Study of Option Strategies and USe of Derivatives

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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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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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.


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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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.


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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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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+ =

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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+ =

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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+ =

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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+ =

Sell call Sell Put

Short Straddle

On expiry Nifty

closes at (Rs.)

Net Payoff from Put

sold(Rs.)


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.


+ =

Buy OTM put Buy OTM Call

Long Strangle

On expiry Nifty

closes at (Rs.)

Net Payoff from Put

Purchased (Rs.)


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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+ =

Sell Call Sell Put Short Strangle

On expiry Nifty

closes at (Rs.)

Net Payoff from Put

sold (Rs.)


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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+ +

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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+ =

Buy lower strike Call Sell OTM Call Bull Call Spread

On expiry nifty

closes at (Rs.)


buy (Rs.)


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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+ =

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.


+ =

Sell lower strike Call Buy OTM Call Bear Call Spread

On expiry nifty closes

at (Rs.)


sold (Rs.)


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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+ =

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.


+

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.


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

Documents

Study of Option Strategies and USe of Derivatives