Investors are increasingly turning to options as a hedging tool for various asset classes, such as stocks and currencies. Market panic forces investors to seek attractive ways to diversify their portfolios and profit from downward trends. Let’s explore how options work in more detail.
Option (from English ‘option’) is a financial instrument that gives the holder the right, but not the obligation, to buy or sell an underlying asset at a specified price on or before the expiration date.
There are two main types of options:
- Put option gives the holder the right to sell an asset. It is purchased when an investor believes the asset’s value will decrease by the option’s expiration date.
- Call option gives the right to buy an asset. It is purchased when an investor expects the price to rise. The seller of the options takes on the corresponding obligations to complete the transaction if the buyer decides to ‘exercise’ their right.
Patrick Genold, Head of Futures and Exchange Options at Saxo Bank
Patrick Genold, Head of Futures and Exchange Options at Saxo Bank, notes: “Options open up additional investment opportunities that can be used during market panic. For example, an investor with Apple shares can use a put option on the same stock or index to offset a price drop and partially or fully protect their investment. In this sense, options work like insurance. If we buy insurance to protect our home from fire or damage, why not protect our capital?”
Advantages of Trading Options
- One advantage of options is that investors can play on price movements with much lower costs compared to buying the actual asset.
- The growing popularity of put options is due to many investors using them to ‘sell’ on the market and make profits even during stock price declines.
Patrick Genold is confident that options are just beginning and their time has not yet come: “Options are among strategic investment tools, and interest in them will grow. We are sure this trend will continue, and therefore we strive to provide our clients with the necessary knowledge and information that will help them use options according to their investment strategies.”
Example of Using Options for Hedging
For example, Apple shares are trading at $100. An investor owns 100 shares and expects them to decline in the next couple of months, but the company still has good long-term potential.
In this case, the investor could buy a May put option with a strike price of $95 and a premium of $4.20 per share. This would cost the investor $420 for one option covering 100 shares.
The put option would allow him to sell Apple shares at $95 at any time until the expiration date in May, thus eliminating the risk of financial losses if the share price falls below that level.
Most Popular Modern Options
- USD: Interest in buying put options on the dollar against the euro has increased over the last month. Market panic and a general anti-risk sentiment make investors doubt whether U.S. rates will rise and the dollar will strengthen.
- GBP: We see increasing interest in options with expiration dates after the referendum scheduled for June 23. This is a great example of using long-term options.
- CNH: Rumors of a possible devaluation of the yuan have led investors to hedge their risks using put options on CNH and call options on USD.
Most popular options on stocks:
- SPDR S&P 500 (ETF)
- Apple
- Energy Select Sector SPDR Fund (ETF)
- Barclays Bank iPath S&P 500 VIX (ETF)
“Exchange-traded funds are gaining popularity among investors worldwide, providing access to global markets, various instruments, and sectors. Many funds have exchange options. In particular, the most popular is the option on S&P 500 ETF shares today. Trading options on ETFs allows investors to reduce systemic risks associated with individual stocks and diversify their portfolio. Also, with instability in the commodity markets, the popularity of options in the energy sector is increasing.”
Currently, there is a wide range of options that perfectly suit risk hedging related to currency rate dynamics, allowing you to profit from their fluctuations and protect your investments from sharp unpredictable swings.
FAQ
What is an option?
An option is a financial instrument that gives the holder the right, but not the obligation, to buy or sell an underlying asset at a specified price on or before the expiration date.
What are the two main types of options?
The two main types of options are put options, which give the right to sell an asset, and call options, which give the right to buy an asset.
How can options be used for hedging?
Options can be used to protect investments from market downturns. For example, a put option allows an investor to sell an asset at a predetermined price, limiting potential losses if the asset’s value decreases.
