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What is a No-Downside Strategy?

True to its name this is a strategy that lets you capture almost all of the upside of the index with ‘almost’ no downside. This strategy requires you to have basic knowledge of Options.

Why would I want downside protection?

As soon as the world factored in the Covid-19 pandemic, everything in the financial markets has been flying. Even the airline stocks whose airplanes aren’t.  And nearly all asset classes are flying too along with the wannabe asset classes.

Almost all financial news these days sounds insane. No one knows where it will stop. Let’s take our own example, Capitalmind Portfolios are beating the market hands down. Obviously, this is not because we are excellent stock pickers. We might be, but at this time, even non-excellent stock pickers are making ridiculous returns, and you have no way to tell the difference.

So let’s assume that this is a mad time and that the party will end in bloodshed at some point. How can we feel better?

Will you feel better if we tell you this

In the next year…

  • If NIFTY goes up, you get to keep most of the upside
  • If NIFTY goes down, you lose almost nothing

This “too good to be true” scenario can be captured by a structured product.

What is a structured product?

It’s essentially a bond that is wrapped with an Index derivative like (Options).

The product is bond+ in the sense, its returns are conditional to an underlying index. I am using the term bond here since it’s an easy-to-understand term, in reality, if you go to the market to invest in a structured product, these are NCDs (Non-convertible debentures) issued by NBFCs. They’ve been in the Indian market since 2006.

Typically when institutions design such products, they have a high ticket size say of 25 Lakhs minimum (RBI mandated), fixed tenure, and a lock-in period of 1 to 3 years.

Also, they use it as a way to raise funds for NBFCs. The bond part of this product is can be a debenture issued by an NBFC. Such products are called Market linked debentures, we have written about them in detail over here.

Raising interest rates combined with a roaring stock market is an ideal regime for NBFCs to lure investors to this product.

From an investor standpoint, so long as you can understand the product, use the product to express a particular market view, you are good.

What kind of product are we creating?

Capitalmind - Nifty50 - No Downside NIFTY Strategy

As highlighted in the illustration above, say you bring in 100 into the strategy, at max you can lose 4%, and on the upside, you precisely know how much you would make given a specific level of NIFTY (Refer to the payoff chart below). This 4% is the cost and you would bear it both on the upside and downside.

If the underlying index, in our case NIFTY goes up we get to capture the returns through options, plus we also get the returns from our investment in the bond, however, if NIFTY goes down, we don’t lose much, as the returns from the Bond cover for the cost of Index derivative, in a way protecting our capital. So this is our own DIY Structured product of sorts.

How has the strategy performed in the past?

We started talking about a Do-It-Yourselves capital protection plan way back in 2013 and systematically tracked the No Downside Strategy as an #actionable strategy available to Capitalmind Premium subscribers since 2017.

Here’s how the strategy has done over the years. Nifty No-downside Strategy 0r NDS has outperformed by a little for some years, though it shouldn’t ideally have. We took a little risk with a fixed income that paid off.

[Premium] You can find the exact strategies for each of these years – 2013 | 2017 | 2018 | 2019 | 2020

This all sounds “too good”, what’s the catch?

Taxation 

You’ll incur taxes as per your income bracket rate for the options instrument is a wrinkle for folks in higher tax brackets. One way to manage this is to run this strategy for Individuals (or HUFs) in lower tax brackets. Another way to think about it is as cost you pay for capital protection.

Liquidity

The far dated (LEAP) option may not always be liquid or priced correctly during the year. So if you intend to exit the strategy then you may get bad fills on the options leg and lose out on some of the returns. So it is best to not touch this strategy until the option expires i.e. the end of the contract.

Why not just buy a put?

You could always hedge your portfolio with Puts, but depending on the constituents of your portfolio, you may not be able to precisely cover the downside, two even if you invest in an Index ETF or Mutual fund there could be a minor impact of the tracking error, plus it may be slightly less tax-efficient than the current structure.

Who is this strategy for?

This strategy is for anyone who understands options and would like to hedge their investments in a structured manner. It’s also ideal for people who have a business incomes and can use offset costs to reduce the tax impact of this strategy. Look at it as a way to express a market view – If you think the market is going to crash and don’t want to miss all the possible upside action, this is the product for you.


How to implement the CM No-downside strategy?

In the last week of each month, you would receive a message for the ideal Long-dated call and Bond combination. You can choose to get started on any given month. We will individually track the pay-off for each of the months.

The update is shared with Premium subscribers in two ways:

  1. Update on the slack #actionable channel
  2. Subsequently, an email update goes out to all those subscribers who enable email notification.

This is not a super time-critical strategy, you can execute the strategy a couple of days from the time that actionable is provided.


For further questions about the No downside strategy, write to us at premium [at] capitalmind [dot] in or on twitter @capitalmind_in

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