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Hedging Equity - Case Study Example

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In this case, the investor can use them even to protect his downside. Options also enable one to employ considerable leverage. The trader…
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Hedging Equity
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Download file to see previous pages Another advantage of using options is its ability to allow the trader to sell them against shares that he or she already owns. Through this option, the trader can earn extra income from the sale of these shares.
On the other hand, option strategies have some drawbacks. Options can be of high risk even though they are designed to reduce risks. Options fall the risk-reward ration in that, options with higher returns are also characterized with greater risks and vice versa. Also, even though options have got the leverage advantage, it also has disadvantages arising from the leverage as the loss resulting from them can be horrible since all losses are multiplied. This is especially where too much leverage is used. The use options are also sophisticated in that it takes long for someone to know how it works ( 2015). Options are also risky where there is less information about the quotes as well as other analytical information such as the implied volatility. Dunbar (2012) notes that, options are also not available to cover all stocks as it limits the number of possibilities available to the trader. Another limitation of using the options strategies is the highest commission per dollar invested, which is incurred during their trade. This is especially common for spreads where an investor pays commissions for both spread sides. According to the (2006), the options have higher spreads due to the lack of liquidity. This makes the trader incur more costs in the form of indirect costs when trading them as he will be giving up the spread. There is always a waste of assets since options lose value over time. Therefore, the traders should be right on the direction as well as his timing.
According to Arunajith (2007), the zero cost collars are also called the castles collar and is an option trading strategy, whose use is in the short term so as to seek ...Download file to see next pagesRead More
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