InvestorQ : What are derivative strategies and how can these derivative strategies help me to manage market risk better?
Dilmini Mercia made post

What are derivative strategies and how can these derivative strategies help me to manage market risk better?

Answer
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Dawn Cherian answered.
1 year ago


Derivative strategies are hybrid positions that refer to a combination of futures and options positions to created limited loss strategies. We can broadly cover four very popular strategies that are regularly used in futures and options trading. Firstly, a protective put refers to a situation when you purchase a future or a stock and it is protected by buying a put option of lower strike. Loss on the downside is limited but profits on the upside are unlimited after the option cost is covered. Secondly, the covered call entails wiring a higher call option on a stock is sold to reduce the cost of your holdings either in the stock or in the stock futures. When stock is in a range, it helps you to reduce your cost of holding. On the upside, the position is fully covered from any kind of loss. However, on the downside the loss can be unlimited as there is not protection.

Thirdly, another popular strategy is a bull call spread which is created by buying a lower strike call option and selling a higher strike call option. This strategy is deployed when the trader is moderately bullish on the stock and uses the premium on the higher call to reduce the price of the lower call option. You can also use a bear put spread when you are moderately bearish on the stock. Lastly, there is popular volatility strategies referred to as strangles and straddles which can be used when markets are difficult to predict in terms of direction. Strangle is more popular than a straddle and it entails buying a call of a higher strike and simultaneously buying a put option of a lower strike. Once the premium costs are covered, the trader makes profits either ways as long as there is volatile movement. Higher the volatility, greater the chances of making profits on this strangle strategy. If you expect the markets to be range bound, you can also sell strangles.