Picture an investor holding shares they have no intention of selling, watching a result, a budget or a global event approach, and worrying about what it might do to the price.
Selling and buying back is the obvious move and it is a bad one. They would crystallise a tax bill, reset a holding period they have been patiently accumulating, and then face the harder question of when to get back in, which people get wrong more often than they get the exit right.
There is a third option, which is to keep the shares and buy protection against the fall. That is hedging, and it is what derivatives were invented for.
This post is about how it works, what it costs, and the arithmetic problem that means most people reading it will not be able to use it.
What hedging actually is
Insurance, with the same logic and the same trade-offs.
You pay a known, certain, relatively small amount now to remove an unknown, uncertain, potentially large loss later. Most years the payment is wasted, in the sense that nothing bad happens. That is not the hedge failing. That is what buying insurance feels like when the house does not burn down.
The mental shift required is the same one house insurance requires. You are not trying to make money from the hedge. You are trying to make the worst case survivable.
Three shapes worth knowing
The protective put. You hold shares and you buy a put option on them. If the price falls below the strike, the put gains roughly what the shares lose. Your downside is limited from there. Your upside remains intact, minus what you paid for the put.
This is the purest form and the easiest to reason about. It is also the most expensive, because you are buying protection outright and someone has to be paid to provide it.
The covered call. You hold shares and you sell a call option on them. You collect a premium immediately. In exchange, if the price rises above the strike, your shares get called away and you stop participating in the gain.
This is not really protection. The premium cushions a small fall and nothing more. What it actually does is convert some of your potential upside into cash today. Useful if you were happy to sell at that price anyway. Painful if the stock runs.
The collar. Buy the put, sell the call, use the premium from one to help pay for the other. Protection at little or no net cost, in exchange for giving up the gains above your call strike.
The collar is what most institutional hedging looks like in practice, because paying for protection every year is a drag that few portfolios can carry.
One catch applies to all three. Stock options trade in lots, and the same minimum contract value applies to them, so each of these structures needs a holding of roughly ₹15 lakh or more in that one stock. The sections below explain why, and what it means for smaller portfolios.
Hedging a portfolio, not a stock
If you hold fifteen companies, buying fifteen separate puts is impractical and expensive. The standard approach is to hedge the whole portfolio with index options or futures instead.
That works because most large Indian portfolios move broadly with the market. This is often measured using beta. A portfolio with a beta of one moves roughly with the Nifty. A beta of 1.2 means it tends to move about 20% more than the index, in either direction. A beta of 0.8, about 20% less.
The hedge you need is not the value of your portfolio. It is the value multiplied by its beta. Hedge a ₹20 lakh portfolio with a beta of 1.2 and you need roughly ₹24 lakh of index exposure, because the portfolio behaves like a larger holding of the index.
Get the beta wrong and you are either under-protected or paying for cover you do not need.
The calculation problem
Here is the part almost nobody states plainly.
One index contract represents roughly ₹15 lakh to ₹20 lakh of exposure, because SEBI requires exchanges to set lot sizes so contract values sit in that band and to revise them as the index moves. In August 2026 a Nifty 50 contract, 65 units, was worth about ₹15.8 lakh. You cannot buy a fraction of a lot.
So the smallest hedge available is ₹15 lakh or so of index exposure. If your portfolio is worth ₹4 lakh, there is no proportionate one-lot hedge. Buying one lot would not protect your portfolio, it would create a new position roughly four times larger than everything you own, pointing the other way. That is not insurance. That is a different bet.
The practical threshold is a portfolio of somewhere around ₹15 to ₹20 lakh before index hedging becomes proportionate at all, and comfortably more before it becomes efficient.
This changed recently and in the unhelpful direction. The minimum contract size tripled, from ₹5 lakh to ₹15 lakh, with effect from 20 November 2024, under SEBI circular SEBI/HO/MRD/TPD-1/P/CIR/2024/132 of 1 October 2024. SEBI’s stated purpose was investor protection and market stability, and the measures were aimed at speculative volumes. It caught hedging in the same net.
If your portfolio is below that threshold, the honest answer is that derivative hedging is not available to you, and the alternatives are the ordinary ones: hold less of what worries you, keep some cash, and accept that a portfolio you can afford to leave alone does not need protecting from a bad Friday.
What it costs
Protection is priced by the market and it is not cheap. Running a protective put continuously through the year costs a meaningful percentage of the portfolio it protects, and the cost rises precisely when you most want it, because premiums climb ahead of events.
This is why permanent hedging rarely makes sense for an individual. The drag compounds against you in every year the market goes up, which historically is most of them.
Hedging around a specific, dated, identifiable risk is a different proposition. A known event, a concentrated position you cannot sell yet, a portfolio you need intact on a particular date. Those are the cases where the cost buys something real.
The tax argument
Worth stating because it is the strongest practical case for hedging over selling.
Selling shares to escape a fall triggers capital gains tax and resets your holding period. Hedging leaves the holding untouched. You keep the shares and, if you have held them for less than 12 months, keep the clock running toward long-term treatment, and pay only the cost of the protection.
For someone sitting on years of unrealised gains, that difference can exceed the cost of the hedge several times over.
One thing to know before you start. Profits and losses on the hedge itself are not capital gains. Income from derivatives is taxed as non-speculative business income at your slab rate, reported in ITR-3, and active trading can bring a tax audit requirement. The shares stay under capital gains rules; the hedge does not. Speak to your tax adviser before assuming the maths works in your favour.
Why hedged positions require less margin
Margin is calculated on the risk of the position as a whole, not separately for each leg. This matters for any structure that includes a sold option. An uncovered short option can have a large potential loss so it can require a large margin. Adding a position that offsets some of that risk can reduce the margin required.
How much it falls depends entirely on the structure. A narrow spread caps the loss tightly and gets a large reduction. A wide one caps it loosely and gets less. Your broker’s margin calculator will give you the real number before you place the order, and it is worth checking rather than estimating.
That is a real and deliberate incentive. The system is built to make defined risk cheaper to carry than open-ended risk.
How hedges break
The characteristic failure is not the hedge being wrong. It is the hedge being dismantled in the wrong order.
Exiting the protective leg first can leave the remaining position unprotected. The margin requirement can then rise, potentially beyond what your account can support, and the broker may square off the position. Enter the protective leg first and exit it last.
Letting the hedge expire while the risk continues. If your protective leg expires before the position it protects, you are unhedged from that moment.
Where a hedge is built across two expiry months and one of them expires that day, the margin benefit no longer applies for that session. Since 1 February 2025, under the same SEBI circular, this calendar-spread benefit is withdrawn on expiry day itself. It used to run until the market closed, at which point the expiring leg vanished and the margin on what remained jumped, after everyone had gone home and nothing could be done about it.
The scale is worth understanding. A two-month spread in a single stock is margined on the small difference between the two legs, often a fraction of what either leg would need alone. With the benefit withdrawn, each contract is margined separately and in full, which on a ₹15 lakh-plus contract can mean several lakh rupees across both legs. On expiry day that relief now stops, and the requirement jumps to the full amount while the market is still open. Your broker's margin calculator will show the exact figure for your position.
That is the rule working as intended, since the alternative was discovering it overnight. But it means a hedge you planned to hold to expiry needs funding on the last day at a level you may not have budgeted for.
Trying to unwind during a ban period. When a stock is in a ban, closing one leg of a hedge can increase your net exposure, and the exchange penalises any increase in exposure, at 1% of the value with a minimum of ₹5,000, so your broker will usually block the order. A hedge you cannot dismantle in the usual order is a hedge you have to plan the exit from.
When not to hedge
If the position is small enough that the loss would not change anything, the hedge costs more than the risk.
If you cannot name the specific risk you are protecting against, you are not hedging, you are taking a view with extra steps.
And if the hedge is complicated enough that you are not certain what happens at expiry, it will find a way to surprise you at exactly the wrong moment.
Common questions
What is hedging in the stock market?
Taking an offsetting position so that a loss on what you hold is compensated by a gain on the hedge. It reduces downside at a known cost, rather than trying to make money.
What is a protective put?
Buying a put option on shares you already own, so that if the price falls below the strike, the option gains roughly what the shares lose.
What is a covered call?
Selling a call option on shares you own. You collect the premium now and give up gains above the strike. It cushions a small fall rather than protecting against a large one.
Can I hedge my whole portfolio with one trade?
Only if the portfolio is large enough. One index contract represents ₹15 lakh to ₹20 lakh of exposure and cannot be split, so portfolios well below that cannot be hedged proportionately.
Does hedging reduce my margin requirement?
It can. Margin is calculated on the net risk of the position, so a defined-risk structure may require less margin than an equivalent uncovered position.
Why did my margin jump on expiry day even though I was hedged?
The margin treatment for certain spreads can change on the expiry day of a leg. From 1 February 2025, SEBI rules remove the calendar-spread margin benefit on the expiry day of a leg, so the margin benefit is removed for that session and the required margin can increase while the market is open.
Is hedging cheaper than selling?
Often, once tax is counted. Selling realises gains and, for recent purchases, resets your holding period. Hedging costs the premium but leaves the holding and the holding period intact.
Should I hedge all the time?
Rarely worth it for an individual. The cost compounds against you in rising years. Hedging around identified, dated risks is where it earns its keep.
The short version
Hedging is buying certainty about the worst case and paying for it. Used against a specific risk, on a portfolio large enough to hedge proportionately, it is the most sensible thing you can do with a derivative.
Used continuously, or on a portfolio too small for the contract sizes, it stops being protection and becomes an expensive habit.
Risk disclosure
Hem Finlease Private Limited, SEBI Registration No. INZ000167734. Hem Securities Limited, SEBI Reg. No. IN-DP-568-2021, CDSL: 17700/17701.
Investments in the securities market are subject to market risks. Read all the related documents carefully before investing. Registration granted by SEBI and membership of recognised stock exchanges do not guarantee the performance of the intermediary or provide any assurance of returns to investors.
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