Definition

Zero-Cost Strategy

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What is Zero-Cost Strategy?

Zero-cost strategy is a business decision that does not involve any incurrence of financial expense or any strategy that costs nothing to implement. The strategy helps in enhancing operations, making procedures more effective, or assisting in alleviating future expenses.

Summary
  • Zero-cost strategy is a business decision that involves no cost while simultaneously improving operations, making processes efficient, or lowering future expenses.
  • This strategy can be used in trading options, equities and commodities.
  • Zero-Cost strategy is used in options trading where an investor can buy one option by simultaneously selling another option of the same value.

Frequently Asked Questions (FAQ)-

How does Zero-Cost Strategy work?

A zero-cost approach indicates that there are no extra costs associated with making upgrades to a business's or other entity's operations. An individual can cut future expenses, simplify processes like time involved in creating and promoting content, workers’ wages etc.

For example, If I want to sell my house, I can decide to clear the clutter lying here and there in the house and make it look clean. This will involve no cost but is a strategy that can assist in the profitable sale of the property.

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A firm can make use of zero-cost marketing strategies like SEO keyword optimisation, email marketing, social media marketing, participating in online communities, etc.

Where can Zero-Cost trading strategies be used?

Options, equities and commodities are just a few of the investment and asset categories where zero-cost trading methods can be used. Buying and selling an item at the same time can also be a zero-cost strategy if the two expenses negate each other.

In investing, a zero-cost portfolio may see an individual develop a long/short method that includes buying stocks that are projected to rise in value and selling those that are anticipated to decrease in value.

For example, an investor might borrow $2 worth of Google shares, sell the $2 investment in Google, and reinvest the proceeds in Microsoft. After a year, presuming the deal went as planned, the investor sells Microsoft in order to repurchase and return the Google shares that he borrowed. The return on this zero-cost method is equal to Microsoft's return minus Google's return.

Is it feasible to build a risk-free portfolio for an investor?

It is feasible to put together a stock portfolio with an expected return that is equivalent to the risk-free rate. These portfolios are often known as zero beta portfolios since they have no systematic risk.

A zero-beta portfolio is one that has been designed to have no systematic risk, or a beta of zero. Provided that its expected return matches the risk-free rate or a very modest rate of return in contrast to higher-beta portfolios, such a portfolio would have zero correlation with market volatility.

How can Zero-Cost strategy work in options trading?

 A zero-cost option strategy is an options trading method in which no-cost options position can be taken for hedging or speculating in equities, currency, and commodities markets. An investor can buy one option by simultaneously selling another option of the same value.

There are 2 methods to construct this strategy:

  • When an investor is optimistic on a certain stock, he may create a bullish position by buying out-of-the-money call option and selling out-of-the-money put option in the same stock.
  • When an investor is pessimistic on a specific stock, he may create a bearish position by buying out-of-the-money put option and selling out-of-the-money call option in the same stock.

The strike price (reveals the price at which contract can be purchased or sold) is selected such that the buy and sell premiums essentially cancel out each other.

When building the aforementioned strategies,  one out-of-money put or call option is sold to pay for the buying of the counter options, making this option approach zero-cost. A zero-Cost approach helps in lowering risk by removing upfront costs.

Investors will still utilize this method even if the premiums do not equal. Investors will go into the trade with a net credit or debit from the premiums, if this occurs.

If an investor entered the transaction with a net debit, a call option can be sold by him that was more out-of-the-money than the put option he was buying. Secondly, if the investor were to undergo the transaction with a net credit, he would instead purchase a put option further out-of-money than the call option he was selling.