One will appreciate this fact that the option buyer faces an interesting situation. He pays for the option in full at the time it is purchased. After this, he only has an upside. There is no possibility of the options position generating any further losses to him (other than the funds already paid for the option). This is different from a futures: which is free to enter into, but can generate very large losses.
Thus one sees that one can have a non linear return with options; however time decay element can eat into your amount paid for the option.
Thus non linear returns makes options as an attractive investment market participants, who cannot put in the time to closely monitor their futures positions.
Thus one can take put options as a buying insurance. To buy a put option on Nifty is to buy insurance which reimburses the full extent to which Nifty drops below the strike price of the put option. This is attractive to many people, and to mutual funds creating “guaranteed return products”.
The Nifty index fund industry will find it very useful to make a bundle of a Nifty index fund and a Nifty put option to create a new kind of a Nifty index fund, which gives the investor protection against extreme drops in Nifty.
Thus we see that options work pretty effectively as a hedge fund, however please keep in mind that buying both Put and call can reduce your returns.
Selling put options is selling insurance, so anyone who feels like earning revenues by selling insurance can set himself up to do so on the index options market. More generally, options offer “nonlinear payoffs” whereas futures only have “linear payoffs”. By combining futures and options, a wide variety of innovative and useful payoff structures can be created.
However remember that there are no free lunches in this mechanism and one must see that one is not unduly paying for the options and should be able to identify the trend correctly and accordingly take a position in it. Remember that Warren buffet has stated Future and Option segment as a systematic method of taking out money from the retail investor and passing the same in the hands of professional and big investors who are generally selling options as they are aware that 90% of the time the options expire worthless.
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