Sunday, August 9, 2015

My experiments with options

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:
Trade DateOptionQuantityCost (with brokerage)
11 FebNIFTY 26 MAR 7200 PUT OPTION75699.19
26 MarchNIFTY 30 APR 7300 PUT OPTION75421.53
9 JuneNIFTY 30 JUL 7000 PUT OPTION1001658.92
5 AugNIFTY 24 SEP 7000 PUT OPTION5003416.8
21 AugNIFTY 24 SEP 7100 PUT OPTION3001809.89

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:

August 1999March 2001
December 2003April 2004
March 2006May 2006
September 2006February 2007
April 2007June 2008
June 2009July 2011
May 2014Not 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.

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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