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Risk Management [1]
If you believe a stock will appreciate and want to risk little to speculate that the stock will rise what are your option?
Holding a call option is fairly low risk because it would allow me to buy future stocks at a current price. An increase in stock value would limit my losses and allow me to profit by means of leveraged speculation. As a holder exercising a call option, I would be able to benefit from the same profit in underlying stock by paying only a minimal amount of money. By risking only a small percentage of my capital towards an insurance premium, I am potentially able to benefit from trends and hedge away risks within the call-option deadline.
Potential losses can be offset against either long-or-short stock portfolios by means of trading call strategies. A Fiduciary call would allow for a reduced capital outlay by means of replacing stock with a corresponding amount of call options, which would shield stock from losses beyond strike price. A Bull Call Spread would take advantage of moderate underlying stock risings by using short call options as a means to cover long call options. Similarly, a Calendar Call Spread would enable me to profit from stagnant or moderate-rising stock by writing or buying call options of different expiration dates. Finally, Stock Replacement -- a strategy based on studied hedging and Deep in the Money call options, would allow for higher profit while reducing risk and volatility.
2. If I can simultaneously 'Buy a call and Sell a put' to the same underlying asset, with each option having the same strike price and time to expiration have I created a synthetic forward? That is,...
This would have the effect of allowing me to take control or own the asset for nothing. Can this be accomplished? Why or why not?
Simultaneously buying a call and selling a put will neutralize the resulting premium balance, although a net option premium would still have to be paid. Synthetic Forward Contracts are risk-reducing investment strategies, though further strategies should still be implemented in order to counteract potential losses. Likewise, a short trigger option would enable me to create a Synthetic Forward Contract in order to hedge a long position, by simultaneously selling a put struck below the original put being sold. Similarly, an at-maturity trigger forward would be nulled if a pre-determined trigger level is breached by the Synthetic Forward's expiration date.
3. Why would a manufacturer elect to use a long call strategy instead of a forward contract to hedge the risk associated with variable costs?
Most forward contracts are not listed on a stock exchange, since they establish the delivery of a future product only after a contract has been made. Prices are locked in a future contract, whereas a long call option allows for a more profitable outcome because it is an investment based on the underlying number of stock shares purchased, as opposed to the specific amount of the initial investment. While holding a long call option, a manufacturer retains the right to purchase at any time an equivalent number of underlying shares at the predetermined strike price until the expiration date is reached,…
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