Often times in the midst of a highly volatile session the market presents us with great anomalies. Such anomalies generally are short-lived and a corrective course that runs within a session or two would bring in swift opportunist gains.
The genesis of the Futures & Options (F&O) is into risk management, more so into the transfer of risk. Let us today discuss how these instruments, especially Options with its non-linear payoff can come in handy.
Often times in the midst of a highly volatile session the market presents us with great anomalies. Such anomalies generally are short-lived and a corrective course that runs within a session or two would bring in swift opportunist gains.
Over course of my trading life, I have had 3 such different types of situations, where it is too lucrative yet too dangerous to take a trade.
Where it’s like trying to fetch treasure out of a snake pit. All we are adding here is a pair of bite proof gloves in Options so that treasure or no treasure, won’t risk our lives.
Case #1 Stock has fallen 30-40-50% … good opportunity to invest for my bottom fishing friends
Here the investor is attempting to catch a falling knife. While there is a possibility that the stock would turn itself around immediately and pivot back to a more reasonable damage, equal chances are that there could be much more left to lose.
Relief comes in terms of Buying a Call. Instead of buying a stock at 100 buy a 100 strike Call. If the view is right, one would get all the benefit.
But, in case things were to deteriorate further from there all that is at stake is the Call Premium. Essentially, a cost paid to get the pair of gloves. On a later date when expiry nears the same can be converted to delivery as the storm calms down.
Case #2 If it has fallen so much at least there will be a recovery if not today maybe tomorrow
Holders of similar view as Case #1 but the class of participants here would be Traders. While the higher premiums are justified in the volatile times, it would ruin risk-reward for traders, who would want to get rid of the position as soon as a day or two if the stock pivots towards to parity.
In such cases, more often than not the premiums are up across strikes (EG 110 Call of Rs100/- stock would be trading at 15 in volatile times instead of 5 in normal times).
To counter this especially when one wishes to get rid of the position with mildest of recoveries. Pair up the Call Buy with a Short position in a few strikes higher call.
While the Call sold would cap the profits, it would give that much-needed funding when the premiums have soared multifold.
Case #3 abrupt move for an Investor Holding stock for Long Term
This is more a wealth preservation technique, instead of a wealth creation. I know the investors would not be tracking the stocks on daily basis, but it wouldn’t hurt to have an alert mechanism in place. (not that difficult in this digital era).
Just a simple drawing of attention would do when the stock starts behaving out of ordinary on the lower side. In such a situation, when there is an above average move Buy a Put Option just till the price stabilizes and shows you signs of firm ordinary behaviour. It is sort of buying medical insurance at the first sight of health irregularities.
God forbid if anything unfortunate were to happen, the pockets are not drained. So, gain all there is to gain if you win but using Options in turbulent times do not lose if you lose.
MORE WILL UPDATE SOON!!
You have a good point here!I totally agree with what you have said!!Thanks for sharing your views...hope more people will read this article!!!
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