InvestorQ : How do I use options for protecting my portfolio positions?
Priyanka N made post

How do I use options for protecting my portfolio positions?

Answer
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Mitali Bhutta answered.
2 years ago


Options, unlike futures, are not linear products as their payoffs are not linear. They are called asymmetric products as the payoff for the buyer and the seller is not same. The buyer of the option has limited risk and unlimited profit potential. On the other hand the seller of the option has limited profits and unlimited loss potential. When you buy a call option or a put option, then your losses will be limited to the option premium but your profits can be unlimited after you cover the hedging cost. If you attach a lower strike put option to your equity stock then you are profitable on the upside once the cost of the put is covered. On the downside you are only risking till the time you are able to break even the put. That means if you are long on a stock at Rs.205 and have also bought a Rs.200 put options at Rs.4, then your actual cost of holding the stock is Rs.209. This is also your beak even level and you start making unlimited profits above this level. Another way of hedging your risk is to convert your equity or your futures position into a call option position. Hedging can also be done to reduce your cost of holding a position. For example, if you have bought a stock at higher levels and the price is down, you can consistently keep selling higher calls to ensure that your average cost of holding is reduced. The big question is when to opt for hedging? Remember that the purpose of hedging is not about being right or wrong on the direction. It is when you are not sure of the direction of the market. The moral of the story is that it is better to be safe than to be sorry.