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Welcome to Option Strategy Explanation 05. Today, we will introduce four types of option hedging strategies. It is especially important for stock investors to learn them.

Many stock investors are aware that buying stocks involves both risks and opportunities. However, if you want to minimize losses and maximize gains, it's crucial to master some option-hedging techniques! These techniques will help you navigate the stock market with confidence and achieve substantial profits.

1. Four Option Hedging Strategies

1. Covered Call Options

If you own stocks and anticipate a minimal increase in their future price, there's a strategy that allows you to earn additional income while holding the stocks - it's called the covered call options strategy! Simply put, you can sell a call option contract while holding the underlying stock. However, it's important to select a higher strike price for the call option. Why?

If the stock price rises, you can enjoy the profit from holding the stock. But if the price exceeds the strike price of the call option, as the seller, you may face losses. Therefore, the strike price of the call option must be higher than the expected price increase of the stock, ensuring you receive the full premium income.

For example: Suppose Alibaba's stock price is around $83. If you own this stock and expect a slight increase to around $86 in the future, using the covered call options strategy, the strike price of the sold call option should be higher than $86. This way, you can mitigate the risk if the stock price actually rises to $86 or higher.

2.Covered Put Options

If you believe that the future stock price will decline and want to generate additional income while selling your existing stocks, the covered put options strategy can help you achieve that. You can sell a put option while simultaneously selling the underlying stock, thus earning premium income. However, it's important to select a lower strike price for the put option. Why?

If the stock price increases, the put option buyer will not exercise their right, allowing you to retain the full premium income. However, if the stock price drops and falls below the strike price of the put option, the buyer will exercise their right, resulting in losses for you. Therefore, the strike price of the put option must be lower than the expected price decrease of the stock. Additionally, the covered put options strategy offers the advantage of capturing the time value of the option as the seller. This means that even if the stock price remains stable or declines slightly, the seller can still profit.

3.Protective Call Options

If you have sold your stocks but are concerned about missing out on future price increases, you can utilize a protective call options strategy by buying a call option contract.

The benefits of this approach are as follows: if the stock price increases in the future, the call option yields significant profits; if the stock price decreases, the only loss incurred is the premium paid for the option, limiting the losses.

For example, let's say you own 100 shares of a company's stock, currently valued at $10 per share. You can purchase a call option, giving you the right to buy the stock at a price of $10. If the stock price declines, the option may be exercised, and you can offset the loss in stock value with the profits from the option. This strategy acts as an insurance policy for your investment portfolio, ensuring you can navigate market fluctuations with peace of mind.

4.Protective Put Options

Protective put options are one of the most common strategies used by stock investors. Whenever we hold stocks, we face the risk of price declines. To mitigate this risk, we can purchase a put option while holding the stocks, effectively providing insurance for the stocks, with the only cost being the premium paid for the option.

Additionally, if you want to hedge at zero cost without spending extra on options, you can also sell a call option with a higher strike price. The specific method can be found in the previous article "Option Strategies Part 3: Free Insurance for Stocks? The Simple Strategy in 'Billions'". When the stock price falls, the profits from the put option can offset the losses from the stock decline. In case of a stock price increase, the only loss is the premium paid for the put option.

2. Summary of Application Scenarios

To summarize, let's review the application scenarios and pros and cons of the four strategies mentioned above.

OK. If you want to learn more about options, feel free to follow our detailed course, "Introduction to Options." We will continue with further explanations.