Options refer to financial derivatives that give the holder the right, but not the obligation, to purchase or sell an underlying asset like stocks, ETFs, or commodities at a predetermined price on or before a particular expiry date. Kavan Choksi / カヴァン・ チョクシ mentions that for many investors, options can be quite a useful tool for risk management. They act as a hedge against a drop in stock prices. Options are available on a variety of financial products, including ETFs, indices, and equities. Options are known as “derivatives”, as the value of the option is “derived” from the underlying asset.
Kavan Choksi / カヴァン・ チョクシ provides an insight into using options for hedging a stock portfolio
Options trading can be a very efficient way of generating wealth, whether as a standalone technique or as part of a wider investment strategy. Their uses in both falling and rising markets make them quite powerful products. Options are a type of financial derivative that can protect an investment portfolio during market volatility, generate income, as well as add speculative upside with limited capital. When wisely used, they can provide a valuable layer of control over the investments.
For all investors, it is crucial to try to safeguard their portfolio from unexpected market downturns. Traditional strategies like asset allocation, diversification, and investing across asset classes are important for reducing risk. Use of options, however, adds extra protection when hedging the equity portfolio. Options hedging strategies can help in reducing risk, protecting gains, and might also enhance investment returns when used correctly.
Hedging implies to insuring the investments from adverse price fluctuations, quite like buying insurance on the overall portfolio. Options enable investors to hedge against downside risk in their stocks, where one may buy or sell the right to buy or sell an underlying asset at a predetermined price on or before a date in the future.
As Kavan Choksi / カヴァン・ チョクシ mentions that there are several reasons why investors should consider using options for hedging stock, including:
- Protection from downside risk: Protection from downside risk is among the most obvious advantages of hedging with options. In case the stock market drops or one of the stocks declines in price, a smartly chosen option can serve as an effective insurance policy.
- Preservation of capital: Hedging with options enables investors to preserve their capital while continuing to hold their stock position. Doing so can be especially helpful if one has a long-term position and does not want to sell off their stock due to short-term volatility.
- Lower cost: In comparison to other hedging alternatives, options are relatively budget-friendly. By having a well-defined strategy in place, investors can hedge their stock portfolio without committing excessive capital.
- Flexibility: The level of flexibility provided by options is not available for other hedging instruments like futures or bonds. Investors can modify their options positions on the basis of updated opinions regarding the market.
Overall, implementing options for hedging the stock portfolio can be a simple yet efficient way to manage risk and protect investments from market drops.
