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Last Updated : Dec 08, 2018 08:30 AM IST | Source: Moneycontrol.com

Options can help investors weather headwinds from Assembly Elections 2018

Every now and then we are faced with a situation where there is a firm possibility of headwinds created by a known event. Be it election outcomes, big trade agreements or major Monetary Regime change.

Moneycontrol Contributor @moneycontrolcom

Shubham Agarwal

Every now and then we are faced with a situation where there is a firm possibility of headwinds created by a known event. Be it election outcomes, big trade agreements or major Monetary Regime change.

While traders often enjoy it, investors are left a bit agitated by the unknown and its aftermath on their long-term portfolios.

Considering the non-linearity of Option pay-off, adding Options to the investment takes the possible pain out of the equation at least till that time clarity emerges. Now, as there no free lunches in the world, adding Options led comfort also comes at a cost.

Let us discuss utilizing 2 Types of Options viz. Call & Put with a tiny brief on their Cost as well as:

Benefits:

After nearly two decades of trading life, I am taking liberty of not defining what each of these Options are in detail aside from mentioning that Call option is an Option to buy and a Put is an Option to sell, giving the buyer of Call a right to buy and buyer of Put a right to sell.

If one ‘sell’ these Options it entails the Obligation to do otherwise.

Case #1 Picking Stocks in a Dip amid the event, Buy a Call

In case one is faced with a situation where there is a price point attractive enough to jump into the stock but there is still no clarity on the aftermath of the event or may be, we are in the middle of the event.

Buy a Call Option of a strike close to the current price for a premium (could range between 3-5% of Price). What ends up happening is that at the cost of that 3-5% we have confirmed our ownership at the strike price level. In case things were to get ugly from there we have nothing more than premium at stake.

One more utility is that if we do see a temporary dip in the near term and the stock going a bit deeper and then coming back. The volatility after creating position will never bother you as the losses are limited, we can sit through the bout of volatility to be able to have that position in case if the stock moves up again after the initial dip.

Case #2 Worried about Negative impact on Holding, Hedge it with a Put

Hedging is not a new word for anyone. The best utility of Options is to hedge. Only two things shall be clear while hedging is that A) It comes at a cost, and B) Hedging can prevent you from any future loss but it cannot undo a loss that is already incurred.

So, any fright of fall can be brought to peace of mind just by going long on a Put Option of that particular stock. Again, the cost of a Put with strike closer to the current market price would around 3-5%.

Position can be held till the time clarity emerges. Meanwhile, in case things do take a wrong turn, one is encouraged to book profits into Put whose premium would rise with a decrement in price along with selling the holding.

These Options premium may not mimic the price movement of the underlying stock for smaller moves. But, the objective here is to make sure that we are safeguarded in case of a much larger move, where there could still be a decent 70-80% replication of the price move.

Finally, it makes sense to blend Options to the portfolio with an event in the offing to add that magic potion that brings peace of mind. Investors can use:

Hedge Long Put
Covered Call
Short Put

Long Call

Disclaimer: The author is CEO & Head of Research at Quantsapp Private Limited. 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.

Assembly Elections 2018: Read the latest news, views and analysis here
First Published on Dec 8, 2018 08:30 am
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