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If stock trading is too vanilla for you or if you want to enjoy the advantages of margin trading, it might be time to look into options trading.
An option is a contract with an underlying security or basket of securities, each with a strike price indicated. For someone who buys options, these contracts give you the right to buy or sell the securities at a particular price on a particular date.
Essentially, options trading enables you to make money from price movements, so it can be particularly useful in volatile markets.
Case in point: The US market has been extremely volatile of late and prices have been fluctuating like crazy. In fact, US stocks have not been this volatile since the 2008 financial crisis. Volatile markets mean that trading stocks the traditional way is going to be risky and discouraging, as there is no telling how long you’ll have to hold on to them before they’ll enjoy decent gains.
With options, you have another way to make money from the US market or generate returns from your “stuck” US stocks.
Here’s how to hedge against the volatile US stock market with options.
Short puts and short calls
Short puts and short calls offer a way to hedge against stock volatility and make some money from price movements.
Simply put (pun intended), buying a put option gives you the right to sell an underlying security at a particular price by a particular date. People buy put options, as they can “lock in” the strike price when the stock price is falling, if they want to sell their stocks.
When you write a short put, you are selling put options (that you don’t already own), earning the premium from that sale. If the asset price falls below the strike price, you’ll be assigned the stock — i.e. you’ll have to buy the security at the strike price from the person who bought your put option.
Here’s how to hedge: If the stock price remains above the strike price, you won’t be assigned to buy the asset off the options buyer (you’re the seller). You’ll keep the premium earned (less any fees) and the option expires quietly with no further action required.
For those who buy a call option, they’ll gain the right to buy an underlying security at a particular price by a particular date. People buy call options, as they can “lock in” the strike price when the stock price is buying, if they want to buy stocks.
In the case of a short call, you are selling call options (preferably of a stock you already own), earning the premium from that sale. If the asset price goes above the strike price, your options contract will be exercised, which means you’ll need to sell off your stocks to the person who bought your call option.
Here’s how to hedge: If the stock price remains below the strike price, the short call won’t be exercised. Similarly, it expires with no further action required, and the premium (less any fees) goes into your trading account.
In essence, if the stock prices are very high, you can execute a short put to own the stock at a lower price, while earning the premium. Otherwise, if your stocks are “stuck” with a paper loss, you can still earn money on the premiums by selling call options (strike price should be higher than the price you paid).
In this way, you can try to make money from upwards or downwards price movements, or hedge against the risk presented by securities you already own. For instance, if you own Apple stocks, you can hedge against declines in Apple stock prices using short calls, earning the premium in the meantime.
Here are some tutorials by moomoo that can help you with options short puts and short calls.
How to buy a call
How to buy a put
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Make sure you’re covered
It’s always a good idea to use a covered call strategy — this means you already own underlying securities for the option you’re trading. Otherwise, you might experience losses that you may not be prepared for (i.e. forced to buy the underlying stock at the high market price to fulfil the short call, which is a lower price).
In addition, with a covered call, you gain two possibilities to earn from your securities: Via the premium of your short option, and capital gains from the sale of your securities.
While a covered call can help you generate income from the securities in your portfolio, there is a catch — you could be “forced” to sell your securities if the strike price is reached, which limits the capital gains potential of your assets.
A cash covered put, on the other hand, is a strategy in which you get a put option on a security you do not own but have the money to buy in case you exercise the option. You receive a premium from selling the put option if the strike price is not reached and the option is not exercised. On the other hand, if the strike price is reached and you exercise the option, you are obliged to buy the security at the strike price.
Cash covered puts give you two ways to earn money from an underlying security — from the option premium, or from buying the securities at a lower price (possible future gains).
Other options strategies
Here are some other strategies available on moomoo that you might want to explore when you’ve gotten more comfortable with trading options:
Spreads — Spreads involve buying and selling several options concurrently in order to maximise profits or manage risk. For instance, you might buy a call option with a lower strike price while at the same time selling another call option with a higher strike price.
Straddles — The straddle strategy involves purchasing a call option and a put option with the same strike price and expiration date on the same underlying security. This enables you to earn from price movements in both directions.
Strangles — The strangle strategy involves holding a long position in a call option as well as a put option, both on the same underlying security and with the same expiration date, at different strike prices. This enables you to profit from price movements in both directions.
Moomoo supports common option strategies including covered calls, spreads, straddles and strangles.
So, how do you pick a strategy? That will depend on your investment objectives, your risk tolerance and the current state of the market and levels of volatility. Make sure you do your research, know the risks involved, and trade on a dummy account for practice before attempting to execute real trades.
Support for your options strategies
The moomoo app supports your options strategies with a plethora of features designed especially for options traders. These include:
Real-time options chain with customisable features
Unusual options activity
Options price calculator
Options P/L analysis
Options volatility analysis
moomoo SG’s exclusive promotions
Looking to start trading options? The moomoo desktop and mobile apps offer the tools and support you need for the greatest chances of success.
What’s more, moomoo SG offers exclusive promotions to reward new users. Check out their current promotions here.
The information and data used in the articles are for illustration only. Past performance does not indicate or guarantee future success. Returns will vary, and all investments carry risks, including the loss of principal. All views expressed in the article are the independent opinions of MoneySmart Singapore. Neither moomoo Singapore or its affiliates shall be liable for the content of the information provided. This advertisement has not been reviewed by the Monetary Authority of Singapore.
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Original article: How to Hedge Against the Volatile US Stock Market with Options.
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