A

Report On

“ Study of Option Trading Strategies and their application And Devising a

model to advice best use of such strategies at Geojit BNP Paribas Ltd.”

Submitted in partial fufillment of the requirement of M.B.A Degree course

of Christ University Institute Of Management

By

APURVA GUPTA

Reg No.1021055

Under the guidance of

Company Guide Faculty Guide

Mr. Vijaya Kumar Prof. Aravind

Branch Manager CUIM

Geojit BNP Paribas Ltd. Christ University

St. Marks Road Bangalore

Bangalore

1

DECLARATION

I hereby declare that the research report project titled” “ Study of Option

Trading Strategies and their application And Devising a model to advice

best use of such strategies at Geojit BNP Paribas Ltd.” is an original work

carried out by me under the guidance of Mr. Vijaya Kumar , Branch Manager ,

Geojit BNP Paribas Ltd, St. Marks Road, Bangalore, submitted in partial

fulfilment of the MBA (Master of Business Administration) Degree . This has

not been submitted in part or full towards any other degree or diploma

Signature

…………………..

(APURVA GUPTA)

Student MBA-J

2

CHRIST UNIVERSITY INSTITUTE OF MANAGEMENT

BANGALORE -560 029

MBA 2010-2012

LETTER OF THE HEAD OF ADMINISTRATION

This is to certify that Ms. Apurva Gupta (Registration no: 1021055) is a bona

fide student of Christ University Institute of Management (MBA batch 2010-

12) and has successfully completed his Summer Internship Project at Geojit

BNP Paribas” Study of Option Trading Strategies and their application And

Devising a model to advice best use of such strategies at Geojit BNP

Paribas Ltd”

Place: --------------------------------

Date:

Head of the Administration

CUIM

3

CERTIFICATE –FACULTY GUIDE

This is to certify that this internship report on the title ” Study of

Option Trading Strategies and their application And Devising a

model to advice best use of such strategies at Geojit BNP Paribas

Ltd” at Geojit BNP Paribas is a bona fide work of Ms. Apurva Gupta

under my guidance and support .This report is a part of MBA course

with specialization in Finance stream and the content and the work

done is genuine with respect to the information covered and thought

expressed.

Place:

Date: ---------------------------

Prof. Aravind

4

ACKNOWLEDGEMENT

At this moment when all my efforts have borne fruit, I would like to place on record my

sincere gratitude to all those who have made this project possible.

My sincere thanks to Rev. Fr. Thomas T. V., Director Christ University Institute of

Management for his support. I would like to express my heartfelt gratitude to Mr. CKT

Chandrashekar, HOD of CUIM, for the guidance and opportunity given to learn through this

experience of Summer Internship Project.

I would like to acknowledge the support and guidance of Mr. Vijaya Kumar, Branch

Manager, Geojit BNP Paribas Ltd. , Bangalore for his able guidance and precise supervision,

which has been instrumental in making this study an interesting experience.

I am pleased to do sincerely record my gratitude to my mentor Prof. Aravind for his constant

support and motivation during the project.

A special mention goes to my family and friends who have constantly extended their support

and guidance towards completion of this project.

At last I thank The Almighty God for his blessings and guidance

APURVA GUPTA

5

EXECUTIVE SUMMARY

In this study I have tried to study the various Option Trading Strategies and providing an

advising model for a broking house. This study was done keeping in mind the Organization

Geojit BNP Paribas. Geojit deals with the Capital Market.

This study was undertaken in the month of April’11 – May ’11, when both the sides of the

market could be seen due to the announcement of recent monetary policy. This study was

done in two stages which included:

Quantitative analysis of various Option Trading Strategies, and advicing the clients so

as to when to use which strategy.

A survey was conducted using the questionnaire to analyse the behaviour of the

investors and their awareness about Option strategies.

The analysis of different strategy was done on the basis of the following

The amount of investment required

Market timing for the strategy to be apt

The survey was used to know the awareness of the service and its used by the clients in its

truest sense.

As a result of the study it was found still the awareness of option strategies is less and people

find it difficult to understand these strategies and trade accordingly.

Also advicing the clients so as when to use which strategy

It was found that most of the investors invested in the equity and were reluctant to invest in

options due a variety of reasons.

6

Contents

1. Company profile 6

2. Introduction to Options 9

Option Strategies

3. Design of the Study 39

4. Interpretation and Analysis 44

5. Recommendation 48

6. Bibliography 49

7. Annexures 50

7

COMPANY PROFILE

Geojit is a retail financial services company in India with a strong presence in the Gulf that

deals with savings and investment products ranging from equities and derivatives to mutual

funds, Life and General Insurance and third party fixed deposits. The client needs are met

via multichannel services- countrywide network of 539 offices, phone service, Customer care

Centre and the Internet. It has Over 525,000 clients serviced through a network of over 500

offices

Geojit BNP PARIBAS is a listed member of The National Stock Exchange (NSE) and The

Bombay Stock Exchange (BSE). The Board of the company consists of professional directors

including Kerela government nominee with 2/3rd of the Board Members being independent.

Geojit is a charter member of the Financial Planning Standard Board Of India and is one of

the largest DP brokers in the country.

Nature Of Business Carried

It is engaged in the following services:

Equity and Derivatives Broking

Wealth Advisory Services: The Company offers these services to its customers

through a dedicated group for giving the most personal attention at every level

PMS- Portfolio Management Services

PMS is a product wherein an equity investment portfolio is created to suit the

investment objective of the client. Geojit invests the customer resources into stocks of

different sectors, depending on their risk return profile. This service is particularly

advisable for investors who cannot afford to give time or don’t have the expertise for

day to day management of equity.

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VISION, MISSION AND QUALITY POLICY

VISION

To be leading financial services intermediary for individual and Institutional clients from

India and overseas. We will continuously strive to raise our service standards by intelligent

application of technology processes.

MISSION

Corporate Governance is about commitment to values and about ethical business conduct.

Timely and accurate disclosure of information regarding the financial situations,

performance, ownership, and governance of the company.

QUALITY POLICY, OBJECTIVES AND PRACTICES

Corporate Governance is one of their major Quality Policy. It is about commitment to values

and ethical business conduct. It is about how an organization is managed. This improves

public understanding of the structure, activities and policies of the organization.

The company believes that sound corporate governance is critical to enhance and retain client

trust. Accordingly the company always seeks to attain performance rules within integrity.

The Board extends its fiduciary responsibilities in the widest sense of term.

The companies disclosure always seek to attain the best practices in international corporate

governance. They are also responsible to enhance long term shareholder value and respect

minority rights in all their business decisions.

Its Current bank partners are

Axis Bank, Federal Bank, City Union Bank, South Indian Bank

Geojit hase been facilitated with the IBA runner-up award

In 2007 and 2008, Axis Bank won the Indian Banks Association’s runner-up award

for the Best Online Trading Platform.

In 2002 Geojit was the first to 1st in India to launch an integrated internet trading system for

Cash & Derivatives segments .

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COMPANY’S PUBLICATIONS

Geodata – Monthly

Barjeel Market Digest – Monthly

Online Research Reports for the use of employees

Research Reports to daily newspapers in Malayalam and English\

SUBSIDARY COMPANIES OF GEOJIT

10

PRODUCTS AND SERVICES

There are wide range of products and services offered by the organization. Certified Financial

advisors help clients to arrive at the right financial solution to meet their individual needs.

The wide range of product and services includes:

Equities

An equity share represents the form of ownership

These are High risk and high return investments

Mainly traded in cash market or intraday

Derivatives

Derivative is a financial contract between two or more parties, which is derived from

the future value of an underlying asset. At a point of tome there will always be a three

month contract period. All settlements are done in cash

Mutual Funds

A mutual fund is a trust that pools the savings of a number of investors who share a

common financial goal. The money thus collected is invested in market instruments.

Here the investors are the unit holders.

Commodity Trade department

Custody Accounts(Demat Accounts)

Currency Futures

IPOs

Margin Funding

Life Insurance( Metlife Insurance Company)

Loans against commodities

11

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.

An important class of options are Exchange traded options form which have standardized

contract features and trade on public exchanges, facilitating trading among large number of

investors. They provide settlement guarantee by the Clearing Corporation .Thus the

counterparty risk is reduced.Options can be used for hedging, taking a view on the future

direction of the market, for arbitrage or for implementing strategies which can help in

generating income for investors under various market conditions.

OPTION TERMINOLOGY

Index options: These options have the index as the underlying. In India, we follow a

European style settlement. Eg. Nifty options, Mini Nifty options etc.

Stock options: Stock options are options on individual stocks. A stock option contract

gives the holder the right to buy or sell the underlying shares at the specified price.

They have an American style settlement.

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 obliged to sell/buy the asset if the buyer exercises

on him.

Call option: A call option gives the holder the right but not the obligation to buy an

asset by a certain date for a certain price.

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Put option: A put option gives the holder the right but not the obligation to sell an

asset by a certain date for a certain price.

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 or simply 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.

American options: American options are options that can be exercised at any time

upto the expiration date.

European options: European options are options that can be exercised only on the

expiration date itself.

In-the-money option: An in-the-money (ITM) option is an option that would lead to a

positive cashflow to the holder if it were exercised immediately. A call option on the

index is said to be in-the-money when the current index stands at a level higher than

the strike price (i.e. spot price > strike price). If the index is much higher than the

strike price, the call is said to be deep ITM. In the case of a put, the put is ITM if the

index is below the strike price.

At-the-money option: An at-the-money (ATM) option is an option that would lead to

zero cashflow if it were exercised immediately. An option on the index is at-the-

money when the current index equals the strike price (i.e. spot price = strike price).

13

Out-of-the-money option: An out-of-the-money (OTM) option is an option that

would lead to a negative cashflow if it were exercised immediately. A call option on

the index is out-of-the-money when the current index stands at a level which is less

than the strike price (i.e. spot price < strike price). If the index is much lower than the

strike price, the call is said to be deep OTM. In the case of a put, the put is OTM if

the ind.ex is above the strike price.

Intrinsic value of an option: The option premium can be broken down into two

components - intrinsic value and time value. The intrinsic value of a call is the

amount the option is ITM, if it is ITM. If the call is OTM, its intrinsic value is zero.

Putting it another way, the intrinsic value of a call is Max[0, (St — K)] which means

the intrinsic value of a call is the greater of 0 or (St — K). Similarly, the intrinsic

value of a put is Max[0, K — St],i.e. the greater of 0 or (K — St). K is the strike price

and St is the spot price.

Time value of an option: The time value of an option is the difference between its

premium and its intrinsic value. Both calls and puts have time value. An option that is

OTM or ATM has only time value. Usually, the maximum time value exists when the

option is ATM. The longer the time to expiration, the greater is an option's time

value, all else equal. At expiration, an option should have no time value.

14

FOLLOWING ARE THE OPTION STRATEGIES

STRATEGY 1 : LONG CALL

STRATEGY 2 : SHORT CALL

STRATEGY 3 : SYNTHETIC LONG CALL

STRATEGY 4 : LONG PUT

STRATEGY 5 : SHORT PUT

STRATEGY 6 : COVERED CALL

STRATEGY 7 : LONG COMBO

STRATEGY 8 : PROTECTIVE CALL

STRATEGY 9 : COVERED PUT

STRATEGY 10 : LONG STRADDLE

STRATEGY 11 : SHORT STRADDLE

STRATEGY 12 : LONG STRANGLE

STRATEGY 13. SHORT STRANGLE

STRATEGY 14. COLLAR

STRATEGY 15. BULL CALL SPREAD STRATEGY

STRATEGY 16. BULL PUT SPREAD STRATEGY

STRATEGY 17 : BEAR CALL SPREAD STRATEGY

STRATEGY 18 : BEAR PUT SPREAD STRATEGY

STRATEGY 19: LONG CALL BUTTERFLY

STRATEGY 20 : SHORT CALL BUTTERFLY

STRATEGY 21: LONG CALL CONDOR

STRATEGY 22 : SHORT CALL CONDOR

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STRATEGY 1 : LONG CALL

This strategy involves buying a call. It is meant for aggressive investors who are very

bullish about the prospects for a stock / index, and expect the underlying stock / index to rise

in future. Buying calls can be an excellent way to capture the upside potential with limited

downside risk. Buying a call is the most basic of all options strategies. It constitutes the first

options trade for someone already familiar with buying / selling stocks and would now want

to trade options.

Example

Mr. XYZ is bullish on Nifty on 9th April, when the Nifty is at 5768.10. He buys a call

option with a strike price of Rs. 5900 at a premium of Rs. 36.35, expiring on 28th April.

On Expiry Nifty Closes At Net Payoff From Call Option

5700 -36.355800 -36.355900 -36.35

5936.35 05950 13.656100 163.656170 233.656250 313.65

ANALYSIS: This strategy limits the downside risk is limited 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 one believes that the market will make an

upward move and is the most common choice among first time investors in Options.

Therefore with the investment of Rs 5936.35 unlimited profit can be earned and loss is only

Rs 36.35 since the investor does not have any obligation to buy the underlying asset.

16

STRATEGY 2 : 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. He is bearish in nature.

Example:

Mr. XYZ is bearish about Nifty and expects it to fall. He sells a Call option with a strike

price of Rs. 5900 at a premium of Rs. 98, when the current Nifty is at 5962. If the Nifty

stays at 5900 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. 98.

On Expiry Nifty Closes At Net Payoff From Call Option

5700 985800 985850 985950 485998 06100 -1026200 -2026300 -302

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, hence are unlimited. Since

the investor does not own the underlying stock that he is shorting this strategy is also called

Short Naked Call. The reward is limited to the premium amount.

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STRATEGY 3 : 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. We wish we 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).

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.

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.

Example

Mr. XYZ is bullish about ABC Ltd stock. He buys ABC Ltd. at current market price of

Rs. 5000 on 4th April. To protect against fall in the price of ABC Ltd. (his risk), he buys

an ABC Ltd. Put option with a strike price Rs.4900 (OTM) at a premium of Rs. 143.80

expiring on

28th April.

ABC Ltd. closes at (Rs.) on expiry

Payoff from the Stock (Rs.)

Net Payoff from the Put Option (Rs.)

Net Payoff (Rs)

4400 -600 356.2 -243.84600 -400 156.2 -243.84800 -200 -43.8 -243.85000 0 -143.8 -143.85143.8 143.8 -143.8 05200 200 -143.8 56.25400 400 -143.8 256.25600 600 -143.8 456.25800 800 -143.8 656.2

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ANALYSIS: This is a low risk strategy. This is a strategy which limits the loss in case of fall

in market (the right of selling given by the Put option helps in limiting the loss) .but the

potential profit remains unlimited when the stock price rises(this very right of selling

prevents from selling the stock at higher prices, thus the gains from the stock price can be

retained).

A good strategy when we 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.

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STRATEGY 4 : LONG PUT

Buying a Put is the opposite of buying a Call. When we buy a Call we 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 when the price of the stock/index falls significantly. It is used to take advantage

of falling markets.

EXAMPLE Mr. XYZ is bearish on Nifty on 24th March, when the Nifty is at 5820. He

buys a Put option with a strike price Rs. 5800 at a premium of Rs. 52, expiring on 28th

April. If the Nifty goes below 5748, Mr. XYZ will make a profit on exercising the

option. In case the Nifty rises above 5800, he can forego the option (it will expire

worthless) with a maximum loss of the premium.

On Expiry Nifty Closes At Net Payoff (Rs)

5600 3485500 2485600 1485700 485748 05900 -526100 -526300 -52

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.

20

STRATEGY 5 : 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 we sell a Put, we earn a Premium (from the buyer of

the Put). We have sold someone the right to sell you the stock at the strike price.

Example

Mr. XYZ is bullish on Nifty when it is at 5855.10. He sells a Put option with a strike

price of Rs. 5800 at a premium of Rs. 170.50 expiring on 28th April. If the Nifty index

stays above 5800, he will gain the amount of premium as the Put buyer won’t exercise

his option. In case the Nifty falls below 5800, Put buyer will exercise the option and the Mr.

XYZ will start losing money.

On Expiry Nifty Closes At Net Payoff (Rs)

5300 -329.55400 -229.55500 -129.5

5629.5 05700 705900 1706000 1706100 170

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. If the

stock price increases beyond the strike price, the short put position will make a limited profit

for the amount of the premium(maximum profit) he earns , since the buyer will not exercise

the Put option But, if the stock price decreases below the strike price, by more than the

amount of the premium. The potential loss being unlimited (until the stock price fall to zero),

since the buyer will exercise the option

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STRATEGY 6 : 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). He uses the Covered Call strategy wherein 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.

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.

Example

Mr A bought a stock of XYZ Ltd at Rs 4850 and simultaneously sells a Call Option at a

strike Price of Rs 5000. This means Mr. A does not think that the price will go beyond

Rs 5000. In case it rises above Rs 5000 Mr A does not mind getting exercised at that

price and exiting the stock at Rs 5000. Mr A receives Rs 80 as premium for selling the

Call Option

XYZ Ltd. price closes at(Rs.)

Net Payoff(Rs.)

4600 -1704700 -704740 -304770 04900 1305100 2305300 230

Following are the two cases:

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1) 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.

2) 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). The payoff of Mr A would be:

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%).

ANALYSIS: This strategy is often used when the investor has a shorterm neutral to

moderately bullish view on the stock he holds.

Here the risk is that if the stock price falls to zero the investor loses the entire value of the

stock but retains the premium since the Call is not exercised against him. The reward is

limited to the (Call strike-Stock price paid) + premium.

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STRATEGY 7 : LONG COMBO : SELL A PUT,

BUY A CALL

A Long Combo is a Bullish strategy. If an investor is expecting the price of a stock to move

up he can do a Long Combo strategy. It involves selling an OTM (lower strike) Put and

buying an OTM (higher strike) Call. This strategy simulates the action of buying a stock (or a

futures) but at a fraction of the stock price. As the stock price rises the strategy starts making

profits.

Example:

A stock ABC Ltd. is trading at Rs. 450. Mr. XYZ is bullish on the stock. But does not

want to invest Rs. 450. He does a Long Combo. He sells a Put option with a strike price

Rs. 400 at a premium of Rs. 1.00 and buys a Call Option with a strike price of Rs. 500 at

a premium of Rs. 2. The net cost of the strategy (net debit) is Rs. 1.

ABC Ltd. closes at (Rs.)

Net Payoff from the Put Sold (Rs.)

Net Payoff from the Call purchased(Rs.)

Net Payoff(Rs.)

250 -149 -2 151300 -99 -2 101350 -49 -2 51400 1 -2 -1450 1 -1 -1501 1 48 -0550 1 98 43600 1 148 99650 1 198 149

ANALYSIS : In this strategy the risk is unlimited and reward is also unlimited. An investor

should use this strategy only when he is strongly bullish about the market. Taking the above

example in consideration, For a small investment of Re. 1 (net debit), the returns can be very

high in a Long Combo, but only if the stock moves up. Otherwise the potential losses can

also be high.

24

STRATEGY 8 : PROTECTIVE CALL /

SYNTHETIC LONG PUT

This is a strategy wherein an investor has gone short on a stock and buys a call to hedge. This

is an opposite of Synthetic Call (Strategy 3). An investor sells a stock and buys an ATM or

slightly OTM Call. In case the stock price falls the investor gains in the downward fall in the

price. However, incase there is an unexpected rise in the price of the stock the loss is limited.

The pay-off from the Long Call will increase thereby compensating for the loss in value of

the short stock position. This strategy hedges the upside in the stock position while retaining

downside profit potential.

This strategy is used when an investor is of the view that the markets will go down (bearish)

but wants to protect against any unexpected rise

in the price of the stock.

Example :

Suppose ABC Ltd. is trading at Rs. 4457 in June. An investor Mr. A buys a Rs 4500 call

for Rs. 100 while shorting the stock at Rs. 4457. The net credit to the investor is Rs.

4357 (Rs. 4457 – Rs. 100)

ABC Ltd. closes at (Rs.)

Payoff from the stock (Rs.)

Net Payoff from the Call Option (Rs.)

Net Payoff(Rs.)

4100 357 -100 2574150 307 -100 2074200 257 -100 1574300 157 -100 574350 107 -100 74357 100 -100 04400 57 -100 -434457 0 -100 -1004600 -143 0 -1434700 -243 100 -1434800 -343 200 -1434900 -443 300 -143

25

ANALYSIS : The net effect of this strategy is that the investor creates a pay-off like a Long

Put, but instead of having a net debit (paying premium) for a Long Put, he creates a net credit

(receives money on shorting the stock).Here the risk is limited ; since the investor expects

the market to fall, in case it goes up he will exercise its call andmake a profit thus reducing

the effect of the loss made by selling the stock.

When the market falls he will make profit since he had sold the stock earlier at a higher price.

26

STRATEGY 9 : COVERED PUT

Covered Put is a neutral to Bearish strategy. We do this strategy when we feel the price of a

stock / index is going to remain range bound or move down. Covered Put writing involves a

short in a stock / index along with a short Put on the options on the stock / index. The

investor shorts a stock because he is bearish about it, but does not mind buying it back once

the price reaches (falls to) a target price. This target price is the price at which the investor

shorts the Put (Put strike price). Selling a Put means, buying the stock at the strike price if

exercised.

Example

Suppose ABC Ltd. is trading at Rs 4500 in June. An investor, Mr. A, shorts Rs 4300 Put by

selling a April Put for Rs. 24 while shorting an ABC Ltd. stock. The net credit received by Mr. A is Rs.

4500 + Rs. 24 = Rs. 4524.

ABC Ltd.closes at (Rs.)

Payoff fromthe stock (Rs.)

Net Payofffrom the PutOption (Rs.)

Net Payoff(Rs.)

4100 400 -176 2244200 300 -76 2244300 200 24 2244400 100 24 1244450 50 24 744524 -24 24 04550 -50 24 -264600 -100 24 -764650 -150 24 -126ANALYSIS : If the stock falls below the Put strike, the investor will be exercised and will

have to buy the stock at the strike price (which is anyway his target price to repurchase the

stock). The investor makes a profit(Stock price +premium-put strike price) because he has

shorted the stock and purchasing it at the strike price simply closes the short stock position at

a profit. And the investor keeps the Premium on the Put sold but still would have to face a

reduced unlimited loss in case the market goes the other way( upward)

27

STRATEGY 10 : LONG STRADDLE

A Straddle is a volatility strategy and is used when the stock price / index is expected to

show large movements. This strategy involves buying a call as well as put on the same

stock / index for the same maturity and strike price, to take advantage of a movement in

either direction, a rising or falling value of the stock / index.

Example

Suppose Nifty is at 5750 on 7th April. An investor, Mr. A, enters into a long straddle by

buying a May Rs 5800 Nifty Put for Rs. 85 and a May Rs. 5800 Nifty Call for Rs. 122.

The net credit received is Rs. 207, which is also his maximum possible profit.

On expiryNifty closes at

Net Payoff from Put Purchased (Rs.)

Net Payoff from Call purchased (Rs.)

Net Payoff(Rs.)

5300 415 -122 2935400 315 -122 1935500 215 -122 935593 122 -122 05600 115 -122 -75700 15 -122 -1075800 -85 -122 -2075900 -85 -22 -1076000 -85 78 -76007 -85 85 06100 -85 178 936200 -85 278 1936300 -85 378 293

ANALYSIS : If the price of the stock / index increases, the call is exercised while the put

expires worthless and if the price of the stock / index decreases, the put is exercised, the call

expires worthless. Either way if the stock/index shows volatility to cover the cost of the trade,

profits are to be made. The loss is limited to the initial premium paid if the market does not

show any movement. Here the investor is direction neutral.

28

STRATEGY 11 : SHORT STRADDLE

A Short Straddle is the opposite of Long Straddle. It is a strategy to be adopted when the

investor feels the market will not show much movement. He sells a Call and a Put on the

same stock / index for the same maturity and strike price. It creates a net income for the

investor. Investor believes that markets will be stagnant.

Example

Suppose Nifty is at 5750 on 27th April. An investor, Mr. A, enters into a short straddle

by selling a May Rs 5800 Nifty Put for Rs. 85 and a May Rs. 5800 Nifty Call for Rs. 122.

The net credit received is Rs. 207, which is also his maximum possible profit.

On expiry Niftycloses at

Net Payoff from Put Sold (Rs.)

Net Payoff from Call Sold (Rs.)

Net Payoff(Rs.)

5300 -415 122 -2935400 -315 122 -1935500 -215 122 -935593 -122 122 05600 -115 122 75700 -15 122 1075800 85 122 2075900 85 22 1076000 85 -78 76007 85 -85 06100 85 -178 -936200 85 -278 -1936300 85 -378 -293ANALYSIS If the stock / index does not move much in either direction from the strike price,

the investor retains the Premium(maximum gain) as neither the Call nor the Put will be

exercised. However, incase the stock /index moves in either direction, up or down

significantly, the investor’s losses can be significant. So this is a risky strategy and should be

adopted and only when the expected volatility in the market is limited.

29

STRATEGY 12 : LONG STRANGLE

A Strangle is a slight modification to the Straddle to make it cheaper to execute. This strategy

involves the simultaneous buying of a slightly out-of-the-money (OTM) put and a slightly

out-of-the-money (OTM) call of the same underlying stock / index and expiration date. Here

again the investor is directional neutral but is looking for an increased volatility in the stock

/ index and the prices moving significantly in either direction.

Example

Suppose Nifty is at 5800 in April. An investor, Mr. A, executes a Long Strangle by

buying a Rs. 5600 Nifty Put for a premium of Rs. 23 and a Rs 6000 Nifty Call for Rs 43.

The net debit taken to enter the trade is Rs. 66, which is also his maxi mum possible loss.

On expiryNifty closes at

Net Payoff from Put Purchased (Rs.)

Net Payoff from Call purchased (Rs.)

Net Payoff(Rs.)

5200 377 -43 3345300 277 -43 2345400 177 -43 1345500 77 -43 345534 43 -43 05600 -23 -43 -665800 -23 -43 -665900 -23 -43 -666000 -23 -43 -666066 -23 23 06100 -23 57 346200 -23 157 1346300 -23 257 2346400 -23 357 334ANALYSIS : Since OTM options are purchased for both Calls and Puts it makes the cost of

executing a Strangle cheaper as compared to a Straddle, where generally ATM strikes are

purchased. However, for a Strangle to make money, it would require greater movement on

the upside or downside for the stock / index than it would for a Straddle. As with a Straddle,

the strategy has a limited risk (i.e. the Call and the Put premium) and unlimited profitpotetial

30

STRATEGY 13. SHORT STRANGLE

This strategy involves the simultaneous selling of a slightly out-of-the-money (OTM) put and

a slightly out-of-the-money (OTM) call of the same underlying stock and expiration date.

This typically means that since OTM call and put are sold, the net credit received by the

seller is less as compared to a Short Straddle, but the break even points are also widened.

Little volatility is expected when adopting this strategy.

Example

Suppose Nifty is at 5800 in May. An investor, Mr. A, executes a Short Strangle by selling a Rs. 5600

Nifty Put for a premium of Rs. 23 and a Rs. 6000 Nifty Call for Rs 43. The net credit is Rs. 66, which is

also his maximum possible gain.

On expiryNifty closes at

Net Payoff from Put Sold (Rs.)

Net Payoff from Call Sold (Rs.)

Net Payoff(Rs.)

5200 -377 43 -3345300 -277 43 -2345400 -177 43 -1345500 -77 43 -345534 -43 43 05600 23 43 665800 23 43 665900 23 43 666000 23 43 666066 23 -23 06100 23 -57 -346200 23 -157 -1346300 23 -257 -2346400 23 -357 -334

ANALYSIS : It tries to improve the profitability of the trade for the Seller of the options by

widening the breakeven points so that there is a much greater movement required in the

underlying stock / index, for the Call and Put option to be worth exercising. Here the risk is

unlimited and profit is limited to the premium received.

31

STRATEGY 14. COLLAR

Collar is a Covered Call with a limited risk. It involves buying a stock, insuring against the

downside by buying a Put and then financing (partly) the Put by selling a Call. The put

generally is ATM and the call is OTM having the same expiration month and must be equal

in number of shares. The collar is a good strategy to use if the investor is writing covered

calls to earn premiums but wishes to protect himself from an unexpected sharp drop in the

price of the underlying security.

Example

Suppose an investor Mr. A buys or is holding ABC Ltd. currently trading at Rs. 4758.

He decides to establish a collar by writing a Call of strike price Rs. 5000 for Rs. 39 while

simultaneously purchasing a Rs. 4700 strike price Put for Rs. 27. Since he pays Rs. 4758

for the stock ABC Ltd., another Rs. 27 for the Put but receives Rs. 39 for selling the

Call option, his total Investment is Rs. 4746.

ABC Ltd. Closes at (Rs.)

Payoff fromCall Sold(Rs.)

Payoff from Put Purchased (Rs.)

Payofffrom stockABC Ltd.

Net payoff(Rs.)

4400 39 273 -358 -464450 39 223 -308 -464500 39 173 -258 -464600 39 73 -158 -464700 39 -27 -58 -464750 39 -27 -8 44800 39 -27 42 544850 39 -27 92 1044858 39 -27 100 1124900 39 -27 142 1544948 39 -27 190 2025000 39 -27 242 2545100 -61 -27 342 2545150 -111 -27 392 2545200 -161 -27 442 2545250 -211 -27 492 2545300 -261 -27 542 254

ANALYSIS : It is a low risk strategy since the Put prevents downside risk. However, do not

expect unlimited rewards since the Call prevents that. It is a strategy to be adopted when the

investor is conservatively bullish. Here the profit is also limited since the profit from stock

is eaten up by the loss from call sold.

32

1) If the price of ABC Ltd. rises to Rs. 5100 after a month, then,

a. Mr. A will sell the stock at Rs. 5100 earning him a profit of Rs. 342 (Rs. 5100 –

Rs. 4758)

b. Mr. A will get exercised on the Call he sold and will have to pay Rs. 100.

c. The Put will expire worthless.

d. Net premium received for the Collar is Rs. 12

e. Adding (a + b + d) = Rs. 342 -100 + 12 = Rs. 254

This is the maximum return on the Collar Strategy.

However, unlike a Covered Call, the downside risk here is also limited :

2) If the price of ABC Ltd. falls to Rs. 4400 after a month, then,

a. Mr. A loses Rs. 358 on the stock ABC Ltd.

b. The Call expires worthless

c. The Put can be exercised by Mr. A and he will earn Rs. 300

d. Net premium received for the Collar is Rs. 12

e. Adding (a + b + d) = Rs.- 358 + 300 +12 = - Rs. 46

This is the maximum the investor can loose on the Collar Strategy.

The Upside in this case is much more than the downside risk.

33

STRATEGY 15. BULL CALL SPREAD BUY CALL OPTION, SELL

CALL OPTION

A bull call spread is constructed by buying an in-the-money (ITM) call option, and selling

another out-of-the-money (OTM) call option. Often the call with the lower strike price will

be in-the-money while the Call with the higher strike price is out-of-the-money. Both calls

must have the same underlying security and expiration month. The net effect of the strategy

is to bring down the cost and breakeven on a Buy Call (Long Call) Strategy. This strategy is

exercised when investor is moderately bullish to bullish.

Example:

Mr. XYZ buys a Nifty Call with a Strike price Rs.5500 at a premium of Rs. 170.45 and

he sells a Nifty Call option with a strike price Rs. 5800 at a premium of Rs. 35.40. The

net debit here is Rs. 135.05 which is also his maximum loss.

On expiryNifty Closes at

Net Payoff from Call Buy (Rs.)

Net Payoff fromCall Sold (Rs.)

Net Payoff(Rs.)

5200 -170.45 35.40 -135.055300 -170.45 35.40 -135.055400 -170.45 35.40 -135.055500 -170.45 35.40 -135.055600 -70.45 35.40 -35.055635.05 -35.40 35.40 05700 29.55 35.40 64.955800 129.55 35.40 164.955900 229.55 -64.60 164.956000 329.55 -164.60 164.956100 429.55 -264.60 164.95ANALYSIS: The Bull Call Spread Strategy has brought the breakeven point down (if only

the Rs. 5500 strike price Call was purchased the breakeven point would have been Rs.

5670.45), reduced the cost of the trade (if only the Rs. 5500 strike price Call was purchased

the cost of the trade would have been Rs. 170.45), reduced the loss on the trade (if only the

Rs. 5500 strike price Call was purchased the loss would have been Rs. 170.45 i.e. the

premium of the Call purchased). However, the strategy also has limited gains and is therefore

ideal when markets are moderately bullish.

34

STRATEGY 16. BULL PUT SPREAD SELL PUT OPTION, BUY PUT

OPTION

The concept is to protect the downside of a Put sold(ITM) by buying a lower strike

Put(OTM), which acts as an insurance for the Put sold. the investor receives a net credit,

because the Put purchased (further OTM) is cheaper than the Put sold. It is used when the

investor is moderately bullish.

Example:

Mr. XYZ sells a Nifty Put option with a strike price of Rs. 5800 at a premium of Rs.

21.45 and buys a further OTM Nifty Put option with a strike price Rs. 5600 at a

premium of Rs. 3.00 when the current Nifty is at 4191.10, with both options expiring on

28th April.

On expiry NiftyCloses at

Net Payoff from Put Buy (Rs.)

Net Payoff fromPut Sold (Rs.)

Net Payoff(Rs.)

5300 297 -478.55 -181.555400 197 -378.55 -181.555500 97 -278.55 -181.555600 -3 -178.55 -181.555700 -3 -78.55 -81.555781.55 -3 3 05800 -3 21.45 18.455900 -3 21.45 18.456000 -3 21.45 18.456100 -3 21.45 18.45

ANALYSIS: If the stock / index rises, both Puts expire worthless and the investor can retain

the Premium. If the stock / index falls, then the investor’s breakeven is the higher strike less

the net credit received. Provided the stock remains above that level, the investor makes a

profit. Otherwise he could make a loss. The maximum loss is the difference in strikes less the

net credit received.

35

STRATEGY 17 : BEAR CALL SPREAD SELL ITM CALL, BUY OTM

CALL

The strategy requires the investor to buy out-of-the-money (OTM) call options while

simultaneously selling in-the-money (ITM) call options on the same underlying stock index.

The investor receives a net credit because the Call he buys is of a higher strike price than the

Call sold. The concept is to protect the downside of a Call Sold by buying a Call of a higher

strike price to insure the Call sold. It is adopted when the investor is mildly bearish about

the market.

Example:

Mr. XYZ is bearish on Nifty. He sells an ITM call option with strike price of Rs. 5600 at a premium of

Rs. 154 and buys an OTM call option with strike price Rs. 5800 at a premium of Rs. 49.

On expiryNifty Closes at

Net Payoff from Call Sold (Rs.)

Net Payoff from Call bought(Rs.)

Net Payoff (Rs.)

5300 154 -49 1055400 154 -49 1055495 154 -49 1055500 154 -49 1055600 154 -49 1055700 54 -49 55705 49 -49 05800 -46 -49 -955900 -146 51 -956000 -246 151 -956100 -346 251 -956200 -446 351 -95ANALYSIS: If the stock / index falls both Calls will expire worthless and

the investor can retain the net credit. If the stock / index rises then the breakeven is the lower

strike plus the net credit. Provided the stock remains below that level, the investor makes a

profit. Otherwise he could make a loss. The maximum loss is the difference in strikes less the

net credit received. It earns a net income for the investor as well as limits the downside risk

of a Call sold

.

STRATEGY 18 : BEAR PUT SPREAD BUY PUT, SELL PUT

36

This strategy requires the investor to buy an ITM (higher) put option and sell an

OTM (lower) put option on the same stock with the same expiration date. This

strategy creates a net debit for the investor. The net effect of the strategy is to bring down the

cost and raise the breakeven on buying a Put (Long Put). The strategy needs a Bearish

outlook since the investor will make money only when the stoc k price / index falls. The

bought Puts will have the effect of capping the investor’s downside. While the Puts sold will

reduce the investors costs, risk and raise breakeven point

Example: Nifty is presently at 5694. Mr. XYZ expects Nifty to fall. He buys one Nifty ITM Put with a

strike price Rs. 5800 at a premium of Rs. 132 and sells on Nifty OTM Put with strike price Rs. 5600 at

a premium Rs. 52.

On expiry Niftycloses at

Net Payoff fromPut Buy (Rs.)

Net Payoff fromPut Sold (Rs.)

Net payoff(Rs.)

5400 268 -148 1205500 168 -48 1205600 68 52 1205700 -32 52 205720 -52 52 05800 -132 52 -805900 -132 52 -806000 -132 52 -80ANALYSIS : If the stock price closes below the OTM (lower) put option strike price on the

expiration date, then the investor reaches maximum profits. If the stock price increases above

theITM(higher) put option strike price, then the investor has a maximum loss potential of the

net debit. The Bear Put Spread Strategy has raised the breakeven point (if only the Rs. 5800

strike price Put was purchased the breakeven point would have been Rs. 5668), reduced the

cost of the trade (if only the Rs. 5800 strike price Put was purchased the cost of the trade

would have been Rs. 132 i.e. the premium of the Put purchased). However, the strategy also

has limited gains and is therefore ideal when markets are moderately bearish.

37

STRATEGY 19: LONG CALL BUTTERFLY: SELL 2 ATM CALL

OPTIONS, BUY 1 ITM CALL OPTION AND BUY 1 OTM CALL

OPTION.

A Long Call Butterfly is to be adopted the investor is looking to gain from low volatility at a

low cost. A long butterfly is similar to a Short Straddle except your losses are limited. The

strategy can be done by selling 2 ATM Calls, buying 1 ITM Call, and buying 1 OTM Call

options (there should be equidistance between the strike prices).

Example: Nifty is at 5800. Mr. XYZ expects very little movement in Nifty. He sells 2

ATM Nifty Call Options with a strike price of Rs. 5800 at a premium of Rs. 97.90 each,

buys 1 ITM Nifty Call Option with a strike price of Rs. 5700 at a premium of Rs. 141.55

and buys 1 OTM Nifty Call Option with a strike price of Rs. 5900 at a premium of Rs. 64. The

Net debit is Rs. 9.75.

On expiryNiftyCloses at

Net Payoff from 2 ATM Calls Sold(Rs.)

Net Payoff from 1 ITM Callpurchased(Rs.)

Net Payoff from 1 OTM Callpurchased(Rs.)

Net Payoff(Rs.)

5400 195.80 -141.55 -64 -9.755500 195.80 -141.55 -64 -9.755600 195.80 -141.55 -64 -9.755700 195.80 -141.55 -64 -9.755709.75 195.80 131.80 -64 05800 195.80 -41.55 -64 90.255890.25 15.30 48.70 -64 05900 -4.2 58.45 -64 -9.756000 -204.2 158.45 36 -9.756100 -404.20 258.45 136 -9.756200 -604.20 358.45 236 -9.75ANALYSIS: The result is positive incase the stock / index remains range

bound. The maximum profit (Difference between adjacent strikes minus net debit) in this

strategy is however restricted and takes place when the stock / index is at the middle strike at

expiration. The maximum loss (Net debit paid) are also limited.

38

STRATEGY 20 : SHORT CALL BUTTERFLY: BUY 2 ATM CALL

OPTIONS, SELL 1 ITM CALL OPTION AND SELL 1 OTM CALL

OPTION.

A Short Call Butterfly is a strategy for volatile markets. It is the opposite of Long Call

Butterfly, which is a range bound strategy. The Short Call Butterfly can be constructed by

Selling one lower strike ITM Call, buying two ATM Calls and selling another higher strike

OTM Call, giving the investor a net credit (therefore it is an income strategy).

Example: Nifty is at 5800. Mr. XYZ expects large volatility in the Nifty irrespective of which

direction the movement is, upwards or downwards. Mr. XYZ buys 2 ATM Nifty Call Options with a

strike price of Rs. 5800 at a premium of Rs. 97.90 each, sells 1 ITM Nifty Call Option with a strike

price of Rs. 5700 at a premium of Rs. 141.55 and sells 1 OTM Nifty Call Option with a strike price of

Rs. 5900 at a premium of Rs. 64. The Net Credit is Rs. 9.75.

On expiryNifty Closesat

Net Payoff from 2 ATM CallsPurchased (Rs.)

Net Payofffrom 1 ITMCall sold (Rs.)

Net Payoff from 1 OTM Call sold(Rs.)

Net Payoff(Rs.)

5400 -195.80 141.55 64 9.755500 -195.80 141.55 64 9.755600 -195.80 141.55 64 9.755700 -195.80 141.55 64 9.755707.75 -195.80 131.80 64 05800 -195.80 41.55 64 -90.255900 -15.30 -48.70 64 06000 4.2 -58.45 64 9.756100 204.2 -158.45 -36 9.756200 404.20 -258.45 -136 9.75ANALYSIS: The resulting position will be profitable in case there is a big move in the

stock / index. The maximum risk occurs if the stock / index is at the middle strike at

expiration. The maximum profit occurs if the stock finishes on either side of the upper and

lower strike prices at expiration. However, this strategy offers very small returns when

compared to straddles, strangles with only slightly less risk.

39

STRATEGY 21: LONG CALL CONDOR: BUY 1 ITM CALL OPTION (LOWER

STRIKE), SELL 1 ITM CALL OPTION (LOWER MIDDLE), SELL 1 OTM CALL

OPTION (HIGHER MIDDLE), BUY 1 OTM CALL OPTION (HIGHER STRIKE)

A Long Call Condor is very similar to a long butterfly strategy. The difference is that the two

middle sold options have different strikes. The profitable area of the pay off profile is wider

than that of the Long Butterfly. The long options at the outside strikes ensure that the risk is

capped on both the sides. The resulting position is profitable if the stock / index remains

range bound and shows very little volatility. The maximum profits occur if the stock finishes

between the middle strike prices at expiration.

Example: Nifty is at 5800. Mr. XYZ expects little volatility in the Nifty and expects the

market to remain rangebound. Mr. XYZ buys 1 ITM Nifty Call Options with a strike

price of Rs. 5600 at a premium of Rs. 41.25, sells 1 ITM Nifty Call Option with a strike

price of Rs.5700 at a premium of Rs. 26, sells 1 OTM Nifty Call Option with a strike

price of Rs. 5900 at a premium of Rs. 9.80 and buys 1 OTM Nifty Call Option with a

strike price of Rs.6000 at a premium of Rs. 6.00. The Net debit is Rs. 11.45 which is

also the maximum possible loss.

On expiryNiftyCloses at

Net Payofffrom 1ITMCallpurchased(Rs.)

Net Payofffrom 1ITM Callsold (Rs.)

Net Payofffrom 1OTM Callsold (Rs.)

Net Payofffrom 1 OTM Callpurchased(Rs.)

Net Payoff(Rs.)

5300 -41.25 26 9.8 -6 -11.455400 -41.25 26 9.8 -6 -11.455500 -41.25 26 9.8 -6 -11.455600 -41.25 26 9.8 -6 -11.455611.45 -29.80 26 9.8 -6 05700 58.75 26 9.8 -6 88.555800 158.75 -74 9.8 -6 88.555900 258.75 -174 9.8 -6 88.555988.55 347.30 -263 -78.8 -6 06000 358.75 -274 -90.2 -6 -11.456100 458.75 -374 -190.2 94 -11.456200 558.75 -474 -290.2 194 -11.45ANALYSIS : Risk is Limited to the minimum of the difference between the lower strike call

spread less the higher call spread less the total premium paid for the

condor. Profit is also Limited. The maximum profit of will be realized when the stock is

trading between the two middle strike prices.

40

STRATEGY 22 : SHORT CALL CONDOR : SHORT 1 ITM CALL OPTION

(LOWER STRIKE), LONG 1 ITM CALL OPTION (LOWER MIDDLE), LONG 1

OTM CALL OPTION (HIGHER MIDDLE), SHORT 1 OTM CALL OPTION

(HIGHER STRIKE).

A Short Call Condor is very similar to a short butterfly strategy. The difference is that the

two middle bought options have different strikes. The strategy is suitable in a volatile market.

The resulting position is profitable if the stock / index shows very high volatility and there is

a big move in the stock / index.

Example: Nifty is at 5800. Mr. XYZ expects high volatility in the Nifty and expects the

market to break open significantly on any side. Mr. XYZ sells 1 ITM Nifty Call Options

with a strike price of Rs. 5600 at a premium of Rs. 41.25, buys 1 ITM Nifty Call Option

with a strike price of Rs. 5700 at a premium of Rs. 26, buys 1 OTM Nifty Call Option

with a strike price of Rs. 5900 at a premium of Rs. 9.80 and sells 1 OTM Nifty Call

Option with a strike price of Rs. 6000 at a premium of Rs. 6.00. The Net credit is of Rs. 11.45.

On expiryNiftyCloses at

Net Payofffrom 1ITMCall sold (Rs.)

Net Payoff from1 ITM Callpurchased (Rs.)

Net Payofffrom 1 OTMCallpurchased(Rs.)

Net Payofffrom 1 OTMCall sold(Rs.)

NetPayoff(Rs.)

5300 41.25 -26 -9.8 6 11.455400 41.25 -26 -9.8 6 11.455500 41.25 -26 -9.8 6 11.455600 41.25 -26 -9.8 6 11.455611.45 29.80 -26 -9.8 6 05700 -58.75 -26 -9.8 6 -88.555800 -158.75 74 -9.8 6 -88.555900 -258.75 174 -9.8 6 -88.555988.55 -347.30 263 78.8 6 06000 -358.75 274 90.2 6 11.456100 -458.75 374 190.2 -94 11.456200 -558.75 474 290.2 -194 11.45

ANALYSIS : Both the risk and the profit (The maximum profit of a occurs when the

underlying stock / index is trading past the upper or lower strike prices.) are limited.

41

OTHER STRATEGIES

Call Back Spread :

Short one ITM call option and long two OTM call options

Similar to a Short Straddle except the loss on the downside is limited. Maximum Loss:

Limited to the difference between the two strikes plus the net premium (which should be a

credit).Maximum Gain: Unlimited on the upside and limited on the downside

Put Back Spread :

Long two OTM put options and short one ITM put option. Use when bullish on volatility.

Maximum Loss: Limited to the difference between the two strikes less the premium received

for the spread. Maximum Gain: Limited on the upside to the net premium received for the

spread. Unlimited on the downside.

Call Ratio Vertical Spread:

Long one ITM call option and short two OTM call options. Use when bearish on volatility.

Maximum Loss: Unlimited on the upside and limited on the downside. Maximum Gain:

Limited to the difference between the two strikes less the net premium paid.

Put Ratio Vertical Spread:

Short two OTM put options and long one ITM put option. Use whem bearish on volatility.

Maximum Loss: Unlimited on the downside and limited to the net premium paid on the

upside. Maximum Gain: The difference between the two strike prices less the premium paid

for the position.

DESIGN OF THE STUDY

42

STATEMENT OF PROBLEM: A study of Option Trading Strategies and their application

by the clients of Geojit BNP Paribas.

Scope of the study :

Compare the strategies used by the clients as against the specified strategies given by

the NSE.

Advice the clients when to use what strategy depending upon their expectation of the

market , to fall or to rise.

Also to find the the possible reasons inhibiting clients to invest in options.

Objective of the study

Primary objective

Study the various Option Trading Strategies and their application at Geojit BNP

Paribas.

Generation of a model for investors advising them when to use which strategy, citing

the risk and profits to be expected by applying a particular strategy.

Secondary objective

To understand the perception of investors about investing in Options either for

Long term or short term.

SAMPLE DESIGN

Sample Universe

Sample Unit : Proffessionally or self employed men and women.

Sampling Size : 70

Sampling Technique: Random Sampling

DATA COLLECTION:

Primary Data:

43

Using Questionnaires

Personal interview with the investors.

Secondary Data

Transaction Details of the clients.

Books and Articles.

STATISTICAL DESIGN :

The collected data will be classified with the help of statistical tools such as percentages for

the purpose of analysis. Data will be then analysed and inferences would be drawn from the

analysis in the form of charts and graphs.

CONTRIBUTION OF STUDY :

Help in finding a new opportunity for Geojit BNP Paribas in the field of Option

Trading.

Helping in generating a model which colud advice them when to use which strategy

based on their expectation about the market.

LIMITATION OF THE STUDY

Restricted only to investors that to a handful of them since access to large scale

investors was not possible.

Time factor was a chief limitation because to understand market no time is enough.

Another major constraint would be the cost which was limited to my affordability.

EXPECTATION OF STRATEGY TO BE

MARKET USED

44

LONG CALL

SHORT PUT

LONG COMBO ( Sell Put Buy Call)

SHORT CALL

LONG PUT

SYNTHETIC LONG PUT

SYNTHETIC LONG CALL

COVERED CALL

COLLAR

BULL CALL SPREAD (Buy ITM Sell OTM)

BULL PUT SPREAD (Buy OTM Sell ITM)

COVERED PUT

BEAR CALL SPREAD (Buy OTM Sell ITM)

BEAR PUT SPREAD (Buy ITM Sell OTM)

LONG STRADDLE

LONG STRANGLE

SHORT CALL BUTTERFLY

SHORT CALL CONDOR

SHORT STRADDLE

SHORT STRANGLE

LONG CALL BUTTERFLY

LONG CALL CONDOR

From investment point of view

45

BULLISHBULLISH

BEARISHBEARISH

MILDLY BULLISHMILDLY BULLISH

MILDLY BEARISHMILDLY BEARISH

HIGH VOLATILITYHIGH VOLATILITY

LESS VOLATILITYLESS VOLATILITY

Options which are close to the spot price be it index/stock are generally traded, since

they show greater movement as compared to the options with much lower or higher

strike price.

The major components of premium amount is

Intrinsic Value

Time Value

Thus by reducing the intrinsic value the premium amount can be reduced. As

compared to the equity market here the investment is less, but the investor has to be

cautious about his/her position.

Strategies involving buying and selling of stock alongwith the options can be little

costly depending on the stock price. But trading in index options does not involve

much of a cost. The premium amounts are falls in the bracket of Rs 100 to 300

Strategies such as Covered call, Synthetic Long Call Synthetic Long Put, Collar

involve buying stock thus might get costly.

Strategies which belong to the high or low volatility market are used frequently by

investors, following an impactful economic decision, taken by the government or a

particular organization, since the investors are not sure whether the market will go up

or fall down.

Strategies involving more than two or three legs become more complex and are

difficult for the investors to keep track of. For eg the condors and the butterfly are not

commonly used.

As a rule not all investor’s decisions have a strong hold on the market, only a handful of them

bring in the major changes which trade in large quantities.

46

Options are not only difficult to trade by investors but also pose complexity in pricing them,

and arriving at the strike price also.

The famous Black Scholes Formula is used to arrive at the premium price of an option . The

inputs required in this model are

The underlying asset’s current price

The time to expiration of the option

The risk-free interest rate

The historical volatility of the underlying asset price

Given an asset’s historical volatility and using probability, the model is used to estimate how

likely it is that an option will reach its strike price within the time left to expiration and thus

its current theoretical premium value. There are also a number of more complex valuation

models ranging from algebraic, to iterative to Monte Carlo simulation techniques.

Analysing the transaction details of the clients at Geojit BNP Paribas, referring to Annexure

I (containing the transaction details of a particular client for the month of April till the expiry

of the Nifty index option) , I came to the following conclusions.

The term for trading used is intraday. Clients after taking a certain position do not

wait till the expiry. On the other hand they square off their previous positions and

take new positions many times before the expiration date.

The clients look for short term gains and do not make much use of strategies.

The number of clients trading in Derivatives Market were very few as compared to

the equity market.

Since I was interning during the months of April and May’11, I got to see both the sides of

the market. In April the market was bullish and in the month of May after announcing of the

RBI monetary policy of increasing the repo rate by 50 basis points the market fell down

drastically and I saw the other side of the market.

47

A lot of volatility was expected in the market by speculators so therefore I would have

advised to go for strategies such as LONG STRADDLE and LONG STRANGLE, which

involves buying a put and a call together. Referring to example given while explaining the

strategy with net debit(outflow) of Rs 66 the profit which could have been earned was

unlimited when the market fell down drastically.

The most common reasons why investors restrict themselves for trading in Options are

Its complexity and thus difficult to understand

Risky since the fluctuations are more than the underlying asset and

Lack of awareness.

Since the trading in Option is settled in terms of cash a certain level of liquidity is required in

the marketwhich at all times is not possible

To understand the investor behaviour towards the opitions as a means of investment I

designed a questionnaire and analysed it

INTERPRETATION AND ANALYSIS

For introducing a new product in the market a through survey is done in order to deter mine

the need for the product, but in this case the product is already there and a need is to be

48

generated by creating awareness about the product. Thus a market survey was done by the

way of questionnaire. There were 40

Graph Age distribution of the respondent

Graph Gender distribution of the respondent

Graph Occupation of the respondent

49

The survey was focussed on the employed professionals and the businessmen

Graph Bar graph showing since when the respondents have been investing in equity

Clients which have been investing in equity for quite some time can start investing in

derivatives since they know the basics of investing in stock markets.

Prior to entering futures and options one should have some experience in equity since a long

term investment in equity is generally rewarding. Therefore 41 % of the respondents can

invest in Options.

Graph Showing percentage of people in different domains of investment

50

The above graph shows that the investors are aware of the derivatives market and use it for

the purpose of hedging it with the equity stocks( equity stocks and their futures ) But

percentage of investors investing in options is very less.

Graph Showing level of satisfaction with the returns from current postions

Majority of the investors are happy or satisfied with the returns from the current portfolio

Graph showing modes of trading

51

38% of the investor trade on Intraday basis thus trading in options can be a field of

investment

Graph Showing reasons behind reluctance for investing in options

Most of the investors consider the complexity of options as a major hinderance

for investment in options. A small section of the investors are unaware about the mechanism

of options while others think that it is a risky mode of investment.

Majority of the investors who are unaware of the option trading would want their specific

brokerage houses to conduct presentations detailing the mechanism by which derivatives are

traded and settled. A very small number of respondents which were questioned used options

and only one or two of them used strategies and that to not in the truest sense.

RECOMMENDATIONS

52

On the basis of the interaction I had with the investors over the last two months and studying

the option trading Strategies in detail , I have the following recommendations to make

Increasing Awareness : The analysis shows that most of the retail investors are

unaware of the Option Trading on their own with the use strategies involving taking

more than one position. Generally derivatives are used for hedging purpose still most

of the investors are unaware of the concept behind it and how association with

derivatives can enhance the value of the portfolio of a particular customer.

Personal mail to Geojit clients : the current clients should be informed by mail

about this service and even offered to meet the Relationship Manager. Even

awareness program can be arranged for the clients.

Conducting presentations: The clients should be invited to office regularly so as

their needs can be taken care of.

The training staff or the business development officers( BDOs) should conduct

presentations for clients who are interested and this could be followed by question

and answer session to clear the doubts, and taking advice from so as to how they can

be served better. These kind of activities make the client feel important since the

brokerage that is deducted can have a negative affect on the clients.

Concessional Charges: The clients who have been with Geojit for quite long time

can be given which helps in customer retention.

Those clients can provide references thus help in increasing the client base.

Differentiated Service: Geojit should strive to differentiate its offerings from the

comparable offerings of the competitors. Some of the possibilities are:

o Geojit can offer Derivatives Research to some reputed firm. This will lend

credibility to its offerings. Thus clients which are still reluctant to trade in

options will consider it again since they will be guided by the experts.

o It can make a mention of their services in a regular Newsletter and

distributing it to their clients and other references for greater awareness

BIBLIOGRAPHY

53

Websites:

www.nseindia.com

www.investopedia.com

www.optiontradingtips.com

www.geojit.com

Books:

THE INVESTMENT GAME By

Prasanna Chandra

THE BIBLE OF OPTION STRATEGIES

By GUY COHEN

ROFIT WITH OPTIONS

BY LAWRENCE G MACMILLAN

HOW TO MAKE MONEY TRADING DERIVATIVES

BY ASHWINI GUJRAL

Optimal Long-Run Option Investment Strategies. By: Rendleman Jr., Richard J.. Financial Management (1972), Spring81, Vol. 10 Issue 1, 

A Study on Estimating Investment Timing of Real Options. By: Han, Hyun J.; Park,

Chan S.. Engineering Economist, 2008, Vol. 53 Issue 3,

Can We Capture the Value of Option Volatility? By: Lewis, Neal A.; Eschenbach, Ted

G.; Hartman, Joseph C.. Engineering Economist, 2008, Vol. 53 Issue 3

Evaluating Product Plans Using Real Options. By: Shil, Prasenjit; Allada, Venkat.

Engineering Economist, 2007, Vol. 52 Issue 3

The Varying Cost of Options and Implications for Choosing the Right Strategy.

Source: Dubil, Robert

Journal of Financial Planning; May2010, Vol. 23 Issue 5, p62-70, 8pANNEXURE I

54

Opt type Stk price Tran date Buy qty Sell qty Rate

CE 6000 18.04 0 100 38.05

PE 5900 18.04 250 0 60.60

PE 5900 18.04 0 250 72.55

CE 6000 18.04 100 0 30.00

CE 6000 18.04 400 0 30.00

PE 5900 18.04 0 750 100

CE 5800 18.04 800 0 95

CE 5800 19.04 50 0 48.00

CE 5800 19.04 500 0 48.00

PE 5800 20.04 500 0 42.00

PE 5800 20.04 250 0 36.00

PE 5800 21.04 1000 0 20.00

PE 5800 25.04 0 1750 16.00

PE 5900 25.04 500 0 45.70

PE 5900 26.04 0 500 78.65

CE 5900 26.04 3350 0 16.50

CE 5900 26.04 0 2000 25.00

CE 5900 26.04 0 2000 29.50

CE 5800 26.04 0 250 88

PE 5800 27.04 400 0 7.60

PE 5800 27.04 300 0 7.65

PE 5800 27.04 200 0 7.70

PE 5800 27.04.\ 500 0 7.65

PE 5800 27.04 100 0 8.00

PE 5800 27.04 0 500 13.65

PE 5800 27.04 0 150 15

PE 5800 27.04 0 250 16

PE 5800 27.04 0 400 16

PE 5800 27.04 0 100 15

Symbol Date Expiry Strike Open High Low Close LTP

55

Price

Settle Price

NIFTY01-Apr-11

28-Apr-11 5800 168.5 177.95 138.25 148.8 149.8 148.8

NIFTY04-Apr-11

28-Apr-11 5800 145.1 205.8 139.15 197.05 199 197.05

NIFTY05-Apr-11

28-Apr-11 5800 209.85 209.85 145.65 185.15 179 185.15

NIFTY06-Apr-11

28-Apr-11 5800 188.1 210.9 148.05 166.35 167.5 166.35

NIFTY07-Apr-11

28-Apr-11 5800 169.9 180 148 156.95 156.3 156.95

NIFTY08-Apr-11

28-Apr-11 5800 156 173.2 111.15 121.25 123.8 121.25

NIFTY11-Apr-11

28-Apr-11 5800 113 114.8 81.1 86.3 82.85 86.3

NIFTY13-Apr-11

28-Apr-11 5800 71.95 179.6 60.15 169.85 174.5 169.85

NIFTY15-Apr-11

28-Apr-11 5800 158 158 89.6 95.4 90 95.4

NIFTY18-Apr-11

28-Apr-11 5800 95 149.9 43.05 45.7 47.4 45.7

NIFTY19-Apr-11

28-Apr-11 5800 44.85 62.95 36 49.95 49.95 49.95

NIFTY20-Apr-11

28-Apr-11 5800 64.9 105.5 46.9 101.55 105 101.55

NIFTY21-Apr-11

28-Apr-11 5800 120 144.9 104 117.8 115.5 117.8

NIFTY25-Apr-11

28-Apr-11 5800 102.95 134.85 90.3 100.05 90.3 100.05

NIFTY26-Apr-11

28-Apr-11 5800 90 113.9 34.2 91.35 85.3 91.35

NIFTY27-Apr-11

28-Apr-11 5800 100 102.2 38.4 47.2 45.9 47.2

NIFTY28-Apr-11

28-Apr-11 5800 56 59 0.05 1.5 0.05 0

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