Abstract

Nandita, a Portfolio Manager, worked with Silver Oak Research & Investment Services (Silver Oak), a stockbroking firm in Mumbai, India. During December 2014, all the departments of Silver Oak shared a positive sentiment for the market owing to decreasing oil prices, easing of inflation, etc. One imperative trading strategy emerged out of the brainstorming sessions, to which almost all departments agreed. The trading strategy was to go long in various assets during the first week of January with a holding period of approximately one month to take advantage of the January Anomaly. In consultation with the fundamental and technical equity research department team, Nandita purchased shares of DLF Limited and Infosys Technologies Limited on January 2, 2015, with a holding period of approximately one month. However, the stock prices started to fall soon after the purchase. In just four days – at the end of the day on January 6, 2015 – the DLF shares fell by 4% and the Infosys shares fell by 3%. On the evening of the same day, Nandita sought the advice of Reema, Senior Analyst in the Derivative Strategy Department of Silver Oak. Reema suggested that because the shares were also trading in the derivatives market, the complete downside risk could be mitigated by taking an equal but opposite position in the derivatives market. Reema suggested several alternatives to Nandita – first, achieve a perfect hedge by selling futures contract; second, insure the position completely by buying put options; and third, implement a collar. Further, she advised that the cost of share purchases could be reduced by selling an equal number of call options. Nandita was puzzled now as to which of the four alternates would be the best to implement.

Learning Objectives

The case is structured to achieve the following Learning Objectives:

• Understand the difference between speculation, hedging, and insurance
• long and short hedges
• perfect and imperfect hedges
• Understand various hedging strategies and the trader’s motives behind hedging through futures, protective put, and collar
• Learn how to select the best hedging strategy in given market conditions

Keywords

Hedging; Capital Market; Portfolio Management Services; Risk Management; Derivative Strategy; Portfolio Risk Management; Insurance; Futures contract; Put options; Call Options; Payoff Table; Collar Strategy; Covered Call