Question

1. In early 2008, the popular prediction is that the market will experience a downturn, hence most hedging strategies focus on loss minimisations. Imagine a scenario where prices are extremely volatile, but no one can predict the direction, and you have a long position in stocks. Design two different strategies involving taking long positions in options to minimise losses and capture potential gains. Justify which one is the best. (Hint: you do not need to provide calculations of profit or loss here).

Answer 1

1st one is covered call in which since I have exposure to the stock I will buy a call and try to make sure the profit which I am making should not loose and at the same time I can minimise the loss.

2nd strategy will be strangle option strategy in which I will buy both call and put on the same strike price and for same expiration. Since I am expecting a volatiltiy will be high any sharp movement will earn me huge profit. In this way we can minimise the loss.

Stangle will be the best strategy in case of huge market volatility.