Options trading in the time of financial crisis for a trader

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Options trading in the time of financial crisis for a trader

For many traders, who do options trading on the stock, in conditions of an economic crisis, and, as a consequence, the prices fall of investable assets, can bring a lot of worries, including substantial material losses. So what the trader should do in the given situation of the absolute instability of the American economy, the losses incurred in the Asian market, as well as economic instability in some countries of the European Union? Is there a sense keep trading on the stock? If the answer is “NO”, then how to make money in a crisis?

The positive thing is that it is possible to make money in a crisis from trading on the financial market with minimal view of the overall situation. Binary options, in fact, provide an opportunity to speculate on the fluctuations of the market, equally as on its grow, as on its collapse.

You probably ask: how is this possible? The answer is very simple: binary options trading is built on forecasts, that is, the investor need only determine the movement of the price of the stock asset – rise or fall. Therefore, with proper forecast even with the collapse of the market, investor will always has the opportunity to earn the same share from his investment. We also want to note that the percentage of this profit is pretty good – about 85% of the investment.

For example, not so long ago the tragedy in USA – hurricane “Irma” has provoked a rapidly falling of quotes of insurance companies operating in the South-East of the country – Everest Re Group, XL Group, Chubb, Allstate, Assurant in the result of worst fears. But as soon as it appeared that the hurricane starts to weaken and is not expected to continue devastating walk through the states, shares of insurers have been partially returned to their perinea position.

Therefore, the trader who managed to correctly predict this trend, had a chance to make a profit of around 85% of the investment amount in own forecast. In other words, if a trader, for example, made a prediction about the fall of the company’s shares such as Everest Re Group and invested in forecast 2000$, then at the end of the day, he could count on profit in the amount of 3500$.

In fact, giving an answer to is it possible to make money in crisis, We want to note that with the phenomenon of binary options to the world – indeed it became possible. The whole point is in the timely response and the correct forecasting of events.

Success is possible, the only important thing is with whom you want to achieve it. Don’t forget that a properly made choosing a binary options broker is a great contribution to the success! Therefore, we highly recommend you to try binary options trading on a Demo account of IQ Options – a verified trusted binary broker!

“General Risk Warning: Binary options trading carry a high level of risk and can result in the loss of all your funds.”

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Investing in Crisis: A High-Risk, High-Reward Strategy

The financial crisis of 2008 and the great recession that followed is still fresh in the memories of many investors. People saw their portfolios lose 30% or more of their values, and older workers saw their 401(k) plans and IRAs drop to levels that threatened their plans for retirement. Instead of acting rationally during severe bear markets, many people tend to overreact and make matters worse. However, while many people panicked or were forced to sell assets at low prices, a small group of patient, methodical investors saw the stock market collapse as an opportunity.

Investing in a crisis is no doubt risky, for the timeline and scope of a recovery is uncertain at best. Double-dip recessions are a real possibility, and attempting to pick a bottom is largely a matter of luck. Still, those investors who are able to invest in a crisis without succumbing to irrational fear and anxiety may reap outsized returns during a recovery.

How Crises Affect Investors

Investors generally do not behave as predicted by traditional financial theory, in which each individual behaves rationally to maximize utility. Rather, people often behave irrationally and let emotions get in the way, especially when the economy is experiencing some chaos. The emerging field of behavioral finance attempts to describe how people actually behave versus how financial theory predicts they should.

Behavioral finance shows that people, rather than being merely risk-averse, are actually more loss-averse. This means that people feel the emotional pain of a loss much more than the pleasure gained from an equal-sized profit. Not only that, but loss-aversion describes peoples’ tendency to sell winners too early and to hold on to losses for too long; when people are in the black, they act risk-averse, yet when they’re in the red they become risk-seeking.

Take for example a blackjack player at a casino. When he is winning, he may start playing more conservatively and betting smaller amounts to preserve his winnings. If that same player is down money, however, he may take on much more risk by doubling down or increasing bets on riskier hands in order to break even. Investors behave similarly. Unfortunately, taking on excess risk when experiencing losses tends to only compound the magnitude of those losses.

These emotional biases may persist even after a recovery has begun. In a survey by online broker Capital One Sharebuilder, 93% of millennials indicated that they distrust the markets and are less confident about investing as a result. Even with historically low-interest rates, more than 40% of this generation’s wealth is in the form of cash. Due to the crisis, young Americans are not gaining the stock and bond market exposure that has helped older generations accumulate wealth.

Taking Advantage of a Crisis

While most investors are panicking as asset prices plummet, those with a cool head are able to see the resulting low prices as a buying opportunity. Buying assets from those restless individuals driven by fear is like buying them on sale. Often, fear drives asset prices well below their fundamental or intrinsic values, rewarding patient investors who allow prices to revert to their expected levels. Profiting from investing in a crisis requires discipline, patience, and, of course, enough wealth in liquid assets available to make opportunistic purchases.

When calamity strikes, markets fear the worst and stocks are punished accordingly. But historically, when the dust clears, optimism returns and prices bounce back to where they were, with markets responding once more to fundamental signals rather than to perceived turmoil. A study by Ned Davis Research group looked at 28 global crises over the past hundred years, from the German invasion of France in World War II to terrorist attacks such as that on 9/11. Each time, markets overreacted and fell too far only to recover shortly thereafter. Those investors who sold on the fear found themselves having to buy back their portfolios at higher prices, while patient investors were rewarded.

After the Japanese attack on Pearl Harbor, the S&P 500 index fell more than 4% and continued to drop another 14% over the next few months. After that, and through the end of the war in 1945, however, the stock market returned more than 25% per year on average. The same pattern can be observed after other geopolitical events. By recognizing the fact that markets tend to overreact, a smart investor can purchase stocks and other assets at bargain prices.

Right now, the stocks are in the midst of a six-year-long bull market following the great recession. Those who didn’t panic saw their portfolio values not only recover, but extend their gains, while those who chose to or were forced to sell, and waited until the bull market was in full swing to re-enter, are still licking their wounds.

Stock markets aren’t the only way to invest in a crisis. The great recession also saw a collapse in home prices as the housing market bubble burst. People who could no longer afford their mortgages foreclosed and many homes were underwater, the mortgage amount owed to the bank exceeding the equity value of the property. Homebuyers and those investing in real estate were able to pick up valuable real assets at below normal prices, and as a result have been able to enjoy handsome returns as the housing market has stabilized and recovered. Similarly, so-called vulture investors have also been able to profit from taking over good companies that have been battered by a recession but have otherwise good fundamentals.

Betting on a Crisis to Happen

Another way to make money on a crisis is to bet that one will happen. Short selling stocks or short equity index futures is one way to profit from a bear market. A short seller borrows shares that they don’t already own in order to sell them and, hopefully, buy them back at a lower price. Another way to monetize a down market is to use options strategies, such as buying puts which gain in value as the market falls, or by selling call options which will expire to a price of zero if they expire out of the money. Similar strategies can be employed in bond and commodity markets.

Many investors, however, are restricted from short selling or do not have access to derivatives markets. Even if they do, they may have an emotional or cognitive bias against selling short. Furthermore, short-sellers may be forced to cover their positions for a loss if markets rise instead of fall and margin calls are issued. Today, there are ETFs that give longs (holders of the ETF shares) short exposure to the market. So-called inverse ETFs may aim to return +1% for every negative 1% return the underlying index returns. Some inverse ETFs may also employ gearing, or leverage, returning +2% or even +3% for every 1% loss in the underlying.

For those individuals seeking simply to protect themselves from a crisis and not necessarily bet on such an event occurring, owning a well-diversified portfolio, including positions in asset classes with low correlations, can help cushion the blow. Those with access to derivatives markets can also employ hedging strategies, such as a protective put or covered call to lessen the severity of potential losses.

The Bottom Line

Economic crises happen from time to time. Recessions and depressions occur. In the 20th century alone there were around twenty identifiable crises – not including geopolitical events such as wars or terrorist attacks, which also caused markets to suddenly drop. Behavioral finance tells us that people are prone to panic in such events, and will not act rationally the way traditional financial theory predicts. As a result, those with cool heads, discipline, and an understanding that, historically, markets have always rebounded from such events can purchase assets at bargain prices and earn excess returns. Those with the foresight that a crisis is impending may implement short strategies to profit from a falling market. Of course, timing is everything, and buying too early or late, or holding on to a short position for too long, can serve to compound losses and take away from potential gains.

The Nasdaq Options Trading Guide

Equity options today are hailed as one of the most successful financial products to be introduced in modern times.

E quity options today are hailed as one of the most successful financial products to be introduced in modern times. Options have proven to be superior and prudent investment tools offering you, the investor, flexibility, diversification and control in protecting your portfolio or in generating additional investment income. We hope you’ll find this to be a helpful guide for learning how to trade options.

Understanding Options

Options are financial instruments that can be used effectively under almost every market condition and for almost every investment goal. Among a few of the many ways, options can help you:

  • Protect your investments against a decline in market prices
  • Increase your income on current or new investments
  • Buy an equity at a lower price
  • Benefit from an equity price’s rise or fall without owning the equity or selling it outright.

Benefits of Trading Options:

Orderly, Efficient and Liquid Markets

Standardized option contracts allow for orderly, efficient and liquid option markets.

Flexibility

Options are an extremely versatile investment tool. Because of their unique risk/reward structure, options can be used in many combinations with other option contracts and/or other financial instruments to seek profits or protection.

Leverage

An equity option allows investors to fix the price for a specific period of time at which an investor can purchase or sell 100 shares of an equity for a premium (price), which is only a percentage of what one would pay to own the equity outright. This allows option investors to leverage their investment power while increasing their potential reward from an equity’s price movements.

Limited Risk for Buyer

Unlike other investments where the risks may have no boundaries, options trading offers a defined risk to buyers. An option buyer absolutely cannot lose more than the price of the option, the premium. Because the right to buy or sell the underlying security at a specific price expires on a given date, the option will expire worthless if the conditions for profitable exercise or sale of the option contract are not met by the expiration date. An uncovered option seller (sometimes referred to as the uncovered writer of an option), on the other hand, may face unlimited risk.

This options trading guide provides an overview of characteristics of equity options and how these investments work in the following segments:

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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