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.
Buying 7000 put is really big gap. Cost of Put is less but the purpose of Put may not happen due to current index price to 7000 .
ReplyDeletePl enlighten.
Hi Karthikraja,
ReplyDeleteYou can see that during the last one month the Nifty went down from 8500+ to around 7700 and settling at 8000 now. The option I had bought went up to as high as 100 from 2.5 giving me 40 times return in less than a month although I haven't sold them yet and price has now come down to 20. My portfolio too went down by 20% wiping of one year of gain but still bouncing back by 10%. I hope this explains my decision.
Hi Chinmay,
ReplyDeleteSeems you are selling spree. Any particular reason? Are you expecting severe downfall? or do you believe these stocks were expensive?
Yeah. I am booking profits and waiting for heavy correction till 6300 on Nifty.
ReplyDelete