Stock Market crash and how to save your portfolio
Stock market crash is the only major fear that is faced by
investors in equities. Stock market crash when happens, results in erosion of
wealth of investors to the tune of billions. Equities is one of the asset class
which provides a superior return in the long-run when compared to other
well-known asset class. The exponential growth potential that equities provide
is not available in any other asset class.
How beneficial it would be if one could take benefit of
investing in equities along with safeguarding portfolio against a crash ?? Is
it possible ??
The answer to above question is YES. Just like we have
insurance for our home, life, car etc. similarly it is possible to have
insurance for our portfolio. The technical term used in financial markets for
insurance is called "Hedging". Hedge means a fence or
boundary formed by closely growing bushes or shrubs for protection from any
external threat. There are many methods and instruments available for purpose
of hedging.
Mutual
Fund managers/ HNI investors / FIIs whose portfolios run into tens of thousands
of crores use hedging strategies to reduce the risk of portfolio to a great
extent and are protected from a stock market crash majority of the time.
The
most effective and cost efficient mode of hedging is purchase of PUT OPTIONS in
our opinion.
There are two types of options : Call option and Put option.
A put option is
an option contract giving the owner the right, but not the
obligation, to sell a specified amount of an underlying security at a specified
price within a specified time. This is the opposite of a call option,
which gives the holder the right to buy shares.
Example of using Put option :
Suppose you own a portfolio of stocks worth
Rs 100. You purchase put options in index (Nifty) of Rs 2 to protect your
portfolio from crash. In case a crash happens and your portfolio and or index
both experiences a decline of 40%. The new portfolio value will be Rs 60 from
Rs 100. However the value of put option in index will have increased from Rs 2
to somewhere around 30 or may be more. So the overall value still remains Rs 90
( Rs 60 of portfolio + 30 Rs of Put option).
Incase you had not purchased Put Option ,
your portfolio had declined to Rs 60 from Rs 100 as per the above example.
40-50% loss is substantial and can gravely affect achievement of long-term
goals of growth. In scenario that the market crash does not happen by the time
of expiry of put option, the Rs 2 invested in put option becomes worthless.
However the same is more or less compensated by increase in the value of
portfolio incase the market had soared higher instead of crashing.
Purchasing appropriate Put Option is a WIN-WIN Situation for equity investors because it gives
protection against sudden unprecedented stock market crash. It is like an
insurance premium. If the stock market crashes the protection is available, if
it does not the premium is gone.
Conservation is pre-condition to growth. If
you can conserve your portfolio and protect it from crash, the growth will be
great in the long-term and there will be no disasters.
If you like our post share it !
Note: Put option is a derivative instrument.
Options are of different strike prices and different expiry and may have
different outcomes. You can contact us or your financial advisor before
purchasing put option and have a practical understanding of the same.
