Put Options to protect your stock portfolio

Discussion in 'Options' started by Mohan, Mar 9, 2005.

  1. Mohan

    Mohan Member

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    Put Options to protect your stock portfolio

    Are you constantly worrying about fall in value of your share portfolio in case of a market fall? Here is a solution - buy put options...

    Worried about the wild market swings, which cause undue harm to your portfolio? Do not despair, as there is an insurance cover available in the form of options. By buying put options one can safely hedge ones portfolio against market downswings without selling ones shares.The only price you pay is a small premium just like you do for your life insurance policies.

    What are put options?
    A put option is a financial instrument like a share, which you can buy and sell in the derivatives segment of the stock market. When you buy a put option, you get the right to sell a specific quantity of the underlying shares, which the put option represents (for instance, Tisco put options will represent a specific number of Tisco shares). However, you are not obliged to sell i.e. if selling the shares would result in a loss to you, you can just let the option lapse.

    A put option gives you the right to sell the underlying shares at a predetermined price called the strike price.For instance,if you buy one Tisco put option of strike price of Rs 400, the option will give you the right to sell the one Tisco share at Rs 400.Also,a put option gives you this right for a specific period of time ranging from one month to three months.

    If the price of the underlying shares rise
    Lets understand this with an example. If you have a put option to sell one share of Reliance at Rs 540 within 1 month and the price of Reliance rises to Rs 550, you simply let the put option lapse i.e. dont sell your Reliance share.

    If the price of the underlying shares fall
    Similarly, if you have a put option to sell 1 share of Reliance at Rs 540 within 1 month and the price of Reliance falls to Rs 530, you can go ahead and exercise your option at Rs 540 and benefit by Rs 10.

    Where does the share come from?
    Since we are discussing how to hedge your portfolio in case of a fall in prices, we assume you already hold some stock. In any case, our derivatives market currently works on settlement by payment or receipt of cash and not on physical delivery of shares.

    So who is obliged to buy when you sell?
    The seller or writer of the put option is obliged to buy the underlying shares at the specified price if you decide to sell. In return for taking that risk, he receives the premium you have paid.

    Cost of options
    Buying an option comes at a cost.You need to pay a premium for purchasing the option.You also need to pay brokerage, stamp duty, service tax and Securities Transaction Tax (STT). This means that even if you decide to exercise your option, when you compute your profits, reduce these costs to know the real (net) amount that will actually come to you.

    Using puts on a portfolio of stocks
    To provide protection in the event of market decline, a put option can also be used in conjunction with a stock portfolio. Most investors hesitate to liquidate a portfolio even in uncertain market conditions, as they feel that the market will eventually move up in their favour. By buying a put option, they can protect themselves against decline in the stock price. If the market price increases, then they can just let the put option lapse. So, what is essentially lost is only the premium.

    One can buy the put options on the stocks that form a part of ones portfolio. Since most of the stocks are not a part of the F&O trading list, it would be best to buy put options on either the Nifty or the Sensex. More so, if one has a portfolio of Rs 4 lakh or more, consisting of stocks that tend to move in tandem with the broad market.The size of the options contract should mirror the size of the portion of the portfolio one is looking to hedge. Since the current minimum lot for Nifty options is 200 and the current index value is around 2100, this gives a minimum contract value of more than Rs 4 lakh. In other words, only if one is hedging a portfolio of at least Rs 4 lakh plus will this strategy work.

    With put options one can safely hedge ones portfolio against market downswings without selling ones shares.

    To provide protection in the event of market decline, a put option can also be used in conjunction with a stock portfolio.

    Since most of the stocks are not a part of the F&O trading list, it would be best to buy put options on either the Nifty or the Sensex.
     
  2. Neal

    Neal Member

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    You can also sell a put option to profit from a static market!

    Buying options allows you to profit from rising markets (in the case of call options) and falling markets (in the case of put options), however, the versatility of options also means that certain option strategies will enable you to profit in a static market.

    Selling a put option, for example, when you feel that the underlying share price will remain stable or at least not fall sharply, allows you take in premium income. As the option nears expiry, the time value of your short put will be eroded and if, as you forecasted, the underlying price has not moved sharply, you will be able to close out your short put position at a cheaper premium than that at which you sold to open the position, thus realising a profit.
     
  3. supratik

    supratik Member

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    Gaurav,
    datta_supratik@rediffmail.com is my mail id, hope to hear from you soon.
    Please put a subject line as Traderji - would help me to trace your mails


    Thanks and Regards
    SUpratik
     
  4. adamke

    adamke New Member

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    Sir Please explain the call and put options with example.
     
  5. VICKY_SEEKINGINR

    VICKY_SEEKINGINR Member

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    Hi Wat is the logic behind the nifty Call?
    NOw market is at 3540+
    but at Nse Active calls, 3600 call is most active? what its mean?

    and also 29 june 3600 call is most active?

    Thanks
     
  6. amit_shriv

    amit_shriv Member

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    Active call means that it is having a high volume. Same for Put.
     
  7. gopii

    gopii Member

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    Hello all seniors

    i am trying to move from futures into options on the nse, however i observe not many scripts are liquid and volumes are too less.
    as the number of scripts avaliable are also quite less, and since the seniors are already trading in options, i sincerely seek the following info:

    1) pl could u suggest me a list of scripts on which options traded in reasonable volumes

    2) also to concentrated on premiums of which calls : ATM / OTM / ITM ???
    and puts : ATM/OTM/ITM (from yr experiences)

    thks
    gopii
     
  8. srikanth_kandalam

    srikanth_kandalam Member

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    There needs to be a caveat for these feel good posts. Buying a PUT option is equivalent Buying a CALL and Shorting the stock. Similarly selling a PUT option IS EXACTLY the Same as what they call is a "COVERED CALL" - while buying puts does provide some risk- it is important to know about your position delta. IF you bought FAR out of the money puts- the rate of fall will not cover the increase in the value of puts- if the whole Idea is to protect you on the way down.

    Please dont trade options based on underlying asset movements- that is one part of a 4 Dimensional puzzle!
     
  9. redhurajender

    redhurajender New Member

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    good morning,
    i want to know about call and put options.could you please help me in any way?
    redhurajender
     
  10. rinku4142

    rinku4142 Member

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    one question what would happen if i sell buy option and buy put option?
     

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