Investing during turbulence
Ways of making money in volatile markets
It is frequently said that one of the pillars of sound investing is time and patience. Substantial profits require time to accumulate, and anyone who’s ever opened even a Fixed deposit account knows that the key lies in compounding money (interest gathering interest). Such is the case with all kinds of assets. But is it really possible to hold on to your investments when their current value is below the value you paid for it? What if it’s significantly below? Benjamin Graham reckons that one mustn’t look at their portfolio more than 2 times a year. Is that really possible in this day and age of constantly barking news, whatsapp forwards and financial gurus? When you’re constantly shown a quote for your investment, can you really turn a blind eye? Is it natural for humans to be able to cope with such temptation? In my experience, it is unnatural to be expected to forget about your investments, or only check it 2 times a year. Such abstinence requires monk level training, and for all purposes, very few of us possess such psychological and emotional clout. The tendency to worry about your investments is even higher when markets are facing turbulent times.
Over the last few years alone, we have had several events where significant market movements have been observed: 2014 election results, demonetization, IL&FS NBFC Crisis, RBI Governor resigning, corporate tax rate cuts, and then most recent yes bank crisis and coronavirus threat. Some of these events have positively impacted and others negatively. But each of them undoubtedly causes an emotional dent in the investors' minds, either one of opportunity lost, or losses mounting up. Surely there must be an insurance policy for such trauma one has to live with? If everything from our life to our mobile phones can have an insurance policy, why can’t our investments have one? The answer to this question is that they do! These insurance policies are called Options. Options are particularly useful in turbulent times to protect erosion of wealth.
You can buy Put options that act as an insurance tool to protect your stock investments against falling in value. As with general insurance, you have to pay a premium to acquire the put option. The riskier the deal is for the put option seller, the higher the premium you will have to pay for it. Let’s take an example. You have TCS shares with you which currently trade at 2000 per share, and you do not want the share to go down by more than 5% this month. You can buy a TCS put option for 1900 by paying a small premium to the option seller. This means that if the share price falls by any amount below 1900, the option seller is liable to pay you the difference. Options contracts have an expiry date at which they mature as well as a lot size. Taking the above example ahead, assume you buy the TCS put option of 1900 April 2020. This means that the expiry will be the last Thursday of April (30th April 2020). So if on April 30th, the TCS stock price is 1850, as you have 1900 put option, you will receive 50 rupees from the option seller. If the stock closes at 1500(catastrophic fall), you will be given 400 rupees! If however, the share price doesn’t close below 1900, you receive nothing and forfeit the premium you paid to acquire the contract. Such options contracts are actively traded on the National Stock exchange. Each contract has a minimum lot size and contracts can be traded only as multiples of lot sizes. The lot size of TCS is 125. So each lot would mean you are buying insurance for 125 shares of TCS. This process of safeguarding from unfavorable outcomes is also known as hedging. Options are perhaps the most powerful hedging tool.
Just like you can buy put options to protect against investments from going down, you can buy call options for the exact opposite purpose. A call option can be purchased to protect against upside risk. If you are not invested due to some conviction, or are short on the market, you might want to insure yourself by buying a call option. It works exactly like how a put option does, but in the opposite direction.
It can be really useful to hedge your investments using options especially during turbulent times. If you don’t want to buy individual stock options, you can also buy NIFTY index options and insure yourself from the overall market moving against your investments.
There is an interesting point to be discussed here. Everyone knows that the insurance company rarely loses. The net effect of them selling insurance is that they become rich powerhouses (think LIC). By learning a little more about options, you can also start selling call and put options to potential buyers on the exchange. Like insurance, options are a complicated but really useful tool. The exchange gives you the opportunity to buy or sell options depending on your needs. You can even make complex buy and sell combination options strategies! For some traders, this is a full-time activity and they make their living just by doing this.
By no means does this mean to imply that options are superior to stock investments. Options are riskier if not used as a tool to hedge investments. However, if you learn to manage risk by doing a deep dive on options, and fully learning how they are priced and how to benefit from them, it opens up new avenues of wealth for investors.
If you find yourself interested in learning more about how options can be used as a hedging tool to protect your investments, we highly recommend you check our webinar course here.
If you are inclined in doing a deeper dive and becoming a professional at trading and benefiting from options, you can explore our advanced courses by clicking here.