Stock Market or Stock? Why not both!! |
| Date Added: October 30, 2010 09:20:09 AM |
| Author: stockinvestmenttips |
| Category: Blogs: Business |
| Trader may buy Infosys thinking that Infosys will announce good results and the stock price would rise. A few days later, S&P CNX Nifty drops, so he makes losses, even if his intrinsic understanding of Infosys was correct. There is a peculiar problem here. Every buy position on a stock is simultaneously a buy position on S&P CNX Nifty. This is because a buy Infosys position generally gains if S&P CNX Nifty rises and generally loses if S&P CNX Nifty drops. It is useful to ask: does the person feel bullish about Infosys or about the Index? • Those who are bullish about the index should just buy S&P CNX Nifty futures; they need not trade individual stocks • Those who are bullish about the Infosys do wrong by carrying along a long position on S&P CNX Nifty as well. There is a simple way out. Every time you adopt a long position on a index stock, you should sell some amount of S&P CNX Nifty futures. When this is done, the stock picker has "hedged away" his index exposure. How do you do this? • We need to know the "beta" of the stock, i.e. the average impact of a 1% move in S&P CNX Nifty, upon the stock. If betas are not known, it is generally safe to assume the beta is 1. Suppose we take LUPINLAB, where the beta is 1.2, and suppose we have a LONG LUPINLAB position of Rs. 200,000. • The size of the position that we need on the index futures market, to completely remove the hidden S&P CNX Nifty exposure, is 1.2 * 200,000, i.e. Rs. 240,000. • Suppose S&P CNX Nifty is at 1200, and the market lot on the futures market is 100(just for example, actually lot size is 50). Hence each market lot of S&P CNX Nifty is Rs. 120.000. To sell Rs.240, 000 of S&P CNX Nifty we need to sell two market lots. • We sell two market lots of S&P CNX Nifty (200 Nifties) to get the position: • Long LUPINLAB Rs. 200,000 • Short S&P CNX NIFTY Rs. 240,000 |
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