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There is always an inherent risk in all kinds of investments and options contracts are no different. When a trader invests money in options, he can be either a risk-taker or a risk-averse investor.Risk Neutrality is a term used for traders who are indifferent to the risks of losing money. They just consider the final outcomes of the investments without taking care of what the other options of the investments are. Obviously, the gains for risk-neutral investors are higher, but the risk of losing money is also proportional to the risks taken by the risk-neutral traders.The term "risk-neutral" is the ... Read More
Hedging is a popular way to protect investments. It helps in mitigating risks and provides optimum exposure to risks. When a portfolio is hedged, it is often required by the investors to know about the portion of the total portfolio that is risk protected. This is where the hedge ratio comes in.In general, the hedge ratio is the ratio of the value of the investor’s open position to the overall position of the portfolio. In other words, the hedge ratio is the ratio of the open position to the overall position with a hedge to the total size of the ... Read More
Capital Budgeting is the process of evaluating, checking, and implementing a large-scale project that requires a significant amount of money. Capital budgeting may be required in the acquisition of land and building, purchase of machinery, and marketing a new product of the company. The large-scale money spent in executing these decisions is called capital expenditure.Budgeting is a process of maximizing profits by allocating money to the appropriate project and managing the project as and when it requires attention.Capital Budgeting ProcessThe following five steps are necessary in Capital Budgeting −Project Identification and GenerationThe first step of the capital budgeting process is ... Read More
There are many options strategies that a trader can apply while dealing in stock options contracts. One such option strategy is the Calendar Spread where selling an option and buying one takes place at the same time. The option that is sold is usually short term, while the one bought is a longer-term call or put option. Needless to say, a calendar spread requires the options to be of the same strike price and have the same underlying assets.A calendar spread strategy is utilized when there is no movement in the market or when there is no movement to hedge ... Read More
Profitability Index (or PI) is a method to evaluate the profitability of investment projects. It is actually a benefit to cost ratio or the ratio of the present value of cash inflows at the required rate of return to the initial cash outflows of the investment.Like NPV and IRR, PI is also a popular investment evaluation technique. However, the measurement procedure and application of the method have some differences in comparison to IRR and NPV. PI is a variation of the NPV method and requires similar computations as the NPV method.Like IRR and NPV, PI also has some merits and ... Read More
There are basically six factors that affect the value of an options contract −The value of the underlying assetExercise priceExpiration timeRisk-free rate of interestVolatilityPayments on the underlying and cost to carry onLet us take a look at each of these factors in detail.The Value of the Underlying AssetThe value of the underlying assets has a significant effect on the value of an options contract. In fact, call options can be considered as buying the underlying, while put options can be viewed as selling the underlying. Therefore, when the value of underlying goes up, the value of the call option increases. ... Read More
Capital Budgeting is a process of evaluating long-term business decisions that need large amounts of capital. It is a way to find a better deal for the growth of the business. Capital budgeting is often related to important capital decisions that impact the bottom-line of a company. It has certain characteristic features. Here are the features one by one.Large InvestmentsCapital budgeting is related to investments of large funds. It is often used to find projects that need large investments. Managers of a company identify the need for a capital budget where large sums of money are required. In capital budgeting ... Read More
The Black Scholes Method works with three different types assets −The risky assetsThe riskless assets, andThe option of the risky asset whose value has to be found.Depending on the type of assets, there are four categories of assumptions that the Black Scholes method follows, which are −Assumptions about the underlying risky assetAssumptions about the underlying riskless assetsAssumptions about the optionsAssumptions about the marketAssumptions about risky assetsThe risky assets such as stocks and bonds have the following assumptions under the Black Scholes model −Random walk − It states that the direction of a risky asset can be gauged but its direction ... Read More
Mutually exclusive investments are investments that are connected to each other where taking up one negates the use of the other investment. These investments usually serve different purposes but when one of them is undertaken, the other cannot be done. There are many examples of mutually exclusive investments, but they are primarily related to funds invested to complete different projects.Note − Mutually exclusive investments are usually for different projects. However, they may be contingent investments that are derived when an extra investment is needed to serve the major purpose.Characteristics of Mutually Exclusive InvestmentsHere are the major characteristics of mutually exclusive ... Read More
Collar Option StrategyA collar option strategy is created to diminish both positive and negative returns of the underlying assets. It can hedge the options against the volatility of the market and limit the return of a portfolio within a specified range.To do this, a protective put and a covered call option are used. Generally, it is created by holding an underlying stock, buying out-of-the-money put options, and selling an out-of-the-money call option.How does a Collar Option Strategy work?A collar option strategy is used to limit both upside and downside of an investment. It involves a long position on an underlying ... Read More