The financial market is made up of hundreds of investment opportunities and, to obtain better results, investors create strategies, one of which is the bearish lock.
As much as it may end up limiting the investor’s earnings, this strategy helps to reduce the risk of loss in a given operation. But before bearish lock, we need to study it to understand the way it works, in order to apply it the right way.
In this post, you will check everything related to the low lock, how it works and its main advantages and disadvantages.
What this article covers:
What is a down lock?
A bearish lock can be defined as a structured trade that may involve one or two options. It comes into play in a scenario where asset prices are devaluing.
The fundamental idea of the bearish lock is that, at the same time as buying an option, the investor sells exactly the same amount of another option that has the same maturity.
In parallel to the bearish lock, we also have the bullish lock, which has a similar concept. But while the bearish lock is set with a view to a fall in asset prices, the bullish lock is made with the expectation of an increase.
What is a low lock used for?
The main purpose of the bearish lock is allow the investor explore the market with greater protection. This is because, thanks to the low lock, it is possible to control the maximum loss that a given operation can generate. But how is this possible? Let’s better understand how the strategy works.
How does a low lock work?
In an operation with a bearish lock, the investor must execute two operations symmetrically. That is, at the same time as selling a certain asset, the investor must acquire exactly the same amount of assets that have the same maturity date as the sold asset.
To simplify, let’s use the bearish lock with call as an example, the right to buy a certain asset at a future time.
Let’s say that a share is worth R$12.00, and the investor believes that this price will suffer a devaluation. In this case, he can market a call option for $2.00 and a strike price of $11.50.
With that, he must also acquire another call option, with the same expiration date as the other, and they must be purchased for R$1.50, with a strike price of R$13.00.
If the operation is carried out with 1,000 shares, he will have raised R$2,000 with the sale and paid R$1,500 in purchases, achieving an initial profit of R$500.00. If, on the expiration date, the value of the share is less than R$11.50, the maximum gain for the share will be exactly R$500.00.
If the value of the share is greater than R$13.00 on the expiration date, it will be necessary to exercise both operations, that is, sell one thousand shares for R$11.50 and acquire the others for R$13.00.
Thus, the investor is left with a loss of $1,500. However, even at the beginning of the operation, the investor had achieved R$500.00 in profit. Thus, the maximum loss of this operation is R$1,000.
What are the advantages of using a bear lock?
The advantage of using the bearish lock is that the investor manages to have greater control over the operation and can protect himself from market volatility, since the operation has a maximum loss that is not changed and, therefore, cannot be affected by the market movement.
The bearish lock is the ideal strategy to use at times when the market has greater volatility — which increases the investor’s chances of losses.
Are there any downsides to using a bear lock?
In order to have greater control over the operation and limit their losses, investors give up having greater gains. This is the only downside of the bearish lock: while the losses are limited, the gains will be limited as well.
However, if used at the appropriate time, the bearish lock can become a great ally of the investor, granting total control over the gains and losses of the operation.