Exit polls are expected to be announced from May 19 evening, once the last phase of the election is over. Therefore, the market is likely to be very volatile from May 20 onwards, HDFC Securities said
Given the importance of general elections for Indian markets, it becomes necessary for traders to hedge their bets.
Generally, election month sees wild swing with indices moving in a range of about 30 percent (May 2004 and May 2009).
Nifty has already lost over 500 points so far in May this year while Sensex has fallen 1,700 points in the same period ahead of election results.
“Exit polls are expected to be announced from May 19 evening, once the last phase of the election is over. Therefore, the market is likely to be very volatile from May 20 onwards,” HDFC Securities said in a note.
One more round of volatility will be witnessed on the day of counting, i.e. May 23. So, there are plenty of uncertainties surrounding the election outcome.
“Depending on the election outcome, Nifty may swing wildly on either side. Investors who are fully invested, it is always advisable to hedge the portfolio ahead of such big events,” said the report.
Therefore, investors who hold large equity portfolio can hedge it by buying Index Put Options. However, one should understand that hedging is like insurance, which comes with some cost.
HDFC Securities lists three election scenarios and what investors’ should do in each case to hedge their position:
SCENARIO 1: IF BJP GETS MORE THAN 272 SEATS
In such a case, we expect the market to rise sharply as investors are not expecting BJP alone to get a majority. Even beaten down mid and small-cap stocks can do well.
Here the simplest thing to do is to buy a Nifty Call. Due to the uncertainty of the election outcome, many traders prefer to use options to express their view.
Cost of the premium is high. So, in order to reduce the overall cost of buying, we are recommending to sell a higher strike Call. This strategy is known as Bull Call spread.Leg 1: Buy NIFTY May 11,200 Call at Rs 297
Leg 2: Sell NIFTY May 12,000 Call at Rs 47
Lot size: 75Total cost of the strategy: Rs 250 per lot
Breakeven point: 11,450
Maximum Profit of 550 points (Rs 41,250) ≥Nifty 12000
Maximum loss of Rs 250 points (Rs 18750) ≤ Nifty 11200
SCENARIO 2: NDA-LED BJP GOVT
This scenario is widely expected by market participants. Markets will react positively as uncertainty would be out of the way. However, the market’s upmove will be limited.
Here, we suggest deploying Long Butterfly spread with a Call option. A Long Butterfly Spread with Calls is a three-part strategy that is created by buying one Call at a lower strike price, selling two Calls at a higher strike price and buying one Call at an even higher strike price.NIFTY (CMP 11,148); Lot size: 75
Leg 1: Buy 1 lot NIFTY May 10,700 Call at Rs 617
Leg 2: Sell 2 lot NIFTY May 11,300 Call at Rs 247.
Leg 3: Buy 1 lot NIFTY May 11,900 Call at Rs 59.Total cost of the strategy: Rs 182 per lot
Breakeven points: 10,882 and 11,718
Maximum Profit of Rs 31,350 at Rs 11,300Maximum loss of Rs 13,650: 1) If Nifty closes at or below 10,700
2) If Nifty closes at or above 11,900
SCENARIO 3: NDA FAILS TO FORM GOVERNMENT
This would be an unexpected outcome for the markets. The market will react violently and experience a severe decline. Volatilities can rise further. Here, the simplest thing to do is to buy a Nifty Put.Buy NIFTY 11,000 Put at Rs 238
Leg 1: Buy NIFTY May 11,300 Put at Rs 238
Lot size: 75Total cost of the strategy: Rs 238 per lot
Breakeven point: 10,762Maximum Profit: Unlimited on the downside
Maximum loss: Rs 17,850 per lot if Nifty is at or above 11,000 on expiry
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