InvestorQ : How can I hedge a stock that is not available in the futures and options (F&O) segment?
swati Bakhda made post

How can I hedge a stock that is not available in the futures and options (F&O) segment?

Dia Deshpande answered.
2 years ago

If a stock is there on F&O, it is quite simple. You just sell futures or buy put options. But what about stocks not in F&O. There are 3 ways you can approach it.

· First and very simple method is to hedge through diversification. How do you go about it?. By creating a portfolio of around 15 stocks with low correlations to each other, you can diversify your risk. Diversification means to spread risk by adding stocks with lower correlation. Systematic risk or market risk cannot be diversified, but the unsystematic risk can be reduced or minimized by diversification. Some argue that this is more of a precaution and not a strategy but this is a popular and simple approach to use.

· You can also hedge with similar correlation profile stocks. Here you sell futures or buy a put option on another stock in similar business having similar correlation with the stock. This is an imperfect hedge and if any correlation shift occurs then this hedge may actually become invalid.

· Finally, you can also beta hedge with the Nifty. Let us see how this works. This is the most comprehensive and scientific way to hedging risk through selling of Nifty futures. This would actually apply more for a portfolio than for individual stocks. Let us focus on what exactly is Beta? Beta is a measure of systematic risk, which is the risk that cannot be diversified away. A beta of more than 1 means that it is an aggressive stock and a beta of less than 1 means that it is a defensive stock. Here you multiply the portfolio value by the portfolio beta and sell equivalent Nifty futures to hedge.

All these are imperfect ways and are not perfect hedges.