Hedging with a Put. Please clarify my doubts in the given example

#1
Hi,
Iam recently initiated into the stock market and made some profits and losses. Iam now interested in FNO (or Options to be exact) as a hedging strategy for the stock transactions. I have studied a lot of material on the net and made up this quick example to clarify my doubts. Some of this is specific to icicidirect (the only trading account that i have)

Suppose I buy 400 shares of Aban @ 966 (current market price)

I want to hedge my purchase with a Put option

1) Lot size for Aban is 400. Can I buy a Put option of 400 lot-size If I only had 200 of the underlying?

2) I only want to limit my losses if my stock goes down. So I assume the best option contract is one near my buy price? In this example i can see an option OPT-ABALLO-30-Jul-2009-960-PA @51.50 for a strike price of 960 (close to my buy price). Is this the best option for me or should I be looking at a higher strike price?

3) I submit a buy for this option with quantity 400 and limit price 30.0. My premium should be calculated as 400 x 30 = 12000 INR. Is this right? when I tried earlier for another stock I saw a difference in the premium compared to what i had given as the limit price for the option

4) I assume that icicidirect will only debit this 12,000 for paying to the seller of the contract (plus brokerage etc, of course)? This 12000 is my only liability and whether the contract is in or outof the money at expiry, icicidirect will not be able to debit anything else?

5) Suppose the stock price comes down to 600 INR near expiry of contract. I assume the right thing for me to do is excercise the option? If i click on excercise will icicidirect debit the 400 shares from my demat and give to seller of Put (and then credit my cash account with the 400 x 966 strike price)

OR

Do I have to sell my stock at 600 in the cash market(making a loss) and then square off my Put contract @ FNO market price (which should be high since stock has come down) and thus get my hedge done?

6) Lastly, if i only had 200 shares of underlying, can I excercise my Put option partly (only 200 out of 400 lot) and then square off the remaining 200?

7) In the reverse case, suppose The stock went up to 1200. I can sell the stock in Cash market and do not need to bother about the Put option, right? if the Put option is still trading at some small value, can I square off the Put by selling off the option (to reduce the premium loss that i paid for this insurance)?

Thanks,
vishwas
 
#2
Hi,
Iam recently initiated into the stock market and made some profits and losses. Iam now interested in FNO (or Options to be exact) as a hedging strategy for the stock transactions. I have studied a lot of material on the net and made up this quick example to clarify my doubts. Some of this is specific to icicidirect (the only trading account that i have)

Suppose I buy 400 shares of Aban @ 966 (current market price)

I want to hedge my purchase with a Put option

1) Lot size for Aban is 400. Can I buy a Put option of 400 lot-size If I only had 200 of the underlying?
You can buy Put option of any stock of any quantity irrespective of whether you own the stock or not.

2) I only want to limit my losses if my stock goes down. So I assume the best option contract is one near my buy price? In this example i can see an option OPT-ABALLO-30-Jul-2009-960-PA @51.50 for a strike price of 960 (close to my buy price). Is this the best option for me or should I be looking at a higher strike price?
That depends entirely upon your stop loss. Your net buy is Rs. 386400. Lets say you want to limit your loss to 10% = 38640.

If the premium of the Put option for 960 strike price is = 51 Rs that makes a net premium payment of 51*400 = 20400.

If the stock has already gone below 966 ( 960 to be precise) you have already lost 6*400 = 2400 Rs.

So the net money out of your account at that point will be 20400+2400 = 22800.

Now since your stop loss is 10% you can still afford to lose 15840. So better option will be the one where you loss in account + option premium = your stop loss capital ( in this case 38640)
3) I submit a buy for this option with quantity 400 and limit price 30.0. My premium should be calculated as 400 x 30 = 12000 INR. Is this right? when I tried earlier for another stock I saw a difference in the premium compared to what i had given as the limit price for the option

4) I assume that icicidirect will only debit this 12,000 for paying to the seller of the contract (plus brokerage etc, of course)? This 12000 is my only liability and whether the contract is in or outof the money at expiry, icicidirect will not be able to debit anything else?

5) Suppose the stock price comes down to 600 INR near expiry of contract. I assume the right thing for me to do is excercise the option? If i click on excercise will icicidirect debit the 400 shares from my demat and give to seller of Put (and then credit my cash account with the 400 x 966 strike price)

OR

Do I have to sell my stock at 600 in the cash market(making a loss) and then square off my Put contract @ FNO market price (which should be high since stock has come down) and thus get my hedge done?
Obviously second option, first one is not feasible. Why would someone in the market buy at 966 when the stock is available at 600?

6) Lastly, if i only had 200 shares of underlying, can I excercise my Put option partly (only 200 out of 400 lot) and then square off the remaining 200?
Partial excercise is not feasible.

7) In the reverse case, suppose The stock went up to 1200. I can sell the stock in Cash market and do not need to bother about the Put option, right? if the Put option is still trading at some small value, can I square off the Put by selling off the option (to reduce the premium loss that i paid for this insurance)?
Chances are that your put option will not be liquid at all.

Cheers,

Vipin.
 
#3
Hi,

I am posting this question on my friend's behalf, although this question is not entirely related to the above question.

He sold Nifty 4500 put @ around 100 (getting a premium amount of 5000 per lot), and it is currently trading at around 20. As you can see, he is in profit right now. Now does he need to square off his position to earn the profit or can he wait till expiry and can keep the whole premium amount (if Nifty expires above 4500). What happens if he doesn't square-off his position before expiry? He doesn't have much idea on options, so a detailed explaination will be very helpful.

Thanks in advance.
 

findvikas

Well-Known Member
#4
He is one of such lucky guy, hold it till expiry and he will eat all the premium :D.

If he is looking for some cash then he can square off the position by buying back those puts to gain 100-20 = 80 points per lot (excluding brokerage) or keep holding it as I do not think we will see 4500 again in this month or in this quarter for the matter of fact.

He can have the remaining 20rs as well if he hold this till expiry and the value will become 0.
 
#6
He is one of such lucky guy, hold it till expiry and he will eat all the premium :D.

If he is looking for some cash then he can square off the position by buying back those puts to gain 100-20 = 80 points per lot (excluding brokerage) or keep holding it as I do not think we will see 4500 again in this month or in this quarter for the matter of fact.

He can have the remaining 20rs as well if he hold this till expiry and the value will become 0.
Thanks Vikas, I will let him know.
 

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