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Options Stratigies

surinder verma, profile picture
surinder verma

The document provides an in-depth overview of various option strategies in international finance, covering call and put options, their pricing mechanisms, and market expectations. It explains different trading strategies such as long calls, short calls, protective puts, and bull/bear spreads, detailing the risks, rewards, and examples for each strategy. The content also outlines option terminology and moneyness, enhancing understanding of trading dynamics in options markets.

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International Finance Option Strategies Call option Put Option Market Volatility Expectations Bullish Bearish
INTRODUCTION TO OPTIONS An option is a contract written by a seller that conveys to the buyer the right — but not the obligation — to buy (in the case of a call option) or to sell (in the case of a put option) a particular asset, at a particular price (Strike price / Exercise price) in future. In return for granting the option, the seller collects a payment (the premium) from the buyer. Exchange traded options form an important class of options which have standardized contract features and trade on public exchanges, facilitating trading among large number of investors
OPTION TERMINOLOGY+ Index options: These options have the index as the underlying. In India, they have a European style settlement. Eg. Nifty options, Mini Nifty options etc. Buyer of an option: The buyer of an option is the one who by paying the option premium buys the right but not the obligation to exercise his option on the seller/writer. Writer / seller of an option: The writer / seller of a call/put option is the one who receives the option premium and is thereby obliged to sell/buy the asset if the buyer exercises on him. Option price/premium: Option price is the price which the option buyer pays to the option seller. It is also referred to as the option premium. Expiration date: The date specified in the options contract is known as the expiration date, the exercise date, the strike date or the maturity. Strike price: The price specified in the options contract is known as the strike price or the exercise price.
In-the-money option: An in-the-money (ITM) option is an option that would lead to a positive cash flow to the holder if it were exercised immediately. At-the-money option: An at-the-money (ATM) option is an option that would lead to zero cash flow if it were exercised immediately. Out-of-the-money option: An out-of-the-money (OTM) option is an option that would lead to a negative cash flow if it were exercised immediately. Moneyness of an Option: Comparing the spot price with the strike price at expiry date, Options will be classified under 3 categories: Call Option Moneyness Put Option Strike Price < Spot Price In The Money Strike Price > Spot Price Strike Price = Spot Price At The Money Strike Price = Spot Price Strike Price > Spot Price Out of the Money Strike Price < Spot Price
STRATEGY 1 : LONG CALL Risk: The risk of the buyer is the amount paid by him to buy the Call Option i.e. the premium value. Reward: The reward will be unlimited as the underlying asset value can rise up to any value until the expiry. Break-Even Point: The break-even point for the Call Option Holder will be ‘Strike Price + Premium.’ Explanation This is one of the basic strategies as it involves entering into one position i.e. buying the Call Option only. Any investor who buys the Call Option will be bullish in nature and would be expecting the market to give decent returns in the near future.
Example Currently NIFTY is trading around 5300 levels, and Mr. X is bullish on NIFTY and buys one 5200 Call Option (ITM) for Rs. 200 premium. Lot size is 50. The investment amount will be Rs. 10000. (200*50) Case 1: NIFTY closes at 5500 levels; Mr. X will make a profit of Rs. 5000. [(300-200)*50] Case 2: NIFTY dips to 5100 levels; Mr. X will incur a loss of Rs. 10000 (200*50) which is the premium he paid for buying one lot of 5200 Call Option. Construction Buy 1 Call Option
Explanation A trader shorts or writes a Call Option when he feels that underlying stock price is likely to go down. Selling Call Option is a strategy preferred for experienced traders. However this strategy is very risky in nature. If the stock rallies on the upside, your risk becomes potentially unquantifiable and unlimited. If the strategy works out in your favor then you will pocket the premium amount as your reward. Risk: Unlimited Reward: Limited STRATEGY 2: SHORT CALL
Example If the NIFTY is trading around 5300 levels, Mr. X feels that Nifty is likely to fall in the near future then he will sell one 5400 Call Option for a premium of Rs. 120. Mr. X will get a credit of Rs 6000 (120*50) in his account for selling or writing the call option. Case 1: NIFTY closes at 5200 levels, Mr. X will bag the premium amount i.e. Rs. 6000. (120*50) Case 2: NIFTY closes at 5600 levels; Mr. X will incur a loss of Rs. 4000. [(Strike Price - Expiry Price) + Premium Price * 50] [(5400-5600) + 120)*50] Construction Sell 1 Call Option
Explanation A trader will short put if he is bullish in nature and expects the underlying asset not to fall below a certain level. Risk: Losses will be potentially unlimited if the stock skyrockets above the strike price of put. Reward: His profits will be capped by the premium amount received. Strategy 3: Short Put
Construction Sell 1 Put Option Example Suppose NIFTY is trading at 5200 level and Mr. X is bullish on the market. He expects NIFTY to stay near 5200-5300 levels or even rise further until expiry. He will sell one NIFTY 5200 Put Option for a premium of Rs. 70. The lot size of NIFTY is 50. Mr. X’s account will be credited by Rs. 3500 (70*50) which is the premium received on sale of Put option. Case 1: If the NIFTY closes at 5400, then Mr. X will receive the maximum profit of Rs. 3500. Case 2: If the NIFTY closes at 5000, then Mr. X will face a loss of Rs. 6500. [(200-70)*50]
Explanation This strategy is implemented by buying 1 Put Option i.e. a single position, when the person is bearish on the market and expects the market to move downwards in the near future. Risk: The maximum loss will be the premium amount paid. Reward: The profits will be limited by the maximum fall in the underlying asset price i.e. potentially null value (i.e. zero ‘0’) Long Put Strategy4:
Construction Buy 1 Put Option Example Mr. X is bearish on NIFTY and expects the market to move downwards in the near future. NIFTY is currently trading around Rs. 5200 level. Lot size of NIFTY is 50. Mr. X buys 1 5300 Put Option of NIFTY for a premium of Rs. 115. His initial investment will be Rs. 5750. (115*50) Case 1: If the market moves as per Mr. X’s expectations and dips down to Rs. 5100 level, then the net profit will be Rs. 4250. [(200-115)*50] Case 2: If the market moves upwards against his expectations then the maximum loss/risk will be the premium amount paid i.e. Rs. 5750. (115*50)
STRATEGY 5: COVERED CALLWhen to Use: This is often employed when an investor has a short-term neutral to moderately bullish view on the stock he holds. He takes a short position on the Call option to generate income from the option premium. Since the stock is purchased simultaneously with writing (selling) the Call, the strategy is commonly referred to as “buy-write”. Risk: If the Stock Price falls to zero, the investor loses the entire value of the Stock but retains the premium, since the Call will not be exercised against him. So maximum risk = Stock Price Paid – Call Premium Upside capped at the Strike price plus the Premium received. So if the Stock rises beyond the Strike price the investor (Call seller) gives up all the gains on the stock. Reward: Limited to (Call Strike Price – Stock Price paid)+ Premium received. Breakeven: Stock Price paid - Premium Received
Example RIL is trading around Rs 745 levels. Lot size of RIL Option is 250. Mr. X is bullish in nature and buys 250 shares of RIL @ Rs 745 from the market. He also shorts one 760 Call Option for a premium of Rs. 15. His net investment will be Rs.182500. [{(745)-(15)}*250] Case 1: If RIL closes at Rs. 755, Mr. X will get a capital appreciation on his investment of Rs. 2500. [(755-745)*250] plus the Call Option premium he received from writing it i.e. Rs.3750 (15*250). His total gain will be Rs 6250. Case 2: If RIL closes at Rs. 780, Mr. X will make a profit on his long position in spot market but incur loss on his short call. His net payoff will be Rs. 7500. [{(780-745) + (15-20)}*250] Construction Buy 250 RIL Shares Sell 1 Call Option
STRATEGY 6: PROTECTIVE PUT Explanation Protective Put Strategy is a hedging strategy where trader guards himself from the downside risk. This strategy is adopted when a trader is long on the underlying asset but skeptical of the downside. He will buy one ATM Put Option to hedge his position. Now, if the underlying asset moves either up or down, the trader is in a safe position. Risk: Limited Reward: Unlimited
Example Suppose that RIL is trading at Rs. 745 and Mr. X buys 250 shares in the Cash Market. He will buy One 740 ATM Put Option at a premium of Rs. 20 to hedge his long position. His net investment will be Rs. 191250. [(745+20)*250] Case 1: At expiry if RIL closes at Rs. 710, then Mr. X will incur a loss of Rs. 6250. [{(710-745) + (30-20)}*250] Case 2: At expiry if RIL closes at Rs. 740, then Mr. X will incur a loss of Rs. 6250. [{(740-745)-(20)}*250] Case 3: At expiry if RIL closes at Rs. 770, then Mr. X will make a profit of Rs. 1250. [{(770-745)-(20)}*250] Note: It is observed that once the stock starts moving up, the time value of Put will shrink half times the cash price. This will also depend on the number of days left in the expiry. A professional trader can also keep a stop loss in ATM Put once stock rallies sharply. Construction Buy 250 RIL Shares in Cash/Futures Market Buy 1 ATM Put Option
STRATEGY 7: BULL CALL SPREAD Explanation Bull Call Spread option trading strategy is used by a trader who is bullish in nature and expects the underlying asset to give decent returns in the near future. This strategy includes buying of an ‘In The Money’ Call Option and selling of ‘Deep Out Of the Money’ Call Option of the same underlying asset and the same expiration date. When you write a call, you receive premium which results in reducing the cost for buying an ITM Call Option. However, the profits are also minimized in case of a windfall rise in the underlying asset’s price. This strategy is also called as ‘Bull Call Debit Spread’ as your account gets debited while deploying the strategy. Risk: Limited Reward: Limited
Example Suppose that the NIFTY is trading around 5180 level, and Mr. X enters into Bull-Call-Spread strategy. Lot Size of NIFTY is 50. He buys one 5100 ITM Call Option for a premium of Rs. 165, and sells one 5300 OTM Call Option for Rs. 55. The net investment will be only Rs. 5500 [(165-55)*50], after premium received from writing the 5300 call. Case 1: At expiry if the NIFTY dips down to 5000 level, the maximum loss will be only Rs. 5500 (Investment Value). Case 2: At expiry if the NIFTY closes at 5200 level, net profit will be Rs. 6000. [{(55) - (100-165)}*50] Case 3: At expiry if the spot NIFTY closes at 5400 level, the intrinsic value of the 5100 ITM call will be Rs. 300 and that of 5300 OTM call will be Rs. 100. At expiry, the cash settlement will be done with a credit of Rs. 4500. [{(300-165) - (100-55)}*50] Construction Buy 1 ‘In The Money’ Call Option Sell 1 ‘Deep Out Of the Money’ Call Option
STRATEGY 8: BULL PUT SPREAD Explanation Bull Put Spread option trading strategy is used by a trader who is bullish in nature and expects the underlying asset to move in an upward trend in the near future. This strategy includes buying of an ‘Out of the Money’ Put Option and selling of ‘In the Money’ Put Option of the same underlying asset and the same expiration date. When you write a Put, you will receive premium thereby engulfing the cost for buying of OTM Put Option. This strategy is also called as ‘Bull Put Credit Spread’ as your account gets credited while deploying the strategy. Risk: Limited Reward: Limited
Example Suppose that the NIFTY is trading around 5300 level and Mr. X enters into Bull-Put-Spread strategy. Lot Size of NIFTY is 50. He buys one 5100 OTM Put Option for a premium of Rs. 45, and sells one 5400 ITM Put Option for Rs. 180. Hence his account will be credited by Rs. 6750. [(180-45)*50] Case 1: At expiry if the NIFTY dips down to 5000 level, his net loss will be Rs. 8250. [{(100-45) + (180- 400)}*50] Case 2: At expiry if the NIFTY closes at 5200, then his net loss will be Rs. 3250. [{(180-400)-(45)}*50] Case 3: At expiry if the spot NIFTY closes at 5500 level, both the Puts expire worthless and Mr. X gets to keep Rs. 6750. Construction Buy 1 ‘Out of the Money’ Put Option Sell 1 ‘In the Money’ Put Option
Explanation Bear Call Spread option trading strategy is used by a trader who is bearish in nature and expects the underlying asset to dip in the near future. This strategy includes buying of an ‘Out of the Money’ Call Option and selling one ‘In the Money’ Call Option of the same underlying asset and the same expiration date. When you write a call, you receive premium thereby reducing the cost for buying of OTM Call Option. This strategy is also called as ‘Bear Call Credit Spread’ as your account gets credited at the time of entering the positions. Risk: Limited Reward: Limited STRATEGY 9: BEAR CALL SPREAD
Example Suppose that the NIFTY is trading around 5300 level, and Mr. X enters into Bear-Call-Spread strategy. The Lot Size of NIFTY is 50. He buys one 5500 OTM Call Option for a premium of Rs. 35, and sells one 5100 ITM Call Option for Rs. 275. His account will be credited by Rs 12000. [(275-35)*50] Case 1: At expiry, if the NIFTY closes at 5000 level, then Mr. X is allowed to keep the credit amount i.e. Rs.12000. Case 2: At expiry, if the NIFTY closes at 5200 level, then the trader will make a profit of Rs. 7000. [{(275-100) - (35)}*50] Case 3: At expiry, if the NIFTY closes at 5600 level, then Mr. X would have made loss on the short position of 5100 which will be mitigated by profits made in the long position of 5500. The loss amount would be Rs. 8000. [{(100-35) – (500-275)}*50] Construction Buy 1 ‘Out of the Money’ Call Option Sell 1 ‘In the Money’ Call Option
STRATEGY 10: BEAR PUT SPREAD Explanation When a trader is moderately bearish on the market he can implement this strategy. Bear-Put-Spread involves buying of ITM Put Option and selling of an OTM Put Option. If prices fall, the ITM Put option starts making profits and the OTM Put option also adds to profit at a certain extent if the expiry price stays above the OTM strike. However, if it falls below the OTM strike, then it starts making losses which will be mitigated by ITM Put which generates profit. Risk: Limited Reward: Limited
Example Suppose that NIFTY is trading at 5200 levels and Mr. X is bearish on the market and expects it to fall in the near future. He implements the Bear-Put-Strategy, he buys one NIFTY 5400 ITM Put Option for a premium of Rs. 200 & sells one NIFTY 5000 OTM Put Option for a premium of Rs. 30. His net investment will be Rs. 13500. [(200-30)*50] Case 1: If the NIFTY closes at 4900, then Mr. X will make a profit of Rs. 11500. [{(500-200)-(100-30)}*50] Case 2: If the NIFTY closes at 5300, then Mr. X will make a loss of Rs. 3500. [{(100-200) + (30)}*50] Case 3: If the NIFTY closes at 5500, then Mr. X will make a loss of Rs. 8500. [(30-200)*50] Construction Buy ITM Put Option Sell OTM Put Option
STRATEGY 11: STRAP ^ Explanation Strap Strategy is similar to Long Straddle, the only difference is the quantity traded. A trader will buy two Call Options and one Put Options. In this strategy, a trader is very bullish on the market and volatility on upside but wants to hedge himself in case the stock doesn’t perform as per his expectations. This strategy will make more profits compared to long straddle since he has bought 2 calls. Risk: Limited Reward: Unlimited
Example Mr. X is bullish on NIFTY and enters in a Strap Strategy. He buys two 5200 NIFTY ATM Call Options at a premium of Rs. 100 and simultaneously buys one 5200 ATM Put Option at a premium of Rs. 85. His net investment will be Rs. 14250 [{(100*2) + (85)}*50] Case 1: At expiry if NIFTY closes at 4900, then Mr. X will make a profit of Rs. 750. [{(300-85) + (0-200)}*50] Case 2: At expiry if NIFTY closes at 5200, then Mr. X will make a loss of Rs. 14250 (Entire investment amount). [{(0- 200) + (0-85)}*50] Case 3: At expiry if NIFTY closes at 5400, then Mr. X will make a profit of Rs. 5750. [{((200-100)*2)-(85)}*50] Construction Buy 2 ATM Call Options Buy 1 ATM Put Option
STRATEGY 12: RATIO CALL SPREAD Explanation As the name suggests, a ratio of 2:1 is followed i.e. buy 1 ITM Call and simultaneously sell OTM Calls double the number of ITM Calls (In this case 2). This strategy is used by trader who is neutral on the market and bearish on the volatility in the near future. Here profits will be capped up to the premium amount and risk will be potentially unlimited since he is selling two calls. Risk: Unlimited Reward: Limited
Construction Buy 1 ITM Call Option Sell 2 OTM Call Options Example Suppose NIFTY is trading around 5200 odd points, Mr. X is bearish on volatility and neutral on the market. He will buy 1 NIFTY 5100 ITM Call Option at a premium of Rs. 165 and sell 2 5300 NIFTY OTM Call Options for a premium of Rs. 110 (55*2). His net investment will be Rs. 2750. [(110-165)*50] Case 1: At expiry if NIFTY closes at 5000, then Mr. X will lose his entire investment value i.e. Rs. 2750. Case 2: At expiry if NIFTY closes at 5200, then Mr. X will make a profit of Rs. 2250. [{(55*2) + (100-165)}*50] Case 3: At expiry if NIFTY closes at 5400, then Mr. X will make a profit of Rs. 2250. [{(300-165) – ((100-55)*2)}*50]
Explanation A trader, who is neutral in nature and believes that there will be very low volatility i.e. expects the market to remain range bound, will implement this strategy. This strategy involves selling of 2 ATM Call Options, buying 1 ITM Call Option & buying 1 OTM Call Option of the same expiry date & same underlying asset. The difference between the strikes should be equal. If the market remains range bound then this strategy will start making profits. If the market moves out of strike range in either way, then it will start making loss. The loss generated will also be capped. Risk: Limited Reward: Limited STRATEGY 13: LONG CALL BUTTERFLY
Construction Sell 2 ATM Call Options Buy 1 ITM Call Option Buy 1 OTM Call Option Example Suppose that NIFTY is trading at 5200 levels, Mr. X thinks that there is low volatility in the market and expects it to stay between a certain range, then he will implement the Long Call Butterfly Strategy. He will sell 2 NIFTY 5200 ATM Call Options for a premium of Rs. 200 (100*2), buy 1 NIFTY 5100 ITM Call Option at a premium of Rs. 165 & buy 1 NIFTY 5300 OTM Call Option at a premium of Rs. 55. The net investment will only be Rs. 1000. [{(100*2)- (165)-(55)}*50] Case 1: At expiry if NIFTY closes at 4900, Mr. X will make a loss of Rs. 1000. [{(100*2)-(165)-(55)}*50] Case 2: At expiry if NIFTY closes at 5200, Mr. X will make a profit of Rs. 4000. [{(100-165) + (100*2)- (55)}*50] Case 3: At expiry if NIFTY closes at 5400, Mr. X will make a loss of Rs. 1000. [{(300-165) - ((200-100)*2) + (100- 55)}*50]
STRATEGY 14: SHORT CALL BUTTERFLY Explanation This strategy is opposite of the Long Call Butterfly Strategy, a trader expects the market to remain range bound in Long Call Butterfly, but here he expects the market to move beyond strike boundaries in Short Call Butterfly. If the trader is bullish on the market’s volatility, he will implement this strategy. Here also there should be equal distance between the strikes. Profits from this strategy are capped. Risk: Limited Reward: Limited
Construction Buy 2 ATM Call Options Sell 1 ITM Call Option Sell 1 OTM Call Option Example Suppose that NIFTY is trading at 5200, Mr. X implements the Short Call Butterfly Strategy. He buys 2 NIFTY 5200 ATM Call Options for a premium of Rs. 200 (100*2), sells 1 NIFTY 5100 ITM Call Option for a premium of Rs. 165 & sells 1 NIFTY 5300 OTM Call Option for a premium of Rs. 55. He will get a credit of Rs. 1000 [{(165) + (55) – (100*2)}*50] since he sold 2 Call Options. Case 1: At expiry if the NIFTY closes at 4900, then Mr. X will make a profit of Rs. 1000. [{165+55 – (100*2)}*50] Case 2: At expiry if the NIFTY closes at 5200, then Mr. X will make a loss of Rs. 10500. [{(100-165) + 55 - (100*2)}*50] Case 3: At expiry if the NIFTY closes at 5500, then Mr. X will make a profit of Rs. 1000. [{(400-165) + ((300- 100)*2) – (200-55)}*50]
Options Stratigies

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Options Stratigies

  • 2. INTRODUCTION TO OPTIONS An option is a contract written by a seller that conveys to the buyer the right — but not the obligation — to buy (in the case of a call option) or to sell (in the case of a put option) a particular asset, at a particular price (Strike price / Exercise price) in future. In return for granting the option, the seller collects a payment (the premium) from the buyer. Exchange traded options form an important class of options which have standardized contract features and trade on public exchanges, facilitating trading among large number of investors
  • 3. OPTION TERMINOLOGY+ Index options: These options have the index as the underlying. In India, they have a European style settlement. Eg. Nifty options, Mini Nifty options etc. Buyer of an option: The buyer of an option is the one who by paying the option premium buys the right but not the obligation to exercise his option on the seller/writer. Writer / seller of an option: The writer / seller of a call/put option is the one who receives the option premium and is thereby obliged to sell/buy the asset if the buyer exercises on him. Option price/premium: Option price is the price which the option buyer pays to the option seller. It is also referred to as the option premium. Expiration date: The date specified in the options contract is known as the expiration date, the exercise date, the strike date or the maturity. Strike price: The price specified in the options contract is known as the strike price or the exercise price.
  • 4. In-the-money option: An in-the-money (ITM) option is an option that would lead to a positive cash flow to the holder if it were exercised immediately. At-the-money option: An at-the-money (ATM) option is an option that would lead to zero cash flow if it were exercised immediately. Out-of-the-money option: An out-of-the-money (OTM) option is an option that would lead to a negative cash flow if it were exercised immediately. Moneyness of an Option: Comparing the spot price with the strike price at expiry date, Options will be classified under 3 categories: Call Option Moneyness Put Option Strike Price < Spot Price In The Money Strike Price > Spot Price Strike Price = Spot Price At The Money Strike Price = Spot Price Strike Price > Spot Price Out of the Money Strike Price < Spot Price
  • 5. STRATEGY 1 : LONG CALL Risk: The risk of the buyer is the amount paid by him to buy the Call Option i.e. the premium value. Reward: The reward will be unlimited as the underlying asset value can rise up to any value until the expiry. Break-Even Point: The break-even point for the Call Option Holder will be ‘Strike Price + Premium.’ Explanation This is one of the basic strategies as it involves entering into one position i.e. buying the Call Option only. Any investor who buys the Call Option will be bullish in nature and would be expecting the market to give decent returns in the near future.
  • 6. Example Currently NIFTY is trading around 5300 levels, and Mr. X is bullish on NIFTY and buys one 5200 Call Option (ITM) for Rs. 200 premium. Lot size is 50. The investment amount will be Rs. 10000. (200*50) Case 1: NIFTY closes at 5500 levels; Mr. X will make a profit of Rs. 5000. [(300-200)*50] Case 2: NIFTY dips to 5100 levels; Mr. X will incur a loss of Rs. 10000 (200*50) which is the premium he paid for buying one lot of 5200 Call Option. Construction Buy 1 Call Option
  • 7. Explanation A trader shorts or writes a Call Option when he feels that underlying stock price is likely to go down. Selling Call Option is a strategy preferred for experienced traders. However this strategy is very risky in nature. If the stock rallies on the upside, your risk becomes potentially unquantifiable and unlimited. If the strategy works out in your favor then you will pocket the premium amount as your reward. Risk: Unlimited Reward: Limited STRATEGY 2: SHORT CALL
  • 8. Example If the NIFTY is trading around 5300 levels, Mr. X feels that Nifty is likely to fall in the near future then he will sell one 5400 Call Option for a premium of Rs. 120. Mr. X will get a credit of Rs 6000 (120*50) in his account for selling or writing the call option. Case 1: NIFTY closes at 5200 levels, Mr. X will bag the premium amount i.e. Rs. 6000. (120*50) Case 2: NIFTY closes at 5600 levels; Mr. X will incur a loss of Rs. 4000. [(Strike Price - Expiry Price) + Premium Price * 50] [(5400-5600) + 120)*50] Construction Sell 1 Call Option
  • 9. Explanation A trader will short put if he is bullish in nature and expects the underlying asset not to fall below a certain level. Risk: Losses will be potentially unlimited if the stock skyrockets above the strike price of put. Reward: His profits will be capped by the premium amount received. Strategy 3: Short Put
  • 10. Construction Sell 1 Put Option Example Suppose NIFTY is trading at 5200 level and Mr. X is bullish on the market. He expects NIFTY to stay near 5200-5300 levels or even rise further until expiry. He will sell one NIFTY 5200 Put Option for a premium of Rs. 70. The lot size of NIFTY is 50. Mr. X’s account will be credited by Rs. 3500 (70*50) which is the premium received on sale of Put option. Case 1: If the NIFTY closes at 5400, then Mr. X will receive the maximum profit of Rs. 3500. Case 2: If the NIFTY closes at 5000, then Mr. X will face a loss of Rs. 6500. [(200-70)*50]
  • 11. Explanation This strategy is implemented by buying 1 Put Option i.e. a single position, when the person is bearish on the market and expects the market to move downwards in the near future. Risk: The maximum loss will be the premium amount paid. Reward: The profits will be limited by the maximum fall in the underlying asset price i.e. potentially null value (i.e. zero ‘0’) Long Put Strategy4:
  • 12. Construction Buy 1 Put Option Example Mr. X is bearish on NIFTY and expects the market to move downwards in the near future. NIFTY is currently trading around Rs. 5200 level. Lot size of NIFTY is 50. Mr. X buys 1 5300 Put Option of NIFTY for a premium of Rs. 115. His initial investment will be Rs. 5750. (115*50) Case 1: If the market moves as per Mr. X’s expectations and dips down to Rs. 5100 level, then the net profit will be Rs. 4250. [(200-115)*50] Case 2: If the market moves upwards against his expectations then the maximum loss/risk will be the premium amount paid i.e. Rs. 5750. (115*50)
  • 13. STRATEGY 5: COVERED CALLWhen to Use: This is often employed when an investor has a short-term neutral to moderately bullish view on the stock he holds. He takes a short position on the Call option to generate income from the option premium. Since the stock is purchased simultaneously with writing (selling) the Call, the strategy is commonly referred to as “buy-write”. Risk: If the Stock Price falls to zero, the investor loses the entire value of the Stock but retains the premium, since the Call will not be exercised against him. So maximum risk = Stock Price Paid – Call Premium Upside capped at the Strike price plus the Premium received. So if the Stock rises beyond the Strike price the investor (Call seller) gives up all the gains on the stock. Reward: Limited to (Call Strike Price – Stock Price paid)+ Premium received. Breakeven: Stock Price paid - Premium Received
  • 14. Example RIL is trading around Rs 745 levels. Lot size of RIL Option is 250. Mr. X is bullish in nature and buys 250 shares of RIL @ Rs 745 from the market. He also shorts one 760 Call Option for a premium of Rs. 15. His net investment will be Rs.182500. [{(745)-(15)}*250] Case 1: If RIL closes at Rs. 755, Mr. X will get a capital appreciation on his investment of Rs. 2500. [(755-745)*250] plus the Call Option premium he received from writing it i.e. Rs.3750 (15*250). His total gain will be Rs 6250. Case 2: If RIL closes at Rs. 780, Mr. X will make a profit on his long position in spot market but incur loss on his short call. His net payoff will be Rs. 7500. [{(780-745) + (15-20)}*250] Construction Buy 250 RIL Shares Sell 1 Call Option
  • 15. STRATEGY 6: PROTECTIVE PUT Explanation Protective Put Strategy is a hedging strategy where trader guards himself from the downside risk. This strategy is adopted when a trader is long on the underlying asset but skeptical of the downside. He will buy one ATM Put Option to hedge his position. Now, if the underlying asset moves either up or down, the trader is in a safe position. Risk: Limited Reward: Unlimited
  • 16. Example Suppose that RIL is trading at Rs. 745 and Mr. X buys 250 shares in the Cash Market. He will buy One 740 ATM Put Option at a premium of Rs. 20 to hedge his long position. His net investment will be Rs. 191250. [(745+20)*250] Case 1: At expiry if RIL closes at Rs. 710, then Mr. X will incur a loss of Rs. 6250. [{(710-745) + (30-20)}*250] Case 2: At expiry if RIL closes at Rs. 740, then Mr. X will incur a loss of Rs. 6250. [{(740-745)-(20)}*250] Case 3: At expiry if RIL closes at Rs. 770, then Mr. X will make a profit of Rs. 1250. [{(770-745)-(20)}*250] Note: It is observed that once the stock starts moving up, the time value of Put will shrink half times the cash price. This will also depend on the number of days left in the expiry. A professional trader can also keep a stop loss in ATM Put once stock rallies sharply. Construction Buy 250 RIL Shares in Cash/Futures Market Buy 1 ATM Put Option
  • 17. STRATEGY 7: BULL CALL SPREAD Explanation Bull Call Spread option trading strategy is used by a trader who is bullish in nature and expects the underlying asset to give decent returns in the near future. This strategy includes buying of an ‘In The Money’ Call Option and selling of ‘Deep Out Of the Money’ Call Option of the same underlying asset and the same expiration date. When you write a call, you receive premium which results in reducing the cost for buying an ITM Call Option. However, the profits are also minimized in case of a windfall rise in the underlying asset’s price. This strategy is also called as ‘Bull Call Debit Spread’ as your account gets debited while deploying the strategy. Risk: Limited Reward: Limited
  • 18. Example Suppose that the NIFTY is trading around 5180 level, and Mr. X enters into Bull-Call-Spread strategy. Lot Size of NIFTY is 50. He buys one 5100 ITM Call Option for a premium of Rs. 165, and sells one 5300 OTM Call Option for Rs. 55. The net investment will be only Rs. 5500 [(165-55)*50], after premium received from writing the 5300 call. Case 1: At expiry if the NIFTY dips down to 5000 level, the maximum loss will be only Rs. 5500 (Investment Value). Case 2: At expiry if the NIFTY closes at 5200 level, net profit will be Rs. 6000. [{(55) - (100-165)}*50] Case 3: At expiry if the spot NIFTY closes at 5400 level, the intrinsic value of the 5100 ITM call will be Rs. 300 and that of 5300 OTM call will be Rs. 100. At expiry, the cash settlement will be done with a credit of Rs. 4500. [{(300-165) - (100-55)}*50] Construction Buy 1 ‘In The Money’ Call Option Sell 1 ‘Deep Out Of the Money’ Call Option
  • 19. STRATEGY 8: BULL PUT SPREAD Explanation Bull Put Spread option trading strategy is used by a trader who is bullish in nature and expects the underlying asset to move in an upward trend in the near future. This strategy includes buying of an ‘Out of the Money’ Put Option and selling of ‘In the Money’ Put Option of the same underlying asset and the same expiration date. When you write a Put, you will receive premium thereby engulfing the cost for buying of OTM Put Option. This strategy is also called as ‘Bull Put Credit Spread’ as your account gets credited while deploying the strategy. Risk: Limited Reward: Limited
  • 20. Example Suppose that the NIFTY is trading around 5300 level and Mr. X enters into Bull-Put-Spread strategy. Lot Size of NIFTY is 50. He buys one 5100 OTM Put Option for a premium of Rs. 45, and sells one 5400 ITM Put Option for Rs. 180. Hence his account will be credited by Rs. 6750. [(180-45)*50] Case 1: At expiry if the NIFTY dips down to 5000 level, his net loss will be Rs. 8250. [{(100-45) + (180- 400)}*50] Case 2: At expiry if the NIFTY closes at 5200, then his net loss will be Rs. 3250. [{(180-400)-(45)}*50] Case 3: At expiry if the spot NIFTY closes at 5500 level, both the Puts expire worthless and Mr. X gets to keep Rs. 6750. Construction Buy 1 ‘Out of the Money’ Put Option Sell 1 ‘In the Money’ Put Option
  • 21. Explanation Bear Call Spread option trading strategy is used by a trader who is bearish in nature and expects the underlying asset to dip in the near future. This strategy includes buying of an ‘Out of the Money’ Call Option and selling one ‘In the Money’ Call Option of the same underlying asset and the same expiration date. When you write a call, you receive premium thereby reducing the cost for buying of OTM Call Option. This strategy is also called as ‘Bear Call Credit Spread’ as your account gets credited at the time of entering the positions. Risk: Limited Reward: Limited STRATEGY 9: BEAR CALL SPREAD
  • 22. Example Suppose that the NIFTY is trading around 5300 level, and Mr. X enters into Bear-Call-Spread strategy. The Lot Size of NIFTY is 50. He buys one 5500 OTM Call Option for a premium of Rs. 35, and sells one 5100 ITM Call Option for Rs. 275. His account will be credited by Rs 12000. [(275-35)*50] Case 1: At expiry, if the NIFTY closes at 5000 level, then Mr. X is allowed to keep the credit amount i.e. Rs.12000. Case 2: At expiry, if the NIFTY closes at 5200 level, then the trader will make a profit of Rs. 7000. [{(275-100) - (35)}*50] Case 3: At expiry, if the NIFTY closes at 5600 level, then Mr. X would have made loss on the short position of 5100 which will be mitigated by profits made in the long position of 5500. The loss amount would be Rs. 8000. [{(100-35) – (500-275)}*50] Construction Buy 1 ‘Out of the Money’ Call Option Sell 1 ‘In the Money’ Call Option
  • 23. STRATEGY 10: BEAR PUT SPREAD Explanation When a trader is moderately bearish on the market he can implement this strategy. Bear-Put-Spread involves buying of ITM Put Option and selling of an OTM Put Option. If prices fall, the ITM Put option starts making profits and the OTM Put option also adds to profit at a certain extent if the expiry price stays above the OTM strike. However, if it falls below the OTM strike, then it starts making losses which will be mitigated by ITM Put which generates profit. Risk: Limited Reward: Limited
  • 24. Example Suppose that NIFTY is trading at 5200 levels and Mr. X is bearish on the market and expects it to fall in the near future. He implements the Bear-Put-Strategy, he buys one NIFTY 5400 ITM Put Option for a premium of Rs. 200 & sells one NIFTY 5000 OTM Put Option for a premium of Rs. 30. His net investment will be Rs. 13500. [(200-30)*50] Case 1: If the NIFTY closes at 4900, then Mr. X will make a profit of Rs. 11500. [{(500-200)-(100-30)}*50] Case 2: If the NIFTY closes at 5300, then Mr. X will make a loss of Rs. 3500. [{(100-200) + (30)}*50] Case 3: If the NIFTY closes at 5500, then Mr. X will make a loss of Rs. 8500. [(30-200)*50] Construction Buy ITM Put Option Sell OTM Put Option
  • 25. STRATEGY 11: STRAP ^ Explanation Strap Strategy is similar to Long Straddle, the only difference is the quantity traded. A trader will buy two Call Options and one Put Options. In this strategy, a trader is very bullish on the market and volatility on upside but wants to hedge himself in case the stock doesn’t perform as per his expectations. This strategy will make more profits compared to long straddle since he has bought 2 calls. Risk: Limited Reward: Unlimited
  • 26. Example Mr. X is bullish on NIFTY and enters in a Strap Strategy. He buys two 5200 NIFTY ATM Call Options at a premium of Rs. 100 and simultaneously buys one 5200 ATM Put Option at a premium of Rs. 85. His net investment will be Rs. 14250 [{(100*2) + (85)}*50] Case 1: At expiry if NIFTY closes at 4900, then Mr. X will make a profit of Rs. 750. [{(300-85) + (0-200)}*50] Case 2: At expiry if NIFTY closes at 5200, then Mr. X will make a loss of Rs. 14250 (Entire investment amount). [{(0- 200) + (0-85)}*50] Case 3: At expiry if NIFTY closes at 5400, then Mr. X will make a profit of Rs. 5750. [{((200-100)*2)-(85)}*50] Construction Buy 2 ATM Call Options Buy 1 ATM Put Option
  • 27. STRATEGY 12: RATIO CALL SPREAD Explanation As the name suggests, a ratio of 2:1 is followed i.e. buy 1 ITM Call and simultaneously sell OTM Calls double the number of ITM Calls (In this case 2). This strategy is used by trader who is neutral on the market and bearish on the volatility in the near future. Here profits will be capped up to the premium amount and risk will be potentially unlimited since he is selling two calls. Risk: Unlimited Reward: Limited
  • 28. Construction Buy 1 ITM Call Option Sell 2 OTM Call Options Example Suppose NIFTY is trading around 5200 odd points, Mr. X is bearish on volatility and neutral on the market. He will buy 1 NIFTY 5100 ITM Call Option at a premium of Rs. 165 and sell 2 5300 NIFTY OTM Call Options for a premium of Rs. 110 (55*2). His net investment will be Rs. 2750. [(110-165)*50] Case 1: At expiry if NIFTY closes at 5000, then Mr. X will lose his entire investment value i.e. Rs. 2750. Case 2: At expiry if NIFTY closes at 5200, then Mr. X will make a profit of Rs. 2250. [{(55*2) + (100-165)}*50] Case 3: At expiry if NIFTY closes at 5400, then Mr. X will make a profit of Rs. 2250. [{(300-165) – ((100-55)*2)}*50]
  • 29. Explanation A trader, who is neutral in nature and believes that there will be very low volatility i.e. expects the market to remain range bound, will implement this strategy. This strategy involves selling of 2 ATM Call Options, buying 1 ITM Call Option & buying 1 OTM Call Option of the same expiry date & same underlying asset. The difference between the strikes should be equal. If the market remains range bound then this strategy will start making profits. If the market moves out of strike range in either way, then it will start making loss. The loss generated will also be capped. Risk: Limited Reward: Limited STRATEGY 13: LONG CALL BUTTERFLY
  • 30. Construction Sell 2 ATM Call Options Buy 1 ITM Call Option Buy 1 OTM Call Option Example Suppose that NIFTY is trading at 5200 levels, Mr. X thinks that there is low volatility in the market and expects it to stay between a certain range, then he will implement the Long Call Butterfly Strategy. He will sell 2 NIFTY 5200 ATM Call Options for a premium of Rs. 200 (100*2), buy 1 NIFTY 5100 ITM Call Option at a premium of Rs. 165 & buy 1 NIFTY 5300 OTM Call Option at a premium of Rs. 55. The net investment will only be Rs. 1000. [{(100*2)- (165)-(55)}*50] Case 1: At expiry if NIFTY closes at 4900, Mr. X will make a loss of Rs. 1000. [{(100*2)-(165)-(55)}*50] Case 2: At expiry if NIFTY closes at 5200, Mr. X will make a profit of Rs. 4000. [{(100-165) + (100*2)- (55)}*50] Case 3: At expiry if NIFTY closes at 5400, Mr. X will make a loss of Rs. 1000. [{(300-165) - ((200-100)*2) + (100- 55)}*50]
  • 31. STRATEGY 14: SHORT CALL BUTTERFLY Explanation This strategy is opposite of the Long Call Butterfly Strategy, a trader expects the market to remain range bound in Long Call Butterfly, but here he expects the market to move beyond strike boundaries in Short Call Butterfly. If the trader is bullish on the market’s volatility, he will implement this strategy. Here also there should be equal distance between the strikes. Profits from this strategy are capped. Risk: Limited Reward: Limited
  • 32. Construction Buy 2 ATM Call Options Sell 1 ITM Call Option Sell 1 OTM Call Option Example Suppose that NIFTY is trading at 5200, Mr. X implements the Short Call Butterfly Strategy. He buys 2 NIFTY 5200 ATM Call Options for a premium of Rs. 200 (100*2), sells 1 NIFTY 5100 ITM Call Option for a premium of Rs. 165 & sells 1 NIFTY 5300 OTM Call Option for a premium of Rs. 55. He will get a credit of Rs. 1000 [{(165) + (55) – (100*2)}*50] since he sold 2 Call Options. Case 1: At expiry if the NIFTY closes at 4900, then Mr. X will make a profit of Rs. 1000. [{165+55 – (100*2)}*50] Case 2: At expiry if the NIFTY closes at 5200, then Mr. X will make a loss of Rs. 10500. [{(100-165) + 55 - (100*2)}*50] Case 3: At expiry if the NIFTY closes at 5500, then Mr. X will make a profit of Rs. 1000. [{(400-165) + ((300- 100)*2) – (200-55)}*50]