Chapter 5 of the NISM Series VIII workbook is titled Strategies using Equity Futures and Equity Options. It carries about 10% of the marks, yet it is one of the fattest chapters in the book. The good news is that if you studied Chapters 3 and 4 properly, you have already met most of its building blocks. This post covers Part A of the chapter: what a strategy is, hedging with stock futures, hedging a portfolio with index futures, and speculation. Part B will cover the option strategies.
At a glance: NISM Series VIII has 100 questions, 2 hours, 60% pass mark and 25% negative marking per wrong answer. The exam fee is ₹1,500 + GST. Chapter 5 questions are almost always numerical, so you must be able to compute an effective price or a hedge ratio under time pressure.
If you are new to the series, start with our Chapter 1 notes on derivatives and the complete NISM VIII roadmap before reading further.
What does “strategy” mean in F&O?
A strategy is simply two or more derivative positions held simultaneously so that their pay-offs combine. The simplest example is a futures position paired with an option that acts as insurance.
Consider a stock trading at ₹500 with a futures lot of 1,600 shares. Buying 1,600 shares in cash needs ₹8 lakh. Buying one futures lot needs only the margin, roughly ₹1.5 lakh. The futures position gives the same ₹1,600 profit for every ₹1 rise, but the loss is also unlimited if the stock falls.
Adding insurance: the protective put
To cap the loss, buy a put option at the ₹500 strike. Suppose the premium is ₹5.45 per share.
- Premium paid: ₹5.45 × 1,600 = ₹8,720 per lot. This is a sunk cost.
- Maximum loss: ₹8,720 per lot, no matter how far the stock falls. Even a 20% gap-down the next morning cannot hurt you beyond this.
- Break-even: ₹500 + ₹5.45 = ₹505.45. Profit starts only above this level.
- Maximum profit: Unlimited, minus the premium.
Because the exchange now knows your loss is capped, the margin requirement on the combined position drops sharply. That is a direct, practical benefit of hedging that the workbook expects you to understand.
Exam tip: Hedging reduces profit on a good day. If the stock rallies ₹5, the unhedged futures trader earns ₹8,000 while the hedged trader earns much less because the put loses value. Questions often test whether you understand that this reduced profit is the price of a defined maximum loss.
Long hedge using stock futures
Use a long hedge when you intend to buy shares in the future and fear the price will rise before then.
Scenario from the workbook: You want 1,500 shares of ABC Ltd on 20 June. Spot is ₹455. Your fixed deposit matures only in a month, so you cannot buy now. June futures trade at ₹457.30 (higher than spot because of cost of carry) and the lot size is 1,500. You buy one futures lot today.
| Outcome on 20 June | Price rises | Price falls |
|---|---|---|
| Spot price | ₹520 | ₹390 |
| Futures price | ₹521.20 | ₹391.10 |
| Cash paid for 1,500 shares | ₹7,80,000 | ₹5,85,000 |
| Futures gain / (loss) | +₹95,850 | (₹99,300) |
| Net cost | ₹6,84,150 | ₹6,84,300 |
| Effective cost per share | ₹456.10 | ₹456.20 |
Whether the stock went to ₹520 or ₹390, your effective purchase price stayed within a rupee of the futures price you locked in. That is exactly what a hedge is supposed to do.
Short hedge using stock futures
Use a short hedge when you hold shares, or plan to sell them on a future date, and fear the price will fall.
Scenario: On 10 May you decide to sell 1,200 shares of PQR Ltd on 10 July to repay a personal loan. Spot is ₹1,690. July futures trade at ₹1,706 and the lot size is 600, so you sell two lots today.
By 10 July the feared fall happens. Spot is ₹1,440 and futures are ₹1,441.
- Sale proceeds in cash market: 1,200 × ₹1,440 = ₹17,28,000
- Futures gain: (₹1,706 − ₹1,441) × 1,200 = ₹3,18,000
- Total realised: ₹20,46,000
- Effective selling price: ₹20,46,000 ÷ 1,200 = ₹1,705 per share
Had the stock risen instead, the futures would have lost money but the shares would have sold higher. Either way the effective price lands near ₹1,705, give or take a rupee.
Exam tip: In both hedges the effective price converges to the futures price, not the spot price. If a question asks what price the hedger “locked in”, the answer is the futures price at the time of hedging.
Hedging a portfolio with index futures
Stock futures work when the stock you hold has an F&O contract. A diversified portfolio of many stocks will not. The solution is to short Nifty futures, because a broad portfolio falls when the market falls.
The question is how many lots. This is where beta enters, and where most candidates lose marks.
Why the naive method fails
Suppose your portfolio is worth ₹90 lakh, Nifty is at 25,000 and the lot size is 25. One lot is worth ₹6,25,000.
The naive approach divides ₹90 lakh by ₹6.25 lakh, giving 14.4, so you short 15 lots. Now assume the market falls 20% to 20,000. If your portfolio beta is 1.3, your portfolio falls 26%, not 20%.
- Portfolio loss: ₹90 lakh × 26% = ₹23.40 lakh
- Futures gain: 5,000 points × 25 × 15 lots = ₹18.75 lakh
- Net result: a loss of ₹4.65 lakh
The hedge was too small because it ignored beta.
The correct hedge ratio
The workbook formula is:
Number of lots = (Portfolio value × Portfolio beta) ÷ Value of one index futures lot
- Total exposure: ₹90 lakh × 1.3 = ₹117 lakh
- Lots to short: ₹117 lakh ÷ ₹6.25 lakh = 18.72, rounded to 19 lots
- Futures gain on a 20% fall: 5,000 × 25 × 19 = ₹23.75 lakh
- Net result: roughly ₹0.35 lakh in your favour, which is negligible against a ₹90 lakh portfolio
That near-zero net is the sign of a correctly sized hedge. Remember that beta measures how much your portfolio moves relative to the index. A beta of 1.3 means a 10% market move produces a 13% portfolio move in the same direction.
Key fact: Hedging does not aim to make money. Its objective is to minimise loss. If you expect the market to rise next month, there is no reason to hedge at all.
Using futures for speculation
Speculation is the opposite objective. Here you are not protecting anything. You want to profit from a directional view.
If you are bullish on a stock, you can buy the shares or buy the futures. The futures route needs far less capital because you only post margin. That magnifies return on capital.
- Cash route: 1,600 shares at ₹500 cost ₹8 lakh. A rise to ₹510 earns ₹16,000, a return of 2%.
- Futures route: The same lot needs about ₹1.6 lakh margin. The same ₹16,000 gain is a return of about 10%.
The leverage cuts both ways. A ₹10 fall wipes out 10% of your margin while a cash investor loses only 2%. SEBI’s own risk disclosure notes that roughly nine out of ten individual traders lose money in equity F&O. The exam will not test that statistic, but you should respect it.
If you are bearish, the mirror image applies. Sell the futures today at the higher price and buy them back after the fall.
How to study this part
- Redo every worked example with your own numbers. Change the spot, the futures price and the lot size, then recompute the effective price. The arithmetic is simple, but the exam rewards speed.
- Draw the pay-off graph for every position. Anyone serious about derivatives must be able to sketch a long futures, short futures, long put and the combined protective put from memory.
- Memorise the hedge ratio formula. Beta-based index hedging is the single most likely numerical question from this part of the chapter.
- Clear your backlog before Part B. Option strategies build directly on these ideas, so any doubt about futures, options or cost of carry should be resolved now.
For a full timeline and the mock-test routine that earned one candidate 82%, see our guide on clearing NISM Series VIII in the first attempt.
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