The market has been in a spiral for more than a week, with a possible comeback on October 27. When such a decline occurs, one wonders if it is a good time to go bargain hunting.
Many times, the decline is overstated, and then a pullback, if not a complete reversal, occurs, providing a fast buck for the brave traders. However, there is a danger involved.
The decline might continue, putting the hasty, small-profit-seeking move at danger of a large loss. However, using options, a restricted loss approach is conceivable even during a large unfavorable shift.
Buy Synthetic Calls
The strategy is formed by combining a future with a put option. We buy a futures contract and a put option with a strike price close to the current market price at the same time.
Why synthetic?
This is due to the fact that the expiry day profit or loss experienced by purchasing a futures contract and a put option is the same as purchasing a call option. Why do we use this method instead of simply purchasing a call option?
There are some minor advantages, more qualitative than quantitative. Let us go over them one by one.
Remember that we purchased the put option along with the future. Assume that the market continues to collapse and that the current decline continues. Which is more popular, the call option or the put option?
Higher demand will cause the price of the put option to climb quicker than it would otherwise. In the event of a further decline, the put option is better positioned than a call option because to the fall-related increment and the demand-related additional rise.
During the collapse, the Future contract would be bleeding (losing a lot of money), therefore any extra profit from the Put Option will assist.
Risk administration
When dealing with a synthetic future, risk management becomes much easier. A basic call option can be controlled with a stop loss and its adjustment during the trade’s duration; but, with the synthetic call, we can do more.
Consider a little up move that turns the position profitable, but you expect the advance to persist longer. Because the buy future is your primary position, you may simply book a little loss (relative to a profit in the future) in the put option and purchase a put option with a higher strike.
This may not increase the profitability of the trade, but if this turns out to be a transitory move and we return to where we started, the position may still have some profit for us to gain.
This may also be accomplished in a buy call transaction by moving to a higher strike call option. However, one would not want to sell a larger money-maker call option and buy a smaller money-maker call option. Higher strike call options increase in value less for every rupee increase in the stock.
As a result, bargain hunting using Synthetic Call Buy makes sense. Finally, as with any bargain-hunting trades, it is best to limit this transaction to two or three sessions.
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