Analysis of Asset Allocation

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You can use leverage techniques to increase the return of your portfolio: definitions and dangers.

Options: Strategies and Market tactics
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Since option costs less than the underlying stock, it provides a high leverage potential to investments. Options can be used to protect a portfolio or to increase potential revenues. Protecting a portfolio with a put option is the typical example of the use of an option to reduce the risk. But, as options are very volatile and dangerous, it is important for all investors to understand really what they are exposed to when they purchase or sell an option.

In this section, we will first explain how we can represent the option or the strategy in a graph, and afterward we will explain some basic and advanced strategies based on options. On each position, the maximum risk (loss) and potential gain will be defined.

GRAPH

Options and strategies are usually represented on a graph. On the horizontal line we find the price of the underlying asset and the strikes of the different options (E1,E2,...). On the vertical line, gain and loss are represented. The result on the strategy is shown by the red line and depends of the underlying price. This red line represent the result at the expiry date (the intrinsic value).

The above graph represent a long call (purchase of a call) strategy. As we have seen, the call has an intrinsic value if the underlying price is over the strike price (E1). When the underlying price is under the strike price, the loss is limited to the premium. We will see in the next section that this strategy is recommended if you are highly bullish on the stock.

Basic strategies.

Advanced strategies.

 

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