What is Hedging stock? Instruments, Disadvantages, Advantages.
Get The details & information regarding of hedging stock.
Hedging stock: Hedging use to reducing or controlling your risk. when the market shows downfalls at that time many investor use options like hedging(Taking a position in FUTURES) to protect their portfolio.hedging is like an insurance on investments at the time of falling market.
Suppose Mr. Ganesh have 1000 shares of Wipro, which is currently quoting at Rs. 550 per share. a total value of Rs. 5.50 lakhs. & his buying price is Rs. 450 per share & his Target price is Rs. 650, At this movement Mr. Ganesh already in a profit of Rs.100 per share but his prediction, is in this month may be market will fall badly, So what is the way he can protect his Profit. Mr. Ganesh will short Futures contract at Rs 550 & protect his investment.
Now Mr. Ganesh has two positions in his portfolio
1) 1000 cash market Shares of Wipro (pay Rs 4.50 lakhs to exchanges)
2) ( one month) Wipro short future contract. (Received Rs. 5.50 lakhs from exchanges)
=1000*450=450000 (cash market Total Value)
=1000*550=550000 (Total value Received from exchange for shorting the futures )
As per his prediction suppose Wipro price down to Rs.475 (End of the expiry of Futures contract)
= 1000*475=475000 (current cash market shares total value)
= 1000*475=475000 (Need to pay for exchanges to cover short position in futures)
Does Mr. Ganesh make some profit from this?
1) =475000( current cash market Wipro shares total value)-450000 (pay to exchange to buy cash market shares)
= Rs. 25000 (profit in cash market)
2) =550000 (received from the exchange for shorting the future contract) – 475000 (Need to pay to exchange to cover the short position of future contract)
= Rs. 75000 ( Profit in the future market)
3) =25000 + 75000 = Rs. 100000 (Total Profit due to using hedging)
There are many types of market instrument which can be used to hedge a portfolio. the study below table for five variations are listed below.
|Short & Ultrashort ETFs.||Can use any brokerage account.||The sacrifice of upside potential, & loses money over time in volatile markets.|
|Sell Covered Calls on stocks in the portfolio.||Makes money in flat markets.||The sacrifice of upside potential; a hedge against small declines only.|
|Buy Puts on the index or specific stocks.||No loss of upside; protects against large losses.||Works like insurance; has up-front cost.|
|Short the index.||Protects against the full range of index declines.||The sacrifice of upside potential; must pay dividends.|
|Sell naked calls on the index.||Makes money in flat markets.||The sacrifice of upside potential; limited downside protection.|
Here are useful articles for you to read next: