May 21, 2024

Hedging has become a crucial component of managing risk in investments. Protecting their portfolios against adverse market movements is a top priority for investors in Singapore’s vibrant stock market. Advanced options hedging techniques offer a powerful means to achieve this goal.

This article will explore various sophisticated options and hedging strategies designed to safeguard your Singapore stock portfolio from unforeseen market turbulence.

Understanding options as hedging instruments

Before diving into advanced hedging techniques, it’s essential to grasp the fundamental concept of options. Options are derivative contracts that give the holder the right (but not the obligation) to buy or sell an underlying asset at a predetermined price (strike price) on or before a specific expiration date. Two primary types of options exist: call options, which grant the right to buy the underlying asset, and put options, which grant the right to sell it.

Saxo Singapore options can be powerful tools for hedging because they enable investors to protect their portfolios from adverse price movements. Depending on their risk tolerance and market outlook, investors can employ different options strategies to mitigate potential losses regarding their stocks.

Using protective put options

One of the most straightforward and effective hedging techniques is using protective put options, also known as “married puts.” This strategy involves buying options on the same number of shares held in your stock portfolio. By doing so, you ensure that, regardless of how much the underlying stock price falls, you have the right to sell those shares at the put option’s strike price.

For example, if you own 1,000 shares of a Singaporean stock trading at $50 per share, you could purchase ten put options with a strike price of $45. If the stock’s price plummeted, you could exercise your put options, selling the shares for $45 each, limiting your losses. However, it’s essential to consider the cost of the put options when implementing this strategy, as it will affect the overall risk-reward profile.

Implementing a collar strategy

The collar strategy combines protective put options and covered call options to create a balanced hedging approach. This strategy is beneficial for investors who are willing to cap their potential gains while also limiting their potential losses.

To establish a collar, an investor simultaneously holds a long position in a stock, purchases protective put options to safeguard against downside risk, and sells covered call options to generate income. The protective puts provide a floor for potential losses, while the covered calls generate income that can offset the cost of the puts.

For example, if you own 1,000 shares of a Singaporean stock trading at $60 per share, you could purchase protective put options with a strike price of $55 and sell call options with a strike price of $65. In this scenario, you limit your potential losses to $5 per share (the difference between the stock price and the put option’s strike price) while generating income from the call options. However, keep in mind that your potential gains are also capped at $5 per share.

Employing a ratio spread strategy

The ratio spread strategy is a more complex options hedging technique that involves creating a hedged position using differing numbers of call and put options. This strategy can be helpful when an investor anticipates moderate price movements in either direction but wants to protect against significant adverse movements.

In a ratio spread, an investor buys a certain number of call options while selling different put options, typically with different strike prices. The goal is to create a position biased toward bullish or bearish market conditions while simultaneously hedging against extreme price movements.

Hedging with advanced options spreads

Options spreads encompass the simultaneous purchase and sale of multiple options contracts, resulting in a strategically hedged position. These sophisticated techniques can be customised to align with an investor’s unique market perspective and risk tolerance. Common types of options spreads include vertical, diagonal, and calendar spreads.

Vertical spreads, for instance, involve buying and selling options of the same type (either calls or puts) with different strike prices but the same expiration date. This strategy can be employed to hedge against moderate price movements in the underlying asset while minimising the cost of the options.

To that end

Advanced options hedging techniques offer investors in the Singapore stock market a range of strategies to protect their portfolios from unexpected market movements. Investors can tailor their hedging strategies to suit their specific risk tolerance and market outlook through protective puts, collars, ratio spreads, iron condors, or advanced options spreads.

However, it’s crucial to remember that options trading involves inherent risks and requires a deep understanding of the options market. Consequently, investors should consider consulting with a qualified financial professional or advisor before implementing advanced options hedging strategies in their portfolios.