Hedging a concentrated holding: futures, protective put or collar
Mr. Rao holds 6,000 shares of a large-cap engineering company at ₹418, worth ₹25.08 lakh, which is about half his net worth. He expects the stock to be flat to mildly weak over the next two months but does not want to sell, both because he believes in the three-year story and because he does not want to book capital gains this year. The stock futures lot is 1,500 and the two-month futures trade at ₹421. A ₹400-strike put expiring in two months trades at ₹9.50. His broker quotes initial margin of about 15% of contract value for futures and warns of daily mark-to-market. Ignoring brokerage, STT and taxes, he wants to know whether to sell four futures lots, buy four lots of puts, or combine the put with writing a ₹440 call at ₹6.20 to cut the cost.
1. Compare selling four futures lots at ₹421 with buying four ₹400-strike puts at ₹9.50 on cost, break-even and protection, and say which fits his stated view.
Read the worked answer
Futures (short 4 lots = 6,000 shares at ₹421)
- Value locked: ₹25,26,000 whatever the stock does, so the position cannot lose on the shares below ₹421 and cannot gain above it.
- Margin: 15% of ₹25.26 lakh is about ₹3.79 lakh blocked, plus daily mark-to-market calls; a sharp rally forces him to fund losses on the short while the shares gain on paper.
- No capital gains triggered, since the shares are untouched; derivative profit is business income, not capital gain.
Protective put (4 lots of ₹400 puts at ₹9.50)
- Cost: 9.50 × 6,000 = ₹57,000, which is 2.27% of ₹25.08 lakh.
- Break-even versus doing nothing: 418 - 9.50 = ₹408.50, so the stock can drift down 2.27% before the hedge costs him anything. Below ₹400, the effective floor is ₹390.50, i.e. ₹23.43 lakh.
- He keeps all upside above ₹418.
Judgement: for a flat-to-mildly-weak view, the put is the better fit, because it protects the tail for a known 2.27% while leaving the three-year upside intact, and it ties up no margin. Futures make sense only if he is genuinely bearish; they also forfeit the upside he says he believes in. If he is truly flat, doing nothing beats both on cost.
2. He asks about financing the put by writing a ₹440 call at ₹6.20. Compute the collar's outcome at expiry if the stock is at ₹380 and at ₹460, and explain the trade-off.
Read the worked answer
Net premium: (9.50 - 6.20) × 6,000 = ₹19,800 paid, i.e. 0.79% of the position, against ₹57,000 for the put alone. The call is covered by the shares he already owns.
At ₹380
- Shares: 380 × 6,000 = ₹22,80,000.
- Put payoff: (400 - 380) × 6,000 = ₹1,20,000.
- Call expires worthless; deduct net premium ₹19,800.
- Total: ₹23,80,200 (put alone would give ₹23,43,000; futures would give ₹25,26,000).
At ₹460
- Shares: 460 × 6,000 = ₹27,60,000.
- Put worthless; call is exercised against him: (460 - 440) × 6,000 = ₹1,20,000 outflow.
- Deduct net premium ₹19,800.
- Total: ₹26,20,200 (unhedged ₹27,60,000).
Trade-off: the collar is a band, not a floor. Protection below ₹400 costs only 0.79% instead of 2.27%, but everything above ₹440 is surrendered. It suits him only if he is content to give up gains above ₹440 for two months. Because the shares are held, the call is covered, but the broker may still block margin and the shares must be available for delivery if assigned.