1. Portfolio Hedging Series VI
October 7, 2009
Derivative Classroom -Series V
` Introduction
Protecting the value of an asset against risk arising out of fluctuations in price is
known as hedging. Technically hedging means transfer of risk from the asset
holder to another person who is willing to carry risk. Equity markets are always
Implied Volatility
“Hedging means transfer moving under the shadow of uncertainty like financial, political, environmental
of risk from the asset
holder to another person etc. To safeguard the portfolio against volatility and financial risk, hedging has
who is willing to carry emerged as one of the ideal tool for every investor. In Uncertain times, to
ssss counter any price volatility in equity markets, hedging has proven its worth.
When an investor is bearish on market, he can hedge his position by taking
countervailing position against his portfolio, say, selling Nifty futures. If the
market falls, the fall in portfolio value will be compensated by the gains on the
Nifty futures. But if the market rises, the rise in the portfolio value would be
offset against the futures loss. Thus, while reducing risk, hedging reduces the
“The result of perfect
profit potential too.
hedge contract is “no
profit, no loss”. Suppose an investor holds 1000 shares of Infosys and feels that the stock is
going to be volatile for the next one month which he wants to protect at the
existing value, then he can sell 1000 Infosys futures in the current month
contract. The result will be if the share price goes up he would profit in the
delivery of scrip that he is holding and in the futures market he would lose and
vice-versa. The futures contract has hedged or protected the value of the
existing holding. The result of perfect hedge contract is “no profit, no loss”.
Calculating Beta of a Portfolio
“Beta measures the
sensitivity of the stock to Hedging is entirely linked with the price volatility of the underlying stock
the broad market index” representing the portfolio. Hence it becomes very important to calculate the beta
for overall portfolio and then hedge the portfolio against the price risk. Beta
measures the sensitivity of the stock to the broad market index so if the beta of
the portfolio is 1.04, and if the markets rises by 1%, then the portfolio is likely
to go up 1.03% and same goes for negative movement too.
Let’s consider a portfolio with Reliance, Bharti Airtel, Tata Steel, Infosys and
State bank.
Karun Mutha
Sr. Vice President& Head Derivatives Beta of stocks is available in www.bseindia.com
Tel +91-22-67897833
Email: Karun.mutha@hsbcinv.com
Tina Khetan
Analyst - Derivatives
Tel +91-22-67897828
Email: Tina.khetan@hsbcinv.com
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2. Portfolio Hedging Series VI
October 7, 2009
Derivative Classroom -Series V
Portfolio Hedging using Nifty futures
Scrip Name Buy Price Qty Value Beta Beta* Value
Reliance 2,130.00 500 1,065,000.00 1.23 1,309,950.00
Bharti 450.00 1,000 450,000.00 0.99 445,500.00
Implied Volatility
Tata 500.00 1,200 600,000.00 1.49 894,000.00
Infosys 2,100.00 600 1,260,000.00 0.65 819,000.00
ssss Sbin 2,150.00 500 1,075,000.00
4,450,000.00
1.08 1,161,000.00
4,629,450.00
Beta of portfolio 1.04
Nifty 1.00 5000.00 50 250,000.00
Hedge ratio 18.50
Accual Quantity of Nifty to hedge 18.00
Unhedge value 129,450.00
Steps involved in calculating Beta of a portfolio
Step 1-
Calculate the Beta of the portfolio by dividing “Beta*Value” by “Value”. Thus, the
portfolio Beta in the above table is (46,29,450/ 44,50,000), i.e. 1.04.
Step-2
Find the value of a Nifty futures contract. For this, the current price of index
futures is used. If Nifty future is trading at 5,000 the value of a Nifty future
would be 5,000 x 50 (the lot size), or 2,50,000.
Step-3
Calculate the number of contracts needed for hedging. This can be done using
the formula (Portfolio Beta x Portfolio Value) / Futures Value. In this case, it
would be around 18 contracts (1.04*44,50,000/2,50,000).
Step-3
Since we are long on the portfolio we need to sell 18 contracts of Nifty futures to
hedge the portfolio
Inference
The best that can be achieved using hedging is the removal of unwarranted risk.
The hedged position will, most of the time, make less profit/loss than the un-
hedged position. One should not enter in a perfect hedge i.e. protecting the
value of entire holding which would result in no profit and no loss. The investor
should use perfect hedge, as a hedging strategy hoping all that can come out of
hedging is reduced risk.
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