Market volatility can significantly impact the success of traders in the financial market. It refers to the unpredictable and sudden changes in market prices, which can cause substantial losses or gains for traders. As a result, traders need to have strategies in place to navigate market volatility effectively. One such approach is hedging, which involves taking positions that offset potential risks from other investments. In Singapore, traders can use hedging strategies when trading listed options to minimise their exposure to market volatility. This article will discuss how traders can navigate market volatility by using hedging strategies when trading listed options in Singapore.
Use of protective puts
Protective puts are a favoured hedging technique traders use to protect their investments from potential losses due to market volatility. This method involves purchasing put options, which give the holder the right to sell the underlying asset at a specified price within a specific time frame. By holding protective puts, traders can mitigate the risk of their investments decreasing in value due to market volatility. If the market price drops, the put option will increase in value, offsetting the losses incurred on the underlying asset.
The protection provided by protective puts can be especially beneficial for traders who have a long position on an investment and want to protect it from downside risk. Traders can also sell their put options if the market becomes less volatile, reducing their cost of hedging and increasing potential profits. However, traders should also consider the premium they pay for protective puts as it reduces their overall returns on the investment. When options trading online, traders can easily access protective puts through various trading platforms offered by brokerage firms in Singapore.
Use of covered calls
The covered call strategy involves selling call options against an existing long position on an asset. By doing so, traders can generate income from the premiums received while holding onto their investments. This method is beneficial in a volatile market as call options tend to have higher premiums during such times, providing traders with more significant returns.
If the market price decreases, the compensation received from selling the call option is a cushion against potential losses on the underlying asset. However, if the market price increases, traders may have to sell their assets at a predetermined price, limiting their potential gains. Traders should also consider the opportunity cost of holding onto an asset and not selling it immediately for potential profits. Assessing the market conditions and choosing the appropriate underlying asset for covered calls is essential.
Use of straddles
A straddle is a hedging strategy that involves buying both put and call options on the same underlying asset with the same expiration date. This method is beneficial in highly volatile markets as it allows traders to profit from upward and downward price movements. If the market price increases, the call option will increase, offsetting potential losses on the put option.
Similarly, if the market price decreases, the put option will increase in value, offsetting potential losses on the call option. The cost of implementing this strategy can be high due to purchasing both put and call options. Therefore, traders should carefully assess the market conditions before using straddles as a hedging strategy. It is also essential to note that this method works best in markets with significant price movements, as small fluctuations may not generate enough profits to offset the costs.
Use of collars
Collars are a hedging strategy that involves combining protective puts and covered calls. This method provides traders both upside potential and downside protection, making it suitable for volatile markets. Traders purchase put options to limit potential losses on their investments while selling call options to generate income from premiums.
The premiums received from the covered calls can offset the cost of purchasing protective puts, resulting in a lower overall cost of hedging. However, traders should note that using collars reduces their upside potential as they have already sold a call option against their investment. Therefore, assessing the potential returns from a collar strategy and comparing them to other hedging methods before implementing it is crucial.
Use of spreads
Spread strategies involve taking positions on multiple options with different strike prices, expiration dates, or underlying assets. This method allows traders to tailor their hedging strategy according to market conditions. For example, traders can use bull call spreads in a volatile market by purchasing an in-the-money call option while selling an out-of-the-money call option.
This method provides the upside potential of a long position on the underlying asset while reducing the cost of purchasing the options through the premium received from selling them. However, this strategy limits potential gains if the market price increases significantly, as traders have sold an out-of-the-money call option. Traders should carefully analyse market conditions and choose the appropriate spread strategy to suit their investment goals.
