Interesting Tricks For Hedging In Stock Markets

How to earn huge money from stock market, how can we buy and sell stocks at right time, what are the tricks and tips to earn easily from stock exchanges? This article gives every detail to earn money from stock markets.

Margin Requirements for Stock and Stock Options

Margin has a very different meaning in options trading than it does in stock trading. Here margin is cost plus. The broker is asking for more money than is required by the purchase so he or she has insurance if there are extraordinary percentage losses.

Strategy for hedging stocks

1. Buy Puts or Calls - Cash transactions only; but securities in a cash or margin account may serve as collateral.

2. Write Uncovered Calls or Puts - Payment must equal the market value of the option, plus the commission, plus from 5-15 percent of the stock.

3. Write Covered Calls - Margin requirements are immediately satisfied because the buyer owns the underlying stock, which must be on deposit with the broker.

For put or call writing, the margin requirements are much stricter. The writer must have in his account the amount required to cover the premium for the option plus 5 percent to 15 percent of the underlying stock's value. Additionally, brokers usually require initial margin before any trading will be allowed. This is because writing options is extremely risky.

Several buying options for stocks

Buying options, however, though risky, is not quite as risky as writing them; and despite the fear many investors have about them, they offer distinct advantages over stock trading. Options contracts offer the potential for:

1. Relatively high returns on minimal investments.
2. Liquidity.
3. For long positions, a ceiling on the amount of losses that can be incurred. (You cannot lose more than you have paid for the option plus commissions.)

The liquidity advantage comes from not having to tie up great deals of money in stock. Five hundred shares of AT&T can cost $30,000. Five in-the-money calls (representing 500 shares of the underlying stock) can be purchased for as low as $1,000. Out-of-the-monies can be purchased for as low as a few hundred dollars.

Tricks for keeping the small investors more liquid

It is true that put and call buyers are faced with the prospect of time decay on their holdings, as well as the fact that calls may expire worthless. But at the same time, contract expirations are often a better alternative to holding on to stock for too long a time. Consider the $30,000 investment in AT&T. Suppose the investment is in the red for five years, and when you finally do profit, it is a mere 5 percent on your money.

The opportunity cost is substantial. Not only could that money have been used for other investments, but it would have possibly prevented the investor from hitting his credit cards or borrowing in other ways to stay liquid. Dealing in puts and calls keeps the small investor much more liquid.

What is the primary interest in bull markets

As a market bull, your primary interest is in buying calls, not writing them. You may buy the very high-priced far in-the-money calls or the very low-priced far out-of-the-money calls. Or you may stay in the middle of the range with at-the-monies.

Example, which follows, shows what might happen if you purchased calls on a stock that moved in price from $30 to $35. While to invest in the stock would require tying up $3,000, investing in any of the options would require a maximum of $750. (These prices do not take into account broker commissions.)

Example for buying stocks

Notice that the in-the-money calls will move roughly point-for-point with the stock, but the out-of-the-monies do not have any significant movement until they are at- or in-the-money. The in-the-monies are always your safest bet because they generally have value right up until expiration time. But it is the out-of-the-monies, when purchased in quantity that can bring the high rates of return.

Suppose that when the stock was at $30, you purchased the October 25 calls for $5. When the stock moved to $35, these calls were now worth $10 1/2. A mere 1/6 of a movement in the price of the stock resulted in a doubling of the value of the call.

If you purchased the October 30s in September, you would have seen your money increase 2 1/2 times.
If you purchased the October 35s, your money would have tripled.

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