Hedging Your Stock Portfolio With Nifty Put Options: A Practical Guide

Key Takeaways

1. The Nifty puts Options may help reduce losses during a market decline, but the level of protection depends on the strike price, expiry, number of lots and how closely your stock portfolio tracks the Nifty 50.
2. The cost of this protection is the premium paid. If the put expires out of the money, the buyer loses the premium paid, even if the stock portfolio has not fallen.
3. A hedge with Nifty  put options works well when your stock portfolio moves broadly in line with the Nifty. Stock-specific falls may not be fully covered.
4. Strike price, expiry and the number of lots affect the cost and potential protection. 
5. Hedging is meant to reduce losses during a fall, not to generate profit, so it should match your portfolio size and risk comfort.

After building a stock portfolio over time, you may want to reduce the impact of a possible market decline without selling all your holdings. Selling shares can involve transaction costs and may have tax implications, depending on your situation.

Some investors may use Nifty put options to help reduce the impact of a market decline without selling their holdings. This blog explains how the hedge works, what it costs, how to consider strike prices and expiry dates, and answers to common queries.

What Are Nifty Put Options?

A put option gives the buyer the right, but not the obligation, to receive a payoff if the underlying falls below the strike price at expiry. Nifty put options are based on the Nifty 50 index.

The Nifty index options are  cash settled,so the Nifty 50 index itself is not transferred. At expiry, a put that finishes below its strike price has a gross payoff based on the difference between the strike price and the final settlement value, multiplied by the contract's lot size. The buyer's net profit or loss also depends on the premium paid and applicable charges.

The buyer pays a premium upfront to get this right. If the Nifty stays above the strike, the option may expire worthless, and the buyer loses the premium paid along with any applicable charges.

How Does a Nifty Put Hedge Protect Your Stock Portfolio?

A diversified Indian stock portfolio may move in the same direction as the Nifty 50, but the extent of the movement depends on the stocks and sectors it holds. A portfolio that does not closely track the index may receive less protection from a Nifty put hedge.

If the market falls, your stock portfolio may lose value. A Nifty put may gain value as the index declines, helping offset part of the portfolio loss. However, the amount of protection depends on the option's terms and how closely your portfolio follows the Nifty 50.

Think of it like insurance: you pay a premium for protection against a particular risk. If the covered event does not occur, you may not receive a payoff. A Nifty put can help offset some losses during a market decline, but it does not cover every risk in your portfolio.

A Simple Illustration

The numbers below are purely illustrative and do not represent actual market prices or a promised outcome.

Suppose your stock portfolio is worth Rs. 16 lakh and broadly tracks the Nifty 50. The Nifty is at 25,000 and you buy Nifty put options at a 24,000 strike. The number of lots needed depends on your portfolio’s exposure to Nifty movements, the option's characteristics and the level of protection you want.

Here's a simple way to see the possible outcomes:

The hedge does not eliminate all losses. If Nifty falls but remains above the put strike, the put may expire worthless at expiry. The premium is still a cost, and the portfolio may lose value. If Nifty falls below the strike, the put's payoff may offset part of the loss, but the result depends on the portfolio's performance and the number of lots held.

How to Set Up the Hedge

1. Work out how much you want to cover

Start by estimating how closely your stock portfolio moves with the Nifty 50. The notional value of one Nifty options lot is based on the index level multiplied by the applicable lot size. However, matching this value to your portfolio value is only a rough starting point. The number of lots needed also depends on your portfolio's sensitivity to Nifty movements, the put's delta and the level of protection you want. Check the exchange's current contract specifications before calculating your position.

2. Choose the strike price

An at-the-money (ATM) or in-the-money put generally costs more than a comparable out-of-the-money (OTM) put, but it may provide protection sooner as the index falls. An OTM put usually costs less, but the index must fall further before the put has intrinsic value at expiry. The appropriate strike depends on the level of protection you want and the premium you are willing to pay.

3. Pick the expiry

Choose an expiry that covers the period during which you want protection. Shorter-dated options may have lower premiums, but they expire sooner and may need to be replaced if you want to continue the hedge. Longer-dated options provide coverage for a longer period, but generally cost more for otherwise comparable contracts.

4. Review and roll over

When nearing expiration, you may allow it to expire, exit the option, or purchase a new contract. A new contract involves an additional premium and may provide a different level of protection.

Common Doubts About Hedging With Nifty Put Options

Will the hedge protect me if one stock crashes?

Not entirely. The put options on Nifty are sensitive to changes in the index. If one stock in your portfolio is down on its own news despite an unchanged index, then the puts may be ineffective.

Should I hedge all the time?

Hedging continuously can add to costs because options expire and replacement contracts require additional premiums. The decision to hedge, and for how long, depends on your portfolio, the risk you want to reduce and the cost of protection.

Is buying puts riskier than selling them?

When you buy a put, your maximum loss on that option is generally limited to the premium paid, plus applicable charges. Selling a put has a different risk profile and involves margin requirements. The protective strategy discussed in this article is buying a put to help offset losses in a stock portfolio.

Do I need an F&O account for this?

Yes. You need a trading account with the F&O segment activated.

How mastertrust Helps With Hedging

mastertrust offers an F&O trading account on mastertrust.co.in that allows you to use the option chain to review Nifty put option premiums across strike prices and expiries, and monitor your positions alongside your stock holdings. 

If you are new to options, you can first read about what put options are and how they work, followed by the basics of option trading.

Final Thoughts

Hedging with Nifty put options can help reduce some losses during a market decline but it doesn’t eliminate all risks, or guarantee a profit.

The result depends on your portfolio size, how closely your stocks follow the Nifty, and how much premium you are comfortable paying.

Frequently Asked Questions (FAQ)

1. What is the purpose of buying nifty put options for a portfolio?

The purpose is to help reduce losses in your stock portfolio during a market decline. A Nifty put may gain value as the index falls, but the amount of protection depends on option’s terms and how closely your portfolio tracks the Nifty 50.

2. How much does a Nifty hedge cost?

The cost is the premium paid. It depends on the strike, expiry, market volatility, applicable charges and the number of lots bought.

3. Can I lose money on the hedge?

Yes. If the put expires out of the money, you lose the premium paid, plus applicable charges. Before expiry, the option may still have market value even if Nifty is above the strike price.

4. Are nifty put options physically settled?

No. Index options are cash-settled, so only the difference in value is paid, as per the contract terms.

5. Does the hedge cover individual stock risk?

Not fully. It mainly covers broad market falls. It may provide little protection against a sharp fall in an individual stock caused by company-specific news.

6. Can I hedge my stock portfolio through mastertrust?

Yes. Once the F&O segment is activated on your mastertrust account, you can buy Nifty put options. Available platform features can help you review option premiums and monitor your positions alongside your stock holdings..