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SHORTING CALL OPTIONS IN FALLING MARKETS

Authored On: 01-Sep-15

Last Modified: 01-Sep-15

      About. . .

 

There are multiple ways to hedge against market falls and to make profits during market falls using derivatives positions and strategies. This article discusses one such method - mainly Shorting Calls.

  • If the market downtrend is not caught on charts, the pure delivery based player gets into losses

  • Delivery players who are not long term players, either will have to make a careful call to book losses, or to hold positions, with anticipation of further averaging opportunity or portfolio adjustment after spotting end of downtrend

  • All these techniques require precise understanding of market falls, when it will end, and reading the signs of market bottoming out

  • While this all could be done accurately by delivery players, it all helps in containing losses, and profit remains quite away

  • However, taking derivative positions may help market players to not only to save equity portofolio from losses, to a certain extent, but also to make additional profits from such market falls.

  • Below illustration explains the same

Derivative Strategies During Market Falls

Strategies when you hold equity portfolio of certain minimum value

SHORTING CALLS

Other strategies

Strategies when no sizeable equity portfolio is held

SHORTING CALLS

8700

8600

Curren Index (say CNX Nifty) level at say - 8500

8500

Your Equity Portfolio

Say 'N' lakhs at current valuations

When expectation builds that market will fall or correct, or if charts confirm the start of such events

'Short' Index Calls at Strike Price above current index level

You get upfront Option Premium, and your open position is Sell Short

Scenario #1 - Market falls and settles below current price at Expiry

Scenario #2 - Market takes direction contrarian to expectation. It thus rises above current level (8500)

Scenario #2 - Rising markets settle below Strike at which you have shorted calls (5600)

Your gross profit in Options trade is entire Premium received

Scenario #2 - Rising markets settle above Strike at which you have shorted calls (5600)

Your equity portfolio will anyway fall with market, but loss in equity is balanced by profit in Call trade

Rise of Call Option premium shorted above the Strike Price and settlement above this level will limit your profits in equity portfolio, that you are about to get due to this recent rise. 

 

Thus when you use this technique, values of the Shorted Calls should be much lesser than equity portfolio value.

   Summary Lines:

  • Shorting calls provide an easy way to benefit from market falls

  • However, for this technique, careful choices are to be made w.r.to Strike Price of call to be shorted, number of Calls to be shorted based on portfolio value, expected downward direction of market - in terms of time the direction will continue and speed of fall assessed among other things

  • Readers should note that derivatives are very risky trading instruments and this article is NO way closer to be tutorial on these techniques. This article however provides only a starting point for you to discuss with your investment advisor about possible use of this or such techniques and fitment of the same to hedge your portfolio.

 

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