Betting
on Results
Depending on
results – good or bad – when and how to
buy shares!
The results season is generally
characterized by a high degree of volatility. Optimistic
investors buy in anticipation of good results while
pessimists sell their holding. In the pre-derivatives
era, all all one could do was buy the stock when good
results were expected or sell one’s holding
and short shares intra-day when expectations were
bad.
With derivatives, one can generate unlimited gains
with limited risk. One can reduce the risk of portfolio
in anticipation or bad results, or make money by taking
low risk even without having a look at the company’s
results. So with little ingenuity, there are lots
of opportunities investors can explore to earn good
returns.
The expectations can be good (same or more than market
expectations) or bad (below the market expectations).
Good Results
If one expects good results, then buy futures contracts.
When stock prices move up, so will the prices of futures,
and vice versa. The advantage of using futures is
that one can leverage one’s funds. However,
if there is a likelihood of declaration of dividend
in that stock, then one should stay clear off buying
futures; it is better to buy stock instead.
People having low-risk appetites can opt for buying
call options (right to buy) on these stocks. In these
cases, the risk to the option buyer is limited to
the option premium paid. If the person is wrong and
the stock price falls, the loss incurred will be limited.
If the stock price moves up, then the option portfolio
value rises, and profit potential is high.
A strategy for people with an even lower risk appetite
would be entering into bull spreads. A bull spread
is created when one buys an option contract and, to
reduce the cost simultaneously, sells another option
contract (of the same type) of a higher strike price.
In case of a bull spread using call options, the
maximum possible loos is the net premium paid (after
deducting premium received after selling the higher
strike price call upon, from the premium paid.)
The maximum profit potential is, however, limited
to the difference between the two-strike price less
the net premium paid.
Bad Results
If one expects bad results along with a dip in prices
before or after the results, short sell futures.
Unlike stocks where short positions have to be squared
off buy the day’s end, short futures’
position can be held for three months. A likelihood
of the declaration of dividend in that stock increases
the probability of making money as the future’
pries fall (as compared to the stock price) in case
dividends are declared and the ex-dividend date falls
during the tenancy of the futures contract.
Investors having low risk appetite can buy put options
(right to sell) to capitalize on the expected fall.
This strategy can also be used when good results are
expected as an addition to the long position in the
cash market to hedge oneself from a possibility of
short-term fall in prices due to profit booking. In
this case if the stock price do fall, the put option
will compensate, to a large extent, for the fall in
stock prices.
Another bearish strategy is the bear spread, in which
one buys as option and sells another option of a lower
strike price. The properties of such a strategy are
similar in some ways to the bull spread. The plain
vanilla strategies are out of fashion; bring in the
derivatives to skew the risk-reward ratio in your
favour. So before planning a summer vacation, you
may want to take a dip into the derivative markets
to finance your trip.
For stocks that do not move too much around their
results, one can sell straddles, that is sell calls
and puts simultaneously with a view that the stock
will remain rangebound. The profit in this case is
limited to the premium received on selling these options.
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