Mr Warren Buffet keeps saying that derivatives are weapons of mass destruction. But as a value investor, I still wanted to try some. I have seen some value investors like Seth Klarman using them to hedge their portfolios. I did the same and tried to use the options to hedge my portfolio. I bought following options during the last six months:
During the last six months, my portfolio which is made up mostly of small cap stocks went up by around 25% and has given me returns much more than the cost of protection above. The reason I am buying 7000 Puts is because the Nifty EPS is around 360. At a P/E of 20, the valuation comes to around 7200 which is still considered quite high by historical standard. At the current level of 8565, P/E is around 24 which has never sustained for longer time. Following table summarizes the time period when Nifty P/E remained higher than 20:
Most of the periods with high P/E ended with sharp correction in Nifty to bring down the P/E ratio below 20. The longer the ratio remained above 20, the longer and sharper was the correction. That's what I am expecting right now and so the buying of options. Have a good luck to you.
Update
I sold 300 Nifty 7000 put options at 40 to cover the cost of all the options that I had bought in the last six months or so. I still have 500 remaining. Nifty spot is at 7656 and chances are that it can go below 7100 by end of the month if some catastrophic event happens.
| Trade Date | Option | Quantity | Cost (with brokerage) |
|---|---|---|---|
| 11 Feb | NIFTY 26 MAR 7200 PUT OPTION | 75 | 699.19 |
| 26 March | NIFTY 30 APR 7300 PUT OPTION | 75 | 421.53 |
| 9 June | NIFTY 30 JUL 7000 PUT OPTION | 100 | 1658.92 |
| 5 Aug | NIFTY 24 SEP 7000 PUT OPTION | 500 | 3416.8 |
| 21 Aug | NIFTY 24 SEP 7100 PUT OPTION | 300 | 1809.89 |
| Total | 8006.33 | ||
During the last six months, my portfolio which is made up mostly of small cap stocks went up by around 25% and has given me returns much more than the cost of protection above. The reason I am buying 7000 Puts is because the Nifty EPS is around 360. At a P/E of 20, the valuation comes to around 7200 which is still considered quite high by historical standard. At the current level of 8565, P/E is around 24 which has never sustained for longer time. Following table summarizes the time period when Nifty P/E remained higher than 20:
| Start | End |
|---|---|
| August 1999 | March 2001 |
| December 2003 | April 2004 |
| March 2006 | May 2006 |
| September 2006 | February 2007 |
| April 2007 | June 2008 |
| June 2009 | July 2011 |
| May 2014 | Not yet |
Most of the periods with high P/E ended with sharp correction in Nifty to bring down the P/E ratio below 20. The longer the ratio remained above 20, the longer and sharper was the correction. That's what I am expecting right now and so the buying of options. Have a good luck to you.
Update
I sold 300 Nifty 7000 put options at 40 to cover the cost of all the options that I had bought in the last six months or so. I still have 500 remaining. Nifty spot is at 7656 and chances are that it can go below 7100 by end of the month if some catastrophic event happens.
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