Current:Home > MyStrategic Uses of Options in Investment: Insights into Hedging Strategies and Value Investing -Lighthouse Finance Hub
Strategic Uses of Options in Investment: Insights into Hedging Strategies and Value Investing
View
Date:2025-04-18 08:39:13
The hedging properties of options
Most of the time, options are used by professional institutional investors as hedging tools to build a safer investment portfolio.
For example, if a short-selling institution wants to protect itself from the risk of a stock continuing to rise, it can use a Long Covered Call. This way, if the stock keeps going up, the gains from the Long Covered Call can offset the losses from the short position.
If you own shares in a company and you anticipate some short-term risks that might cause the stock to drop, you can use a Long Naked Put. This way, if the stock price falls, the gains from the put option can offset the losses from the stock.
So, buying Calls can lock in losses for short sellers, and buying Puts can lock in gains for stockholders. You can think of the premium as a form of insurance. When I looked it up, I found that the term "premium" also means insurance in some contexts.
What can value investors do with options?
In my research, I found that many people recommend selling options rather than buying them. While buying options has limited losses and unlimited potential gains, the premium paid for buying options can be quite high due to time value, making it hard to ensure profitability. Of course, this advice is not typically aimed at speculators.
So, when can we use the strategy of selling options?
1. Buying the Dip: When you want to increase your holdings of a stock but prefer to buy when the price drops another 10%, you can use a Sell Naked Put with a strike price set at 90% of the current stock price. If the stock price rises, the put options expire worthless, and you pocket the premium. If the stock price drops, the options are exercised, and you acquire the stock at your target price, with the premium effectively acting as a discount. This makes Sell Naked Puts a powerful tool for value investors to build positions. Warren Buffett is a big advocate of this method.
2. Selling scenario: When you want to sell a stock if it goes up by 10%, you can use a Sell Covered Call with a strike price set at 110% of the current stock price. If the stock doesn't reach the target price, you get to keep the premium. If the stock price reaches the target, you sell the stock at the target price and also keep the premium.
Both of these strategies make the returns from buying and selling stocks more predictable. But are there any downsides? The downside is that in the event of a dramatic stock price increase or decrease, your gains are capped at the strike price due to the Sell Put and Sell Call strategies, preventing you from benefiting from further gains.
Options are a derivative form of stock trading, divided into call options (CALL) and put options (PUT), which can be used to go long or short. Although some people use options as a leveraged speculative tool, their primary use is to provide risk hedging for institutions. For value investors, Sell Naked Puts can be used to increase stock holdings, while Sell Covered Calls can be used to sell stocks.
veryGood! (69757)
Related
- Apple iOS 18.2: What to know about top features, including Genmoji, AI updates
- Give Them Lala With These Fashion Finds Under $40 Chosen by Vanderpump Rules Star Lala Kent
- Maryland reports locally acquired malaria case for first time in more than 40 years
- Where is Vanna White? The 'Wheel of Fortune' host has rarely missed a show.
- A South Texas lawmaker’s 15
- Pickleball, the fastest growing sport in the country, is moving indoors
- Utilities begin loading radioactive fuel into a second new reactor at Georgia nuclear plant
- Top 10 deadliest hurricanes in U.S. history
- Pregnant Kylie Kelce Shares Hilarious Question Her Daughter Asked Jason Kelce Amid Rising Fame
- Residents of east Washington community flee amid fast-moving wildfire
Ranking
- Tony Hawk drops in on Paris skateboarding and pushes for more styles of sport in LA 2028
- Connecticut kitten mystery solved, police say: Cat found in stolen, crashed car belongs to a suspect
- Teen in stolen car leads police on 132 mph chase near Chicago before crashing
- 2023 track and field world championships: Dates, times, how to watch, must-see events
- Juan Soto to be introduced by Mets at Citi Field after striking record $765 million, 15
- The Bachelor Host Jesse Palmer Expecting First Baby With Pregnant Wife Emely Fardo
- Abuse, conspiracy charges ensnare 9 Northern California cops in massive FBI probe
- DonorsChoose sees banner donation year with help from Gates Foundation and millions of small gifts
Recommendation
Trump wants to turn the clock on daylight saving time
George Santos says ex-fundraiser caught using a fake name tried a new tactic: spelling it backwards
Natural history museum closes because of chemicals in taxidermy collection
Taekwondo athletes appear to be North Korea’s first delegation to travel since border closed in 2020
Man charged with murder in death of beloved Detroit-area neurosurgeon
US postal worker sentenced to federal prison for PPP loan fraud in South Carolina
Are you a Trump indictment expert by now? Test yourself in this week's news quiz
North Dakota AG, tribal nation, BIA partner to combat illegal drugs on tribal lands