Smart portfolio hedging in market downturns: Shubham Agarwal

The Nifty Mid-cap index rose 2 percent, led by gains in GE Vernova TD India, Oil India, Hitachi Energy India, Aegis Vopak Terminals, Cochin Shipyard, Gillette India, Jindal Stainless, Star Health & Allied Insurance Company, and Relaxo Footwears. On the other hand, key losers included KPIT Technologies, Inventurus Knowledge Solutions, Laurus Labs, Bharti Hexacom, Balkrishna Industries, and Emami.

January saw Nifty tumble from 26,300 levels. When markets fall this sharply, portfolio holders panic. The anxiety is real. Should I hold? Book partial profits? The answer is clear: hedge your portfolio. Hedging manages risk while keeping upside potential alive. You don't have to sweat over market direction. Yet many avoid it, either burned by past experiences where hedges didn't provide adequate cover, or watching their puts expire worthless. The real question isn't whether to hedge but how to hedge effectively.

How many lots should you buy to hedge effectively?

Let's say your portfolio is worth Rs 20 lakhs. Nifty trades at 25,500 with a lot size of 65. One Nifty contract equals Rs 16.57 lakhs (25,500 × 65). You'd need 2 lots to cover your entire portfolio.

But there's more to consider. If your portfolio contains large cap stocks, your portfolio beta is 1 (meaning it moves point-to-point with Nifty). In this case, buy puts worth your portfolio value. If you hold mid and small caps, your beta is roughly 1.3. Your portfolio moves 30% more than Nifty. So multiply your portfolio value by 1.3. For Rs 20 lakhs, that's Rs 26 lakhs worth of protection.

For our large cap example, here's the catch. Since large caps move in sync with Nifty (beta of 1), you need Rs 20 lakhs of protection. One Nifty lot covers Rs 16 lakhs. Two lots mean Rs 32 lakhs, which over-hedges your Rs 20 lakh portfolio by 60%. Institutions avoid this. They typically hedge 60-70% of their portfolio. Seventy percent of Rs 20 lakhs is Rs 14 lakhs, so one lot suffices. If you expect a deeper correction, go for the complete hedge.

Which Expiry to Buy?

Don't buy current expiry. Time decay eats your premium fast. Go three or six months out. For today, buy April or June puts. This gives longer protection. ITM puts work better as they provide superior coverage.

Consider the April 26,000 put trading at Rs 631. That's 2% of your portfolio. Many skip hedging to save this 2%, then face massive risk when markets fall.

Recovering Your Hedging Cost

You bought April puts at Rs 631. Twelve weekly expiries remain till April. Your job: recover some of that Rs 631 using weekly expiries.

Sell OTM weekly puts when markets bounce. For example, if you expect an uptick, sell the 3rd Feb 25,300 put trading at Rs 124. Trade this intraday to avoid overnight risk. You need Rs 52 per week (631 ÷ 12) to recover your hedge cost. Recover even 50% of Rs 631, and your hedging costs drop to just 1% of your portfolio.

Conclusion:

Hedging offers one more benefit. When markets actually fall, your puts not only reduce losses but also give you cash near the bottom. This cash is gold. Deploy it to add quality stocks to your long-term portfolio at attractive prices. The best buying opportunities come when you have liquidity and others don't.

Done smartly, portfolio hedging delivers capital protection, flexibility, mental peace, and dry powder to deploy at lower levels.

Disclaimer: The views and investment tips expressed by experts on Moneycontrol.com are their own and not those of the website or its management. Moneycontrol.com advises users to check with certified experts before taking any investment decisions.