Question

How could options be used to enhance the rebalance process?

Answer 1

Options are the financial instrument that gives the buyer right but not an obligation to buy or sell an underying asset at a strike price on a predetermined date. Option carries premium that the option buyer needs to pay to the option writer.

Many institutional investors try to rebalance the portfolio following the Strategic Asset Allocaton (SAA). Strategic Asset Allocation suggest the upper and lower boundary of each asset class which acts like a trigger to buy or sell that particular asset which reaches the boundary and thus rebalancing the portfolio. The rebalancing of portfolio can also be achieved with the help of option but with an added advantage. As option carries premium to be paid by the option buyer to the writer of the contract gives an extra earning on the execution of the contract. In case, the contract is not executed the option writer can earn in the form of premium. Thus, option can help in rebalancing the portfolio by entering into the contract of buying and selling the particular class of asset as buyer of the contract is not obliged to execute the contract if the future prices are not in accordance.