Zebu blog

Tag: risk management

  • Let’s Make Sense Of Option Greeks – Part 1

    A lot of factors influence an option’s pricing, which can benefit or hurt traders depending on their positions. The “Greeks” are a set of risk metrics named after the Greek letters that identify them, which reflect how sensitive an option is to time-value decay, changes in implied volatility, and movements in the price of its underlying security.

    Theta, vega, delta, and gamma are the four basic Greek risk measurements. Here’s a closer look at each.

    Before we begin…
    Options trading can be extremely profitable if done with the right trading system and with discipline. However, you need to back up your strategy with the best Indian trading platform like Zebull from Zebu. We provide one of the lowest brokerages for intraday trading and are one of the top brokers in the share market right now. And we would love to help you with your options strategy execution.

    Why option Greeks
    For the uninitiated, options can be exercised, or converted into shares of the underlying asset, at a set price. Every option has an expiration date and a premium connected with it. One of the most popular option pricing models is Black-Scholes, which leads to price fluctuations. Greeks are frequently viewed alongside an option price model to properly assess risk.

    Volatility
    Volatility refers to how much an option’s premium (or market value) changes before expiration. Financial, economic, and geopolitical risks can all create price changes.

    Implied volatility measures the market’s expectation of price movement. Investors use implied volatility (or implied vol) to forecast future price movements in a securities or company. If implied volatility is predicted to rise, the premium on an option will likely rise as well.

    Profitability
    Several words describe a profitable or unprofitable option. The intrinsic value is the difference between the strike price and the price of the underlying stock or asset.

    At-the-money options have the same strike price as the underlying asset. An in-the-money option has a profit because the strike price is higher than the underlying price.

    In contrast, an out-of-the-money option has no profit when compared to the underlying’s price. In the case of a call option, the underlying price is less than the strike price. A put option is OTM when the underlying price exceeds the strike price.

    Influences on an Option’s Price
    Assuming other variables stay constant, an increase in implied volatility increases an option’s price.

    Traders that are long or short will have different returns. If a trader is long a call option, increased implied volatility is beneficial since it increases the option premium. For traders holding short call options, an increase in implied volatility has the opposite (or negative) effect.

    A surge in volatility would not assist a naked option writer because they want the option’s price to fall. Writers are option sellers. If a writer sells a call option, the buyer will exercise the option if the stock price rises above the strike. That is, if the stock price rose enough, the seller would have to sell shares to the option holder at the strike price.

    Sellers of options are compensated for the risk of their options being exercised against them. This is called shorting.

    A decrease in implied volatility, shorter expiration time, and a decline in the underlying security’s price favour the short call holder.

    Increasing volatility, time left on the option, and underlying will benefit long call holders.

    Indicated volatility decreases, time till expiration increases, and the price of the underlying security rises for short put holders, whereas long puts profit from an increase in implied volatility, time until expiration increases, and the underlying security price decreases.

    During the life of most option deals, interest rates play a little influence. Its impact on an option’s price is measured by rho, a lesser-known Greek. Generally, higher interest rates make call options more expensive and put options cheaper.

    All of this sets the stage for examining the risk categories used to assess these variables’ relative impact.

    Remember that the Greeks help traders forecast price fluctuations. In this article, we have laid a foundation on what moves an option price. In the next article, let’s take a closer look at the different Greeks in an option.

    At Zebu, we strive to provide our customers with the lowest brokerage for intraday trading. Zebull is our proprietary trading platform that lets you analyse option greeks to perfection and is growing fast to become the best Indian trading platform. As one of the top brokers in share market, we believe that we have the right products and features to help you make the best trades. Please get in touch with us to know more.

  • A Beginner’s Guide To Hedging

    Hedging is a beneficial investment strategy that every investor should know about. Hedging in the stock market provides portfolio safety, which is often as important as portfolio growth. Hedging is commonly discussed but not explained. But it’s not a mystical term. Even a novice investor can benefit from learning about hedging.

    Before hedging

    When it comes to trading and investment, you need to choose the right one from a plethora of brokerage firms . One of the important factors you need to look for while executing hedging strategies is the lowest brokerage and someone with a fast-growing online brokerage background.

    Hedging

    Consider hedging as a type of insurance. By hedging, people protect themselves from the financial consequences of an unfavourable event. This does not stop all bad things from happening. However, if a negative event occurs, properly hedged, the damage is lessened.

    Hedging happens very universally. For example, buying a homeowner’s insurance protects you against fires, burglaries, and other unanticipated events. Portfolio managers, investors, and organisations employ hedging to decrease risk. In the financial markets, hedging is not as straightforward as paying an annual insurance premium.

    Hedging investment risk involves strategically using financial instruments or market tactics to offset price risk. Traders hedge one investment by trading in another. To hedge, you must conduct counter-trades in securities having negative correlations. Of course, you must still pay for this type of insurance. For example, if you own XYZ stock, you can buy a put option to protect your investment from large declines. However, to buy an option, you must pay a premium.

    Less risk means less possible profit. So, hedging is a practice used to decrease prospective losses (and not maximise potential gain). If the investment you’re hedging against is profitable, you’ve usually lowered your prospective profit. If the investment fails, your hedging will have decreased your loss.

    Hedging Explained

    Derivatives are commonly used in hedging strategies. One of the most common derivatives is options. In trading techniques involving derivatives, a loss in one investment is compensated by a gain in another.

    Assume you hold Tata motors stock. You believe in the company’s long-term success, but you are concerned about recent losses. Put options let you protect yourself against a decline in CTC by selling it at a predetermined strike price. This is called a married put. If your stock price falls below the strike price, the gains from the put option reduce your losses.

    Hedging Drawbacks

    Every hedging approach has a cost. So, before you utilise hedging, consider whether the possible benefits outweigh the costs. Hedging is used to safeguard against losses, not to create money. The cost of hedging, whether it’s an option or lost earnings from a futures contract, is unavoidable.

    While hedging is similar to insurance, insurance is more precise. With insurance, you are fully paid. Portfolio hedging isn’t exact. Things can get unpredictable. The perfect hedge is a goal that risk managers strive for but rarely accomplish.

    Hedging and You

    Most investors will never trade a derivative. In fact, most long-term investors overlook short-term volatility. Hedging has little value for these investors because they let their investments expand with the market. So why hedge?

    In order to understand how it works, you should hedge your own portfolio. Many large corporations and financial funds will hedge their protfolio. Examples of hedges include oil companies. For example, an international mutual fund may protect against currency swings. Understand and assess these investments with a rudimentary understanding of hedging.

    Forward Hedge Example

    A wheat farmer and the wheat futures market are two examples of hedging. The farmer sows in the spring and harvests in the fall. In the interim, the farmer faces the danger of decreased wheat prices in the fall. While the farmer wants to maximise his harvest’s profit, he does not want to bet on wheat’s price. At the present price of $40 per bushel, he can sell a three-month futures contract. It’s called a forward hedge.

    After three months, the farmer is ready to harvest and sell his wheat at market price. It is now only $32 per bushel. They buy wheat for that price. Simultaneously, he buys back his short futures contract for $32, netting $8. His wheat sells for $32 + $8 hedging profit = $40. When he planted his crop, he locked in the $40 price.

    Assume now that wheat is $44 a bushel. Sells his wheat at market price and buys back his short futures for $4. His net profit is $40 ($44 – $4). Both his losses and gains are reduced.

    The Verdict

    Investing involves a certain amount of risk. A fundamental understanding of hedging methods can help any investor understand how corporations and investors protect themselves.

    Whether or not you decide to start using complex derivatives, learning about hedging will improve your market knowledge and make you a better investor.

    At Zebu, we are one of the best brokerage firms in the country. We provide one of the lowest brokerages and are becoming one of the most sought-after online brokerages in India. Please get in touch with us to know more about our services and products.