Current:Home > StocksStrategic Uses of Options in Investment: Insights into Hedging Strategies and Value Investing-InfoLens
Strategic Uses of Options in Investment: Insights into Hedging Strategies and Value Investing
View Date:2024-12-23 15:22:07
The hedging properties of options
Most of the time, options are used by professional institutional investors as hedging tools to build a safer investment portfolio.
For example, if a short-selling institution wants to protect itself from the risk of a stock continuing to rise, it can use a Long Covered Call. This way, if the stock keeps going up, the gains from the Long Covered Call can offset the losses from the short position.
If you own shares in a company and you anticipate some short-term risks that might cause the stock to drop, you can use a Long Naked Put. This way, if the stock price falls, the gains from the put option can offset the losses from the stock.
So, buying Calls can lock in losses for short sellers, and buying Puts can lock in gains for stockholders. You can think of the premium as a form of insurance. When I looked it up, I found that the term "premium" also means insurance in some contexts.
What can value investors do with options?
In my research, I found that many people recommend selling options rather than buying them. While buying options has limited losses and unlimited potential gains, the premium paid for buying options can be quite high due to time value, making it hard to ensure profitability. Of course, this advice is not typically aimed at speculators.
So, when can we use the strategy of selling options?
1. Buying the Dip: When you want to increase your holdings of a stock but prefer to buy when the price drops another 10%, you can use a Sell Naked Put with a strike price set at 90% of the current stock price. If the stock price rises, the put options expire worthless, and you pocket the premium. If the stock price drops, the options are exercised, and you acquire the stock at your target price, with the premium effectively acting as a discount. This makes Sell Naked Puts a powerful tool for value investors to build positions. Warren Buffett is a big advocate of this method.
2. Selling scenario: When you want to sell a stock if it goes up by 10%, you can use a Sell Covered Call with a strike price set at 110% of the current stock price. If the stock doesn't reach the target price, you get to keep the premium. If the stock price reaches the target, you sell the stock at the target price and also keep the premium.
Both of these strategies make the returns from buying and selling stocks more predictable. But are there any downsides? The downside is that in the event of a dramatic stock price increase or decrease, your gains are capped at the strike price due to the Sell Put and Sell Call strategies, preventing you from benefiting from further gains.
Options are a derivative form of stock trading, divided into call options (CALL) and put options (PUT), which can be used to go long or short. Although some people use options as a leveraged speculative tool, their primary use is to provide risk hedging for institutions. For value investors, Sell Naked Puts can be used to increase stock holdings, while Sell Covered Calls can be used to sell stocks.
veryGood! (1913)
Related
- Investigation into Chinese hacking reveals ‘broad and significant’ spying effort, FBI says
- No. 6 Texas survives Kansas State with goal-line stand in overtime to stay in Big 12 lead
- China Premier Li seeks to bolster his country’s economic outlook at the Shanghai export fair
- Khloe Kardashian's Daughter True Thompson Reveals How She Lost Her Front Tooth in Adorable Video
- Climate Advocacy Groups Say They’re Ready for Trump 2.0
- Kourtney Kardashian Gives Birth, Welcomes First Baby With Travis Barker
- Maine considers electrifying proposal that would give the boot to corporate electric utilities
- Sheryl Crow's Sons Look All Grown Up During Rare Red Carpet Outing With Mom
- Women suing over Idaho’s abortion ban describe dangerous pregnancies, becoming ‘medical refugees’
- Israel tightens encirclement of Gaza City as Blinken urges more civilian protection — or else there will be no partners for peace
Ranking
- West Virginia governor-elect Morrisey to be sworn in mid-January
- Connor Stalions, Michigan football staffer at center of sign-stealing scandal, resigns
- RHONJ's Teresa Giudice Reveals She's Spending Christmas 2023 With Ex Joe Giudice
- China Premier Li seeks to bolster his country’s economic outlook at the Shanghai export fair
- Report: Jaguars' Trevor Lawrence could miss rest of season with shoulder injury
- Ukraine minister says he wants to turn his country into a weapons production hub for the West
- U.S. regulators will review car-tire chemical that kills salmon, upon request from West Coast tribes
- Winners and losers of college football's Week 10: Georgia, Oklahoma State have big days
Recommendation
-
Alexandra Daddario Shares Candid Photo of Her Postpartum Body 6 Days After Giving Birth
-
Mark Zuckerberg undergoes knee surgery after the Meta CEO got hurt during martial arts training
-
Virginia school board elections face a pivotal moment as a cozy corner of democracy turns toxic
-
Bleach can cause your hair to break off. Here's how to lighten your hair without it.
-
Song Jae-lim, Moon Embracing the Sun Actor, Dead at 39
-
Did the Beatles song 'Now and Then' lead you to gently weep? You weren't alone
-
Would Summer House's Lindsay Hubbard Ever Get Back With Carl Radke After Split? She Says...
-
A nonbinary marathoner's fight to change anti-doping policy