Optimizing the returns of option strategies using fundamental and technical analysis of the underlying

Abstract

Option Strategies have been long used for hedging downside risk and ascertaining a profit whenever the underlying asset shows an upside or downside movement. Derivatives are securities whose value depends upon the price of the underlying asset. One of these derivatives are options with an underlying stock associated with it. There are 2 types of options, call and put both of which provide you with a right to either buy or sell a particular stock at a predefined price at the time or before expiry respectively. Options often can be seen as a leverage over the underlying stock and thus involve a lot of risk. To hedge such high risk, several strategies have been defined. Some of the popular strategies include Straddle, Strangle, Spreads, Collar and Butterfly. We in our research are trying to study the risk and return characteristics of these strategies. Some of these strategies also play on the volatility of the underlying stock and thus are very useful in times of distress. To study such characteristics, two sectors have been chosen Automobile and Metals and Mining which have seen periods of crisis when the whole sector plunged badly. How could someone have used the option strategies to get a reasonable return in these periods of stress and also during periods of upsides when the sectors were doing really well. How did the same strategy perform in such contrast environments and which strategy is good for which period is also included in the scope of the research. Apart from looking just on the technicals of these sectors we have also tried to incorporate fundamentals of the stock which can play an important role in executing these strategies. The volatility of the stock is one of the key parameters which also depends on some fundamentals such as revenue, leverage and exchange rate movements. On the other hand the leverage itself is dependent on the momentum of the stock price movement. These factors are often overlooked and thus this research is a humble effort to study the option premium movement during different periods and also to study the extent of their movement based on different fundamental analysis of the stock.