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Wednesday 27 June 2012

Using derivatives to manage portfolio volatility

This post in response to a query by Kiran on one of my previous posts. I sometimes use put options in my portfolio. Since, this is more a call on absolute levels of the market and its likely future direction, I use it sparingly.

Even when I do buy a put option, I buy a far out-of-the-money one so that I pay a low premium. Since, my portfolio is long-only, I don't need to buy call options for hedging. Also, I don't employ complicated option strategies like straddles, strangles or other such esoteric ones. My thoughts are simple, I buy puts with little premium so that if the market suddenly collapses, then I will make up for some of the loss in the stock values. And I am ready to write-off that premium if the market does not fall off the cliff.

And for this reason I use options only when we are close to a important event which has a large risk or a long term market top. So, for example, I might but a put option close to the 2014 elections or when Nifty goes to 6000.

Personally, I do not think small investors should try their hand at options. The certainty of losing money is much much higher than the possibility of making it over a period of time. It is much better to buy, hold (and pray!!) than to speculate on the future direction of the market.