Derivative Strategies

8/7/2019 Derivative Strategies

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Derivative Strategies Future

Hedging

Long Hedge Short Hedge Cross Hedge

Cash Market Position

to be hedged by

Long Position in Future


to be hedged by

Short Position in Future


to be hedged by

Futures of cross Products


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Arbitrage

Cash & CarryArbitrage

Reverse

Cash & CarryArbitrage

Inter-ExchangeArbitrage

Long in Cash&

Short in Future

Short in Cash&

Long in Future

Two Positions ofSame Contract in

Different Markets


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Speculation & Spread

Taking one Side Position without havingposition in underlying in cash market onanticipation of rally or fall is speculation &

known as Naked Position. Spread refers to two opposite positions in

two contracts with different maturities on

same product. This is also known asCalendar Spread / Time Spread orHorizontal Spread.


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Derivative Strategies - Options

Vertical

Option Spreads

Two Opposite Positions

of different Strike Price

& same Expiration dateof one Underlying

Bullish Vertical

Buy Low & Sell High

Bearish Vertical

Buy High & Sell Low

Calls

Max Profit = H-L-NPP

Max Loss = NPP

BEP = L + NPP

Puts

Max Profit = NPR

Max Loss = H-L-NPR

BEP = H - NPR

Calls

Max Profit = NPR

Max Loss = H-L-NPR

BEP = L + NPR

Puts

Max Profit = H-L-NPP

Max Loss = NPP

BEP = H - NPP


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Example of Bullish Vertical Spread with CallsSuppose You are bullish on a stock with CMP Rs.100/- then buy a call of

Rs.100/- (ATM) & sell call of Rs.110/- (OTM) of current month.

Assumed. Call of 100 is traded at Rs.5/- & call of 110 is traded at Rs.2/-

Price of

stock on

expiry

Long call with strike price of 100/-

Premium Value Profit / Loss

Rs. Rs. Rs.

Short call with strike price of 110/-


Rs. Rs. Rs.

Net Profit

/ Loss in

Rs.

80 - 5 0 -5 2 0 2 -3

85 - 5 0 -5 2 0 2 -3

90 - 5 0 -5 2 0 2 -3

95 - 5 0 -5 2 0 2 -3

100 - 5 0 -5 2 0 2 -3

103 - 5 3 -2 2 0 2 0

105 - 5 5 0 2 0 2 2

110 - 5 10 5 2 0 2 7

112 - 5 12 7 2 -2 0 7

115 - 5 15 10 2 -5 -3 7

120 - 5 20 15 2 -10 -8 7


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Example of Bullish Vertical Spread with PutsSuppose You are bullish on a stock with CMP Rs.100/- then buy a Put of

Rs.100/- (ATM) & sell Put of Rs.110/- (ITM) of current month.

Assumed. Put of 100 is traded at Rs.5/- & put of 110 is traded at Rs.12/-

Price of

stock on

expiry

Short Put with strike price of 110/-


Rs. Rs. Rs.

Long put with strike price of 100/-


Rs. Rs. Rs.

Net Profit

/ Loss in

Rs.

80 12 -30 -18 - 5 20 15 -3

85 12 -25 -13 - 5 15 10 -3

90 12 -20 -8 - 5 10 5 -3

95 12 -15 -3 - 5 5 0 -3

98 12 -12 0 - 5 2 -3 -3

100 12 -10 2 - 5 0 -5 -3

103 12 -7 5 - 5 0 -5 0

105 12 -5 7 - 5 0 -5 2

110 12 0 12 - 5 0 -5 7

115 12 0 12 - 5 0 -5 7

120 12 0 12 - 5 0 -5 7


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Example of Bearish Vertical Spread with CallsSuppose You are bearish on a stock with CMP Rs.100/- then buy a call of

Rs.100/- (ATM) & sell call of Rs.90/- (ITM) of current month.

Assumed. Call of 100 is traded at Rs.5/- & call of 90 is traded at Rs.12/-

Price of

stock on

expiry

Long call with strike price of 100/-


Rs. Rs. Rs.

Short call with strike price of 90/-


Rs. Rs. Rs.

Net Profit

/ Loss in

Rs.

80 - 5 0 -5 12 0 12 7

85 - 5 0 -5 12 0 12 7

90 - 5 0 -5 12 0 12 7

95 - 5 0 -5 12 -5 7 2

97 - 5 0 -5 12 -7 5 0

100 - 5 0 -5 12 -10 2 -3

102 - 5 2 -3 12 -12 0 -3

105 - 5 5 0 12 -15 -3 -3

110 - 5 10 5 12 -20 -8 -3

115 - 5 15 10 12 -25 -13 -3

120 - 5 20 15 12 -30 -18 -3


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Example of Bearish Vertical Spread with PutsSuppose You are bearish on a stock with CMP Rs.100/- then buy a Put of

Rs.100/- (ATM) & sell Put of Rs.90/- (OTM) of current month.

Assumed. Put of 100 is traded at Rs.5/- & put of 110 is traded at Rs. 2/-

Price of

stock on

expiry

Long put with strike price of 100/-


Rs. Rs. Rs.

Short put with strike price of 90/-


Rs. Rs. Rs.

Net Profit

/ Loss in

Rs.

80 - 5 20 15 2 -10 -8 7

85 - 5 15 10 2 -5 -3 7

88 - 5 12 7 2 -2 0 7

90 - 5 10 5 2 0 2 7

95 - 5 5 0 2 0 2 2

97 - 5 3 -2 2 0 2 0

100 - 5 0 -5 2 0 2 -3

105 - 5 0 -5 2 0 2 -3

110 - 5 0 -5 2 0 2 -3

115 - 5 0 -5 2 0 2 -3

120 - 5 0 -5 2 0 2 -3


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Diagonal

Option Spreads

Two Opposite Positions

of different Strike Price &different Expiration date

of one Underlying

Bullish Diagonal

Buy Low & Sell High

Bearish Diagonal

Buy High & Sell Low


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Option Spreads

Horizontal Spread

Two Opposite Positions of same Strike Price but

different Expiration date of one Underlying

Expecting Short Term Stability in underlying


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Price of

stock on

expiry

Premium

paid for

Straddle

position

Profit /

Loss on

call

option

Profit /

Loss on

Put

option

Total

Profit /

loss on

Straddle

75 -10 0 25 15

80 -10 0 20 10

85 - 10 0 15 5

90 -10 0 10 0

95 - 10 0 5 -5

100 -10 0 0 -10

105 -10 5 0 -5

110 -10 10 0 0

115 -10 15 0 5

120 -10 20 0 10

125 -10 25 0 15

STRADDLETraders if uncertain about the movement & direction of the market

follow this strategy.

Suppose you expect high

movement in either

direction of stock with CMP

of Rs.100/- Then buy one

call and one put of strike

price of Rs.100/- . Assumed

both bought at premium of

Rs.5/- each.

It is buying or selling a

combination of ATM call

and ATM put of same

strike price.

Buy if high movement isexpected and Sell if very

narrow movement is

expected.


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STRANGLETraders if uncertain about the direction of the market but expect

substantial movement follow this strategy

It is buying or selling a

combination of OTM call

and OTM put of different

strike price.

Buy if high movement is

expected and Sell if verynarrow movement is

expected.

Suppose you expect high

movement in either

direction of stock with CMP

of Rs.100/- Then buy one

call of Rs.110/- and one put

of strike price of Rs.90/- .

Assumed both bought at

premium of Rs.2/- each.

Price of

stock on

expiry

Premium

paid for

Strangle

position

Profit /

Loss on

call

option

Profit /

Loss on

Put

option

Total

Profit /

loss on

Strangle

75 -4 0 15 11

80 -4 0 10 6

85 -4 0 5 1

86 -4 0 4 0

90 -4 0 0 -4

95 -4 0 0 -4

100 -4 0 0 -4

105 -4 0 0 -4

110 -4 0 0 -4

114 -4 4 0 0

115 -4 5 0 1

120 -4 10 0 6

125 -4 15 0 11


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Protective Put Buying

A protective put buying involves buying a

put option to protect value of existing

portfolio. Although this comes at a price

(premium for option), it limits the downside

risk of the investors while keeping the

upside open.


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15/22

Covered Call Writing

Covered call writing involves a long

position in cash / futures market and short

position in call option. This strategy is very

efficient for generating money on the basis

of stable to moderately positive outlook.


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Collar

In covered call writing, trader is still

exposed to the risk of downside price

movement in the stock. To cover this

downside risk, he can buy a put option at

lower strike. His position will then have a

cap on upside profit potential created buy

short call and a floor on the downside riskpotential created by long put. This is called

collar strategy.


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Covered Put Writing

Covered put writing involves a short

position in cash\future market and a short

position in put option. This strategy is very

efficient for generating money on the basis

of stable to moderately negative outlook.


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Reverse Collar

In covered put writing, trader is still

exposed to the risk of upward price

movement in the stock. To cover this

upside risk, he can buy a call option at

higher strike. His position will then have a

cap on the downside profit potential

created by short put and a floor on theupside risk potential created by long call.

This also called collar strategy.


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Butterfly Spread

A butterfly spread can be created throughdifferent combinations of call and putoptions. To establish a butterfly spread, a

trader takes position in four optioncontracts at three different strike prices.For instance, he may buy calls at twoextreme strike prices K1 and K3 (one

contract at each strike) and sell two callsat the middle strike price K2 (K1 < K2

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Derivative Strategies