Hedging strategies
In this chapter: Protective put, covered call · Collar and strangle for portfolio protection
Hedging uses derivatives to reduce existing portfolio risk. Protective put: own stock + buy put — limits downside, costs premium. Covered call: own stock + sell call — generates income, caps upside. Collar: own stock + buy put + sell call — defined range, low net cost. Each is a specific risk-management tool.
Protective put: for ₹10L NIFTY exposure, buy ATM put (cost ~2-3% of portfolio for 1-month protection). Limits worst-case loss to put strike. Covered call: own stock at ₹500, sell ₹530 call for ₹10 premium. Income: 2% per month if stock stays below ₹530 at expiry. Caps upside at ₹530 + ₹10 = ₹540. Collar: buy ₹470 put + sell ₹530 call. Worst case ₹470 (loss capped); best case ₹530 (gains capped). Net cost low if puts and calls have similar premiums. For a portfolio: hedge with NIFTY/BANKNIFTY puts (lower transaction costs than stock-specific puts).
A nuanced angle: hedge ratios. To hedge a portfolio with beta 1.2 vs NIFTY, you need 20% more NIFTY puts than the portfolio value (i.e., for ₹10L portfolio, hedge ₹12L of NIFTY notional). Imperfect hedges: stock-specific risk isn't hedged by index puts; for material single-name risk, use stock-specific options. Cost-benefit: hedging is insurance — has a real annual cost. Constant hedging drags returns; use it tactically (around major events: budget, election, earnings). Most investors hedge too late (after a move) or too early (paying premium for years before any need).