Options: how to hedge investments against panic in the market?

Options are growing in popularity among investors as hedging tools for various asset classes such as equities and currencies. The panic in the financial markets is forcing investors to look for attractive ways to allocate their portfolios and opportunities to capitalize on downtrends. So let's talk about working with options in more detail.

An option (from the English option) is a A financial instrument that gives the holder the right, but not the obligation, to buy or sell the underlying asset at a stated price on or before the expiration date.

There are 2 main types of options:

• Put option (put) gives the holder the right to sell the asset. It is purchased when the investor believes that the value of the asset will decline before the expiration date of the option.
• Call option (call) gives the right to buy an asset. It is purchased if the investor expects the price to rise. The seller of the options assumes the corresponding obligations to fulfill the transaction if the buyer decides to "exercise" his right.

Patrick Eno, head of futures and exchange-traded options at Saxo Bank, notes: "Options offer us additional investment opportunities that can be utilized during times of market panic. For example, an investor with Apple stock can use a put option on the same stock or index to neutralize a price drop and partially or fully protect their investment. In this sense, options work like insurance. If we buy insurance to protect our house from fire or damage, why not protect our capital?".

Benefits of trading options

• One of the advantages of options is that an investor can play on price dynamics at a much lower cost compared to buying the real asset.
• The growing popularity of options is due to the fact that many investors use put options to "sell" in the market and make money even during falling stock prices.

Patrick Eno is convinced that options are only at the beginning of their journey, and their finest hour has not yet arrived: "Options are among the strategic investment instruments in which interest will continue to grow. We are confident that this momentum will continue and we are therefore committed to providing our clients with the necessary knowledge and information to help them utilize options in line with their investment strategies".

Example of using options for hedging purposes

For example, Apple's stock is selling at $100, at the investor there are 100 shares and he anticipates that they will get cheaper over the next couple of months, but the company still has good potential in the long term.

In this case, the investor can buy a May put option with a strike price of $95 and a premium of $4.20 per share. Thus, one option for 100 shares would cost him $420.

The put option would allow him to sell Apple shares for $95 at any time up to the maturity date, which is in May, and thus eliminate the possibility of financial loss if the stock price falls below that mark.

The most popular modern options

The following options are the most popular among Saxo Bank clients:

• USD: Interest in buying put options on the dollar against the euro has increased over the past month. The panic in the stock markets and the general risk aversion makes investors doubt that US rates will rise and the dollar will strengthen.
• GBP: We are seeing increasing interest in buying options with expiration dates after the June 23 referendum. This is a great example of using long term options.
• CNH: Rumors of a possible devaluation of the yuan are forcing investors to hedge their risks with CNH put options and USD call options.

The most popular stock options:

• SPDR S&P 500 (ETF)
• Apple
• Energy Select Sector SPDR Fund (ETF)
• Barclays Bank iPAth S&P 500 VIX (ETF)
• Facebook

"Exchange-traded funds are gaining popularity among investors around the world, providing access to global markets, different instruments and sectors. Many funds have exchange-traded options. In particular, the S&P 500 ETF stock option is considered the most popular today. Trading options on ETFs allows investors to reduce the systemic risks inherent in individual stocks and diversify your portfolio. Also, with the volatility in commodity markets, options in the energy sector are growing in popularity".

Currently, there is a wide range of options that are ideal for hedging the risks associated with the dynamics of exchange rates, they allow you to earn on their fluctuations and insure your investment from sharp unpredictable fluctuations.

Related articles

• What is an option?
• Spots, options and futures: take advantage of market opportunities at 100%
• Futures option or futures option

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