Derivatives - Option strategies.
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The document discusses various option strategies including long call, long put, short call, synthetic long call, and short put. A long call strategy involves buying call options and profits if the underlying stock or index price rises above the strike price plus premium paid. A long put strategy involves buying put options and profits if the price falls below the strike price minus premium paid. A short call strategy involves selling call options and profits if the price remains below or at the strike price, collecting premium as maximum profit. A synthetic long call strategy involves buying stock and buying protective put options to limit downside risk while retaining upside potential. A short put strategy involves selling put options and profits as long as the underlying price remains above
![Strategy – Covered Call
The price of XYZ Ltd. stays at or below Rs. 4000. The Call
buyer will not exercise the Call Option. Mr. A will keep
the premium of Rs. 80. This is an income for him.
So if the stock has moved from Rs. 3850 (purchase price) to
Rs. 3950, Mr. A makes Rs. 180/- [Rs. 3950 – Rs. 3850 +
Rs. 80 (Premium) ] = An additional Rs. 80, because of the
Call sold.
Suppose the price of XYZ Ltd. moves to Rs. 4100, then the
Call Buyer will exercise the Call Option and Mr. A will
have to pay him Rs. 100 (loss on exercise of the Call
Option). What would Mr. A do and what will be his pay –
off?](https://image.slidesharecdn.com/optionstrategies-part-151104042225-lva1-app6891/85/Derivatives-Option-strategies-44-320.jpg)
Derivatives - Option strategies.
- 2. Strategy – Long Call For aggressive investors who are very bullish about the prospects for a stock / index, buying calls can be an excellent way to capture the upside potential with limited downside risk.
- 3. Strategy – Long Call Buying a call is the most basic of all options strategies. When you buy it means you are bullish. Buying a Call means you are very bullish and expect the underlying stock / index to rise in future. When to Use: Investor is very bullish on the stock / index.
- 4. Strategy – Long Call Risk: Limited to the Premium. (Maximum loss if market expires at or below the option strike price). Reward: Unlimited Breakeven: Strike Price + Premium
- 5. Strategy – Long Call Example Mr. XYZ is bullish on Nifty on 24th June, when the Nifty is at 4191.10. He buys a call option with a strike price of Rs. 4600 at a premium of Rs. 36.35, expiring on 31st July. If the Nifty goes above 4636.35, Mr. XYZ will make a net profit (after deducting the premium) on exercising the option. In case the Nifty stays at or falls below 4600, he can forego the option (it will expire worthless) with a maximum loss of the premium.
- 6. Strategy – Long Call Current Nifty index 4191.10 Call Option Strike Price (Rs.) 4600 Mr. XYZ Pays Premium (Rs.) 36.35 Break Even Point (Rs.) (Strike Price + Premium) 4636.35
- 7. Strategy – Long Call The payoff schedule On expiry Nifty closes at Net Payoff from Call Option (Rs.) 4100.00 -36.35 4300.00 -36.35 4500.00 -36.35 4636.35 0 4700.00 63.65 4900.00 263.65 5100.00 463.65 5300.00 663.65
- 8. Strategy – Long Call ANALYSIS: This strategy limits the downside risk to the extent of premium paid by Mr. XYZ (Rs. 36.35). But the potential return is unlimited in case of rise in Nifty. A long call option is the simplest way to benefit if you believe that the market will make an upward move and is the most common choice among first time investors in Options. As the stock price / index rises the long Call moves into profit more and more quickly.
- 9. Strategy – Short Call When an investor is very bearish about a stock / index and expects the prices to fall, he can sell Call options. This position offers limited profit potential and the possibility of large losses on big advances in underlying prices.
- 10. Strategy – Short Call A Call option means an Option to buy. Buying a Call option means an investor expects the underlying price of a stock / index to rise in future. Selling a Call option is just the opposite of buying a Call option. Here the seller of the option feels the underlying price of a stock / index is set to fall in the future.
- 11. Strategy – Short Call When to use: Investor is very aggressive and he is very bearish about the stock / index. Risk: Unlimited Reward: Limited to the amount of premium Break-even Point: Strike Price + Premium
- 12. Strategy – Short Call Example: Mr. XYZ is bearish about Nifty and expects it to fall. He sells a Call option with a strike price of Rs. 2600 at a premium of Rs. 154, when the current Nifty is at 2694. If the Nifty stays at 2600 or below, the Call option will not be exercised by the buyer of the Call and Mr. XYZ can retain the entire premium of Rs. 154.
- 13. Strategy – Short Call Current Nifty index 2694 Call Option Strike Price (Rs.) 2600 Mr. XYZ receives Premium (Rs.) 154 Break Even Point (Rs.) (Strike Price + Premium)* 2754
- 14. Strategy – Short Call The payoff schedule On expiry Nifty closes at Net Payoff from the Call Options (Rs.) 2400 154 2500 154 2600 154 2700 54 2754 0 2800 -46 2900 -146 3000 -246
- 15. Strategy – Short Call ANALYSIS: This strategy is used when an investor is very aggressive and has a strong expectation of a price fall (and certainly not a price rise). This is a risky strategy since as the stock price / index rises, the short call loses money more and more quickly and losses can be significant if the stock price / index falls below the strike price. Since the investor does not own the underlying stock that he is shorting this strategy is also called Short Naked Call.
- 16. Strategy – Synthetic Long Call – Buy Stock, Buy Put In this strategy, we purchase a stock since we feel bullish about it. But what if the price of the stock went down. You wish you had some insurance against the price fall. So buy a Put on the stock. This gives you the right to sell the stock at a certain price which is the strike price. The strike price can be the price at which you bought the stock (ATM strike price) or slightly below (OTM strike price).
- 17. Strategy – Synthetic Long Call – Buy Stock, Buy Put In case the price of the stock rises you get the full benefit of the price rise. In case the price of the stock falls, exercise the Put Option (remember Put is a right to sell). You have capped your loss in this manner because the Put option stops your further losses. It is a strategy with a limited loss and (after subtracting the Put premium) unlimited profit (from the stock price rise). The result of this strategy looks like a Call Option Buy strategy and therefore is called a Synthetic Call!
- 18. Strategy – Synthetic Long Call – Buy Stock, Buy Put But the strategy is not Buy Call Option (Strategy 1). Here you have taken an exposure to an underlying stock with the aim of holding it and reaping the benefits of price rise, dividends, bonus rights etc. and at the same time insuring against an adverse price movement. In simple buying of a Call Option, there is no underlying position in the stock but is entered into only to take advantage of price movement in the underlying stock.
- 19. Strategy – Synthetic Long Call – Buy Stock, Buy Put When to use: When ownership is desired of stock yet investor is concerned about near-term downside risk. The outlook is conservatively bullish. Risk: Losses limited to Stock price + Put Premium – Put Strike price Reward: Profit potential is unlimited. Break-even Point: Put Strike Price + Put Premium + Stock Price – Put Strike Price
- 20. Strategy – Synthetic Long Call – Buy Stock, Buy Put Example Mr. XYZ is bullish about ABC Ltd stock. He buys ABC Ltd. at current market price of Rs. 4000 on 4th July. To protect against fall in the price of ABC Ltd. (his risk), he buys an ABC Ltd. Put option with a strike price Rs. 3900 (OTM) at a premium of Rs. 143.80 expiring on 31st July.
- 21. Strategy – Synthetic Long Call – Buy Stock, Buy Put Break Even is from the point of view of Mr. XYZ. He has to recover the cost of the Put Option purchase price + the stock price to break even. Buy Stock (Mr. XYZ pays) Current Market Price of ABC Ltd. (Rs.) 4000 Strike Price (Rs.) 3900 Buy Put (Mr. XYZ pays) Premium (Rs.) 143.80 Break Even Point (Rs.) (Put Strike Price + Put Premium + Stock Price – Put Strike Price)* 4143.80
- 22. Strategy – Synthetic Long Call – Buy Stock, Buy Put Example : ABC Ltd. is trading at Rs. 4000 on 4th July. Buy 100 shares of the Stock at Rs. 4000 Buy 100 July Put Options with a Strike Price of Rs. 3900 at a premium of Rs. 143.80 per put.
- 23. Strategy – Synthetic Long Call – Buy Stock, Buy Put Net Debit (payout) Stock Bought + Premium Paid Rs. 4000 + Rs. 143.80 Rs. 4,14,380/- Maximum Loss Stock Price + Put Premium – Put Strike Rs. 4000 + Rs. 143.80 – Rs. 3900 Rs. 24,380 Maximum Gain Unlimited (as the stock rises) Breakeven = Put Strike + Put Premium + Stock Price – Put Strike Rs. 3900 + Rs. 143.80 + Rs. 4000 – Rs. 3900 = Rs. 4143.80
- 24. Strategy – Synthetic Long Call – Buy Stock, Buy Put The payoff schedule ABC Ltd. closes at (Rs.) on expiry Payoff from the Stock (Rs.) Net Payoff from the Put Option (Rs.) Net Payoff (Rs.) 3400.00 -600.00 356.20 -243.80 3600.00 -400.00 156.20 -243.80 3800.00 -200.00 -43.80 -243.80 4000.00 0 -143.80 -143.80 4143.80 143.80 -143.80 0 4200.00 200.00 -143.80 56.20 4400.00 400.00 -143.80 256.20 4600.00 600.00 -143.80 456.20 4800.00 800.00 -143.80 656.20
- 25. Strategy – Synthetic Long Call – Buy Stock, Buy Put ANALYSIS: This is a low risk strategy. This is a strategy which limits the loss in case of fall in market but the potential profit remains unlimited when the stock price rises. A good strategy when you buy a stock for medium or long term, with the aim of protecting any downside risk. The pay-off resembles a Call Option buy and is therefore called as Synthetic Long Call.
- 26. Strategy – Long Put Buying a Put is the opposite of buying a Call. When you buy a Call you are bullish about the stock / index. When an investor is bearish, he can buy a Put option. A Put Option gives the buyer of the Put a right to sell the stock (to the Put seller) at a pre-specified price and thereby limit his risk.
- 27. Strategy – Long Put A long Put is a Bearish strategy. To take advantage of a falling market an investor can buy Put options. When to use: Investor is bearish about the stock / index. Risk: Limited to the amount of Premium paid. (Maximum loss if stock / index expires at or above the option strike price). Reward: Unlimited Break-even Point: Strike Price - Premium
- 28. Strategy – Long Put Example: Mr. XYZ is bearish on Nifty on 24th June, when the Nifty is at 2694. He buys a Put option with a strike price Rs. 2600 at a premium of Rs. 52, expiring on 31st July. If the Nifty goes below 2548, Mr. XYZ will make a profit on exercising the option. In case the Nifty rises above 2600, he can forego the option (it will expire worthless) with a maximum loss of the premium.
- 29. Strategy – Long Put Current Nifty index 2694 Put Option Strike Price (Rs.) 2600 Mr. XYZ Pays Premium (Rs.) 52 Break Even Point (Rs.) (Strike Price - Premium) 2548
- 30. Strategy – Long Put The payoff schedule On expiry Nifty closes at Net Payoff from Put Option (Rs.) 2300 248 2400 148 2500 48 2548 0 2600 -52 2700 -52 2800 -52 2900 -52
- 31. Strategy – Long Put ANALYSIS: A bearish investor can profit from declining stock price by buying Puts. He limits his risk to the amount of premium paid but his profit potential remains unlimited. This is one of the widely used strategy when an investor is bearish.
- 32. Strategy – Short Put Selling a Put is opposite of buying a Put. An investor buys Put when he is bearish on a stock. An investor Sells Put when he is Bullish about the stock – expects the stock price to rise or stay sideways at the minimum. When you sell a Put, you earn a Premium (from the buyer of the Put). If the stock price increases beyond the strike price, the short put position will make a profit for the seller by the amount of the premium, since the buyer will not exercise the Put option and the Put seller can retain the Premium (which is his maximum profit). But, if the stock price decreases below the strike price, by more than the amount of the premium, the Put seller will lose money. The potential loss being unlimited (until the stock price fall to zero).
- 33. Strategy – Short Put When to Use: Investor is very Bullish on the stock / index. The main idea is to make a short term income. Risk: Put Strike Price – Put Premium. Reward: Limited to the amount of Premium received. Breakeven: Put Strike Price - Premium
- 34. Strategy – Short Put Example Mr. XYZ is bullish on Nifty when it is at 4191.10. He sells a Put option with a strike price of Rs. 4100 at a premium of Rs. 170.50 expiring on 31st July. If the Nifty index stays above 4100, he will gain the amount of premium as the Put buyer won’t exercise his option. In case the Nifty falls below 4100, Put buyer will exercise the option and the Mr. XYZ will start losing money. If the Nifty falls below 3929.50, which is the breakeven point, Mr. XYZ will lose the premium and more depending on the extent of the fall in Nifty
- 35. Strategy – Short Put Current Nifty index 4191.10 Put Option Strike Price (Rs.) 4100 Mr. XYZ receives Premium (Rs.) 170.5 Break Even Point (Rs.) (Strike Price - Premium)* 3929.5
- 36. Strategy – Short Put The payoff schedule On expiry Nifty Closes at Net Payoff from the Put Option (Rs.) 3400.00 -529.50 3500.00 -429.50 3700.00 -229.50 3900.00 -29.50 3929.50 0 4100.00 170.50 4300.00 170.50 4500.00 170.50
- 37. Strategy – Short Put ANALYSIS: Selling Puts can lead to regular income in a rising or range bound markets. But it should be done carefully since the potential losses can be significant in case the price of the stock / index falls. This strategy can be considered as an income generating strategy.
- 38. Strategy – Covered Call You own shares in a company which you feel may rise but not much in the near term (or at best stay sideways). You would still like to earn an income from the shares. The covered call is a strategy in which an investor Sells a Call option on a stock he owns (netting him a premium). The Call Option which is sold in usually an OTM Call. The Call would not get exercised unless the stock price increases above the strike price. Till then the investor in the stock (Call seller) can retain the Premium with him. This becomes his income from the stock. This strategy is usually adopted by a stock owner who is Neutral to moderately Bullish about the stock.
- 39. Strategy – Covered Call An investor buys a stock or owns a stock which he feel is good for medium to long term but is neutral or bearish for the near term. At the same time, the investor does not mind exiting the stock at a certain price (target price). The investor can sell a Call Option at the strike price at which he would be fine exiting the stock (OTM strike). By selling the Call Option the investor earns a Premium. Now the position of the investor is that of a Call Seller who owns the underlying stock. If the stock price stays at or below the strike price, the Call Buyer will not exercise the Call. The Premium is retained by the investor.
- 40. Strategy – Covered Call In case the stock price goes above the strike price, the Call buyer who has the right to buy the stock at the strike price will exercise the Call option. The Call seller (the investor) who has to sell the stock to the Call buyer, will sell the stock at the strike price. This was the price which the Call seller (the investor) was anyway interested in exiting the stock and now exits at that price. So besides the strike price which was the target price for selling the stock, the Call seller (investor) also earns the Premium which becomes an additional gain for him. This strategy is called as a Covered Call strategy because the Call sold is backed by a stock owned by the Call Seller (investor). The income increases as the stock rises, but gets capped after the stock reaches the strike price.
- 41. Strategy – Covered Call When 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
- 42. Strategy – Covered Call Example Mr. A bought XYZ Ltd. for Rs 3850 and simultaneously sells a Call option at an strike price of Rs 4000. Which means Mr. A does not think that the price of XYZ Ltd. will rise above Rs. 4000. However, incase it rises above Rs. 4000, Mr. A does not mind getting exercised at that price and exiting the stock at Rs. 4000 (TARGET SELL PRICE = 3.90% return on the stock purchase price). Mr. A receives a premium of Rs 80 for selling the Call. Thus net outflow to Mr. A is (Rs. 3850 – Rs. 80) = Rs. 3770. He reduces the cost of buying the stock by this strategy. If the stock price stays at or below Rs. 4000, the Call option will not get exercised and Mr. A can retain the Rs. 80 premium, which is an extra income. If the stock price goes above Rs 4000, the Call option will get exercised by the Call buyer. The entire position will work like this
- 43. Strategy – Covered Call Mr. A buys the stock XYZ Ltd. Market Price (Rs.) 3850 Call Options Strike Price (Rs.) 4000 Mr. A receives Premium (Rs.) 80 Break Even Point (Rs.) (Stock Price paid - Premium Received) 3770
- 44. Strategy – Covered Call The price of XYZ Ltd. stays at or below Rs. 4000. The Call buyer will not exercise the Call Option. Mr. A will keep the premium of Rs. 80. This is an income for him. So if the stock has moved from Rs. 3850 (purchase price) to Rs. 3950, Mr. A makes Rs. 180/- [Rs. 3950 – Rs. 3850 + Rs. 80 (Premium) ] = An additional Rs. 80, because of the Call sold. Suppose the price of XYZ Ltd. moves to Rs. 4100, then the Call Buyer will exercise the Call Option and Mr. A will have to pay him Rs. 100 (loss on exercise of the Call Option). What would Mr. A do and what will be his pay – off?
- 45. Strategy – Covered Call a) Sell the Stock in the market at Rs. 4100 b) Pay Rs. 100 to the Call Options buyer - Rs. 100 c) Pay Off (a – b) received : Rs. 4000 (This Was Mr. A’s target price) d)Premium received on Selling Call Option : Rs. 80 e) Net payment (c + d) received by Mr. A : Rs. 4080 f) Purchase price of XYZ Ltd. : Rs. 3850 g) Net profit : Rs. 4080 – Rs. 3850 = Rs. 230 h) Return (%) : (Rs. 4080 – Rs. 3850) X 100 / Rs. 3850 5.97% (which is more than the target return of 3.90%)
- 46. Strategy – Covered Call The payoff schedule XYZ Ltd. price closes at (Rs.) Net Payoff (Rs.) 3600 -170 3700 -70 3740 -30 3770 0 3800 30 3900 130 4000 230 4100 230 4200 230 4300 230