Bouts of volatility and uncertainty come with opportunities. Especially lucrative enough to get the long-term investors glued to the screen for attractive prices.
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It has been more than a year now since we have been overwhelmed by this global pandemic. The highs and lows are part of the equity market and so are the bouts of volatility. However, today's headline-driven market has lost significance of data analytics and has thrown the predictive models under the bus.
But there is
one thing for sure about bouts of volatility. Such bouts of volatility and
uncertainty come with opportunities. Especially lucrative enough to get
the long-term investors glued to the screen for attractive prices.
However,
such bouts could trap some of the crucial portions of investable capital for a
long time if one wrong call is made. Hence, it is quintessential in such an
unpredictable market to introduce Options in our investment portfolios.
We have
talked about how traders optimize the equity Options to modify their risk
profiles and amplify their returns but let us revisit Options' utility for
investors, who could be interested in modifying the price profile of their
invested stocks at least for a while (till the dust settles).
Here we will focus on how a set of intentions of an investor
can be monetized using equity options. But before we go any further let us
revisit the four option transactions, what would they essentially mean:
A. Buying a Put would entail a Choice to Sell a Stock
B. Buying a Call would entail a Choice to Buy a Stock
C. Selling a
Put would entail Obligation to Buy a Stock
D. Selling a Call would entail Obligation to Sell a Stock
Two additional notables.
Firstly, all aforementioned transactions would happen at a
predefined price point for the stock a.k.a Strike Price.
Secondly the cost, while buying options would be onetime
cost of Premium, selling options would require margin (portion of entire
transaction value) to be deposited upfront but with a small receipt of premium.
Let us see how these Option trades can be embedded into
investment activity to improve our efforts of dealing with uncertainty.
1. With the existing uncertainty-led volatility there would
definitely come a fear of losing wealth in stock if it is at an attractive
price led by deep cuts gets even deeper, let us understand how Options can help
investors take care of this fear.
Use the transaction A (as outlined above) and Buy a Put of a
Strike Price below which one would not be comfortable holding the stock. In
case the stock falls below the strike upon expiry we have a choice to sell the
stock at strike price.
Alternatively, one may also Buy a Call (Transaction B)
instead, now one gets the 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.
Cost would be Premium (3-5 percent of the stock price). Put
Option will protect the investor against any fall below the strike price at the
end of expiry. Call Option Premium is paid to buy a comfort of getting in only
if turns out to be a money maker.
Lastly transactions C&D involve selling of Options where
comes a commitment but still if in case one wishes to sell a stock at a
predefined price and wouldn't want anything more than what the stock has to
offer - resort to transaction D and Sell a Call of the Strike Price at
which one wishes to sell the stock.
Transaction D would require margin but that could partially
be covered with the stock holding or earmarked capital for a further Buy.
Transactions A&B are protection mechanism and in today's
situation a must have addition to every investment activity undertaken.
