HomeBusinessHow to Use Sensex Options to Hedge Your Portfolio?

How to Use Sensex Options to Hedge Your Portfolio?

Published on

Hedging your portfolio is a way of safeguarding your trades against market fluctuations. Sensex options are one of the effective tools for this objective.

These instruments allow for minimizing losses due to aggressive drops in the value of the market while still benefiting from potential gains. 

In this article, we will discuss various hedging techniques available for the protection of your capital and trades.

What Are Sensex Options?

Sensex options are financial contracts that derive their value from the Sensex, which is India’s stock market index representing 30 top companies. 

There are two basic types of Sensex options: ‘call options’ (the right to purchase the given index at a predefined rate) and ‘put options’ (the right to sell the index at a predefined price). 

These options are either used to speculate on the future movement of the market or hedge the portfolio from losing value in the event of a declining market.

Hedging Strategies Using Sensex Options

Hedging using Sensex options is a good practice for managing risks and securing your capital from market fluctuations. Here are a few common hedging strategies suitable with Sensex options:

1. Protective Put Strategy

A Protective Put Strategy is a strategy, where a trader buys a put option on the Sensex to hedge his portfolio from a downtrend in the market.

While purchasing a put, you acquire a right that allows you to sell the Sensex at the decided price, no matter how low the market goes.

In case the Sensex falls below the threshold, the value of the put option goes upwards which helps to mitigate losses.

For instance, if the worth of the portfolio is about ₹1,00,000, the put option protects from the risk of a steep fall in the market.

2. Covered Call Strategy

A trader using the Covered call strategy holds a stock portfolio that mimics the performance of the Sensex and sells a call option on the index.

In this way, the option buyer sells the call and earns the premium, which adds to the profits even when the index turns out to be neutral or bullish to some extent.

However, if the Sensex rises above the option’s strike price, the trader may have to sell the stocks at that price, capping potential gains. 

This strategy works well for obtaining additional revenue in a neutral or slightly bullish market.

3. Long Straddle

This is a strategy where a trader buys both a call option and a put option on the Sensex at the same strike price and expiration date. 

This strategy is used when the trader expects significant market volatility but is unsure of the direction. If the Sensex rises, the call option becomes profitable; if it falls, the put option gains value. 

Losses are limited to the premium paid for the options, making it an effective way to hedge against large market swings in either direction.

4. Collar Strategy

A collar strategy involves holding a stock or index like the Sensex while simultaneously buying a put option and selling a call option. 

The put provides downside protection by allowing the trader to sell the Sensex at a specific price if it falls, while the call limits potential upside as the trader must sell the Sensex if it rises above the call strike price.

This strategy limits both gains and losses, making it suitable for traders who want to reduce risk but are willing to cap their profits.

Conclusion

Hedging with Sensex options offers a practical way to reduce the risk in your portfolio, especially in unpredictable markets. Using strategies like protective puts or covered calls, you can shield your trades while still participating in potential market gains.

Whether you are new to FNO trading or have some experience, understanding how these options work can help you make better decisions for your financial future.