Ready to Hedge? Explore Options!3 min read
In options trading, a hedge refers to a strategy used to reduce or manage the risk of adverse price movements in an underlying asset. The primary goal of hedging is to limit potential losses, although it may also cap potential gains.
A common hedging strategy in options trading is to use a “protective put.” This involves buying a put option on the underlying asset. If the price of the underlying asset drops, the put option will increase in value, offsetting some or all of the losses on the underlying asset. Example: For say, you have 400 quantity Infosys stocks in the cash segment. After the result there is fear of stock going down so you can buy the Infy Put option as a protection to minimize the loss.
How to hedge an options position?
Option Buy position:
For an example Nifty is trading at 18,000 and you are bullish on Nifty. You would like to buy Call Option to get the benefit if your view goes right. So you decided to buy an 18,000 call option. There is a chance that the Nifty will go down and you may lose money. To protect from the loss you can choose to hedge your position by Selling 18200 Call option. This strategy is called Bull Call Strategy. If the market goes down then you will lose money in the 18,000 buy Call position but you will make profit in the 18,200 sell call position.
How to execute Hedge position in Paytm Money?
To effectively execute this strategy you can use Basket Order in Paytm Money.
- Go to the “Stocks” dashboard and click on 3 dots (hamberg menu) on the right top side.
- Select “Basket”
- Click on “Add Basket”
- Name the basket, let say “Option Buy with Hedge”
- Select Search and Add. Add the 18000 Call option as a Buy trade and add 18,200 as a Sell trade.
- Now your basket is ready for execution. Just swipe to Execute!! So both the orders will be executed simultaneously.
Hedging Option Sell Position
Lets say you have sold Nifty 18,100 Call Option by expecting Nifty will remain below 18,100 till expiry. There may be a chance of Nifty moving above 18,100 and you may lose money. Protect yourself from the unlimited losses you can Buy 18300 or 18,500 Call option as hedge and limit your loss.
Benefits of Hedging:
- Reduced Risk: Hedging can help reduce the risk of adverse price movements in an underlying asset.
- Reduce Margin Requirement: Option selling needs approximately Futures trade margin. You can reduce option selling margin upto 80% by buying a hedge position.
- Increased Flexibility: Options trading provides investors with a high degree of flexibility in managing risk.
- Enhanced Returns: Some hedging strategies can also potentially enhance returns. For example, a covered call strategy can generate income from option premiums while also limiting potential losses if the price of the underlying asset declines.
- Protection against Unexpected Events: Hedging can also provide protection against unexpected events that could impact the value of an underlying asset. For example, a protective put can help mitigate losses if a company’s stock price drops suddenly due to negative news or an unexpected event.
Overall, hedging can be a powerful tool for managing risk and potentially enhancing returns in options trading. However, it’s important to note that options trading can also be complex and carries its own unique risks, and investors should carefully consider their goals and risk tolerance before implementing any hedging strategy.
Disclaimer: Investments in the securities market are subject to market risks, read all the related documents carefully before investing. This content is purely for information purpose only and in no way to be considered as an advice or recommendation. Paytm Money Ltd SEBI Reg No. Broking – INZ000240532. NSE (90165), BSE(6707) Regd Office: 136, 1st Floor, Devika Tower, Nehru Place, Delhi – 110019. For complete Terms & Conditions and Disclaimers visit: https://www.paytmmoney.com/stocks/policies/terms. The securities are quoted as an example and not as a recommendation
Written By: Peter Cutinho