PREPARING FOR A MARKET DECLINE; HEDGE RISK WITH PUT OPTIONS

Experienced, sophisticated investors have a huge advantage over beginners. One of the prime reasons is that the novice tends to jump from one strategy to another, taking advice from whomever has a hot hand. What those new investors fail to understand is that past performance is seldom worth much in predicting future performance and thus, those who have recently performed well tend to do poorly as soon as market conditions change.
Instead of following an advisor who made money last month, last week, or yesterday, it makes far more sense for each investor to adopt a long-term basic methodology for putting his/her money to work.
USING OPTIONS
One of the best ways for investors to have a less rocky ride -- as markets soar and plunge -- is to use options as a risk-reducing investment hedge.
One such strategy is buying puts as portfolio protection. If you like that idea, it is essential to have those options in your portfolio before the decline picks up steam. The reason why this is so important concerns the way that options are priced. If you are new to the options world, then the simple explanation is as follows:
Option prices are based on several factors, such as the stock price and the strike price of the options. However, the most important factor in option pricing is the expectation of just how volatile the market is expected to be in the future. When markets are calm or rising, most traders see little reason to expect market volatility to suddenly increase. For that reason, there is no special demand to buy options, and the supply is sufficient to match the demand.
As a result, option premium (price of options in the marketplace) makes it painless to buy options.
The problem is that, most traders/investors see no need to own options when markets are calm.
When markets are falling, investors tend to get nervous. Because markets (on average) fall faster than they rally, whenever any decline threatens investors with large losses, (think late 2008 or Jan 2016), there is suddenly a demand for put options.
Unfortunately for people who want to buy those options, the supply diminishes and it becomes necessary to pay much higher prices to get any options. There are two reasons for that. First, as stocks decline, puts are worth more. (Think about a stock that falls from 90 to 85. The right to sell stock at a specific price, a put option, is worth more when the stock is 85 than when it is 90). Second, fear that markets will become more volatile and that the decline will continue makes people raise their volatility estimates for the future. And volatility plays a very large role in the price of options. 
Those who wait to buy options until a decline is well underway are forced to pay big prices for their put options. And the price increases are not trivial. Using the CBOE Options Calculator for a stock priced at $100 per share, and paying no dividend, compare the estimated future volatility (referred to as the implied volatility of the option) of put options vs. the calculated fair value of the option.
IMPLIED VOL VS. OPTION PREMIUM

IV	Premium
20	$ 3.91
30	$ 5.89
40	$ 7.86
50	$ 9.83
60	$11.79
70	$13.74

The bottom line for investors who want to own put options as part of their portfolio, is that waiting until you need the puts can be very costly. That's especially true when the decline begins suddenly and demand overwhelms supply.

DON'T LET THE MARKET'S VOLATILITY SEND YOU INTO PANIC MODE

No one can argue with the fact that we’ve seen extreme volatility in the stock market over the past week.  At times like this, it’s not uncommon to feel fear and panic.  We’re all human and too many of us have lived through challenging financial crises in the past.  While I can’t predict the future or tell you definitively that everything is going to absolutely be alright, I think it’s critically important to keep a few things in mind during this time. 

WHAT'S CAUSING THE VOLATILITY?

First, it’s important to understand why the stock market is acting this way. Fundamentally, the U.S. economy is doing well.  But due to a confluence of events including fears of a slowdown in China, currency devaluation from emerging market countries (China, Vietnam, Kazakhstan, etc.), and uncertainty about the Fed’s pending rate decision, the market has seen a huge sell-off.

 In addition to these events, our market is finally nearing correction territory, and this is a correction that is long overdue. 

UNDERSTANDING STOCK MARKET CORRECTIONS

Corrections are a lot like a circuit breaker.  They usually occur when a hot market gets hit with worrisome news- such events cause the market to pause and fall back as institutional and individual investors reassess their positions based on the new information.  These respites are actually good for the market.  Looking back to historical data beginning with the year 1928, the market typically undergoes a five percent correction about every 10 weeks, and a 10 percent correction every 33 weeks. Our research shows that the market has not seen a full 10% correction in 46 months, which is the third longest in history, so we are definitely due.

IRON CONDOR

The iron condor is a strategy that can be a good introduction for beginning options traders to option selling. It can be a relatively safe way to sell options because you can’t lose on both sides of the trade. Here, you pick a likely trading range for an underlying asset and sell out-of-the-money option spreads around that range, “If you collect a total premium of $2 for selling two $5-wide spreads – both an out-of-the-money call spread and an out-of-the-money put spread, your total risk is only $3 because the commodity can’t go through both spreads at expiration. You have spread the risk across a wider range of possible prices. If your trading range thesis changes or volatility explodes and threatens to put one of the spreads in-the-money, you can exit one or both spreads at any time. Collecting $2 against $3 of risk offers you a potential return on risk of 67%”.
The market outlook for the iron condor is neutral. “You’re trying to be strategic with your use of leverage. You’re trying to be systematic and probability minded, looking at what the best odds in the long run [are] if you did this consistently,”.
An iron condor can be entered from the short side or the long side, explains Charlie

“A trader who enters a short iron condor is looking to profit from a range bound underlying asset. As long as the underlying asset stays within the inside strikes by expiration, the trade will be profitable. If it moves outside of the inside strikes by expiration, the trader will take a loss, which could be as high as the difference between the sold call/put and the purchased call/put”. A trader who enters a long iron condor is looking for the exact opposite, or, a large move in one direction or the other by expiration.

Dos and don’ts 
As with any type of trading, with beginning options strategies, having a trading plan and having an exit strategy are crucial. “Everybody has a plan for when to get into a particular stock or index, but few think it through to the point of when to take profits or cut losses”.

CALENDAR/TIME SPREADS

another strategy used in options is calendar, or time, spreads. In a calendar spread, you establish your position by entering a long and short position at the same time on the same underlying asset, but with different delivery months.
The point of this strategy is, time decay happens much more quickly the closer we get to expiration. The theory is that when you short the front-month option, you’ve got that quickly-evaporating time premium working with you, faster than the decay in the further out option that you bought. “Just like the call and put spreads, you’re paying a debit for the spread and the further out you go in time; the bigger that debit’s going to be. You’re looking for a stock at expiration to be at the strike that you have put this spread on”.

BULL CALL & BEAR PUT SPREADS

Bull call spreads and bear put spreads also are called vertical spreads because they occur in the same month and they have two different strikes. Unlike with the covered call strategy, your risk with the bull and bear spread strategies is more easily quantified, says Joe Burgoyne, director of institutional and retail marketing at the Options Industry Council.

OPTION STRATEGY; COVERED CALL

Options are excellent tools for both position trading and risk management, but finding the right strategy is a key to using these tools to your advantage. Beginners have several options when choosing a strategy, but first you should understand what options are and how they work.
An option gives its holder the right, but not the obligation, to buy or sell the underlying asset at a specified price on or before its expiration date. There are two types of options: a call, which gives the holder the right to buy the option, and a put, which gives its holder the right to sell the option. A call is in-the-money when its strike price (the price at which a contract can be exercised) is less than the underlying price, at-the-money when the strike price equals the price of the underlying and out-of-the-money when the strike price is greater than the underlying. The reverse is true for puts. When you buy an option, your level of loss is limited to the option’s price, or premium. When you sell a naked option, your risk of loss is theoretically unlimited.
Options can be used to hedge an existing position, initiate a directional play or, in the case of certain spread strategies, try to predict the direction of volatility. Options can help you determine the exact risk you take in a position. The risk depends on strike selection, volatility and time value.
No matter what strategy they use, new options traders need to focus on the strategic use of leverage. Being systematic and probability-minded pays off greatly in the long run, instead of buying out-of-the-money options just because they are cheap, new traders should look at closer-to-the-money option spreads that have a higher probability of success.

Example: If you are bullish on RELIANCE and want to use the NSE exchange, which is currently trading at 1024, instead of spending 15000 Rs on the JAN 1020 call looking for a home run, you have a greater chance of making profits by buying the JAN 1040/1060 call spread for 7500 Rs.

Picking the proper options strategy to use depends on your market opinion and what your goal is.

COVERED CALL

HOW TO HANDLE STOCK MARKET CORRECTIONS

What is a Market Correction?

A market correction is typically defined as a drop in stock prices of 10% or greater from their most recent peak. If prices continue down to the point where they are down 20% or more, it is then called a bear market.

Frequency of Market Corrections

·         Stock market corrections occur, on average, about every eight to twelve months.

·         On average, a market correction lasts about 54 days.

According to Fidelity (as of May 2010) Since 1926, there have been 20 stock market corrections during bull markets, meaning 20 times the market declined 10% but did not subsequently fall into bear market territory.

How to Handle Stock Market Corrections

If there was a way to “time the market” and figure out when it was going to go up, and then sell before a market correction occurred, well, who wouldn’t do that?

It seems there is plenty of information on the internet that suggests this is possible. Let’s think about this: if you had this skill, would you be writing articles on the internet... or sitting on the beach somewhere with your laptop, drinking a Corona and making money?

Most people lose money by trying to move their money around to participate in the ups and avoid the downs. This is a documented behavior which I discuss in Why Average Investors Earn Below Average Returns.

As a professional financial advisor, when we build a portfolio, we expect that one out of every four calendar quarters it will have a negative return. We control the magnitude of the negative returns by selecting a mix of investments that has either more potential for upside, which comes along with more potential for market corrections, or a mix that has less potential for high returns, and also less risk.

If you are going to invest in the market, it is best to understand that stock market corrections are going to occur, and it’s often best to just ride them out.

Think of it like going to an amusement park; you can’t get on the roller coast only for the up, and avoid the big downs. That isn’t how the ride works.

WHY PUTS COST MORE THAN CALLS

ITC 300 PUT ALMOST ACHIEVED 1ST TGT

FOR MORE CALLS FILL UP THE FORM GIVEN HERE>>>>
For almost every stock or index whose options trade on an exchange, puts are more costly than calls.

Clarification: When comparing options whose strike prices are equally far out of the money (OTM), the puts carry a higher premium than the calls. They also have a higher Delta.

·         This is the result of volatility skew. Let's see how this works with a typical example.

·         SPX (the Standard & Poor’s 500 Stock Index) is currently trading near 1891.76 (but the same principle holds whenever you look at the data).

·         The 1940 call (48 points OTM) that expires in 23 days costs $19.00 (bid/ask midpoint)
The 1840 put (50 points OTM) that expires in 23 days costs $25.00

The difference between $1,920 and $2,610 is quite substantial, especially when the put is 2 points farther out of the money. Of course, this favors the bullish investor who can buy single options at a relatively favorable price. On the other hand, the bearish investor who wants to own single options must pay a penalty when buying put options.

In a normal, rational universe, this situation would never occur, and those options listed above would trade at prices that were much nearer to each other. Sure, interest rates affect option prices (calls cost more when rates are higher), but with interest rates near zero, that is not a factor for today's trader.

So why are the puts inflated? Or if you prefer, you may ask: why are calls deflated?

The answer is that there is volatility skew. In other words,

·         As the strike price declines, implied volatility increases.

·         As the strike price increases, implied volatility declines.

Why does this Happen?
Over the years that options have been trading on an exchange (since 1973), market observers noticed one hugely important situation: Even though markets were bullish overall and the market always rebounded to new highs at some future time, when the market did decline, those declines were (on average) more sudden and more severe.

COVERED CALLS: AN OPTION STRATEGY FOR THE NOVICE INVESTOR

"BUY VEDL 95 CALL @ 0.50 TGT 1.25/1.75" 

"BUY ITC 300 PUT @1.40 TGT 2.20/2.90"

When learning to use options, covered call writing is a good, basic strategy to adopt because it offers the opportunity:

·         To own stocks with less downside risk, compared with other stockholders.

·         To earn more frequent profits and to have fewer losing trades compared with other stockholders.
Limited Profits

There is a cost to gaining those benefits. Profits are limited. Therefore, it is not appropriate to adopt this strategy when you invest in companies whose stock price is expected to double every year.

This strategy is for investors who want to earn good, but limited profits.

How it Works

1.       Buy 100 shares (or multiples of 100 shares) of a stock that you want to own.

2.      Write (sell) one call option for each 100 shares. That call is "covered" because you own stock that can be delivered to the call owner, if and when you are assigned an exercise notice. NOTE: If tiy do not own the stock, then the call sale is "uncovered" or "Naked."

3.      The cash (premium) that you collected when selling the call option is always yours to keep.

4.      By writing the call, you agree to the terms of the option contract. In this example, you are obligated to sell that stock -- at the option strike price -- but only when the option owner elects to exercise his rights to buy your shares.

5.      If expiration passes and the call owner does not elect to buy the stock, then the option is worthless and your obligations end.

Example

YFS (Your Favorite Stock) is currently trading at $43.80 and you buy 100 shares. 

Your outlook for this company is positive (that is why you are buying shares), and you hope to earn 10% to 15% per year as the company continues to grow. However, rather than just hold onto the shares, you adopt the covered call writing strategy with the hope of increasing your profits.

There are always several choices for an option to sell. They come with different expiration dates and different strike prices. Let's assume that you choose to sell one call option that expires in 60 days (Mar 19, 20XX). Let's further assume that you are willing to make a commitment to sell the shares at $45 per share at any time on, or before, that expiration date.

PRUDENT INVESTING WITH OPTIONS

HINDUNILVR CALL  GIVEN ON 11 JAN POST ROCKS..!!! ACHIEVED ALL THE TGTS

Prudent investor must act as other prudent investors who manage similar portfolios, with similar investment objectives, act. Professional money managers can exercise judgment when taking care of other people's money -- but they cannot take any action that is too risky -- they cannot speculate by buying options, nor can they trade penny stocks, etc.

The definition of a prudent investor has undergone major changes over the years and the prudent investor rule describes the standards to which managers must adhere when investing client money.

One hundred years ago, no manager would consider investing in the stock market. Before 1945, prudent investment professionals, and the law governing their liabilities, condemned stock investing as imprudent speculation.

Later (after WW2), as inflation became part of our lives and the legal view of stock investing changed, stocks became the core holding of most investment portfolios.

In modern times, as it became clear that few investment professionals could outperform the stock market (as measured by the performance of broad-based indexes, such as the S&P 500), the law came to accept passive investing (indexing) as a prudent strategy. Advisors may now own index funds and are not required to search for outstanding investment opportunities.

This simplified road to investing became the norm. Prudent money managers were pleased when they matched the returns of their peers. Imprudent managers remain in business. They seek higher returns by taking extra risk because they want to achieve results that attract new investors.

 As the market soared during the 1980's and 1990's those 'average' returns were more than acceptable to most investors as the value of their portfolios grew. When the bubble burst, and the markets declined, average returns turned negative. That’s when people noticed that hedge funds were outperforming the overall market.

 Although these funds keep their trading strategies secret, it is known that they take advantage of derivatives (including options) to find investment opportunities that are not available to traditional money managers.