6 Investment Options Trading Strategies, UBS Downside Protection
- UBS Global Wealth Management is bullish on equities for 2021.
- However, the company also acknowledged that investors are concerned about short-term corrections.
- We break down the basics of six options strategies investors can use to protect their portfolio, highlighted in a new research note from UBS.
- Visit Business Insider’s homepage for more stories.
Investors experienced one of the most tumultuous days of trading in recent times yesterday as retail investors, mostly from the Reddit Wall Street Bets forum, piled into small-cap stocks, waging a war on funds speculators who had sold them short.
and potential asset bubbles in the stock market were already on the rise, not least due to the growing influence of retail investors.
UBS Global Wealth Management does not believe the market is in a bubble and remains positive on equities for 2021, but it recognizes that investors are examining these dynamics.
“We recognize that the post-pandemic rally has left some segments of the stock market looking expensive,” Luca Henzen, UBS derivatives strategy analyst, said in a Jan. 27 note.
Read more: Jeremy Grantham predicted the last 2 financial meltdowns. Now he says these 3 signals foreshadow a crash into another bubble created by stocks and SPACs.
UBS analysts are positive on equities due to a combination of COVID-19 vaccine rollouts, low interest rates and government stimulus measures, which will provide a favorable backdrop.
But they also acknowledge that there is potential for a short-term market setback and investors might want to understand how to position themselves cautiously given recent market rallies. So in this new research note, Henzen outlines six options strategies that investors can leverage to protect themselves.
“Stocks that have rebounded robustly from the March 2020 correction and are currently trading at extraordinary valuation multiples could be exposed to a short-term pullback if investors unwind their positions,” he said.
And while selling stocks right now reduces exposure to a price correction, it could also mean investors could miss further price increases, Henzen said.
“Options can be the tool of choice when it comes to protecting existing portfolio positions,” Henzen said.
Before we dive into Henzen’s strategy, Insider provides a refresher on options and some common terms.
What is a put option?
Put options give the holder the right, but not the obligation, to sell an asset at a specified price within a specified time.
Investors often use put options as a form of investment insurance to ensure that losses do not exceed a certain amount.
What is a call option?
Calls give the buyer the right, but not the obligation, to buy a stock at a specific price within a specific time frame.
Selling a call involves owning the stock while giving someone else the right to buy your holdings.
The investor receives the premium and expects the option to expire unexercised. This provides income to the investor, but it also limits the profit potential because if the stock goes up, the buyer will act on the strike price.
Common option conditions:
Premium: The price an investor pays for the option.
Strike price: If the investor chooses to exercise the option, this is the price at which the asset can be bought or sold.
Expiration date: The date on which the options contract becomes void.
Implied volatility: The market’s prediction of a probable movement in the price of an asset
Volatility bias: The implied volatility disparity between different strike prices with the same expiration.
Read more: ‘This one looks a lot like 1999’: Ex-Wall Street strategist explains why he approaches markets with a ‘tactically bullish’ strategy – and 3 tips on how to play a market for a correction
The options strategies offered by UBS allow investors to continue to participate in the market while protecting themselves from potential losses.
“The cost of protection, which is usually the total option premium, remains the biggest downside investors face when buying options,” Henzen said. “However, options can be deployed in many structures with varying degrees of efficiency and cost, allowing investors to optimize downside protection according to their needs.”
Each option strategy has unique characteristics as well as strengths and weaknesses, Henzen said.
We break down the basics of the six strategies provided in the research note.