study of option strategies and use of derivatives
TRANSCRIPT
A
PROJECT REPORT ON
“Study of Option Strategies and use of Derivatives”
By
Vikash Kumar Sinha
(Roll No. 9258)
Submitted in partial fulfillment of the requirements for the
Post Graduate Diploma in Management
(Business Management)
At
Narnolia Securities Limited, Ranchi
As Prescribed By
ASM’s
INSTITUTE OF INTERNATIONAL BUSINESS & RESEARCH, PUNE
2009-2011
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ABSTRACT
Title of the Project : Study of Option Strategies and Use of Derivatives
Name of the Organization : Narnolia Securities Limited, Ranchi
Name of the Institute : ASM’s Institute of International Business &
Research, Pune
Name of the Guide
Organizational : Mr. Rajesh Kumar Singh
Charted Accountant and Head - Marketing
Institutional : Mr. Ranjit Chavan
Faculty Member
Institute of International Business & Research
Project Period : 19.05.2010 to 31.07.2010
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DECLARATION
This is to certify that the project report entitled “Study on Option Strategies and Use of
Derivatives is done by me is an authentic work carried out for the partial fulfillment of the
requirements for the award of the degree of PGDM. The matter embodied in this project work
has not been submitted earlier for award of any degree or diploma to the best of my
knowledge and belief.
Vikash Kumar Sinha
Roll No. - 9258
PGDM (BM) 2009-11
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ACKNOWLEDGEMENT
I take great pleasure to express my gratitude to all those who initiated and helped me
complete this project successfully.
I thank MR. S.B MATHUR (DIRECTOR), INSTITUTE OF INTERNATIONAL
BUSINESS AND RESEARCH, for allowing me to take up my project through this
esteemed institute.
I am very grateful to MR. RANJIT CHAVAN for their constant inspiration and help
extended to me during the project. Their timely suggestion and constant encouragement are
greatly acknowledged.
I would like to express my profound gratitude to MR. RAJESH KUMAR SINGH
(CHARTED ACCOUNTANT) NARNOLIA SECURITES LTD., for permitting me to
do my project in the organization and for sparing their precious time for me and constantly
guiding me through my project, without which I would not be able to complete my project.
Last but not least, I would like to thank all my friends and every other person who has
been involved in helping me complete my project.
Vikash Kumar Sinha
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TABLE OF CONTENTS
SR. No. TOPIC PAGE NO
1. Title Page i
2. Abstract ii
3. Certificate iii
4. Acknowledgement iv
5. Introduction 8
6. Objectives 9
7. Limitation 10
8. Research Methodology 11- 12
9. About Organization 13 - 19
10. Derivatives
A. Introducton 20
B. Derivative Market in India 21
C. Future 22 - 23
D. Option 24 - 26
11. Option Strategies (20 strategies) 27 - 70
12. Finding & Observation 71
13. Conclusion 72
14. Recommendation 73
15. Questionnaire 74-75
16. Bibliography 76
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INTRODUCTION OF THE STUDY
Narnolia Securities Limited is a reputed organization in the field of share trading. Narnolia
Securities Ltd. is the Sub-Broker of Motilal Oswal. The company keeps its vision and mission
always very clear. It works with the noble purpose of understanding the people’s needs of
securing their investment stable and risk free. The company always believes in
complementing its objective and motto with hard work and dedication. The Management team
always works in synchronization with the people’s needs and always takes the active consult
of the company’s development. It has always proven its excellence at providing quality
services to its customers at every single opportunity they have in their sight. The purpose of
the study is to employees and officials before arriving at any decision. The chairman/M.D
takes into account each and every board member’s active suggestion before taking any
financial decision. In this way the entire organization behaves like a single family and thus it
is marching forward on the path of growth and continued assess the customer’s attitude
towards the investment. I can only say that this project report will be very helpful for the
company in understanding and fulfilling the customer’s needs and to attain the company’s
goals and objectives up to maximum extent interns of cost benefit analysis.
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OBJECTIVE OF THE STUDY
� To study Indian Derivative Market
� To study different strategies used in Future and Options.
� To suggest the various Option Strategies by considering risk appetite and future market
expectations.
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LIMITATIONS
� Lack of awareness about Futures and Options segment:
Since the area is not known before it takes lot of time in convincing people to start
investing in Futures and Options market for hedging purpose.
� Mostly people comfortable with traditional brokers: --
As people are doing trading from there respective brokers, they are quite comfortable
to trade via phone.
� Some respondents are unwilling to talk: -
Some respondents either do not have time or willing does not respond as they are quite
annoyed with the adverse market conditions they faced so far.
� Misleading concepts: -
Some people think that Derivatives are too risky and just another name of gamble but
they don’t know it’s not at all that risky for long investor.
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RESEARCH METHODOLOGY
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1. Sampling:
The sampling was collected from 60 client of Narnolia Securities Ltd.
A sample questionnaire was given to the respondents has been shown
in the appendix I. To get reasonable and correct response we introduced relevant
question in the questionnaire, just to bring the respondents to ease. Care had been
taken the question close ended although in some question sufficient options were
provided.
2. Data collection: The availability and quality of information is mainly depending on
the resources of information. I have taken mostly primary data through
questionnaire, customer interviews and observation methods to get more reliable
information. Some secondary data has also been collected through various
secondary sources like magazines, books and company profile through websites.
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SURVEY FINDINGS:
Following are the data which are the outcome of survey:
Age Group percentage
(1) 20-30 35%
(2) 30-40 38%
(3) >40 27%
Profession
(1) Business 15%
(2) Govt. job 22%
(3) Pvt. Job 28%
(4) Student 35%
QUALIFICATION:
(1) Non Graduate 15%
(2) Graduate 65%
(3) Post Graduate 20%
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ABOUT THE ORGANISATION
The history of the company back to 1993. The brilliant academic track record and a deep
understanding of capital market of its founder CMD Mr. Krishna N Narnolia helped him to
lay the solid foundation of Narnolia with well defined philosophies and core values. In 1997
the firm was corporatized. In the same year Mr. Shailendra Kumar (B.E., M.Tech, IIT, Delhi)
joined the company as one of the co-founding director who brought with him his experience
of fund management and advisory.In 1999 Became the first company in the area to open self
managed branches and franchisee outlets with both NSE & BSE terminals. In 2002 the
company entered into strategic tie up with premier house Motilal Oswal as their exclusive
regional partner for the states of Bihar, Jharkhand and parts of West Bengal & Select towns.
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Award and Achievements:
� In 2002 Won the Best Franchisee Network of the Country Award.
� In 2007 Recognized by Franklin Templeton as the Best Distribution House in the
East in terms of No. of applications.
� Got ISO-9001: 2008 certification for Quality Management.
� The company was converted in to Public Ltd Co.
� In 2009 Honored with “Hall of Fame” award at Singapore and again with prestigious
“Champion of the Champions” Trophy of the country by MOSL.
VISION:
We will be the most trusted, most knowledgeable, most understanding and most concerned
provider of value added and customer centric financial services in our strategically chosen
class and also mass market.
MISSION:
We commit ourselves both in thought and action to raise ourselves in the eyes of our true boss
i.e., the investors from being a mere transaction broker to a true family financial doctor and a
secretary to help them to protect and improve their financial health. We further resolve not to
sell Daru (gambling) in the bottle of Dawa (investment) and will dare to tell them the
difference between the two even if it results into low revenue in the short term. We shall
invest most of our time, energy and resources to reduce gaps at each touch points with our
existing investors and shall see our growth in their growth. Let us believe that quantity
follows quality.
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QUALITY POLICY:
Narnolia is committed to implementing appropriate quality management system to ensure
satisfaction of the client (core purpose ) and other interested parties by ensuring the planning
and delivery of consistently high level of service as per the predetermined high standards of
systems, processes, policies, procedures and behaviors required for each of our financial
products throughout the extensive area of operation. We all share the responsibility to ensure
continual improvement and establish long term relationship with each Stakeholder.
Narnolia Securities Ltd. Growth
Year Locations No. of Clients No. of Employees
1993-1998 1 600 6
2000 7 3000 28
2005 86 25000 221
March 2010 215 75000 700
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Management Team
The beauty and strength of NSL is the team led by its Managing Director, Mr. Krishna Nand
Narnolia. The team comprises IITian, Charted Accountants and MBAs. Following are the key
functionaries of NSL.
NAME DESIGNATION
Krishna Nand Narnolia (Gold Medalist, M.B.A.) CMD
Shailendra Kumar (B.E., M.Tech, IIT-Delhi) Director – Corporate Strategy
Dilip Losalka (B.E. Hons, BITS, Pilani) Director – Executions & HR
C.A. Jasleen Kaur Bhasin (DISA) V.P. & Head – NPC (Delhi)
C.A. Vikash Ranjan Sahay Head – Back office operations
OM Prakash Agarwalla (BTECH- Indus. Engg.) Vice President
Dharmendra Kumar Sinha (MBA) A.V.P. Internal Accounts
C.A. Anand Kumar Agarwal Associate V.P.- Corporate (Fin.)
C.A. Rajesh Kumar Singh Head- Marketing
Sunil Waghela Head- Business Development
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PRODUCT & SERVICES OF THE ORGANISATION
INVESTMENT & TRADING IN SHARES (STOCK MARKET)
Globally it has been experienced that over time, a portfolio of well chosen shares will always
out perform bond or fixed deposit. Motilal Oswal Securities Ltd (MOSt) is the member of
both NSE & BSE. It is one of the leading stock brokers of the country.
Cash Trading:
It is a delivery based trading system wherein transactions can be settled intraday or can be
settled by taking delivery of shares or monies.
Margin Trading:
It is similar to cash trading except an additional facility wherein the investor interested in
taking leveraged position can do so by paying only certain % of the total payment & the
balanced amount is financed by an independent investment company. A separate form is
required to be filled up for availing this facility. Click here for list of shares.
Spot Payment:
Normally under T+ 2 settlement cycle it takes around 3-5 days before the payment gets
credited in clients account. In cases where a client having shares in our depository account
needs payment early or same day he/she can avail this facility with prior intimation.
BNST:
Buy Now Sell Tomorrow (BNST) facilitates a client to sell specified shares (as attached) on
T+1 basis even before the receipt of shares into his/her demat account.
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Portfolio Management Service (PMS):
It is an alternative to investing directly. All those who do not have time or discipline or
inclination or expertise to understand the complex ways of investment ,still want to take
benefits of it , can do so by putting their money with the fund managers
INVESTMENT IN EQUITY DERIVATIVES
Trading volume in derivative segment of the exchanges has surged significantly over last few
months/years. However, the bias is more towards future than options. There are few
misconceptions about this market. It is largely used by speculators to take leveraged positions
in the market. It is considered as a mere replacement of the age old badla system of BSE. But
the fact is that this derivative market has much larger role to play not only for the speculators
but more so for the investors, particularly the high net worth & institutional investors. With
the use of certain financial management tools like; Standard Deviation, Theta, Delta, Beta,
Gamma, Rho, Vega etc. , one can create several strategies using multiple types of financial
instruments of derivatives market. These strategies can be used by the investors for risk
management, hedging, arbitrage and generation of regular incomes out of the idle investment.
INVESTMENT THROUGH MUTUAL FUNDS
It is an alternative to investing directly. All those who do not have time or discipline or
inclination or expertise to understand the complex ways of investment ,still want to take
benefits of it , can do so by putting their money with the money managers :mutual funds who
are supposedly the experts in investment matters and are expected to perform better than
individual common investor because of their economies of scale, professional approach,
experience, investing acumen, access to money market instruments to park their short
term/surplus funds etc.
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PRIMARY MARKET
Initial Public Offer (IPO) by non listed companies or follow on offer by presently listed
companies presents a good opportunities for making high returns on investment in a very
short period of time. However, contrary to common belief investment through new issues
does not always give high return or guarantee capital protection. NARNOLIA, provide the
list of all forthcoming new issues & in-depth analysis of all such issues.
DEPOSITORY SERVICES
The depository services with the trade name of "MODES"- Motilal Oswal Depository Related
Services (Member NSDL & CDSL) is available to both the trading & non trading client of
Narnolia. At NARNOLIA, manage around 40,000 depository accounts of clients.
COMMODITY
Motilal Oswal Commodities Broker (P) Ltd is the clearing and trading members of both the
exchange and has a big research team to support various participants in their own way.
INSURANCE
The sister concern of Narnolia, NARNOLIA INSURANCE AGENTS CO (P) LTD is the
exclusive jeevan chakra partner of Birla Sun life for Jharkhand and serves its clients from its
various outlets in Bihar, Jharkhand & West Bengal, through their qualified advisors
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DERIVATIVES
Derivative is a product whose value is derived from the value of one or more basic variables
i.e. underlying asset in a contractual manner. The underlying asset can be equity, forex,
commodity or any other asset. For example, wheat farmers may wish to sell their harvest at a
future date to eliminate the risk of a change in prices by that date. Such a transaction is an
example of a derivative.
There are several product of Derivative, but the most common among them are
1. Forwards
2. Future
3. Option
Forward: - A forward contract is a customized contract between two entities, where
settlement takes place on a specific date in the future at today's pre-agreed price.
Future: - A futures contract is an agreement between two parties to buy or sell an asset at a
certain time in the future at a certain price. Futures contracts are special types of forward
contracts in which exchange act as a mediator and it is also known as standardized exchange-
traded contracts.
Option: -Options are of two types - calls and puts. Calls give the buyer the right but not the
obligation to buy a given quantity of the underlying asset, at a given price on or before a given
future date. Puts give the buyer the right, but not the obligation to sell a given quantity of the
underlying asset at a given price on or before a given date.
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Difference between futures and forwards
Future Forward
Trade on an organized exchange OTC in nature
Standardized contract terms Customized contract terms
hence more liquid hence less liquid
Requires margin payments No margin payment
Follows daily settlement Settlement happens at end of period
Derivative Markets in India
Derivatives trading commenced in India in June 2000. SEBI permitted the derivatives
segments of two stock exchanges. NSE and BSE, and their clearing house / corporation to
commence trading and settlement in approved derivatives contracts. To begin with, SEBI
approved trading in index futures contracts based on S&P CNX Nifty and BSE – 30 (Sensex)
index. Later approval for trading in options commenced in June 2001 and the trading in
options on individuals securities commenced in July 2001. Futures contracts on individuals
stocks were launched in November 2001. Trading and settlement in derivatives contracts is
done in respective exchanges and their clearing house or corporation duly approved by SEBI
and notified in the official gazette.
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FUTURES
A futures contract is an agreement between two parties to buy or sell an asset at a certain time
in the future at a certain price. But unlike forward contracts, the futures contracts are
standardized and exchange traded, to facilitate liquidity in the futures contracts, the exchange
specifies certain standard features of the contract. It is a standardized contract with standard
underlying instrument, a standard quantity and quality of the underlying instrument that can
be delivered, (or which can be used for reference purposes in settlement) and a standard
timing of such settlement. A futures contract may be offset prior to maturity by entering into
an equal and opposite transaction.
FUTURES TERMINOLOGY
Spot price: The price at which an asset trades in the spot market.
Futures price: The price at which the futures contract trades in the futures market.
Contract cycle: The period over which a contract trades. The index futures contracts on the
NSE have one- month, two-month and three months expiry cycles which expire on the last
Thursday of the month. Thus a January expiration contract expires on the last Thursday of
January and a February expiration contract ceases trading on the last Thursday of February.
On the Friday following the last Thursday, a new contract having a three- month expiry is
introduced for trading.
Expiry date: It is the date specified in the futures contract. This is the last day on which the
contract will be traded, at the end of which it will finish to exist. All futures and option
contracts expire on last Thursday of the expiry month. Incase of holiday, contract shall expire
on preceding day. The lot size on the futures and options market is 50 for Nifty.
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Contract size: The amount of asset that has to be delivered under one contract. It is also
called as lot size.
Basis: In the context of financial futures, basis can be defined as the futures price minus the
spot price. There will be a different basis for each delivery month for each contract. In a
normal market, basis will be positive. This reflects that futures prices normally exceed spot
prices.
Cost of carry: The relationship between futures prices and spot prices can be summarized in
terms of what is known as the cost of carry. This measures the storage cost plus the interest
that is paid to finance the asset less the income earned on the asset.
Initial margin: The amount that must be deposited in the margin account at the time a futures
contract is first entered into is known an initial margin.
Marking-to-market: In the futures market, at the end of each trading day, the margin
account is adjusted to reflect the investor's gain or loss depending upon the futures closing
price. This is called marking-to-market.
Maintenance margin: This is somewhat lower than the initial margin. This is set to ensure
that the balance in the margin account never becomes negative. If the balance in the margin
account falls below the maintenance margin, the investor receives a margin call and is
expected to top up the margin account to the initial margin level before trading commences on
the next day.
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OPTIONS
Options are fundamentally different form forward and futures contracts. An option gives the
holder of the option the right to do something. The holder does not have to exercise this right.
In contrast, in a forward or futures contract, the two parties have committed themselves to do
something. Whereas it costs nothing (except margin requirements) to enter into a futures
contract, the purchase of an option requires an upfront payment.
OPTIONS TERMINOLOGY
Index options: These options have the index as the underlying. Some options are European
while others are American. Like index futures contracts, index options contracts are also cash
settled.
Stock options: Stock options are options on individual stocks. Options currently trade on
over 500 stocks in the United States. A contract gives the holder the right to buy or sell shares
at the specified price.
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 of an option: The writer 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. There are
two basic types of options, call options and put options.
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.
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.
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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.
American options: American options are options that can be exercised at any time upto the
expiration date. Most exchange-traded options are American.
European options: European options are options that can be exercised only on the expiration
date itself. European options are easier to analyze than American options, and properties of an
American option are frequently deduced from those of its European counterpart.
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. 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
cash flow 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).
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. 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 index is above the strike price.
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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.
Difference between futures and option
Future Option
Exchange traded, with novation Same as future
Exchange defines the product Same as future
Price is zero, strike price moves Strike price is fixed, price moves
Price is zero Price is always positive
Linear payoff Non linear payoff
Both long and short at risk Only short at risk
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OPTION STRATEGIES
In finance an option strategy is the purchase and/or sale of one or various option positions and
possibly an underlying position.
Options strategies can favor movements in the underlying that are bullish, bearish or neutral.
In the case of neutral strategies, they can be further classified into those that are bullish on
volatility and those that are bearish on volatility. The option positions used can
be long and/or short positions in calls and/or puts at various strikes.
Bullish strategies
Bullish options strategies are employed when the options trader expects the underlying stock
price to move upwards. It is necessary to assess how high the stock price can go and the time
frame in which the rally will occur in order to select the optimum trading strategy.
The most bullish of options trading strategies is the simple call buying strategy used by most
novice options traders.
Stocks seldom go up by leaps and bounds. Moderately bullish options traders usually set a
target price for the bull run and utilize bull spreads to reduce cost. (It does not reduce risk
because the options can still expire worthless.) While maximum profit is capped for these
strategies, they usually cost less to employ for a given nominal amount of exposure. The bull
call spread and the bull put spread are common examples of moderately bullish strategies.
Mildly bullish trading strategies are options strategies that make money as long as the
underlying stock price does not go down by the option's expiration date. These strategies may
provide a small downside protection as well. Writing out-of-the-money covered calls is a
good example of such a strategy.
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Bearish strategies
Bearish options strategies are the mirror image of bullish strategies. They are employed when
the options trader expects the underlying stock price to move downwards. It is necessary to
assess how low the stock price can go and the time frame in which the decline will happen in
order to select the optimum trading strategy.
The most bearish of options trading strategies is the simple put buying strategy utilized by
most novice options traders.
Stock prices only occasionally make steep downward moves. Moderately bearish options
traders usually set a target price for the expected decline and utilize bear spreads to reduce
cost. While maximum profit is capped for these strategies, they usually cost less to employ.
The bear call spread and the bear put spread are common examples of moderately bearish
strategies.
Mildly bearish trading strategies are options strategies that make money as long as the
underlying stock price does not go up by the options expiration date. These strategies may
provide a small upside protection as well. In general, bearish strategies yield less profit with
less risk of loss.
Neutral or non-directional strategies
Neutral strategies in options trading are employed when the options trader does not know
whether the underlying stock price will rise or fall. Also known as non-directional strategies,
they are so named because the potential to profit does not depend on whether the underlying
stock price will go upwards or downwards. Rather, the correct neutral strategy to employ
depends on the expected volatility of the underlying stock price.
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Bullish on volatility
Neutral trading strategies that are bullish on volatility profit when the underlying stock price
experiences big moves upwards or downwards. They include the long straddle, long strangle,
short condor and short butterfly.
Bearish on volatility
Neutral trading strategies that are bearish on volatility profit when the underlying stock price
experiences little or no movement. Such strategies include the short straddle, short strangle,
ratio spreads, long condor and long butterfly.
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STRATEGY 1 : LONG CALL
If an investor thinks that the value of stock or index will go up then only he will use this
option strategy.
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.
Therefore breakeven point will be 4636.35. at this point there will be no profit no loss of the
investor and above this price he will be in profit.
When to Use: Investor is very bullish on the stock / index.
Risk: Limited to the Premium. (Maximum loss if market expires at or below the option strike
price).
Reward: Unlimited
Breakeven: Strike Price + Premium
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The payoff schedule and Payoff Diagram
On expiry Nifty
Closes At
Net Payoff From Call
Option
4100 -36.35
4300 -36.35
4500 -36.35
4636.35 0
4700 63.65
4800 163.65
4900 263.65
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STRATEGY 2: SHORT CALL
When the investor thinks that the Index or Stock will go down or it will be bearish in near
future then only he uses this strategy. This position offers limited profit potential and the
possibility of large losses on big advances in underlying prices. it is a risky strategy since the
seller of the Call is exposed to unlimited risk.
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
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.
The breakeven point for this strategy is 2754. Risk is unlimited for this strategy and reward is
limited to the premium.
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The payoff schedule and Payoff Diagram
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On expiry Nifty Closes At Net Payoff from Call
Option
2500 154
2600 154
2700 54
2754 0
2800 -46
2900 -146
3000 -246
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STRATEGY 3: LONG PUT
Buying a Put is the opposite of buying a Call. Investor buys call when he is bullish but when
he is bearish for near future then he uses long put strategy. A Put Option gives the buyer of
the Put a right to sell the stock at a pre-specified price and thereby limit his risk.
When to use: Investor is bearish about the stock / index.
Risk: Limited to the amount of Premium paid. (Maximum loss if stock / index expire at or
above the option strike price).
Reward: Unlimited
Break-even Point: Stock Price - Premium
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.
The breakeven point in this example is 2548. In this strategy risk is limited to the premium
paid and reward is unlimited. Here breakeven point is calculated by subtracting premium from
strike price.
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The payoff schedule and Payoff Diagram
On expiry Nifty Closes At Net Payoff from Call Option
2300 248
2400 148
2500 48
2548 0
2600 -52
2700 -52
2800 -52
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STRATEGY 4: SHORT PUT
Selling a Put is opposite of buying a Put. An investor Sells Put when he is Bullish about the
stock – expects the stock price will go up or stay sideways at the minimum. When you sell a
Put, you earn a Premium. You have sold someone the right to sell you the stock at the strike
price. 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. But, if the stock price decreases below the
strike price, by more than the amount of the premium, the Put seller will lose money.
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
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
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lose the premium and more depending on the extent of the fall in Nifty. In this case the
breakeven point is 3929.5 here risk is unlimited whereas reward is limited.
The payoff schedule and Payoff Diagram
Short put
On expiry Nifty Closes
At
Net Payoff from Call
Option
3700 229.50
3800 129.50
3900 -29.50
3929.5 0
4000 170.5
4100 170.5
4200 170.5
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STRATEGY 5: SYNTHETIC LONG CALL: (BUY STOCK, BUY PUT)
In this strategy, we purchase a stock since we feel bullish about it but on the other hand we
think what happened 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).
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. You have limited your loss in this manner because the
Put option stops your further losses.
When to use: When ownership is desired of stock yet investor is concerned about near-term
Down side 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
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.
In this example the breakeven point is 4143.80 it is calculated by Put Strike Price + Put
Premium + Stock Price – Put Strike Price. Losses limited to Stock price + Put Premium – Put
Strike price and profit is Unlimited.
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The payoff schedule and Payoff Diagram
This strategy is the addition of two payoff diagram one is of buy stock another is of buy put and the
resultant diagram is given below.
+ =
Buy stock Buy Put Synthetic Long Call
On expiry Nifty Closes Net Payoff from put
Option
Payoff from Stock Net Payoff
3800 -43.80 -200 -243.80
3900 -143.80 -100 -243.80
4000 -143.80 0 -143.80
4100 -143.80 100 -43.80
4143.80 -143.80 143.80 0
4200 -143.80 200 56.20
4300 -143.80 300 156.20
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STRATEGY 6: COVERED CALL
You own shares in a company which you feel may rise but not much in the near term and you
still like to earn income in term of premium. This strategy is usually adopted by a stock owner
who is Neutral to moderately Bullish about the stock. An investor buys a stock or owns a
stock which he feels 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. The
investor can sell a Call Option at the strike price at which he would be fine exiting the stock
by selling the call option he will get the premium and if the price goes above 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.
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.
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
Reward: Limited to (Call Strike Price – Stock Price Paid) + Premium Received
Break Even Point: Stock Price Paid – Premium Received
Example :Mr. A bought XYZ Ltd. for Rs 3850 and simultaneously sells a Call option at a
strike price of Rs 4000. Which means Mr. A does not think that the price of XYZ Ltd. will
rise above Rs. 4000. However, in case 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.
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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.
For this particular case the breakeven point is 3770 here profit is limited and risk is unlimited.
The payoff schedule and Payoff Diagram
This strategy is a combination of buy stock and sells call.
+ =
Buy Stock Sell Call Covered Call
On expiry Nifty
Closes At
Net Payoff from
put Option
Payoff from Stock Net Payoff
3600 80 -250 -130
3700 80 -150 -70
3740 80 -110 -30
3770 80 -80 0
3800 80 -50 30
3850 80 0 80
3900 80 50 130
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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 Put and buying an OTM
Call. This strategy simulates the action of buying a stock but at a fraction of the stock price. It
is an inexpensive trade, similar in pay-off to Long Stock, except there is a gap between the
strikes. As the stock price rises the strategy starts making profits. Let us try and understand
Long Combo with an example.
When to Use: Investor is Bullish on the stock.
Risk: Unlimited (Lower Strike + net debit)
Reward: Unlimited
Breakeven : Higher strike + net debit
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 is Rs. 1.
Breakeven point is 501 and risk and reward is unlimited.
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The payoff schedule and Payoff Diagram
This strategy is combinations of sell put and buy call.
+
Sell Put Buy Call
=
Long Combo
On expiry Nifty
Closes At
Net Payoff from put
Sold
Net Payoff from Call
purchased
Net Payoff
600 1 98 99
550 1 48 49
501 1 -1 0
450 1 -2 -1
400 1 -2 -1
400 -49 -2 -1
350 -99 -2 -51
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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 shorts a stock and buys an ATM or
slightly OTM Call. The net effect of this 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). In case the stock price falls the investor gains in the
downward fall in the price. However, in case there is an unexpected rise in the price of the
stock the loss is limited.
When to Use: If the 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.
Risk: Limited. Maximum Risk is Call Strike Price – Stock Price + Premium
Reward: Maximum is Stock Price – Call Premium
Breakeven: Stock Price – Call Premium
In this case risk is limited and profit is unlimited and breakeven point is 4357.
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The payoff schedule and Payoff Diagram
+ =
Sell Stock Buy Call synthetic long put
On expiry Nifty
Closes At
Net Payoff from put
Sold
Net Payoff from
Call purchased
Net Payoff
4200 1 98 99
4300 1 48 49
4350 1 -1 0
4357 1 -2 -1
4400 1 -2 -1
4457 -49 -2 -1
4600 -99 -2 -51
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STRATEGY 9: COVERED PUT
This strategy is opposite to a Covered Call. A Covered Call is a neutral to bullish strategy,
whereas a Covered Put is a neutral to Bearish strategy. You do this strategy when you feel the
price of a stock / index is going to remain in a 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.
When to Use: If the investor is of the view that the markets are moderately bearish.
Risk: Unlimited if the price of the stock rises substantially
Reward: Maximum is (Sale Price of the Stock – Strike Price) + Put Premium
Breakeven: Sale Price of Stock + Put Premium
Example:-
Suppose ABC Ltd. is trading at Rs 4500 in June. An investor, Mr. A, shorts Rs 4300 Put by
selling a July Put for Rs. 24 while shorting an ABC Ltd. stock. The net credit received by Mr.
A is Rs. 4500 + Rs. 24 = Rs. 4524.
In this case the breakeven point is Rs 4524, risk is unlimited and return is limited and
maximum return is Sale Price of the Stock – Strike Price + Put Premium.
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The payoff schedule and Payoff Diagram
+ =
Sell stock Sell Put Covered Put
ABC Ltd. closes at
(Rs.)
Payoff from the
stock
Net Payoff from Put
option
Net Payoff
4100 400 -176 224
4200 300 -76 224
4300 200 24 224
4400 100 24 124
4524 -24 24 0
4600 -100 24 -76
4650 -160 24 -136
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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; in
this case we use this strategy. 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.
When to Use: The investor thinks that the underlying stock / index will experience
significant volatility in the near term.
Risk: Limited to the initial premium paid.
Reward: Unlimited
Breakeven:
· Upper Breakeven Point = Strike Price of Long Call + Net Premium Paid
· Lower Breakeven Point = Strike Price of Long Put - Net Premium Paid
Example
Suppose Nifty is at 4450 on 27th April. An investor, Mr. A enters a long straddle by buying a
May Rs 4500 Nifty Put for Rs. 85 and a May Rs. 4500 Nifty Call for Rs. 122. The net debit
taken to enter the trade is Rs 207, which is also his maximum possible loss.
In this case there are two breakeven point one is higher another is lower, upper breakeven
point is Rs 4707 and lower breakeven point is Rs 4293. In this case loss is limited and profit is
unlimited.
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The payoff schedule and Payoff Diagram
+ =
Buy call Buy Put
Long Straddle
On expiry Nifty
closes at (Rs.)
Net Payoff from Put
Purchased (Rs.)
Net Payoff from call
purchased (Rs.)
Net Payoff (Rs.)
4100 315 -122 193
4200 215 -122 93
4293 122 -122 0
4300 115 -122 -7
4400 15 -122 -107
4500 -85 -122 -207
4600 -85 -22 -107
4707 -85 85 0
4800 -85 178 93
4900 -85 278 193
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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. If
the stock / index does not move much in either direction, the investor retains the Premium as
neither the Call nor the Put will be exercised.
When to Use: The investor thinks that the underlying stock / index will experience very little
volatility in the near term.
Risk: Unlimited
Reward: Limited to the premium received
Breakeven:
· Upper Breakeven Point = Strike Price of Short Call + Net Premium Received
· Lower Breakeven Point = Strike Price
Example
Suppose Nifty is at 4450 on 27th April. An investor, Mr. A, enters into a short straddle by
selling a May Rs 4500 Nifty Put for Rs. 85 and a May Rs. 4500 Nifty Call for Rs. 122. The
net credit received is Rs. 207, which is also his maximum possible profit.
Here again we have two breakeven point one is higher and another is lower in this case the
upper breakeven point is Rs 4707 and lower breakeven point is Rs 4293. For this case risk is
unlimited and reward is limited i.e premium which we received.
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The payoff schedule and Payoff Diagram
+ =
Sell call Sell Put
Short Straddle
On expiry Nifty
closes at (Rs.)
Net Payoff from Put
sold(Rs.)
Net Payoff from call
sold (Rs.)
Net Payoff (Rs.)
4100 -315 122 -193
4200 -215 122 -93
4293 -122 122 0
4300 -115 122 7
4400 -15 122 107
4500 85 122 207
4600 85 22 107
4707 85 -85 0
4800 85 -178 -93
4900 85 -278 -193
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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. 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. Since the initial cost of a
Strangle is cheaper than a Straddle, the returns could potentially be higher. 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
downside (i.e. the Call and the Put premium) and unlimited upside potential.
When to Use: The investor thinks that the underlying stock / index will experience very high
levels of volatility in the near term.
Risk: Limited to the initial premium paid
Reward: Unlimited
Breakeven:
· Upper Breakeven Point = Strike Price of Long Call + Net Premium Paid
· Lower Breakeven Point = Strike Price of Long Put - Net Premium Paid
Example: Suppose Nifty is at 4500 in May. An investor, Mr. A, executes a Long Strangle by
buying a Rs. 4300 Nifty Put for a premium of Rs. 23 and a Rs 4700 Nifty Call for Rs 43. The
net debit taken to enter the trade is Rs. 66, which is also his maxi mum possible loss.
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In this strategy again we have two breakeven point upper one at Rs 4766 and lower point at
Rs 4234. In this case reward is unlimited and risk is limited.
The payoff schedule and Payoff Diagram
+ =
Buy OTM put Buy OTM Call
Long Strangle
On expiry Nifty
closes at (Rs.)
Net Payoff from Put
Purchased (Rs.)
Net Payoff from call
purchased (Rs.)
Net Payoff (Rs.)
4100 177 -43 134
4200 77 -43 34
4234 43 -43 0
4300 -23 -43 -66
4400 -23 -43 -66
4500 -23 -43 -66
4600 -23 -43 -66
4766 -23 23 0
4800 -23 57 34
4900 -23 157 134
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STRATEGY 13. SHORT STRANGLE
A Short Strangle is a slight modification to the Short Straddle. 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. 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. In this case the break even points are also widened. The
underlying stock has to move significantly for the Call and the Put to be worth exercising. If
the underlying stock does not show much of a movement, the seller of the Strangle gets to
keep the Premium.
When to Use: This options trading strategy is taken when the options investor thinks that the
underlying stock will experience little volatility in the near term.
Risk: Unlimited
Reward: Limited to the premium received
Breakeven:
· Upper Breakeven Point = Strike Price of Short Call + Net Premium Received
· Lower Breakeven Point = Strike Price of Short Put - Net Premium Received
Example: Suppose Nifty is at 4500 in May. An investor, Mr. A, executes a Short Strangle by
selling a Rs. 4300 Nifty Put for a premium of Rs. 23 and a Rs. 4700 Nifty Call for Rs 43. The
net credit is Rs. 66, which is also his maximum possible gain.
The upper and lower breakeven point for this case is Rs 4766 and Rs 4234 respectively, in
this case the risk is unlimited and reward is limited.
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The payoff schedule and Payoff Diagram
+ =
Sell Call Sell Put Short Strangle
On expiry Nifty
closes at (Rs.)
Net Payoff from Put
sold (Rs.)
Net Payoff from call
sold (Rs.)
Net Payoff (Rs.)
4100 -177 43 -134
4200 -77 43 -34
4234 -43 43 0
4300 23 43 66
4400 23 43 66
4500 23 43 66
4600 23 43 66
4766 23 -23 0
4800 23 -57 -34
4900 23 -157 -134
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STRATEGY 14. COLLAR
A Collar is similar to Covered Call but involves another leg – buying a Put to insure against
the fall in the price of the stock. It is a Covered Call with a limited risk. So a Collar is buying
a stock, insuring against the downside by buying a Put and then financing the Put by selling a
Call.
When to Use: 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.
Risk: Limited
Reward: Limited
Breakeven: Purchase Price of Underlying – Call Premium + Put Premium
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.
The breakeven point for this case is Rs 4746, in this case the reward is limited as well as risk
is also limited.
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The payoff schedule and Payoff Diagram
+ +
Buy Stock Buy put Sell Call
=
Collar
ABC ltd. closes
at (Rs.)
Payoff from call
sold (Rs.)
Payoff from put
purchased (Rs.)
Payoff from
stock ABC Ltd
Net Payoff
(Rs.)
4500 39 173 -258 -46
4600 39 73 -158 -46
4700 39 -27 -58 -46
4750 39 -27 -8 4
4800 39 -27 42 54
4850 39 -27 92 104
4900 39 -27 142 154
5000 39 -27 242 254
5100 -61 -27 342 254
5200 -161 -27 442 254
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STRATEGY 15. BULL CALL SPREAD STRATEGY (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. This strategy is exercised when
investor is moderately bullish to bullish, because the investor will make a profit only when the
stock price / index rise.
When to Use: Investor is moderately bullish.
Risk: Limited to any initial premium paid in establishing the position. Maximum loss occurs
where the underlying falls to the level of the lower strike or below.
Reward: Limited to the difference between the two strikes minus net premium cost.
Maximum profit occurs where the underlying rises to the level of the higher strike or above
Break-Even-Point (BEP): Strike Price of Purchased call + Net Debit Paid
Example:
Mr. XYZ buys a Nifty Call with a Strike price Rs. 4100 at a premium of Rs. 170.45 and he
sells a Nifty Call option with a strike price Rs. 4400 at a premium of Rs. 35.40. The net debit
here is Rs. 135.05 which is also his maximum loss.
The breakeven point for this strategy is Rs 4235.05 and for this case risk and return are
limited.
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The payoff schedule and Payoff Diagram
+ =
Buy lower strike Call Sell OTM Call Bull Call Spread
On expiry nifty
closes at (Rs.)
Net Payoff from call
buy (Rs.)
Net Payoff from call
sold (Rs.)
Net Payoff (Rs.)
3900 -170 35.40 -135
4000 -170 35.40 -135
4100 -170 35.40 -135
4235 -35.40 35.40 0
4300 29.55 35.40 64
4400 129.55 35.40 164
4500 229.55 -64 164
4600 329.55 -164 164
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STRATEGY 16. BULL PUT SPREAD STRATEGY (SELL PUT OPTION,
BUY PUT OPTION)
A bull put spread can be profitable when the stock / index are either range bound or rising.
The concept is to protect the downside of a Put sold by buying a lower strike Put, which acts
as an insurance for the Put sold. The lower strike Put purchased is further OTM than the
higher strike Put sold ensuring that the investor receives a net credit, because the Put
purchased (further OTM) is cheaper than the Put sold. This strategy is equivalent to the Bull
Call Spread but is done to earn a net credit (premium) and collect an income.
When to Use: When the investor is moderately bullish.
Risk: Limited. Maximum loss occurs where the underlying falls to the level of the lower
strike or below
Reward: Limited to the net premium credit. Maximum profit occurs where
underlying rises to the level of the higher strike or above.
Breakeven: Strike Price of Short Put - Net Premium Received
Example:
Mr. XYZ sells a Nifty Put option with a strike price of Rs. 4000 at a premium of Rs. 21.45
and buys a further OTM Nifty Put option with a strike price Rs. 3800 at a premium of Rs.
3.00 when the current Nifty is at 4191.10, with both options expiring on 31st July.
Here the breakeven point is Rs 3981.55 and both risk and return are limited.
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The payoff schedule and Payoff Diagram
+ =
Buy lower strike Put Sell OTM Put Bull Put Spread
On expiry nifty closes
at (Rs.)
Net Payoff from put
buy (Rs.)
Net Payoff from put
sold (Rs.)
Net Payoff (Rs.)
3700 97 -278.55 -181.55
3800 -3 -178.55 -181.55
3900 -3 -78.55 -81.55
3981 -3 3 0
4000 -3 21.45 18.45
4100 -3 21.45 18.45
4200 -3 21.45 18.45
4300 -3 21.45 18.45
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STRATEGY 17: BEAR CALL SPREAD STRATEGY (SELL ITM CALL,
BUY OTM CALL)
The Bear Call Spread strategy can be adopted when the investor feels that the stock / index is
either range bound or falling. 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. In this strategy the investor receives a net
credit because the Call he buys is of a higher strike price than the Call sold. 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. This strategy can
also be done with both OTM calls with the Call purchased being higher OTM strike than the
Call sold. If the stock / index falls both Calls will expire worthless and the investor can retain
the net credit.
When to use: When the investor is mildly bearish on market.
Risk: Limited to the difference between the two strikes minus the net premium.
Reward: Limited to the net premium received for the position i.e., premium received for the
short call minus the premium paid for the long call.
Break Even Point: Lower Strike + Net credit
Example:
Mr. XYZ is bearish on Nifty. He sells an ITM call option with strike price of Rs. 2600 at a
premium of Rs. 154 and buys an OTM call option with strike price Rs. 2800 at a premium of
Rs. 49.
In this strategy the breakeven point is Rs 2705, here the risk is Limited to the difference
between the two strikes minus the net premium and return is Limited to the net premium
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received for the position i.e., premium received for the short call minus the premium paid for
the long call.
The payoff schedule and Payoff Diagram
+ =
Sell lower strike Call Buy OTM Call Bear Call Spread
On expiry nifty closes
at (Rs.)
Net Payoff from call
sold (Rs.)
Net Payoff from call
bought (Rs.)
Net Payoff (Rs.)
2400 154 -49 105
2500 154 -49 105
2600 154 -49 105
2705 49 -49 0
2800 -46 -49 -95
2900 -146 51 -95
3000 -246 151 -95
3100 -346 251 -95
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STRATEGY 18: BEAR PUT SPREAD STRATEGY (BUY PUT, SELL
PUT)
This strategy requires the investor to buy an in-the-money (higher) put option and sell an out-
of-the-money (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 stock price / index falls.
When to use: When you are moderately bearish on market direction
Risk: Limited to the net amount paid for the spread. i.e. the premium paid for long position
less premium received for short position.
Reward: Limited to the difference between the two strike prices minus the net premium paid
for the position.
Break Even Point: Strike Price of Long Put – Net Premium Paid
Example:
Nifty is presently at 2694. Mr. XYZ expects Nifty to fall. He buys one Nifty ITM Put with a
strike price Rs. 2800 at a premium of Rs. 132 and sells one Nifty OTM Put with strike price
Rs. 2600 at a premium Rs. 52.
In this example the breakeven point is Rs 2720, risk is Limited to the premium paid for long
position less premium received for short position.
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The payoff schedule and Payoff Diagram
+ =
Sell lower strike Put Buy Put Bear Put Spread
On expiry nifty
closes at (Rs.)
Net Payoff from put
buy (Rs.)
Net Payoff from put
sold (Rs.)
Net Payoff (Rs.)
2400 268 -148 120
2500 168 -48 120
2600 68 52 120
2720 -52 52 0
2800 -32 52 20
2900 -132 52 -80
3000 -132 52 -80
3100 -132 52 -80
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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 when the investor is expecting very little movement in
the stock price / index. The investor is looking to gain from low volatility at a low cost. The
strategy offers a good risk / reward ratio, together with 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). The result is positive incase the stock / index remains range bound.
The maximum reward in this strategy is however restricted and takes place when the stock /
index is at the middle strike at expiration. The maximum losses are also limited.
When to use: When the investor is neutral on market direction and bearish on volatility.
Risk Net debit paid.
Reward Difference between adjacent strikes minus net debit
Break Even Point:
Upper Breakeven Point = Strike Price of Higher Strike Long Call – Net Premium Paid
Lower Breakeven Point = Strike Price of Lower Strike Long Call + Net Premium Paid
Example
Nifty is at 3200. Mr. XYZ expects very little movement in Nifty. He sells 2 ATM Nifty Call
Options with a strike price of Rs. 3200 at a premium of Rs. 97.90 each, buys 1 ITM Nifty Call
Option with a strike price of Rs. 3100 at a premium of Rs. 141.55 and buys 1 OTM Nifty Call
Option with a strike price of Rs. 3300 at a premium of Rs. 64. The Net debit is Rs. 9.75.In this
case there are two breakeven point upper and lower , upper breakeven point is Rs 3290.25 and
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lower breakeven point is Rs 3109.75, risk is net debit paid and return is Difference between
adjacent strikes minus net debit.
The payoff schedule and Payoff Diagram
+
Buy lower strike call sell middle strike call
=
Long call
butterfly
+
Sell middle strike call buy higher strike call
On expiry nifty
closes at (Rs.)
Net Payoff
from 2 ATM
call sold (Rs.)
Net Payoff from
1 ITM call
purchased (Rs.)
Net Payoff from
1 OTM call
purchased(Rs.)
Net payoff
(Rs)
2900 195 -141.55 -64 -9.75
3000 195 -141.55 -64 -9.75
3109.75 195 -131.80 -64 0
3200 195 -41.55 -64 90.25
3290.25 15 48.70 -64 0
3300 -4.20 58.45 -64 -9.75
3400 -204.20 158.45 36 -9.75
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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 striking in-the-money Call, buying two at-the-money Calls and selling
another higher strike out-of-the-money Call, giving the investor a net credit. There should be
equal distance between each strike. 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 are 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.
When to use: You are neutral on market direction and bullish on volatility. Neutral means
that you expect the market to move in either direction - i.e. bullish and bearish.
Risk Limited to the net difference between the adjacent strikes (Rs. 100 in this example) less
the
Premium received for the position.
Reward Limited to the net premium received for the option spread.
Break Even Point:
Upper Breakeven Point = Strike Price of Highest Strike Short Call - Net Premium Received
Lower Breakeven Point = Strike Price of Lowest Strike Short Call + Net Premium Received
Example:
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Nifty is at 3200. 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. 3200 at a premium of Rs. 97.90 each, sells 1 ITM Nifty Call Option with a
strike price of Rs. 3100 at a premium of Rs. 141.55 and sells 1 OTM Nifty Call Option with a
strike price of Rs. 3300 at a premium of Rs. 64. The Net Credit is Rs. 9.75.
In this case again we have two breakeven one is upper and another is lower, upper breakeven
point is 3290.25 and lower breakeven point is Rs 3109.75, Risk is Limited to the net
difference between the adjacent strikes less the premium received for the position and Reward
is Limited to the net premium received for the option spread.
The payoff schedule and Payoff Diagram
On expiry nifty
closes at (Rs.)
Net Payoff from 2
ATM call
purchased (Rs.)
Net Payoff from
1 ITM call sold
(Rs.)
Net Payoff from
1 OTM call
sold(Rs.)
Net payoff
(Rs)
2800 -195 141.55 64 9.75
2900 -195 141.55 64 9.75
3000 -195 141.55 64 9.75
3109.75 -195 131.80 64 0
3200 -195 41.55 64 -90.25
3290.25 -15 -48.70 64 0
3300 4.20 -58.45 64 9.75
3400 204.20 -158.45 -36 9.75
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Sell lower strike call buy middle strike call =
+
Short call butterfly
buy middle strike call sell higher strike call
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FINDINGS AND OBSERVATION
� Investors are not much aware about the derivatives market as well as the future and
options.
� Value of an option depends upon the strike price, expiration date, value of underlying
asset etc.
� Value of an option comprises intrinsic value of option and time value of option.
� Option values have lower and upper boundries.
� Previously rolling settlement is T+5 days, now it changed to T+2 days and further it
will be changing to T+1 days
� It was also observed that many broking houses offering internet trading allow clients
to use their conventional system as well just ensure that they do not loose them and this
instead of offering-broking services they becomes service providers.
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CONCLUSION
Derivatives are extremely important and have a big impact on other financial market and the
economy. The project is designed to upgrade investor’s knowledge with the basics of how to
make investment decisions in futures and options with reference to bear market. It is
important for the investors that they must analyze the fundamental (Economic & Financial),
technical and other factors for dealing in futures and options. For many investors options are
useful as tools of risk management. Different Option Strategies and the options help to earn a
risk-less profit. The option strategies are used according to the nature of market condition. If
market is bullish - Long Call, Covered Call is useful. In case of bearish market Long Call and
Long Put option strategies is useful. In neutral option - Condor and Long Straddle is useful
tools for the investment.
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RECOMMENDATION
� I recommend the exchange authorities to take steps to educate investors about their
rights and duties. I suggest to the exchange authorities to increase the investors
confidences.
� I also recommend the exchange authorities to appoint a well educated persons, so that
he can provide the basic information to the client regarding the future and options.
� I recommend the exchange authorities to be vigilant to curb wide fluctuations of
prices.
� The speculative pressures are responsible for the wide changes in the price, not
attracting the genuine investors to the greater extent towards the market.
� Genuine investors are not at all interested in the speculative gain as their investment is
based on the future profits, therefore the authorities of the exchange should be more
vigilant to curb the speculation.
� Necessary steps should be taken by the exchange to deal with the situations arising
due to break down in online trading.
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QUESTIONNAIRE
1. NAME : ………………………………………………
ADDRESS :
………………………………………………….
………………………………………………….
………………………………………………….
CONTACT NO. : ………………………………………………...
2. Age group:
(a) 20-25 (b) 25-30 (c) 30-35 (d) 35-40 (e) >40
3. Qualification: ……………………………………………..
4. Occupation: ……………………………………………….
5. Are you often a day trader or medium trader
A. Day Trader { }
B. Medium Trader { }
6 Generally risk taking capacity
A. Higher { }
B. Lower { }
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7 What is your earning per year from derivatives?
………………………………………..
8 Are you aware about the future and option trading?
A. Yes { }
B. No { }
9 Do you know about the different option strategies which give the more profit?
A. Yes { }
B. No { }
If yes than name of the strategies …………………………………
11. Have you ever earned any profit by invest in derivatives?
A. Yes { }
B. No { }
10 Do you want to invest in derivatives without any risk that will give you profit in
any market condition?
A. Yes { }
B. No { }
Date -----/------/----------
(Signature)
Place -----------------------
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BIBLIOGRAPHY
Books:
� Guide To Indian Stock Market, By Jitendra Gala
� Kothari C.R., Research Methodology, New Delhi, Vikas Publishing House pvt.Ltd.
1978
Websites:
� www.google.com
� www.bseindia.com
� www.nseindia.com
� www.moneycontrol.com