HEDGING STRATEGIES

WHAT IS HEDGING? Hedging is a mechanism to reduce price risk Derivatives are widely used for hedging Its main purpose is to reduce the volatility of a portfolio, by reducing risk Hedging does not maximizes the return it just reduces the variation in the return

HEDGING STRATEGIES One of the popular strategies for hedging is : "If you are long in cash underlying - Short Future; and If short in cash underlying - Long Future“ For e.g. If one has bought 100 shares of say Reliance Industries and want to Hedge against market movements, he has to short an appropriate amount of Index Futures. This will reduce his overall exposure to events affecting the whole market

WHERE HEDGING STRATEGIES ARE USEFUL Reducing the equity exposure of a Mutual Fund by selling Index Futures Investing funds raised by new schemes in Index Futures so that market exposure is immediately taken Partial liquidation of portfolio by selling the index future instead of the actual shares where the cost of transaction is higher

HEDGING STRATEGIES FOR INVESTORS Hedging Strategy #1 – Dedicated Short Bias Hedging Strategy #2 – Fixed Income Arbitrage Hedging Strategy #3 - Market Timing Hedging Strategy #4 – Aggressive Growth Hedging Strategy #5: Opportunistic

To hedge short underlying position with options Buy call Sell put Buy call spread Sell put spread Buy semi-futures

To hedge short underlying position with options AnticipantsCharacteristics Short callImplied volatility downLimited profit - Unlimited loss - Limited protection - Cash credit - Risk profile at expiration equivalent to a short put Long putImplied volatility upUnlimited profit - Limited loss - Unlimited protection - Important cost - Risk profile at expiration equivalent to a long call Short semi-futuresImplied volatility direction depends on the strikes Buy put and sell call with a higher strike Limited profit - Limited loss - Unlimited protection - Low cost - Risk profile at expiration equivalent to a long fence or a bull spread

To hedge short underlying position with options short call spread or bull spread Implied volatility direction depends on the strikes: Sell call and buy call with higher strike Unlimited profit - Unlimited loss - Limited protection - Low cost - Risk profile at expiration equivalent to a long semi-futures Long put spread or bear spread Implied volatility direction depends on the strikes: Sell put and buy put with higher strike Unlimited profit - Unlimited loss - Limited protection - Low cost - Risk profile at expiration equivalent to a long semi-futures

To hedge long underlying position with options Sell call Buy put Sell call spread Buy put spread Sell semi-futures

To hedge long underlying position with options AnticipatesCharacteristics Short callImplied volatility downLimited profit - Unlimited loss - Limited protection - Cash credit - Risk profile at expiration equivalent to a short put Long putImplied volatility upUnlimited profit - Limited loss - Unlimited protection - Important cost - Risk profile at expiration equivalent to a long call Short semi-futuresImplied volatility direction depends on the strikes: Buy put and sell call with a higher strike Limited profit - Limited loss - Unlimited protection - Low cost - Risk profile at expiration equivalent to a long fence or a bull spread

To hedge long underlying position with options short call spread or bull spread Implied volatility direction depends on the strikes: Sell call and buy call with higher strike Unlimited profit - Unlimited loss - Limited protection - Low cost - Risk profile at expiration equivalent to a long semi-futures Long put spread or bear spread Implied volatility direction depends on the strikes: Sell put and buy put with higher strike Unlimited profit - Unlimited loss - Limited protection - Low cost - Risk profile at expiration equivalent to a long semi-futures