How to hedge your equity risk against the currency before election results?

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How to hedge your equity risk against the currency before election results?
Election result outcomes are almost always uncertain. Investors would know from the 2004 and 2009 experience. In 2004, it was almost certain that Vajpayee would return to power riding high on the "India Shining" campaign. It never happened. Ditto for 2009, when the NDA was again expected to be voted back to power, only for the Congress led UPA to romp home again.

If you have a penchant for risk and want to take positions in the market, it's best to hedge your risk against the uncertain election outcome. Indian markets have factored a NDA win in almost 230 seats across the country. Anything less than that could possibly see a reaction in the equity markets.

So, if you are not sure, here's what you can do. You could hedge your equity risk with the currency market. If you believe that 230 seats would be crossed by the NDA go long in the derivatives segment of the capital markets, while also going long on the dollar. That would help you hedge your risk and here's how.

Say you bought 1000 shares of Canara Bank in the Futures segment of the derivatives market and decided to hedge your risk by simultaneously buying dollars in the currency derivatives market.

Say, the NDA manages just 200 seats. Be rest assured that the shares of Canara Bank would fall. Now, the rupee also would fall against the dollar, enabling you to hedge your risk against the fall of Canara Bank.

Here's how it would work?

Let's assume an investor bought 1 lot or 1000 shares of Canara Bank June Futures at Rs 290. Simultaneously, he bought 10,000 units of the dollar at Rs 60. Read how to trade the currency markets here

If the NDA does not get 230 seats Canara Bank would fall to say Rs 280 and he would incur a loss of Rs 10,000. But, it's highly likely that the rupee will also fall to Rs 61 on the uncertain outcome. Now, since he has bought 10,000 units at Rs 60, he can possibly square it off at Rs 61, which means a profit of Rs 10,000.

This means he has hedged his risk perfectly. Now, this is just an example for hedging risk and it's not necessarily that everything will play in line. This is not the ideal model, but, just an example.

Election results are uncertain and investors could make or lose money, though by hedging he could lower the risk or even make a profit.

Read more about: elections
Story first published: Tuesday, April 29, 2014, 8:50 [IST]
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