Option can be used to Reduce the Stock which you have bought at Higher levels during Bull Phase or in an event of extreme exuberance.
This Strategy will work for Stocks which are in Future and Options. AS of today there are 203 Stocks which are Listed in F&O space in Indian Stock Market..
The technique to reduce the acquisition cost is popularly known as a covered call strategy.
It involves selling higher strike price call option of the stock you hold.
Lets give me a Clear Picture of Covered Call Strategy with a Example.
Most of us including myself subscribed to NHPC and were allocated the Shares at Rs 36 shares.Market was excepting a listing around rs 45 but all went in haywire stock made a high of Rs 39.75 after minutes it listed and after that it never saw those levels till date.
It became a liability to the person who are holding the stock in portfolio.I truly believed in long term potential of the stock but in short term it is a Liability.
NHPC recently got listed in F&O segment and now we can apply our Covered Call Strategy to reduce our acquisition cost.
How we will do that ?
Before Starting I would like to make it clear Options should be used by FII/HNI/Retailers who are holding more than 8000 shares of NHPC.
Let us assume that we are holding 8000 shares at the IPO price. Now, we would like to sell our shares if it goes beyond Rs 37.5. If it does not rise, still we would like to generate some income and reduce our acquisition cost.
When NHPC rises and comes near to our cost, we will be selling higher strike call options. For example, if the stock price rise and touches of Rs 36, we can sell call option of the strike price Rs 37.5. That call is likely to fetch around Rs 0.5. Lot size of NHPC is kept at 8000 shares, so that will generate income of 8000 x 0.5 = Rs 4000.
Let us try and understand what will happen on both possible scenarios of stock price going higher or lower from 36.
If stock price remains at or below 37.5 at the end of the month, we will pocket the premium we earned.That means gain of Rs 4000 and reduction of acquisition cost by Rs 0.5 on your holding of 8000 shares. Cost of our holding will reduce to Rs 35.5.
Let us assume, stock price rises sharply and closes at 40 by the end of the month. In derivative market. we will lose 40 minus 37.5 that is Rs 2.5 per share. For 8000 shares we will have to cough out Rs 20000 to the option buyer. But, in cash market, we will now be able to sell our shares at Rs 40, 2.5 higher than what we hoped for. This will generate extra Rs 20000, exactly the amount we are required to tender to the option buyer in derivatives market. This means that we did not lose any money actually.
It is conceivable that NHPC may remain in a small range for long time and does not rise beyond 37.5. This exercise can be repeated month after month till NHPC rises and closed beyond our desired price. This way you will earn premium every month, which will reduce the cost of the holding. If we are successfully in repeating the mentioned strategy for six months, we will be
able to reduce our cost by princely sum of Rs 3.
Taken From HSBC Report