Many F&O stocks dont open where it closed yesterday and open way too low or above the closing, why does this happen and how do some investors stay invested in such unpredictable moment?
Why do “investors” need to worry about FNO?
Well even with a stop loss, if a person has bought several lots of a stock and it opens down next day, it loses money if the F&O opens way too down.
First of all if anyone is buying “several lots” they usually have a big stop loss.
Yes Futures is highly risky, that is why only people with big capital should do that (especially positional trades where you hold it for days).
Examples - TITAN opened 5% down recently, SRTRANSFIN was 10% down within 15 minutes of opening on one fine day, these are good stocks but see they can behave like this.
One way to reduce this risk is by hedging your positions but it comes with a price. There are many hedging strategies. For example, if you have bought Futures of some stock at lets say Rs 100, you can hedge this trade by buying puts of strike 95. That way any downside below 95 is insured. This is just one example. There are many ways to do hedging.
I am new to hedging, can you take some examples and explain step by step?
Glad you asked. I will give a few scenarios in purely option strategies.
Following two are from a clearnifty app that I follow:
- First scenario shows that how hedging can help in controlling losses:
One recommendation was generated on 14th Aug in which it was suggested to sell CADILAHC Aug 350 Call option. However they also suggested to hedge the trade by buying CADILAHC Aug 360 Call option. Basically you can hedge a sell call option by buying a higher strike call option.
In this case, after the kerala flood tragedy struck, stock prices of all health care companies skyrocketed including that of CADILAHC. As the stock price rises, call option prices also goes up. Hence, CADILAHC call option prices also shot up. Fortunately, the trade was hedged, loss of Rs 45520 in 350 call was compensated by gain of Rs 33920 in 360 call.
- However hedging comes with a cost. Consider this trade.
Clearnifty.com generated a suggestion on 2nd Aug in which put option of DRREDDY of strike 2200 were sold. This trade was also hedged by buying put option of strike 2100 with the same expiry. Basically selling of put options is hedged with buying of put option of lower strike. If the trade moves in your favour then the profit is restricted.
- There are many other ways to do hedging. For example, if you are buying NIFTY futures, then you can either buy puts or sell calls. If you are buying puts, your loss is limited however future price has to move higher to break even. If you are selling calls, then loss is unlimited however you start with a profit which you obtain by selling calls.
This is the gist of hedging. By combining various derivative (futures and options) instruments, you can do various types of hedging. If you have any other doubt, feel free to ask.