How to hedge your portfolio for the elections

With the elections round the corner, the big question on investors' minds is how to protect themselves from losses if the election springs a surprise or fractured mandate. Investors may not be able to hedge their portfolio against a complete loss of value as hedging costs have increased substantially.

So an investor will have to determine how much losses they are willing to bear if the market were to tank. Hence, to hedge your portfolio optimally ask yourself two questions: do you expect the market to slide post elections? And, if yes: how much do you expect the markets to slide?

There are three ways in which one can hedge their portfolios against losses in the market. One is to sell index futures, buy put options or sell call option. But experts point out that the cost of hedging in recent times for the May series has gone up substantially as the implied volatility for has increased significantly.

Besides, experts point out that the the structural changes that are adding a positive undercurrent to the market. The rupee is strengthening. Globally, India is in a relatively better position as other countries such as Russia, China and Brazil are facing problems of their own. Stock valuations are low. Economy is showing signs of an early greenshoots. India is becoming a favourite emerging market, hence the stock market may not get badly mauled if the verdict does not go in its favour.

Says Siddarth Bhamre, derivatives analyst, Angel Broking: "Our take is that this rally has more to it than just elections. We are not expecting a significant downside post the elections."

Besides, the cost of hedging that is buying a put option has risen considerably in the past few weeks. It will also mean that investors will lock-in their portfolios profit at the time of buying the put option. In other words, investors will not be able to participate in the upside if there's any.

Hence, to hedge your portfolio in this market Bhamre recommends that investors sell deep out of the money call options after the market heads up a little higher in a week or so. This strategy is a bit risky, but it will help partially hedge ones portfolio when the market falls. Says Bhamre: "Even if you are hedging you need to take market direction in to account, and we don't expect the market to fall considerably. In fact, if the market falls it will be a good time to buy stocks. Hence, do a partial hedging by selling out of the money call options."

Experts point out that buying options or selling futures may not lead to optimum results in this market, and investors will be unnecessarily incurring a huge costs to hedge their portfolios. "A full hedge of is not needed at this point in time. And the cost of this strategy will also not be much for the investor against which he will get protect a part of his portfolio," says Bhamre.