Futures Hedged Strategy For Consistent Profits:
In my Futures & Options Workshop we are discussing a strategy to make consistent profit through Hedged Stock Futures. I had written about it on Quora in June 2017.
The post is taken from my Quora answer. It is as relevant today as it was at that time.
The year 2008 Crash and Hedging Strategy ? :
The NIFTY Index was 6144.35 at close of market on the New Year Day January 01, 2008.
The market was in a strong bullish move from mid 2007.
Then came the crash. It began in mid January and continued till October end of 2008.
On October contracts expiry, NIFTY was at 2697.05 on 29–10–2008.
It translates into a 56.11% decline.
How a hedged Futures trade would have been profitable, is illustrated here:
In January 2008, the top 5 weighted constituents of NIFTY were:
Their prices as on January 01, 2008 and October 29, 2008 were as stated below:
Stock ——— Price Jan 01, 2008———- Price Oct 29, 2008 —— Loss %
Reliance—- 2853——————————- 1215———————- (-) 57.4
ONGC——— 1249—————————— 648———————- (-) 48.1
Bharti——— 967——————————- 616———————— (-) 36.3
NTPC———- 257—————————— 134————————— (-) 47.8
SBIN ———- 2383————————— 1099————————-(-) 53.9
On an average basis, this top end portfolio suffered a decline of 48.7%.
If this portfolio was hedged by selling equivalent amount of NIFTY Futures, the sale of Futures would have resulted in a profit of about 56.1% ( NIFTY decline ).
The resultant profit would have been 56.1 – 48.7 = 7.4 %.
Considering the margin on stocks at 11% and on NIFTY at 8%, the money in margin would be 19% of the value or let us say 20% for ease of calculation.
So the effective profit on these trades would be about 37% ( 5 times of 7.4).
Of course, there will be brokerage and taxes to pay, but 37% profit is not something to be scoffed at when markets actually declined by 56%.
Present Day Example:
I have done a similar exercise with the current top 10 NIFTY stocks.
The strategy is to Buy Futures 1 Lot of each stock and sell NIFTY Futures of equal value. It will not be possible to get the exact value match but that is not required.
The stocks are:
Larsen and Toubro
Kotak Mahindra Bank
The trades are entered on the first day of the new monthly contracts and settled at every monthly expiry.
The Profit and Loss fro the period November 2016 to May Expiry 2017 is as in the screenshot below:
Column B indicates the total value of of the trade with 1 Lot of each stock considered.
Column C indicates the equivalent value of NIFTY Futures to be shorted.
Column G is the total margin requirement and is the sum of the figures in Columns D and E.
Profit and Loss at monthly expiry is shown in Column F.
Starting with a margin of Rs. 1237925, the trades end up with a profit of Rs. 378434 at May Expiry.
This is 30.57% in 7 months.
Yes, there were 2 losses in 7 months, but as a good portfolio should generally outperform the Index, it eventually did and there is actual profit to be made while not being in trades very actively.
Small trades do not need hedging. They require a sensible stop loss.
Hedging can be used as a strategy to prevent a big loss ( year 2008 case ) and for earning decent profits by using hedging as a profitable trading strategy. ( Current Example )
There will be occasions when some loss will have to be taken, but ultimately it would work out.
One question can be— If it was so simple and straightforward, why everyone is not doing it?
For the reason that it is simple and does not require much action.
Most of the traders are in the market for a quick profit and quick action. Such strategies appear boring to them. They need their profits today and not over 6 months or one year.
People with patience are carrying out these simple strategies and making decent gains . They do not talk about it.
Those who lack patience , make few small gains and few big losses and are gone from the market once the money is gone to replaced by another bunch to repeat exactly the same thing.
Every strategy requires patience. Patience is the key.