By Lokesh Sethia, SEBI Registered Research Analyst
Indian equity markets had reacted unprecedentedly ahead of the outcome of the 2004 general elections. The markets had rallied ahead of the outcome under the general assumption that the NDA government would come to power, but the outcome was completely opposite to what the markets had estimated. A Black Swan event brought the benchmark index down ~20% in two, straight trading days and eroded an enormous amount from investors’ portfolio
The Indian equity markets are, once again, on a hot streak ahead of the general elections 2019 as a consensus is building in favor of the Modi-led NDA government.
Most long-term investors continue to hold on to their long-only equity exposures as the level of greed surges higher ahead of the poll outcome on May 23, 2019. Hence, selling an entire long-term portfolio ahead of a big event will not be a sensible move but ensuring your portfolio with a downside hedge to counter a Black Swan event, such as the one in 2004, could be the right approach to the 2019 General elections.
Let’s consider a hypothetical equal-weighted portfolio. Mr. A holds 10 stocks with a portfolio beta of 0.83x. As the portfolio comprises many stocks, creating a hedge on all of them would be cumbersome; instead, you can simply buy a Nifty put option of May 30, 2019, expiry.
Thus, a portfolio worth `8,00000 with 0.83x beta implies an almost similar risk as to the Nifty 50 index. Therefore, an investor can buy 1 lot of Nifty 11400PE (May 30, 2019) at `257 to approximately get his downside risk covered. The insurance does come with a cost of 2.4%, but remember, it is worth taking a marginal hit to avoid a bigger plunge.
PROTECTIVE PUT STRATEGY
LONG IRON BUTTERFLY: BENEFIT FROM VOLATILITY
A Long Iron Butterfly Spread can be implemented when a trader is expecting higher volatility in the underlying assets. This strategy is initiated to capture the movement outside the wings of options at expiration. It is a limited risk-limited reward strategy.
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