NRI Corner: Hedging Strategies For Investors
The world’s greatest investor, Warren Buffett, has said ‘never lose money.’ Does that means to hold investment until it gives you maximum returns? Surely the answer is NO….
As an NRI, you are not allowed intra-day trading, so one might think, why to lock our money for long terms as many of us don’t have patience to wait and watch how our investments grow.
But again, isn’t trading a dangerous game. Hence, this week we bring some timely proven strategies which will definitely help you play safe. The trading strategy involves some hedging ideas wherein the risk of loss is either limited or removed completely.
A small re-cap, the NRIs are allowed to invest in stock markets – via the cash segment, but allowed to trade in the derivates (futures & options) for short-term and intra-day gains.
HEDGING VIA FUTURES TRADING
In this case, say for e.g., the NRI has bought over 10,000 shares of XYZ company at Rs 100 each, in anticipation of a price target of Rs 200.
Six months down-the-line, the share price of the XYZ company is at Rs 150. However, due to some fundamental reasons the markets may seem a bit uncertain in the near future. Here, the NRI has an option to Hedge his investment by trading in the futures segment.
The NRI can look forward to short at least half his outstanding shares say, around 5,000 shares of the XYZ company in the futures market. In case, the price does fall on expected line, the NRI is bound to make some short-term gains in the futures trade, while continue to hold on his long-term bets.
The only worry seems that in case, the share price of XYZ does not fall, and instead rises towards the anticipated target price. In this case, the then the NRI is bound to suffer notional loss for the number of shares he shorted in the futures segment.
HEDGING VIA OPTIONS TRADING
Having indentified the element of risk in Hedging via the futures trading, we present the slightly better option of Hedging via the options trading.
Take the same example of an NRI having bought 2,000 shares of the XYZ company for a share price of Rs 100 each, in anticipation of a price target of Rs 200.
Six months down the line when the share price is Rs 150, the NRI has two options to Hedge his investments.
Option 1: He can buy Put options with a lower strike price; say Rs 140 or so, at a prevalent price of Rs 3 or so. In this case, the NRI stands to lose maximum of Rs 3 multiplied by Lot size (number of shares) he buys. At the same, in case, of an adverse fall to Rs 120 or Rs 130 odd levels, the NRI is able to book some profit on his puts.
The other more subtle option is to write (sell) out-of-money call options. Say selling 160 call at a premium of Rs 3. This in theory means, the NRI is selling ‘n’ number of shares at a price of Rs 163, when the cash market price is Rs 150.
In this case, the NRI stands to gain the entire Rs 3 as long as the share price of XYZ company remains below Rs 160 till the expiry of the particular month. He may incur notional loss, only in case; the XYZ share price crosses Rs 163-mark.
These are some of the basic Hedging strategies or tools which the NRI or any investor can use while trading in the cash and derivatives market.