Hedging Basics

Hedging is like buying car insurance. You don't buy insurance because you want to crash. You buy it so that if you crash, you don't go bankrupt. In finance, Hedging means taking a position to offset potential losses.

Why Hedge?

Imagine you have a portfolio of ₹50 Lakhs. You are afraid the market might crash due to a war or election results. You have two options:

1. Sell Everything: But then you pay taxes and miss out if market goes up.
2. Hedge: Keep the stocks, but buy "Insurance."

Common Hedging Strategies

1. Put Options (The Classic Hedge)

Buying a Put Option (PE) gives you the right to sell at a fixed price.

• Scenario: You own Nifty ETF worth ₹10 Lakhs. Nifty is at 22,000.
• Fear: Nifty might fall to 20,000.
• Action: Buy Nifty 21,500 PE.
• Outcome:
  • If Market Crashes: Your ETF loses value, but Put Option gains value. Net Loss is minimized.
  • If Market Rallies: You lose the premium paid for Put Option (cost of insurance), but ETF gains value.

2. Gold (The Natural Hedge)

Gold often moves inversely to the Stock Market.

• When stocks crash (fear), people rush to Gold (safety).
• Strategy: Keep 10-15% of portfolio in Gold (SGB or Gold ETFs).

3. Inverse ETFs (Not common in India yet)

ETFs that go UP when the market goes DOWN.

4. Diversification (The Poor Man's Hedge)

Holding assets that don't move together (Uncorrelated assets).

• Stocks + Bonds + Real Estate + Gold.
• If Stocks fall, Bonds usually rise.

Hedging for Business (Currency Risk)

Exporters (like TCS, Infosys) earn in Dollars.

• If Dollar falls (from ₹83 to ₹80), they lose money.
• Hedge: They sell "USD Futures" to lock in the rate at ₹83.

The Cost of Hedging

Hedging is not free.

• Option Premium: You pay money to buy Put Options.
• Opportunity Cost: Gold might give lower returns than stocks in a bull market.

Rule: Only hedge if the risk of loss is catastrophic. Don't hedge small fluctuations.

7-Day Action Plan

Day 1: Calculate your total equity exposure.
Day 2: Check how much Gold you own. Is it at least 10%?
Day 3: Read about "Put Options" again. (Don't trade, just understand).
Day 4: Understand "Beta Hedging". (Advanced concept: Shorting Futures to neutralize Beta).
Day 5: Look at the "VIX" (Volatility Index). High VIX means hedging is expensive.
Day 6: Check if you have enough Cash. Cash is the ultimate hedge against a crash (allows you to buy low).
Day 7: Decide: Do you really need to hedge? Or is your time horizon (10+ years) your hedge?

Quiz

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💡 Final Wisdom: The best hedge against a market crash is not a Put Option. It is a long time horizon and a calm mind.