Hedging Portfolio with Options & Futures: A Beginner’s Guide to Risk Protection | CapitalKeeper 05 Aug 2025
By CapitalKeeper | Pre Market Opening | Indian Equities | Market Moves That Matter
Hedging Portfolio with Options & Futures: A Practical Guide for Smart Investors
By CapitalKeeper
Introduction
The stock market offers immense opportunities for wealth creation but also comes with inherent risks—volatility, unexpected events, and sudden corrections. For investors holding diversified portfolios, protecting gains and minimizing downside risk is as crucial as identifying multibagger opportunities. This is where hedging strategies using options and futures come into play.
In this article, we will explore what hedging is, why it’s necessary, and how tools like options and futures can help you safeguard your portfolio without exiting your positions prematurely.
What is Hedging?
Hedging is a risk management strategy designed to reduce potential losses by taking an offsetting position in a related asset. In simple terms, it’s like buying insurance for your investments. For example, if you own a large number of Nifty 50 stocks and fear a short-term correction, you can hedge your exposure by taking a short position in Nifty futures or buying put options.
Why Hedging Matters?
- Protects capital during market volatility
- Locks in profits without liquidating holdings
- Provides psychological comfort to investors
- Effective tool during events like elections, budgets, or global crises
Instruments for Hedging: Options vs. Futures
1. Options for Hedging
Options are derivative contracts that give you the right (but not obligation) to buy or sell an asset at a predetermined price before expiry.
- Put Options: Provide downside protection by allowing you to sell at a strike price.
- Call Options: Can hedge short positions or bet on upside moves.
Example:
If you hold a portfolio similar to Nifty 50 worth ₹25 lakhs and fear a correction, buying a Nifty 25,000 strike Put Option ensures you have protection below that level.
2. Futures for Hedging
Futures are standardized contracts obligating the buyer/seller to transact at a fixed price on a future date. Unlike options, futures carry unlimited profit/loss potential.
Example:
If you hold large-cap stocks like Reliance, HDFC Bank, and Infosys and expect market volatility, shorting Nifty futures equivalent to your portfolio beta can reduce risk.
Key Concepts in Hedging
1. Delta Hedging
- Measures sensitivity of an option’s price to changes in the underlying asset.
- Helps in calculating how many contracts are needed to hedge exposure.
2. Beta Hedging
- Involves analyzing the beta of your portfolio (sensitivity to market movement) and using index derivatives proportionally.
3. Cost of Hedging
- Options require paying a premium (insurance-like cost).
- Futures involve margin requirements but no upfront premium.
Step-by-Step Guide: Hedging with Options
Step 1: Assess Portfolio Exposure
- Calculate your portfolio’s total value and correlation with Nifty or Bank Nifty.
- Example: A ₹10 lakh portfolio with high Nifty correlation.
Step 2: Choose Strike and Expiry
- Select put options near current market levels (ATM or slightly OTM).
- Prefer monthly expiry for longer coverage.
Step 3: Position Sizing
- Buy sufficient lots to cover portfolio exposure.
- Example: 1 Nifty lot = 50 units; if portfolio mimics 2 lots exposure, buy 2 puts.
Step 4: Monitor and Adjust
- Track market movement, IV (implied volatility), and time decay.
- Roll over or adjust strikes if market trends strongly.
Step-by-Step Guide: Hedging with Futures
Step 1: Identify Market Risk
- Example: You own ITC, Reliance, and Infosys worth ₹5 lakh. Nifty future trading at 25,000.
Step 2: Calculate Hedge Ratio
- Portfolio Beta × Portfolio Value ÷ Nifty Value per Lot = Lots Required
- If Beta = 1, ₹5 lakh ÷ (25,000×50) = 0.4 lots → round off to 0.5 or 1 lot.
Step 3: Execute Hedge
- Short Nifty future for downside hedge.
- Exit hedge once event risk passes or trend reverses.
When to Use Hedging?
- Event-Driven Risks: Elections, budget announcements, RBI policy meetings.
- High Volatility Periods: Global sell-offs, Fed announcements, geopolitical events.
- Portfolio Protection: During profit-booking phases or uncertain global macro trends.
Advantages and Drawbacks
Advantages
- Protects gains without liquidating holdings
- Flexible (can hedge partially or fully)
- Enhances portfolio stability during volatility
Drawbacks
- Costs premium (options) or margin (futures)
- Not a profit-making strategy; purely defensive
- Requires timing and understanding of derivatives
Practical Example: Hedging a Mid-Cap Heavy Portfolio
Scenario:
- Portfolio Value: ₹15 lakh
- Major Holdings: Midcaps (Cipla, Pidilite, Tata Power)
- Fear: Market correction of 5-10% during global uncertainty
Solution:
- Buy Nifty 25,000 put options (3 lots = 150 units) for ₹120 each (₹18,000 total).
- This ensures protection below 25,000, limiting losses on downside move.
Final Thoughts
Hedging is not about predicting markets it’s about protecting your capital. Whether you’re a new investor or an experienced trader, learning to use options and futures strategically ensures longevity in the markets. By incorporating hedging into your strategy, you’re playing defense while still allowing room for offense when opportunities arise.
Key Takeaways:
- Hedging shields your portfolio from adverse moves without selling core holdings.
- Use put options for cost-effective downside protection and futures for quick hedges.
- Always calculate cost vs. benefit and size positions correctly.
- Hedging should complement, not replace, sound asset allocation and risk management.
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