my investment which will be equal to 9-15% per annum.
Am I missing anything out here?

13

I’m aware of covered call , but it depends on how bullish the stock is… if it’s in wave 5 or something , then covered call makes sense , but if it’s in wave 2 , then perhaps not such a good idea. A covered call would be killing ones own profit for some small premium credit and higher the strike , lower the premium

I personally like to hedge the moment I take a one sided position

14

Certainly call options are one of the most used options to hedge your investments. However, you need to calculate that option purchase comes with cost and there is also expiry date. So, you need to make good hedging plan before you buy your hedging