Freeze your gains….

12 Sep

A volatile market invariably unnerves an investor. Or rather a speculator. Any which way, wouldn’t it be great if there was a way where you could lock your gains in a particular scrip. We came across such a strategy in an article titled “Here’s a way to lock-in minumum gains on your investments”, Business Line (7th Sep, 2008). The following article explains the above strategy using real life data for Maruti Suzuki. So, here goes…

Assume you purchased 200 shares of Maruti Suzuki @ Rs. 500 per share. The scrip presently trades at Rs. 679 per share (closing price for 12th Sep 2008). That leaves you with an unrealized gain of about Rs. 35,800. Now, given the present volatility in the markets, you are concerned about preserving the above unrealized gain. You can use the option market to bail you out of this risk.

Suppose the minimum gain that you would like to lock out of your investment in Maruti Suzuki is about Rs. 12000, i.e., you would not want to be in a situation where you have to sell your shares at a price less than Rs. 560. Also assume that the maximum gain that would satisfy your greed to the point of you converting your unrealized gain into realized gain (i.e. selling your shares) is Rs. 40,000. In short, on an investment of Rs. 1,00,000 (Rs. 500 per share X 200 shares), you would like to pocket a minimum gain of Rs. 12,000 (gain of Rs. 60 per share X 200 shares) and a maximum gain of Rs. 40,000 (gain of Rs. 200 per share X 200 shares).

Now, all you have to do is sell a Rs. 700 27-Nov Maruti Suzuki Call option on nifty which presently trades at Rs. 66.05 (on 12th Sep 2008). Given a lot size of 200, that would fetch you Rs. 13,210 (Rs. 66.05 per call X 200 calls). Correspondingly, you have to buy a Rs. 560 27-Nov Maruti Suzuki Put option on nifty which presently trades at Rs. 37.95 per put (on 12th Sep 2008). That would cost you Rs. 7,590 (Rs. 37.95 per put X 200 puts). Lo and behold, you have done it. Lets see how the above strategy would unfold.

If the share price, which currently trades at Rs. 679 per share, falls below Rs. 560, you will have the option of selling at Rs. 560 and lock in a minimum gain of Rs. 12,000 (gain of Rs. 60 per share X 200 shares). And if the share price moves above Rs. 700, you should be willing to sell your shares at Rs. 700 per share and pocket a neat sum of Rs. 40,000 (gain of Rs. 200 per share X 200 shares). Thus from now (mid September) to November end when the options expire, you can just sit back and relax and smile over the fact that on an investment of Rs. 1,00,000, you have ensured yourself a minimum gain of Rs. 12000 and a maximum gain of Rs. 40,000.

Now for the icing on the cake. The puts cost you Rs. 7,590. But how much did you make on the calls? A cool Rs. 13,210. That leaves you with Rs. 5,620. In other words, the market is paying you a premium to guard yourself against its volatility. Woa !!

Published by Ravi Saraogi

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One Response to “Freeze your gains….”

  1. Sulis November 12, 2008 at 12:00 am #

    Interesting to know.

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