Investments and Options were looked at from completely different perspectives and objectives a few years back. However, penetration of options due to its very versatility in utility has brought even these two together. The reason for this is that nonlinearity of options’ pay-off brings in unique solutions for peculiar times.
One such peculiar time is now when the undertone of the market is positive but at the same time, we are sitting on a fairly large amount of gains. Now, for a trader, this may not be a big deal considering the smaller horizons but for investors where the horizon can be multi-month or even multi-years. There could be snippets of times that would push fear and reduce conviction among investors.
We will address 3 scenarios here. Getting over resistance to Buy, Looking to Invest for a Short-Term, Profit Locking vs Profit Booking in investments with the help of Option Embedded Investments.
#1Getting over the Resistance to Buy: A typical fear that creeps into a buying instinct regardless of one being a trader or investor, whenever there has been a decent amount of gains in the recent past. To overcome this fear especially for the investor, Option Embedded Investments could be the way forward.
Here, the strategy is really simple, go ahead and Buy the stock of your choice and alongside Buy a Put Option. The only drawback is, there is a restricted universe of Investment opportunities considering the number of stocks in the F&O segment is limited.
Now, this is just for us to be Investment ready. Typically, the investment decision would show its true colours in the longer run, however, one is more afraid of making a timing mistake that does get identified within a matter of weeks.
During such times the Put option is there to protect just in case there is a mistake. By the time Put expires one will be in a position to overcome the resistance by validating the decision in time to keep or to give-up the investment.
#2Invest for Short-Term: In case, one has a horizon of few weeks for a short-term investment. There could be a slight modification to this strategy we adopted in scenario #1. Since this will be an investment that will be tight in times, it will be tight in terms of price objective as well.
In such situation the cost of Put could eat away a sizable chunk of Profits. In such a situation, one may resort to another addition to the Buy Stock and Buy Put Trade. This addition is of Selling a Higher Strike Call with strike price closer to the Short Term Price Objective.
What this would do is reduce the cost of Put by the premium received in Call at the cost accepting an obligation to sell the stock at the strike price of the call. Locked upside is a bummer, but it usually works well when one is nibbling short term profits out of investments as it reduces the possibility of getting stuck into a bad investment to Zero.
#Locking Profits Vs Booking Profits: Many of us holding investments from Pre-COVID times are sitting on decent gains on many of our investments (that we have not booked out yet). Now every time there is a Pull back after a big rise to newer high, one gets tempted to book profit. In such commotion, chances are that we may lose on an even bigger rally.
So, finally with the same simple strategy of Option Embedded Investments one could get out of this dilemma of to or not to book profits. Once such a situation comes along just buy Puts till your view of further upside either establishes or completely gets destroyed.
By the virtue of Buying a Put we have locked the profits yet the potential for even more profits is completely open. Sure, this comfort of locking vs booking profits comes at a cost but 2-3% cost is far better than giving up an opportunity to see your investments rise 10-20%.
These are some of the very simple ideas that one can use to associate Investments with Options and get more confidence in riding this wonderful 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.