Thursday, September 20, 2012

How to Hedge Bursa Malaysia stock market KLCI with FKLI?

How to Hedge Bursa Malaysia stock market KLCI with FKLI?:
Recently I started investing in Futures and Options to hedge my equity position. I wanted to do it long time ago but the question is how to hedge using FKLI? FKLI is the Futures product for KLCI.

The obvious answer will be Short FKLI. If the market up, I will lose money in FKLI but I make from equity. If the market down, my share value will drop but I will make from FKLI. However, with this kind of hedging, what do I make? If market up I will not be making much because I will lose in FKLI.

Then I thought of I normally can perform better than KLCI. Meaning if my stocks value up 10% maybe KLCI up just 7%, I make 10% and lose 7%, net make 3%. But this is too little. Although the risk is much lower as I’m not worried about market crash, the return is too little. If during bull run also I will make very little.

Then I thought of buying FKLI Put Options OKLI. For example I pay 0.8% every month to buy Options. 0.8% is the maximum that I can lose within a month.

If the market down 3% within the month, I make 2.2% (after minus 0.8%)

If market down 0.5%, I lose 0.3%.

If the market up 9% within the month, I lose only 0.8% because that is the maximum I will lose and I will make 9% from equity, the net gain is 8.2%.

If market unchanged, I lose 0.8%.


But I was thinking, if the market keep going up gradually, assuming within the year Mr A make 20% from his equity portfolio, but Mr A will lose 0.8% X 12 months = 9.6%. Meaning Mr A will only make 10.4% net. Although market fluctuate within the year, if market is on uptrend, from rough estimate most probably Mr A will make about 14% to 15%%, as compared with 20% if he didn’t hedge.

If market down 20%, Mr A will make 20% minus 9.6% = 10.4% from FKLI. If adjusted for market fluctuation, rough estimate Mr A will make about 8% but lose 20% from equity.


If I average out the market up and the market down, it appears that with Options, Mr A will make about 2% to 3% for the two years combined as compared with Zero if without Options. But one thing we must understanding, for long term the market is generally on the uptrend. Assuming now is year 2008 where the KLCI was down and at lower range, if we look at the KLCI 10 years ago from 2008 to 1998, 20 years ago 1988 or 30 years ago 1978, the 2008 index point is generally higher.

On the longer term, Mr A will keep losing on Options and making from Equity. But because of the losses in Options his profit from Equity will be lower than the profit without hedging.


Another issue is why we need to worry about market crash, why need to hedge? If market crash, we will be able to buy cheap stocks and later will make substantial profit once the market recover.


After much thought, I have decided not to hedge equity portfolio with FKLI futures. Of course the above is just some rough estimate, I am not a speculator, I am merely doing investing without a need to predict the market because I don’t know how to predict the market.


Then few weeks ago, I found a way that “MAYBE” I can actually hedge my equity portfolio, without losing much money from hedging in the long run. Meaning if the market is on the uptrend, I will make from equity but will not lose much from Futures or Options. In fact, with the hedging there is a possibility that “MAYBE” I can make from both Equity and Futures and Options.

Is that possible? Let me try it out for one year or go through market crash and I will know the answer.


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