Options have been more recognised as investors' choice than traders', especially in more developed markets where Options have been available as instruments of trade for more decades
Options trading has always been looked at as an activity undertaken by traders.
But, Options have been more and more recognised as investors' choice than traders' especially in more developed markets where options have been available as instruments of trade for many more decades.
The reason is very simple: investors will always have the commitment required for honoring the obligation created by a possible in the money expiry. On the other hand, investors with deeper pockets and longer duration of holding on to the underlying would have more appetite to bare the premium loss.
We need to keep in mind that the earmarked capital will be used as margin money while selling Puts and stock holding partially at least will be making good the margin money while selling Calls. For Buyside transactions there would be a premium on money spent which would be just tiny fraction of investable funds. This can be considered as insurance money paid to reduce the possibility of getting stuck in a bad timing call on a good stock.
Let us have a look at four possible transactions with two options viz. Buy/Sell, Call/ Put and understand their utilities
Case #1. An Investor first starts tracking the stock for that one sweet dip to get a bargain.
Here instead of waiting, Sell a Put option of a strike price, close to that lower market price. This would entail obligation of buying of the stock at strike price if the stock were to end up below strike price on the day of F&O expiry, else premium is pocketed.
Case #2. Let us say after buying the stock goes up and the investment objective is almost attained.
Here instead of waiting again, sell a Call option of a strike price, closer to the price objective. This would entail obligation to Sell the stock at strike price, if the stock were to end up above the strike price on the day of expiry. If not, nothing happens, and the premium is pocketed.
In terms of transaction cost, one does pay a margin for both cases 1 and 2, which would come out of money ear marked for investment in case 1 and at least partially out of the Stock holding that can be used as collateral in case 2. And one would get remunerated with the Premium of option sold between (1-2 percent depending upon strike) while waiting around.
Case #3. Now that we have addressed the greed (Buying lower and selling higher), let us understand how Options can help investors take care of their fears. First up, fear of losing value in portfolio in shaky markets.
Well, buy a Put of a strike below which one would not be comfortable holding the stock. In case the stock falls below the strike on expiry, we have a choice to Sell the stock at strike price.
Case #4. Lastly, the fear of losing while trying to catch a falling knife. While being the investor to the core and buying the stock amid the most pessimism, buy a Call instead of the underlying.
Now one gets choice to buy the stock on the day of expiry. Exercise the choice if the stock ends up above the strike price upon expiry. But in case if the stock were to fall further, just don't buy it.
These are basic yet overlooked utilities of Options that can come in really handy for investors.
(The author is CEO & Head of Research at Quantsapp Private Limited.)Disclaimer: The views and investment tips expressed by investment expert on moneycontrol.com are his own and not that of the website or its management. Moneycontrol.com advises users to check with certified experts before taking any investment decisions.