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Expert advice.
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Too often, traders jump into the options game with little or no understanding of how many
options strategies are available to limit their risk and maximize return. With a little bit of effort,
however, traders can learn how to take advantage of the flexibility and full power of options as a
trading vehicle. Options are extremely versatile securities that can be used in many different
ways. Traders use options to speculate, which are a relatively risky practice, while hedgers use
options to reduce the risk of holding an asset. An investor can create a butterfly strategy using all
the options. This study covers how options are profitable for traders and investors. The Securities
Laws Amendment Ordinance, promulgated by the President on 25 January 1995, amended the
Securities Contract Regulation Act, 1956 and removes the prohibitions on options in the
preamble to the Act. The ordinance paved the way for the introduction of options trading on
stock exchanges. The National Stock Exchange of India Ltd. and other stock exchanges
introduced index-based derivatives to facilitate the hedging of risk exposures.
Options present a world of opportunities to sophisticated investors. The power of options lies in
their versatility. They enable investor to adapt or adjust his position according to any situation
that arises. Options can be as speculative or as conservative. This means he can do everything for
protecting a position from a decline to outright betting on the movement of a market or index.
This versatility, however, does not come without its costs. Options are complex securities and
can be extremely risky. This is why, when trading options, one will see a disclaimer like the
following:
Options involve risks and are not suitable for everyone. Option trading can be speculative in
nature and carry substantial risk of loss. Only invest with risk capital.
Stock options dont lose money. People lose money. Options are an incredibly flexible tool that
investors can use to protect, boost and diversify their portfolios or lose a whole lot of money.
Smart options investors can reduce their risk, while reckless investors can lose 80% or more of
their money much faster than sticking with stocks. But we know that clients of Well India
Securities invest intelligently and options can certainly be part of a smart strategy. Options
arent for beginning investors. But this doesnt mean one need to be a super-sophisticated
professional trader to benefit from them.
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Volatility of an Asset
Some argue that options are just a more volatile form of stock trading, but now the investors
views has been transformed which argues that option volatility is actually a separate asset class,
one that can be used to diversify a stock portfolio and actually reduce its level of risk.
The great thing about a volatility trade is that traders can make money even if in the absence of
any clue of what direction a stock is going to take. Buying a straddle (the simultaneous purchase
of a call and a put) makes sense when implied volatility is very low and you expect an explosive
increase. Selling put options is a great strategy after a general market panic because the price of
options (i.e., implied volatility) skyrockets. People become afraid and are willing to pay almost
any price for put insurance leaving the contrarian put seller sitting pretty collecting the
rewards.
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Speculating is a technique when investors bet on the future price of the asset. Because
options offer investors the ability to leverage their positions, large speculative plays can
be executed at a low cost.
Thus, a trader can use options to profit in any kind of market. Buy an option in a speculative
attempt to triple your money or as risk-reduction insurance to protect an existing stock position.
Traders can sell options to generate monthly income. Or spreads are also used to buy and sell at
the same time possibly turning a losing investment into a winner.
Benets of trading in Options:
a) Able to transfer the risk to the person who is willing to accept them.
b) Incentive to make prots with minimal amount of risk capital.
c) Lower transaction costs
d) Provides liquidity, enables price discovery in underlying market
Options help the traders to make profit from bear markets as well as range-bound markets, and
that means theyre a perfect way to diversify away from a long-only, buy-and-hold stock
portfolio. Profiting from stagnant and declining prices are just two ways you can row your
portfolio to gains in a difficult market full of headwinds.
Calls and puts, alone or combined with each other or positions in the underlying stock, can
provide leverage or protection to a portfolio and help an investor:
Options should be used intelligently to make profits and for minimizing risk. Further, the study
shows the various strategies of investment used to hedge the portfolio.
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Giovanni Cespa and Xavier Vives (2014) considered a two-period market with persistent
liquidity trading and risk averse privately informed investors who have a one period horizon.
With persistence, prices reect average expectations about fundamentals and liquidity trading.
Informed investors engage in retrospective learning to reassess the inference about
fundamentals made at the early stage of the trading game. This introduces strategic
complementarities in the use of information and can yield two stable equilibria which can be
ranked in terms of liquidity, volatility, and informational eciency. They establish the limits of
the beauty contest analogy for nancial markets and derive a rich set of implications to explain
market anomalies, and empirical regularities.
World Economic Forum Report The Future of Long-term Investing (2013) sheds light on long
term investing, long term investor, risk and returns, hedging of portfolios and the impact of long
term investing on investors, corporations and society and thus, provides a foundation for the
growing conversation about long-term investing.
Khwanchanok Kessakorn (2013) examined effectiveness of currency hedging of forward
contracts and options in international portfolio, consisting of assets denominated in Chinese
Yuan and Indian Rupee. The finding shows that hedging strategies, either with forwards or
options yield better performance compared to unhedged strategy.
H. Windcli (2013) investigates the behavior and hedging of discretely observed volatility
derivatives. It investigated the eects of assumptions regarding the underlying asset price
movements and eects of the contractual design on the pricing of volatility derivatives.
The article How to Use Stock Options to Reduce Risk and Enhance Your Portfolios Returns
written by Jim Fink (2012) outlines the options pricing behavior, options strategies and how
options cover the risk the risk of investor.
Colin Bennett (2012) explains the advantages of using options over investing in equity. Options
provide leverage and an ability to take a view on volatility as well as equity direction. The paper
examines how investors can choose the appropriate strategy, strike and expiry. It also explains
hidden risks, such as dividends and the difference between delta and the probability an option
ends up in-the-money.
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Chris Brooks (2006) evaluates the efficiency of cross hedging with single stock futures (SSF)
contracts. Iraj Kani, Emanuel Derman and Michael Kamal (2006) describe the use of option to
for hedging.
Menachem Brenner and Jin E. Zhang (2005) introduced a new volatility instrument, an option on
a straddle which could be used to hedge volatility risk. They suggested the design and valuation
of straddle are the basic ingredient of a successful financial product.
Vikas Agarwal and Narayan V. Naik (2004) characterized the systematic risk exposures of hedge
funds using buy-and-hold and option based strategies. The results showed that a large number of
equity oriented fund strategies exhibit payoffs resembling a short position in the put option on
the market index.
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Objectives
To analyze the varied use of options as a means of hedging the portfolio of securities.
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Options Basics
An option is a contract written by a seller that conveys to the buyer the right but not the
obligation to buy (in the case of a call option) or to sell (in the case of a put option) a
particular asset, at a particular price (Strike price / Exercise price) in future. In return for granting
the option, the seller collects a payment (the premium) from the buyer. Exchange- traded options
form an important class of options which have standardized contract features and trade on public
exchanges, facilitating trading among large number of investors. They provide settlement
guarantee by the Clearing Corporation thereby reducing counterparty risk. 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 seller
Option buyer
Option broker
The option seller or writer is a person who grants someone else the option to buy or sell.
He receives a premium on its price.
The option buyer pays a price to the option writer to induce him to write the option.
The option broker, who is an agent, finds the buyer and seller, and receives a commission
or fee for it.
The derivatives trading at NSE commenced with futures on the Nifty 50 in June 2000.
Subsequently, various other products were introduced and presently futures and options contracts
on the following products are available at NSE:
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1) Indices: Nifty 50, CNX IT Index, Bank Nifty Index, CNX Nifty Junior, CNX 100, Nifty
Midcap 50, Mini Nifty and Long dated Options contracts on Nifty 50.
2) Single stocks 228
The Options are classified based on type of exercise. At present the Exercise style can be
European or American.
European Option
American Option
American Option - American options are options contracts that can be exercised at any
time up to the expiration date. Options on individual securities available at NSE are
American type of options.
European Options - European options are options that can be exercised only on the
expiration date. All index options traded at NSE are European Options.
There are two types of options: calls and puts. And there are two sides to every option
transaction: the party buying the option, who has a long position, and the party selling (also
called writing) the option, who has a short position. Each side comes with its own risk-reward
profile and its own strategies.
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Types of Option
Call
Puts
A call is the option to buy the underlying stock at a predetermined price (strike price) by a
predetermined date (expiration, which is usually the third Friday of a month). The expiration
can be as soon as next month or as distant as two and a half years away. If the call buyer decides
to buy the stock an act known as exercising the option the call writer is obliged to sell his
shares to the call buyer at the strike price.
If a call is the right to buy, then a put is the option to sell the underlying stock at a predetermined
strike price until the expiration date. The put buyer has the right to sell shares at the strike price,
and if he decides to sell, the put writer is obliged to buy at that price.
Call
Put
Buyer (Long)
Seller (Short)*
* Note: Because an option is a derivative contract, it can be sold without owning it first.
A call buyer makes a profit when the price of the underlying shares rises. The call options price
will normally rise as the shares do, because the right to buy stock at a constant strike price
becomes more valuable if the stock is priced higher. The call writer is making the opposite bet,
hoping for the stock price to decline or, at the very least, not rise above the strike price by more
than the amount he received for selling the call in the first place.
The put buyer profits when the underlying stock price falls. A put increases in value as the
underlying stock decreases in value, because the right to sell stock at a constant strike price
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becomes more valuable if the stock is priced lower. Conversely, a put writer is hoping for the
stock price to rise or, at the very least, not decline below the strike price by more than the
amount he received for selling the put in the first place.
In reality, few retail investors hold options all the way to expiration and actually see their shares
change hands through the exercise process. Options are, after all, tradable securities. As
circumstances change, most investors lock in their profits (or losses) before expiration by selling
options they had previously bought or buying back options they had sold.
In the Money At the money Out the Money
Traders describe options by the relationship of the strike price to the price of the underlying
stock. For calls, if the stock price is above the strike price, the option has intrinsic value,
because it allows you to buy the stock at a better (lower) price than someone who doesnt own
options could buy it on the open market. That makes the option in the money (ITM).
For puts, the reverse is true; the option has intrinsic value if the stock price is below the strike
price, because it allows the holder to sell the stock at a higher price than available on the open
market. If the stock price is equal to the strike price, the option is considered at the money
(ATM), because its on the verge of having intrinsic value.
An option is out of the money (OTM) when it has no intrinsic value. For calls, this occurs when
the strike price is above the stock price, and for puts, this occurs when the strike price is below
the stock price.
The following table illustrates the point with a fictional XYZ stock trading at different prices
in relation to its call and put options at the Rs.75 strike price
Rs. 70
Rs. 75
Rs. 80
Rs. 75 Call
OTM by Rs. 5
ATM
ITM by Rs. 75
Rs. 75 Put
ITM by Rs. 5
ATM
OTM by Rs. 5
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Option premium
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, (S t 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.
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.
Options Payoff
The optionality characteristic of options results in a non-linear payoff for options. In simple
words, it means that the losses for the buyer of an option are limited; however the profits are
potentially unlimited. For a writer (seller), the payoff is exactly the opposite. His profits are
limited to the option premium; however his losses are potentially unlimited. These non- linear
payoffs are fascinating as they lend themselves to be used to generate various payoffs by using
combinations of options and the underlying.
a) Payoff profile of buyer of asset: Long asset
In this basic position, an investor buys the underlying asset, ABC Ltd. shares for instance, for
Rs. 2220, and sells it at a future date at an unknown price, St. Once it is purchased, the
investor is said to be "long" the asset.
The figure shows the profits/losses from a long position on ABC Ltd. The investor bought
ABC Ltd. at Rs. 2220. If the share price goes up, he profits. If the share price falls he loses.
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f) Payoff profile for the writer (seller) of put options: Short Put
A put option gives the buyer the right to sell the underlying asset at the strike price specified
in the option. For selling the option, the writer of the option charges a premium. The
profit/loss that the buyer makes on the option depends on the spot price of the underlying.
Whatever is the buyer's profit is the seller's loss. If upon expiration, the spot price happens to
be below the strike price, the buyer will exercise the option on the writer. If upon expiration
the spot price of the underlying is more than the strike price, the buyer lets his option unexercised and the writer gets to keep the premium.
The figure shows the profits/losses for the seller of a three-month Nifty 2250 put option. As
the spot Nifty falls, the put option is in-the-money and the writer starts making losses. If
upon expiration, Nifty closes below the strike of 2250, the buyer would exercise his option
on the writer who would suffer a loss to the extent of the difference between the strike price
and Nifty- close. The loss that can be incurred by the writer of the option is a maximum
extent of the strike price (Since the worst that can happen is that the asset price can fall to
zero) whereas the maximum profit is limited to the extent of the up-front option premium of
Rs.61.70 charged by him.
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Options offer a very wide range of strategies, and each of these strategies has a different
risk/reward profile. People who are unfamiliar with options overlook the potential for more
conservative methods of (a) protecting portfolio positions, (b) spreading and hedging risk, and
(c) generating additional income on your stock holdings.
Option strategies are the simultaneous, and often mixed, buying or selling of one or
more options that differ in one or more of the options' variables. This is often done to gain
exposure to a specific type of opportunity or risk while eliminating other risks as part of a trading
strategy. A very straight forward strategy might simply be the buying or selling of a single
option, however option strategies often refer to a combination of simultaneous buying and or
selling of options. These strategies make options one of the more interesting ways to invest, and
they are especially useful dealing with the challenges of volatile market conditions.
One of the significant advantages of options is their flexibility. When an investor owns a stock,
he makes a profit only if stocks price moves above its current trading range. But options are so
flexible that he can even make a profit if a stock stays within a limited trading range.
Other strategies are designed to create profits if the stock price moves in either direction, such as
long straddles.
Options can also be used to insure your position.
Covered writing is often touted as a safe way to generate extra income from a stock portfolio. It
follows from the purchase of stock and results in immediate income. And it is considered to be as
safe as simply investing in stock.
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4191.10
Call Option
4600
Premium (Rs.)
36.35
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4636.35
4100
-36.35
4300
-36.35
4500
-36.3.5
4636.35
4700
63.65
4900
263.65
5100
463.65
5300
663.65
Profit
Strike Price
Loss
ANALYSIS: This strategy limits the downside risk to the extent of premium paid by Mr. XYZ
(Rs. 36.35). But the potential return is unlimited in case of rise in Nifty. A long call option is the
simplest way to benefit if investor believes that the market will make an upward move and is the
most common choice among first time investors in Options. As the stock price / index rise the
long call moves into profit more and more quickly.
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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.
Strategy : Sell Call Option
Current Nifty Index
2694
Call Option
2600
Premium (Rs.)
154
2754
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2400
154
2500
154
2600
154
2700
154
2754
2800
-46
2900
-146
3000
-246
Strike Price
Loss
ANALYSIS: This strategy is used when an investor is very aggressive and has a strong
expectation of a price fall. 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
fall below the strike price. Since the investor does not own the underlying stock that he is
shorting this strategy is also called Short Naked Call.
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Suppose 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
Strategy : Buy Stock + Buy Put Option
Buy Stock (Mr. XYZ pays)
4000
3900
Premium (Rs.)
143.80
4143.80
Stock Price)
Maximum Loss
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(Rs.) on expiry
Stock (Rs.)
3400.00
-600.00
356.20
-243.80
3600.00
-400.00
156.20
-243.80
3800.00
-200.00
-43.80
-243.80
4000.00
0.00
-143.80
-143.80
4143.00
143.80
-143.80
0.00
4200.00
200.00
-143.80
56.20
4400.00
400.00
-143.80
256.20
4600.00
600.00
-143.80
456.20
4800.00
800.00
-143.80
656.20
Profit
Profit
Stock Price
Loss
Buy Stock
Stock Price
Loss
Stock Price
Loss
Buy Put
ANALYSIS: This is a low risk strategy. This is a strategy which limits the loss in case of fall in
market but the potential profit remains unlimited when the stock price rises. A good strategy is
when an investor buys 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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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.
Strategy : Buy Put Option
Put Option
2694
2600
Premium (Rs.)
Mr. XYZ pays
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52
2548
2300
248
2400
148
2500
48
2548
2600
-52
2700
-52
2800
-52
2900
-52
Profit
Stock Price
Loss
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 strategies when an investor is bearish.
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4191.1
Put Option
4100
Premium (Rs.)
170.5
3929.5
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3400.00
-529.50
3500.00
-429.50
3700.00
-229.50
3900.00
-29.50
3929.50
0.00
4100.00
170.50
4300.00
170.50
4500.00
170.50
Stock Price
Loss
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
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When to Use: This is often employed when an investor has a short-term neutral to moderately
bullish view on the stock he holds. He takes a short position on the Call option to generate
income from the option premium.
Since the stock is purchased simultaneously with writing (selling) the Call, the strategy is
commonly referred to as buy-write.
Risk: If the Stock Price falls to zero, the investor loses the entire value of the Stock but
retains the premium, since the Call will not be exercised against him. So maximum risk =
Stock Price Paid Call Premium
Upside capped at the Strike price plus the Premium received. So if the Stock rises beyond the
Strike price the investor (Call seller) gives up all the gains on the stock.
Reward: Limited to (Call Strike Price Stock Price paid) + Premium received
Breakeven: Stock Price paid - Premium Received
Mr. A bought XYZ Ltd. For Rs. 3850 and simultaneously sells a call option at an strike price of
Rs. 4000 which means Mr. A does not think that the price of XYZ Ltd. will rise above Rs. 4000.
However, 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. Thus, net outflow to Mr. A is (Rs.
3850 Rs.80) = Rs.3770. he reduces the cost of buying the stock by this strategy.
If the stock price stays at or below Rs. 4000, the Call Option will not get exercised and Mr. A
can retain the Rs. 80 premium, which is an extra income.
If the stock price goes above Rs.4000, the Call option will get exercised by the Call buyer. The
entire position will work like this:
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3850
Call Options
4000
Mr. A receives
Premium (Rs.)
80
3770
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). What would Mr. A do and what will be his pay off?
: Rs. 4100
: - Rs. 100
: Rs. 4000
(This was Mr. As target price)
: Rs. 80
: Rs. 4080
Net profit
Return (%)
: Rs. 3850
: Rs. 4080 Rs. 3850 = Rs. 230
:
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3600
-170
3700
-70
3740
-30
3770
3800
30
3900
130
4000
230
4200
230
4300
230
Profit
Stock Price
Stock Price
Loss
Loss
Buy Stock
Sell Call
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Profit
Stock Price
Loss
Covered Call
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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.
Strategy : Sell a Put + Buy a Call
ABC Ltd.
450
Sells Put
400
Premium (Rs.)
Buys Call
500
Premium (Rs.)
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501
at (Rs.)
sold (Rs.)
700.00
1.00
198.00
199.00
650.00
1.00
148.00
149.00
600.00
1.00
98.00
99.00
550.00
1.00
48.00
49.00
501.00
1.00
-1.00
0.00
500.00
1.00
-2.00
-1.00
450.00
1.00
-2.00
-1.00
400.00
1.00
-2.00
-1.00
350.00
-49.00
-2.00
-51.00
300.00
-99.00
-2.00
-101.00
250.00
-149.00
-2.00
-151.00
Profit
Profit
=
Stock Price
Loss
Loss
Stock Price
Loss
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.
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Risk: Limited. Maximum Risk is Call Strike Price Stock Price + Premium
Reward: Maximum is Stock Price Call Premium
Breakeven: Stock Price Call Premium
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).
Strategy : Short Stock + Buy Call Option
Sell Stock (Mr. A receives)
4457
Buy Call
4500
Premium (Rs.)
Mr. A pays
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4357
(Rs.)
(Rs.)
4100
357
-100
257
4150
307
-100
207
4200
257
-100
157
4300
157
-100
57
4350
107
-100
4357
100
-100
4400
57
-100
-43
4457
-100
-100
4600
-143
-143
4700
-243
100
-143
4800
-343
200
-143
4900
-443
300
-143
5000
-543
400
-143
Profit
SP
Loss
Sell Stock
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Profit
SP
Loss
Buy Call
SP
Loss
Synthetic Long Put
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.
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4500
Sell Put
4300
Mr. A receives
24
4524
Net Payoff
(Rs.)
4300
200
24
224
4400
100
24
124
4450
50
24
74
4500
24
24
4524
-24
24
4550
-50
24
-26
4600
-100
24
-76
4635
-135
24
-111
4650
-150
24
-126
Profit
Profit
SP
Loss
Sell Stock
44 | P a g e
Stock Price
Loss
Stock Price
Loss
Sell Put
Covered Put
Upper Breakeven Point = Strike Price of Long Call + Net Premium Paid
Lower Breakeven Point = Strike Price of Long Put - Net Premium Paid
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.
Strategy : Buy Put + Buy Call
Nifty Index
4450
4500
Mr. A receives
207
45 | P a g e
4707 (U)
4293 (L)
Option
Call Option
(Rs.)
(Rs.)
4000
415
-122
293
4100
315
-122
193
4200
215
-122
93
4234
181
-122
59
4300
115
-122
-7
4400
15
-122
-107
4500
-85
-122
-207
4600
-85
-22
-107
4700
-85
78
-7
4707
-85
85
4766
-85
144
59
4800
-85
178
93
4900
-85
278
193
5000
-85
378
293
5100
-85
478
393
On expiry Nifty
closes at
Net Payoff
(Rs.)
Profit
Stock Price
SP
+
Loss
46 | P a g e
SP
=
Loss
Buy Put
Profit
Buy Call
Loss
Long Straddle
to look for an implied volatility close to a 52-week low and fortunately, the all-about-options
website www.ivolatility.com does the work for you. In example, Amgen options have an implied
volatility of 20.25%, very near their 52-week low of 19.74%.
Step 2: Near Term Catalyst
The best time to start a straddle position is three to five weeks before the event when stock is
expected to move. This will allow investor to get in at a cheap implied volatility before the
market starts to anticipate the event. In the Amgen example, the earnings report is three weeks
away on Oct. 23, so our straddle looks good to go.
With Amgen trading at $70.45, investor decides to use the closest strike price, $70. For the
expiration, he selects January, which is about two months after the catalyst of the October
earnings release. Options time decay accelerates in the last two months before expiration, so by
choosing the January expiration, he ensures this straddle trade is low-risk. Hell close out the
trade Oct. 23 or 24, which is right before the options start to suffer serious time decay.
He could pick an expiration that was even further out than January, but those options would be
more expensive. That would reduce your potential profit but wouldnt provide much more
protection from time decay. Picking the expiration month two months after the expected
explosive event is the sweet spot for a straddle trade. He buys one Amgen January $70 call for
$4.50 and one January $70 put for $1.95. Buying them both costs $6.45. If the investor were to
wait until expiration, this trade would only be profitable if the stock were to close above $76.45
($70+$6.45) or below $63.55 ($70-$6.45), a 9.2% move.
A volatile biotech could certainly move more than 9%, but its no sure thing. Thats why a riskaverse straddle trader almost never holds a position all the way until expiration. By exiting two
months before expiration, he can avoid the time decay, take advantage of the options rising time
value and profit from a much smaller move in the stock. And if the stock did move explosively,
all the better!
How it played Out: Within two weeks, the market began to anticipate Amgens earnings, and
implied volatility began to rise. On Oct. 13, the stock has risen to $73.22. The $70 call has
increased in value by $1.35 to $5.85, while the $70 put has decreased in value by $0.35 to $1.60
48 | P a g e
see how the winning call option gains more than the losing put option gives back? That makes
the straddle worth $7.45 ($5.85+$1.60), and investor decide to sell it for a 15.5% profit.
Sometimes the investor doesnt have to wait for the earnings report to make money. Often, the
mere increased expectation of a stocks explosive move is enough to cause options time value to
rise and make the straddle gain value. Straddles profit potential may be lower than the other
option strategies in this report, but the time decay risks make it important to take profits quickly.
A straddle trade succeeds either from an increase in time value or from an explosive move, so it
makes you money whether the stock moves up or down.
49 | P a g e
Upper Breakeven Point = Strike Price of Short Call + Net Premium Received
Lower Breakeven Point = Strike Price of Short Put - Net Premium Received
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.
Strategy : Sell Put + Sell Call
Nifty Index
Current Value
4450
4500
Mr. A receives
207
50 | P a g e
4707 (U)
4293 (L)
Net Payoff
closes at
Sold (Rs.)
Sold (Rs.)
(Rs.)
3800
-615
122
-493
3900
-515
122
-393
4000
-415
122
-293
4100
-315
122
-193
4200
-215
122
-93
4234
-181
122
-59
4293
-122
122
4300
-115
122
4400
-15
122
107
4500
85
122
207
4600
85
22
107
4700
85
-78
4707
85
-85
4766
85
-144
-59
4800
85
-178
-93
4900
85
-278
-193
5000
85
-378
-293
Profit
SP
Profit
SP
+
Loss
Loss
Sell Put
51 | P a g e
SP
Sell Call
Loss
Short Straddle
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
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.
52 | P a g e
Current Value
4500
4700
Mr. A pays
Premium (Rs.)
43
4766
4300
Mr. A pays
Premium (Rs.)
23
4234
closes at
Sold (Rs.)
Sold (Rs.)
3800
-523
-43
-566
3900
-423
-43
-466
4000
-323
-43
-366
4100
-223
-43
-266
4200
-123
-43
-166
4234
-89
-43
-132
4300
-23
-43
-66
4400
-23
-43
-66
4500
-23
-43
-66
4600
-23
-43
-66
4700
-23
-43
-66
4766
-23
23
4800
-23
57
34
4900
-23
157
134
5000
-23
257
234
5100
-23
357
334
5200
-23
457
434
53 | P a g e
Profit
Stock Price
Profit
SP
Loss
Loss
54 | P a g e
SP
Loss
Long Strangle
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
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.
Strategy : Sell OTM Put + Sell OTM Call
Nifty index
Current Value
4500
4700
55 | P a g e
Premium (Rs.)
Mr. A receives
43
4766
4300
Mr. A receives
Premium (Rs.)
23
4234
closes at
Sold (Rs.)
Sold (Rs.)
3800
-477
43
-434
3900
-377
43
-334
4000
-277
43
-234
4100
-177
43
-134
4200
-77
43
-34
4234
-43
43
4293
16
43
59
4300
23
43
66
4400
23
43
66
4500
23
43
66
4600
23
43
66
4700
23
43
66
4766
23
-23
4800
23
-57
-34
4900
23
-157
-134
5000
23
-257
-234
5100
23
-357
-334
5200
23
-457
-434
5300
23
-557
-534
56 | P a g e
Profit
SP
Loss
Sell OTM Put
57 | P a g e
Profit
SP
Loss
SP
Loss
Sell OTM Call
Short Strangle
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
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.
58 | P a g e
4758
5000
Mr. A receives
Premium (Rs.)
Mr. A pays
Premium (Rs.)
Break Even point (Rs.)
39
4700
27
4746
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.
59 | P a g e
Payoff from
Payoff from
closes at (Rs.)
Purchased (Rs.)
4400
39
273
-358
-46
4450
39
223
-308
-46
4500
39
173
-258
-46
4600
39
73
-158
-46
4700
39
-27
-58
-46
4750
39
-27
-8
4800
39
-27
42
54
4850
39
-27
92
104
4858
39
-27
100
112
4900
39
-27
142
154
4948
39
-27
190
202
5000
39
-27
242
254
5050
-11
-27
292
254
5100
-61
-27
342
254
5150
-111
-27
392
254
5200
-161
-27
442
254
5248
-209
-27
490
254
5250
-211
-27
492
254
5300
-261
-27
542
254
60 | P a g e
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.
61 | P a g e
Strategy : Buy a Call with a lower strike (ITM) + Sell a Call with a higher Strike (OTM)
Nifty index
Current Value
4191.1
Premium (Rs.)
4400
Premium (Rs.)
35.4
4100
170.45
135.05
4235.05
closes at
Buy
Sold (Rs.)
3500
-170.45
35.4
-135.05
3600
-170.45
35.4
-135.05
3700
-170.45
35.4
-135.05
3800
-170.45
35.4
-135.05
3900
-170.45
35.4
-135.05
4000
-170.45
35.4
-135.05
4100
-170.45
35.4
-135.05
4200
-70.45
35.4
-35.05
4235.05
-35.4
35.4
4300
29.55
35.4
64.95
4400
129.55
35.4
164.95
4500
229.55
-64.6
164.95
4600
329.55
-164.6
164.95
4700
429.55
-264.6
164.95
4800
529.55
-364.6
164.95
4900
629.55
-464.6
164.95
5000
729.55
-564.6
164.95
62 | P a g e
5100
829.55
-664.6
164.95
5200
929.55
-764.6
164.95
Profit
SP +
Loss
Buy Lower strike Call
Profit
SP
Loss
SP
Loss
Sell OTM Call
The Bull Call Spread Strategy has brought the breakeven point down (if only the Rs. 4100 strike
price Call was purchased the breakeven point would have been Rs. 4270.45), reduced the cost of
the trade (if only the Rs. 4100 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. 4150 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.
63 | P a g e
Strategy 16: BULL PUT SPREAD STRATEGY: SELL PUT OPTION, BUY
PUT OPTION
A bull put spread can be profitable when the stock / index is 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
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.
If the stock / index rise, both Puts expire worthless and the investor can retain the Premium. If
the stock / index falls, then the investors 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.
This strategy should be adopted when the stock / index trend is upward or range bound.
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
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.
64 | P a g e
On expiry Nifty
closes at
Buy
3500
297
-478.55
-181.55
3600
197
-378.55
-181.55
3700
97
-278.55
-181.55
3800
-3
-178.55
-181.55
3900
-3
-78.55
-81.55
3981.55
-3
4000
-3
21.45
18.45
4100
-3
21.45
18.45
4200
-3
21.45
18.45
4300
-3
21.45
18.45
4400
-3
21.45
18.45
4500
-3
21.45
18.45
4600
-3
21.45
18.45
4700
-3
21.45
18.45
4800
-3
21.45
18.45
The strategy earns a net income for the investor as well as limits the downside risk of a Put sold.
The payoff chart (Bull Put Spread)
Profit
Profit
SP
Loss
Profit
SP
Loss
Buy Lower Strike Put
65 | P a g e
SP
Loss
Sell OTM Put
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-themoney (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. 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.
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.
66 | P a g e
Strategy : Sell a Call with a lower strike (ITM) + Buy a Call with a higher strike (OTM)
Nifty index
Current Value
2694
2600
Premium (Rs.)
154
2800
Premium (Rs.)
49
105
2705
Payoff from
closes at
(Rs.)
Purchased (Rs.)
2100
154
-49
105
2200
154
-49
105
2300
154
-49
105
2400
154
-49
105
2500
154
-49
105
2600
154
-49
105
2700
54
-49
2705
49
-49
2800
-46
-49
-95
2900
-146
51
-95
3000
-246
151
-95
3100
-346
251
-95
3200
-446
351
-95
3300
-546
451
-95
67 | P a g e
The strategy earns a net income for the investor as well as limits the downside risk of a Call sold.
Profit
SP
Loss
Sell lower strike call
Profit
SP
Loss
SP
Loss
Buy OTM Call
ANALYSIS: The break-even is attained when nifty reaches to Rs. 2705 (i.e. lower strike price of
call + Net credit of premium). This strategy works when investor presumes that market is either
range bound or bearish. Thus, he sell the call at the strike price of Rs. 2600 assuming market will
not show bullish trends and the call sold remain unexercised but being conservative, he insured
his position by buying a call at the price of Rs. 2800. Profit is limited to Rs. 105 and loss is
limted to Rs. 95. The strategy earns a net income for the investor as well as limits the downside
risk of a Call sold.
68 | P a g e
69 | P a g e
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-ofthe-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. The bought Puts will have the
effect of capping the investors downside. While the Puts sold will reduce the investors costs,
risk and raise breakeven point (from Put exercise point of view). If the stock price closes below
the out-of-the-money (lower) put option strike price on the expiration date, then the investor
reaches maximum profits. If the stock price increases above the in-the-money (higher) put option
strike price at the expiration date, then the investor has a maximum loss potential of the net debit.
70 | P a g e
Strategy : BUY A PUT with a higher strike (ITM) + SELL A PUT with a lower strike
(OTM)
Nifty index
Current Value
2694
2800
Premium (Rs.)
132
2600
Premium (Rs.)
52
80
2720
closes at
(Rs.)
Sold (Rs.)
2200
468
-348
120
2300
368
-248
120
2400
268
-148
120
2500
168
-48
120
2600
68
52
120
2720
-52
52
2700
-32
52
20
2800
-132
52
-80
2900
-132
52
-80
3000
-132
52
-80
3100
-132
52
-80
71 | P a g e
Profit
Stock Price
Loss
Profit
Stock Price
Loss
SP
Loss
ANALYSIS: The Bear Put Spread Strategy has raised the breakeven point (if only the Rs.
2800 strike price Put was purchased the breakeven point would have been Rs. 2668), reduced the
cost of the trade (if only the Rs. 2800 strike price Put was purchased the cost of the trade would
have been Rs. 132), reduced the loss on the trade (if only the Rs. 2800 strike price Put was
purchased the loss 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.
72 | P a g e
When to use: When the investor is neutral on market direction and bearish on volatility.
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
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.
73 | P a g e
Strategy : Sell 2 ATM Call, Buy 1 ITM Call Option and Buy 1 OTM Call Option
Nifty index
Current value
3200
Sell 2 ATM
3200
Premium
195.8
3100
Premium
Premium
141.55
3300
64
3290.25
3109.75
Nifty Closes
ITM Call
1 OTM Call
at
(Rs.)
purchased (Rs.)
purchased (Rs.)
2700
195.8
-141.55
-64
-9.75
2800
195.8
-141.55
-64
-9.75
2900
195.8
-141.55
-64
-9.75
3000
195.8
-141.55
-64
-9.75
3100
195.8
-141.55
-64
-9.75
3109.75
195.8
-131.8
-64
3200
195.8
-41.55
-64
90.25
3290.25
15.3
48.7
-64
3300
-4.2
58.45
-64
-9.75
3400
-204.2
158.45
36
-9.75
3500
-404.2
258.45
136
-9.75
3600
-604.2
358.45
236
-9.75
3700
-804.2
458.45
336
-9.75
74 | P a g e
Net Payoff
(Rs.)
3800
-1004.2
558.45
436
-9.75
3900
-1204.2
658.45
536
-9.75
ANALYSIS: Two at the money Calls are sold at strike price of Rs. 3200 and receives premium
of Rs. 195.80, bought one Call at Rs. 3100 and oother call at Rs. 3300. This strategy is applied
by investr only when market does not show the signs of volatility and limits the losses to Rs.
9.75 and maximum profit is Rs. 90.25.
75 | P a g e
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
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
76 | P a g e
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.
Strategy : Buy 2 ATM Call Option, Sell 1 ITM Call Option and Buy 1 OTM Call Option
Nifty index
Current value
3200
3200
Premium
195.8
3100
Premium
Premium
141.55
3300
64
3290.25
3109.75
Net Payoff
2 ATM Calls
from 1 OTM
Purchased (Rs.)
(Rs.)
2700.00
-195.80
141.55
64.00
9.75
2800.00
-195.80
141.55
64.00
9.75
2900.00
-195.80
141.55
64.00
9.75
3000.00
-195.80
141.55
64.00
9.75
3100.00
-195.80
141.55
64.00
9.75
3109.75
-195.80
131.80
64.00
0.00
3200.00
-195.80
41.55
64.00
-90.25
3290.25
-15.30
-48.70
64.00
0.00
3300.00
4.20
-58.45
64.00
9.75
.3400.00
204.20
-158.45
-36.00
9.75
3500.00
404.20
-258.45
-136.00
9.75
On expiry
Nifty Closes at
77 | P a g e
Net Payoff
(Rs.)
3600.00
604.20
-358.45
-236.00
9.75
3700.00
804.20
-458.45
-336.00
9.75
3800.00
1004.20
-558.45
-436.00
9.75
3900.00
1204.20
-658.45
-536.00
9.75
ANALYSIS: The strategy is for volatile market where the profit is when stock finishes on
either side of the upper and lower strike prices at expiration. In this, the profit is Rs. 9.75 and
loss is Rs. 90.
78 | P a g e
When to Use: When an investor believes that the underlying market will trade in a range with
low volatility until the options expire.
Risk: 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.
Reward Limited: The maximum profit of a long condor will be realized when the stock is
trading between the two middle strike prices.
Break Even Point:
79 | P a g e
Suppose Nifty is at 3600. 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. 3400 at a
premium of Rs. 41.25, sells 1 ITM Nifty Call Option with a strike price of Rs. 3500 at a
premium of Rs. 26, sells 1 OTM Nifty Call Option with a strike price of Rs. 3700 at a premium
of Rs. 9.80 and buys 1 OTM Nifty Call Option with a strike price of Rs. 3800 at a premium of
Rs. 6.00. The Net debit is Rs. 11.45 which is also the maximum possible loss.
Strategy: 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)
Nifty index
Current Value
3600
3400
Premium (Rs.)
41.25
3500
Premium (Rs.)
Premium (Rs.)
Premium (Rs.)
80 | P a g e
26
3700
9.8
3800
6
3788.55
3411.45
OTM
On expiry
Net Payoff
from 1
Call
Nifty Closes
1 ITM Call
from 1 ITM
OTM Call
purchase
Net Payoff
at
purchased (Rs.)
sold (Rs.)
d (Rs.)
(Rs.)
3000
-41.25
26
9.8
-6
-11.45
3100
-41.25
26
9.8
-6
-11.45
3200
-41.25
26
9.8
-6
-11.45
3300
-41.25
26
9.8
-6
-11.45
3400
-41.25
26
9.8
-6
-11.45
3411.45
-29.8
26
9.8
-6
3500
58.75
26
9.8
-6
88.55
3600
158.75
-74
9.8
-6
88.55
3700
258.75
-174
9.8
-6
88.55
3788.55
347.3
-262.55
-78.75
-6
3800
358.75
-274
-90.2
-6
-11.45
3900
458.75
-374
-190.2
94
-11.45
4000
558.75
-474
-290.2
194
-11.45
4100
658.75
-574
-390.2
294
-11.45
4200
758.75
-674
-490.2
394
-11.45
81 | P a g e
ANALYSIS: At 3200, all the options expire worthless, so the initial debit taken of Rs. 11.45 is
the investors maximum loss. At 3800, the long Rs. 3400 call earns Rs. 358.75 (Rs. 3800 Rs.
3400 Rs. 41.25). The two calls sold result in a loss of Rs. 364.20 (The call with strike price of
Rs. 3500 makes a loss of Rs. 274 and the call with strike price of Rs. 3700 makes a loss of Rs.
90.20). Finally, the call purchased with a strike price of Rs. 3800 expires worthless resulting in a
loss of Rs. 6 (the premium). Total loss (Rs. 358.75 Rs. 364.20 Rs. 6) works out to Rs. 11.45.
Thus, the long condor trader still suffers the maximum loss that is equal to the initial debit taken
when entering the trade. If instead on expiration of the contracts, Nifty is still at 3600, the Rs.
3400 strike price call purchased and Rs. 3700 strike price call sold earns money while the Rs.
3500 strike price call sold and Rs. 3800 strike price call sold end in losses.
The Rs. 3400 strike price call purchased earns Rs. 158.75 (Rs. 200 Rs. 41.25). The Rs. 3700
strike price call sold earns the premium of Rs. 9.80 since it expires worthless and does not get
exercised. The Rs. 3500 strike price call sold ends up with a loss of Rs. 74 as the call gets
exercised and the Rs. 3800 strike price call purchased will expire worthless resulting in a loss of
Rs. 6.00 (the premium). The total gain comes to Rs. 88.55 which is also the maximum gain the
investor can make with this strategy.
The maximum profit for the condor trade may be low in relation to other trading strategies but it
has a comparatively wider profit zone. In this example, maximum profit is achieved if the
underlying stock price at expiration is anywhere between Rs. 3500 and Rs. 3700.
82 | P a g e
When to Use: When an investor believes that the underlying market will break out of a trading
range but is not sure in which direction.
Risk Limited. The maximum loss of a short condor occurs at the center of the option spread.
Reward Limited. The maximum profit of a short condor occurs when the underlying stock /
index is trading past the upper or lower strike prices.
Break Even Point:
83 | P a g e
Nifty is at 3600. 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.
3400 at a premium of Rs. 41.25, buys 1 ITM Nifty Call Option with a strike price of Rs. 3500 at
a premium of Rs. 26, buys 1 OTM Nifty Call Option with a strike price of Rs. 3700 at a premium
of Rs. 9.80 and sells 1 OTM Nifty Call Option with a strike price of Rs. 3800 at a premium of
Rs. 6.00. The Net credit is of Rs. 11.45
Strategy: 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)
Nifty index
Current Value
3600
3400
Premium (Rs.)
41.25
3500
Premium (Rs.)
Buy 1 OTM Call Option
84 | P a g e
26
3700
9.8
3800
6
3788.55
3411.45
Net Payoff
from 1 ITM
from 1 OTM
Net Payoff
Call
Call
from 1
Net
On expiry Nifty
purchases
purchased
OTM Call
Payoff
Closes at
(Rs.)
(Rs.)
(Rs.)
sold (Rs.)
(Rs.)
3000
41.25
-26
-9.8
11.45
3100
41.25
-26
-9.8
11.45
3200
41.25
-26
-9.8
11.45
3300
41.25
-26
-9.8
11.45
3400
41.25
-26
-9.8
11.45
3411.45
29.8
-26
-9.8
3500
-58.75
-26
-9.8
-88.55
3600
-158.75
74
-9.8
-88.55
3700
-258.75
174
-9.8
-88.55
3788.55
-347.3
262.55
78.75
3800
-358.75
274
90.2
11.45
3900
-458.75
374
190.2
-94
11.45
4000
-558.75
474
290.2
-194
11.45
4100
-658.75
574
390.2
-294
11.45
4200
-758.75
674
490.2
-394
11.45
85 | P a g e
ANALYSIS: The losses accurs at between two strike prices i.e. Rs. 3500 and Rs. 3700 and thus
limited to Rs. 88.5. Profit starts when the index is lower than or equals Rs. 3400 or when it is
trading past Rs. 3800.
86 | P a g e