Shubham Agarwal
Markets have run up quite a bit with a slow and steady move from the recent bottom. This situation makes the trend followers a bit nervous. The nervousness is generally created when one takes a new trade after booking profit in the previous trade.
While the trend is still up, the rise that was posted recently makes it difficult to take a buy trade with the same confidence. On the other hand, given the fact that one does enter into a trade by gathering courage, there is always a bit of fear.
Options provide a perfect way to tackle fear as well as a lack of confidence. Simplest way to do this is by adding protective Put to the trade. Let us see,
1. How does we do this?
2. How do we manage once Entered?
3. What is the Exit Strategy?
But before that let us refresh our memories a bit. Put options are options to sell that are bought by paying a premium. Put options rise with a fall in the price of the underlying stock / index and fall with the rise in the fall of the underlying.
Now, how does this work?
When we are struggling to decide whether to buy a stock or not after a rise. Just simply evaluate your study and go ahead and buy the future of the stock or index you intend to buy without any hesitation. Just one addition to this trade is to go ahead and simultaneously buy a Put Option of the same stock/index with same expiry date as futures and strike price which is closest to the current market price of the stock/index.
This position will require us to pay upfront premium of the Put Option bought. However, this addition will reduce the margin requirement on the combined position much lower than what we would have paid for a single future.
How do we manage once Entered?
Remember, the Buy future position will rise with the rise in the underlying and the Buy Put Option position will fall. The other way around will also be true. However, the movement in Put Option price will be smaller than the movement in Future price.
So, we can be rest assured that if there is a fall there will be partial portion of the fall that will be compensated by the Buy position in Put Option at all times. On top of that, if there is a sudden big fall, all we will lose is to the extent of Put Option premium paid.
In case, there is a big rise, remember on Future we can make theoretically unlimited amount of money (it can rise to any level), but on Put Option we will lose maximum of Premium amount.
So, for management just hold the Put Option for the life of the trade.
What is the Exit Strategy?
Keep this Put Option position married to the Future at all times. We know that there is only limited loss that we can make on this combination of positions, but it is still advisable to hold the position with a stop loss and target in Futures. If either one of them is triggered it is best to exit both the positions simultaneously.
That is how with Protective Put we can take bullish trade with Peace and Confidence even after a big rise.
Disclaimer: The views and investment tips expressed by experts on Moneycontrol.com are their own and not those of the website or its management. Moneycontrol.com advises users to check with certified experts before taking any investment decisions.
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