FINANCIAL PLANNING AND WEALTH MANAGEMENTAPPLIED PROJECTCPL-5559Submitted To: Diana OliveiraFPWT – 0056SUBMITTED BY-Navdeep Kaur (C0687396)Daljeet Kaur (C0699887)Gurpreet Kaur (C0705588)Amrutha Lilly (C0690981)Introduction In this project, we hedge our client stocks investments. We assume that they rebalanced their stock portfolio and had 1200 shares in each of AGI and ARX. We will hedge using options. So, we determine the following:1.
Key characteristics of hedging using options.2. Advantages and disadvantages of this strategy.
- Thesis Statement
- Structure and Outline
- Voice and Grammar
3. Describe the Call and Put options.4. Correct selection of the option.
5. Identify the option contracts that should be bought/ sold.Options An option is an agreement that gives the purchaser the right, yet not the commitment, to purchase or offer an underlying asset at a cost at the latest a specific date. A choice, the same as a stock or bond, is security. It is likewise a binding contract with strictly characterized terms and properties. Options include hazards and are not reasonable for everybody. Options trading can be theoretical and carry the substantial risk of loss. Just contribute to risk capital.
There are two primary reasons why an investor would utilize options: to speculate and to hedge. (Investopedia, 2018) Hedging using optionsA hedge is an investment to decrease the risk of unfriendly value developments in a benefit. Regularly, a hedge consists of taking an offsetting position in a related security, for example, a futures contract. There is no doubt that the hedging strategy can be valuable, particularly for large institutions. Even the individual investor can profit. Imagine that you needed to take pros of technology stocks and their upside, yet you likewise required to restrict any losses.
By utilizing options, you would have the capacity to limit your drawback while getting a charge out of the full upside in a cost-effective way. (Investopedia, 2018)Key characteristics of hedging using optionsThe following are some key characteristics of the hedging using the options:1. Hedging protects against the losses and reduces the several types of risks.
2. Hedging is primarily used for managing the risk.3. Hedging is used for the large industries.4.
Hedging is the cost-effective way.5. Hedging grew in all areas of finance and business.6. The strategy like secured calls and protective puts are used to hedge.
Advantages and disadvantages of this strategyAdvantages:1. Leverage: Options enable you to utilize powerful force. This is a favorable position to disciplined traders who know how to utilize use.2. Risk ratio:A few strategies, such as purchasing options, allows you to have unlimited upside with a restricted drawback.3. Unique Strategies:Options enable you to make unique procedures to take benefit of different qualities of market-like instability.
4. Low capital necessities:Options allow you to take a situation with low capital requirements.Disadvantages:1. Lower liquidity:Many individual investment opportunities don’t have much volume at all. The way that each optionable stock will have option trade at various strike costs and expirations implies that the specific option you are trading will be low volume except if it is a standout amongst the most popular stocks or stock lists. This lower liquidity won’t make any difference much to a little broker that is exchanging only ten contracts, however.2.
Higher spreads:Options tend to have higher ranges because of the absence of liquidity. This means it will cost you more in indirect costs while completing an alternative exchange since you will be giving the spread when you trade. 3. Higher commissions:Options trade will cost you more in commission per dollar contributed. These commissions might be much higher for spreads where you need to pay commissions for the two sides of the spread. 4.
Complicated: Options are extremely complicated to first-time investors. Most beginners and even some financial specialists think they understand them when they don’t.5.
Time Decay:When purchasing options, you lose the time estimation of the options as you hold them. There are no cases to this standard. 6. Less data:Options can be harder to get quotes or other standard analytical data like the suggested unpredictability.
7. Options not available for all stocks:Although options are available on several stocks, this still confines the number of potential outcomes available to you. (Thinktrade, 2006)The Call and Put optionsCall option:Call options are an understanding that gives the option purchaser the right, however not the commitment, to purchase a stock, bond, commodity or different instruments at a predetermined cost inside a time. The stock, bond, or ware is known as the underlying assets. Profits gain regarding increases in the price of underlying assets.A call option gives the rights to buy a share on a strike price with an expiry date.
The share price of the call option is known as the premium. It is the cost paid for the rights that the call option gives. On the off chance that at expiry the primary resource is underneath the strike value, the call purchaser loses the premium paid.
This is the greatest misfortune. (Investopedia, 2018)Call option commonly uses for:1. Tax management Speculators at times use option as a method for changing the designation of their portfolios without really purchasing or offering the hidden security. The main expense to the investor for taking part in this technique is merely the expense of the option contract.
2. Income generationA few speculators utilize call option to produce income through a covered call technique. This method includes owning an underlying stock while in the meantime composing a call option or giving another person the right to purchase your share. The investor gathers the option premium and expectations the option lapses useless (below strike cost). This strategy creates an additional income for the investor yet can likewise constrain benefit potential if the underlying stock value rises forcefully.
3. SpeculationOptions contracts give purchasers the chance to get a noteworthy introduction to a stock at a generally little cost. Utilized in seclusion, they can provide significant additions if the stock rises yet can likewise prompt a 100% loss of the premium if the call option expires useless because the underlying stock value fails to move over the strike cost. Advantages of the call option? Cost efficiencyOptions have incredible utilizing power. A speculator can get an option position like a stock position, however at a huge cost investment funds. For instance, to buy 200 shares of an $80 stock, an investor must pay out $16,000.
Be that as it may, if the investor were to buy two $20 calls (with each contract representing to 100 shares), the aggregate expense would be just $4,000 (2 contracts x 100 offers/contract x $20 market price). The speculator would then have an extra $12,000 to use at his or her caution.It isn’t exactly as straightforward as that. The investor needs to pick the right call to buy to emulate the stock position appropriately. However, this system, known as the stock replacement, isn’t just reasonable yet additionally practical and cost-efficient.? Lesser riskier than equitiesThere are circumstances in which purchasing options is more dangerous than owning equities, but there are times when options can be utilized to diminish risk. It indeed relies upon how you use them. Options can be less dangerous for investors since they require less financial commitment than equities, and they can likewise be less risky because of their relative impenetrability to the possibly cataclysmic impacts of hole openings.
? Ability to give a high returnYou needn’t bother with calculations to make sense of if you spend less cash and create nearly a similar profit, you’ll have a higher rate return. When they pay off, that is the thing that option ordinarily offer to investors. ? Wide varieties of strategic alternatives The last significant position of options is they offer greater venture options. Choices are an extremely adaptable instrument.
There are numerous approaches to utilize the option to reproduce various locations. We call these positions synthetics. Synthetics positions present investors with different approaches to accomplish a similar investment objective, which can be extremely helpful.
While synthetics positions viewed as a propelled option subject, options offer numerous other key alternatives. ( Ron Ianieri, 2018)Disadvantages of the call option? Lower liquidityNumerous individual investment opportunities don’t have much volume by any stretch of the imagination. The way that each optionable stock will have alternatives exchanging at various strike costs and lapses implies that the specific option you are transferring will be low volume except if it is a standout amongst the most popular stocks or stock records. This lower liquidity won’t make any difference a lot to a little dealer that is exchanging only ten contracts, however.? Higher spreads Options will, in general, have higher ranges considering the absence of liquidity. This implies it will cost you more indirectly while completing an options trade since you will surrender the spread when you trade.? Higher commissionsOption-trade will cost you more in commission per dollar contributed.
These commissions might be considerably higher for spreads where you need to pay commissions for the two sides of the spread.? Complicated Options are extremely complicated to new investors. Most beginners and even some advanced investors think they comprehend them when they don’t.? Time DecayWhen purchasing options, you lose the time estimation of the options you hold them. There are no cases to this standard. (Thinktrade, 2006)Put option:A put option gives their buyer the right to sell the underlying assets at the selected price at a selected time.
The person that sells the option is called a writer of the option. The put options traded on stock, currencies and underlying assets. The strike cost is the cost at which an alternative purchaser can offer the underlying stock.
For example, a stock put option with a strike cost of $10 implies the put choice buyer can sell the provide share at $10 before the given time. ( Adam Milton, 2018)Types of the put option:1. Long Put option: The Long-put choice technique is an essential methodology in choices exchanging where the financial specialist purchase put alternatives with the beliefs that the cost of the hidden security will go fundamentally below the attractive price before the expiry date. 2. Short Put option: Despite a long-put choice, a short or composed put alternative commits a financial specialist to take conveyance or buy shares, of the underlying stock. Strategies of options:1.
Covered Call: With calls, one system is primarily to purchase an exposed call choice. You can likewise structure an essential secured call or buy-write. It is an exceptionally mainstream system since it creates wage and reduces some risk of being long stock alone. The exchange off is that you should offer your offers at a set value: the short strike cost. 2. Married Put: In a married put strategy, a financial specialist buys an asset, and all the while buys put options for a comparable number of suggestions.
The holder of a put choice has the privilege to offer stock at the strike price. Each agreement is worth 100 shares. The reason an investor would utilize this system is to secure their drawback hazard when holding a stock. 3.
Bull Call Spread: In this system, a speculator will at the same time purchase calls at a higher strike price and offer a similar number of calls at a higher strike price. Both call alternatives will have a similar expiration and primary resource. 4. Bear Put Spread: The bear put spread procedure is another type of vertical spread. In this system, the financial specialist will all the while buying put alternatives at a specific strike cost and offer a similar number of puts at a lower strike cost. The two options would be for the equivalent essential resource and have a similar termination date.
5. Protective Collar: A protective collar procedure performed by obtaining an out-of-the-cash put option and all the while composing an out-of-the-cash call option for the equivalent primary assets and expiration. 6. Long Straddle: A long straddle options strategy is the point at which a speculator at the same time buys a call and put option on the equivalent hidden resource, with a similar strike cost and lapse date. A financial specialist will frequently utilize this technique when he or she trusts the value of the essential support will move substantially out of a range, however, is uncertain of which heading the move will take. 7. Long Strangle: In a long strangle options strategy, the financial specialist buys an out-of-the-cash get choice and an out-of-the-cash put option all the while on the equivalent fundamental asset and expiration date. A speculator who utilizes this technique trusts the hidden resource’s cost will encounter an extensive development yet is uncertain of which course the move will take.
( Lucas Downey, 2018) Advantages of the put option:1. Put holders confront a hazard that restricted to the underlying expense of the put. Short merchants, however, face possibly great misfortunes since, in principle, there are no furthest cut-offs on a stock’s cost, and in this manner the value at which a short vender may need to cover the deal by repurchasing the stock.
2. Choices are paid for when you get them; short-dealers must keep up enough edge and, in this way, might be required to store more cash if the stock’s value rises.3. Put holders aren’t at risk for any profits paid by the stock – short merchants are.4.
Put choices quite often offer possibly higher rate returns since you, for the most part, pay a little portion of the hidden stock’s an incentive than you do short stock.Disadvantages of a put option:The primary drawback of purchasing a put alternative is the reality they have a constrained life. A short position can hold for a significant period, in principle.
Too, a put alternative opens you to possibly more noteworthy rate misfortunes.Correct selection of the optionWe select the protective put strategy. Reason for choosing this: ? It is a supporting procedure picked by the proprietor of the security to preplan for the diminishing in the stock cost of that security.
? With this, we can get the most ultimate benefit after giving less premium.Identify the option contracts that should be bought/ soldAlamos Gold Inc. (AGI)Number of shares = 1200 sharesPrice of share = $5.12 (ADVFN, 2018)Total investment = 1200 * $5.12 = $6,144Exercise price of put option= $3.75Number of options in 1 contract= 100Value of 1 contract = $375Number of put option contracts= value of investments/ value of 1 option contract= 6,144/375= 16.38 contractsNumber of put option contracts = 16 contracts (approx.
)ARC Resources Ltd. (ARX)Number of shares = 1200 sharesPrice of share = $12 (ADVFN, 2018)Total investment = 1200 * $12 = $14,400Exercise price of put option = $5.45Number of options in 1 contract= 100Value of 1 contract = $545Number of put option contracts= value of investments/ value of 1 option contract= $14,400/545= 26.42 contractsNumber of put option contracts = 26 contracts (approx.)Conclusion After analyzing the above, we conclude that with the protective put strategy option we hedge our client stocks investments.
Therefore, to cover for the future fall in value, the investor needs to put resources into put options.References(n.d.).Adam Milton. (2018, November 06). Retrieved from https://www.
thebalance.com/call-and-put-options-definitions-and-examples-1031124Lucas Downey. (2018, October 12). Retrieved from www.investopedia.
com: https://www.investopedia.com/trading/options-strategies/Ron Ianieri. (2018, March 05). Retrieved from https://www.
investopedia.com/articles/optioninvestor/06/options4advantages.asp ADVFN. (2018, November 05). Retrieved from ca.advfn.com: https://ca.advfn.
com/stock-market/TSX/AGI/stock-priceADVFN. (2018, November 05). Retrieved from ca.advfn.
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com/walkthrough/corporate-finance/5/risk-management/options.aspxInvestopedia. (2018). Retrieved from www.investopedia.com: https://www.investopedia.com/walkthrough/corporate-finance/5/risk-management/hedging-options.
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Retrieved from www.thinktrade.net: http://www.thinktrade.net/options-advantages-and-disadvantages.phpThink trade. (2006).
Retrieved from www.thinktrade.net: http://www.thinktrade.net/options-advantages-and-disadvantages.php