Preface

National Institute of Financial Market (NIFM) is introducing second revised

edition Option Trading Strategy module.

While writing this book NIFM content management team consider both the practical and
theoretical aspects towards various option trading strategy. This Book is intended to serve both
the fresher and vintage professionals. The uniqueness of this book is to provide in depth
knowledge about Option Trading Strategies.

We hope this book will help the students / industry professionals/investors in terms of
gathering the knowledge of Options Strategies.

All the Best,

NIFM content management team

Copyright© 2015
National Institute of Financial Market (NIFM)
Educational Institutions Ltd
1st Edition 2015
2nd Edition 2016
Option trading strategy

This Module will provide you the basic understanding of

options and its application in various stages.
We will discuss about vanilla option strategy and exotic
Option strategy

We will discuss the following pay offs in option segments

Pay off for a buyer of an assets

Pay off for a seller of an assets

Payoff for a call buyer ( Long call)

Payoff for a call seller ( short call)


Payoff for a put buyer ( Long call)

Payoff for a put seller ( short call)

 INTRODUCTION TO OPTIONS

What is an Option?
An option is a contract giving the buyer the right, but not the obligation, to buy or sell an
underlying asset (a stock or index) at a specific price on or before a certain date.

An option is a derivative. That is, its value is derived from something else. In the case of a
stock option, its value is based on the underlying stock (equity). In the case of an index
option, its value is based on the underlying index (equity).

What is American option ?

An American option can be exercised (uploaded )

PAY PREMIUM at any time before the expiry date

Seller
What is European option ?
Buyer
A European option may be exercised only at
the expiry date of the option, i.e. at a single pre-
defined point in time.
OPTIONS
Obligation of option buyer and seller

Role of option buyer Role of option seller

The person, who sells option contract to the

The person who buy the option option buyer as his opening trade, is also
contract from option seller is called known as option writer, seller or granter
option buyer
The option seller receive an upfront amount
Option buyer pay upfront amount to from option buyer
the option seller .
The upfront amount is called received
The upfront amount is called premium premium .
If the option buyer doesn't exercise The option seller receive the premium and
his or her option, the option contract provide safeguard to the option buyer for any
will be left to expire worthless risk
The maximum loss to the option buyer The maximum profit of the option seller is
is the amount paid as premium. the amount received as premium.
Option Terminology
Index options: Have the index as the underlying. The option value is They are also cash
settled.
Stock options: They are options on individual stocks and give the holder the right to
buy or sell shares at the specified price. They can be European or American.

Buyer of an option: The buyer of an option is the one who buy the option and pay premium
to the seller.
Seller of an option: The Seller of a call/put option is the one who sells the options and
receive the premium.

Option price/premium: It 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.
 Type of options

Call option Put option

What is Calls option ? What is put option ?

A Call option is an option to buy a stock at a A Put option is an options to sell a stock at a
specific price on or before a certain date. specific price on or before a certain date.
In this way, Call options are like security deposits.
In this way, Put options are like insurance policies.
If, for example, you wanted to rent a certain If you buy a new car, and then buy auto insurance
property, and left a security deposit for it, the on the car, you pay a premium and are, hence,
money would be used to insure that you could, in protected if the asset is damaged in an accident. If
fact, rent that property at the price agreed upon this happens, you can use your policy to regain
when you returned. the insured value of the car.

If you never returned, you would give up your In this way, the put option gains in value as the
security deposit, but you would have no other value of the underlying instrument decreases.
liability.
If all goes well and the insurance is not needed,
Call options usually increase in value as the value the insurance company keeps your premium in
of the underlying instrument increases return for taking on the risk.
With a Put option, you can "insure" a stock by
fixing a selling price
 Moneyness tells option holders whether
What is Moneyness of options exercising will lead to a profit. The following’s are
the three type of Moneyness involved in options.

In The money(ITM) At The money (ATM) Out The money(OTM)

For a long call option, the An at-the-money (ATM) option, An out-of-the-money (OTM) A call
option will be ITM if the An option on the index is at-the- option on the index is out-of-the
strike price is below the money when the current money when the current index
current value of the stock index equals the strike price (i.e. stands at a level which is less than
trading in the market (spot spot price = strike price). the strike price, In the case of a
price). Opposite in case of put, the put is OTM if the index is
long put. above the strike price.
 What is option premium ?

The amount paid by the option buyer to the option seller is called option premium. The
option premium is primarily affected by the difference between the stock price and the strike
price, the time remaining for the option to be exercised, and the volatility of the
underlying stock.

Intrinsic value The intrinsic value of an option is the

difference between the actual price of the underlying
security and the strike price of the option.

The time value It is determined by the remaining

lifespan of the option, the volatility and the cost of
refinancing the underlying asset (interest rates).
Time value = option price - intrinsic value

Example Nifty spot is trading at 5000 a 4900 call

The option premium has two is trading at Rs 122. That denotes the Intrinsic
components intrinsic value and value is (5000-4900) =Rs 100and the time value is
time value (Rs 122 –Rs 100) = Rs 22.
 What is option pay off ?

Payoff means return from the derivative with change in the spot price of the
underlying assets. `

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. Once it is purchased, the
investor is said to be "long" the asset. Following Figure shows the payoff for a long position
on ABC Ltd.

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 will earn profits. If the
share price falls he will loses money.
Payoff profile for seller of asset: Short asset

In this basic position, an investor shorts the underlying asset, ABC Ltd. shares for instance,
for Rs. 2220, and buys it back at a future date at an unknown price, . Once it is sold, the
investor is said to be "short" the asset. Following figure shows the payoff for a short position
on ABC Ltd.

The figure shows the profits/losses from a short

position on ABC Ltd. The investor sold ABC Ltd.
at Rs. 2220. If the share price falls, he will earn
profits. If the share price rises, he make loses.
Payoff for a call buyer ( Long call)
Anticipations - Long Call
A strong, upward move in the underlying asset is anticipated.
Maximum Profit / Loss - Long Call
Unlimited profit / limited loss.
Max profit - unlimited.
Max loss - limited ( the amount paid by the buyer as premium)

Lest assume an investor bought 1000 call option

of 5200 nifty strike at 20 per call.

How much he has to pay as premium ?

1000 call × 20 = 20000

Investor can earn money only if the NIFTY

cross above 5220.
Loss
The profits possible on this option are
potentially unlimited.
Payoff for a call seller ( short call)

Profit
Premium receive
Rs 154
Anticipations short call
A downward move in the underlying asset is
anticipated.

Loss
Maximum Profit / Loss - short Call Maximum profit
Limited profit / unlimited loss.
Max profit - limited to the net credit received.
Max loss - unlimited

Mr. XYZ is bearish about Nifty and expects it

to fall.
He sells a Call option with a strike price of Rs.
5100 at a premium of Rs. 154, when the
current Nifty is at 5194.
If the Nifty stays at 5100 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.

Here the maximum profit is limited to Rs 154,

and maximum loss is unlimited.
Payoff for a put buyer ( Long put)

Profit
Anticipations
A strong, downward move in the underlying asset
is anticipated.
Maximum Profit / Loss - short Call

Loss
Limited profit (stock price can not be negative) /
limited loss.
Max profit - unlimited.
Max loss - limited to the net debit required to
establish the position.

Mr. XYZ is bearish on Nifty on 24th June, when the

Nifty is at 5194.

He buys a Put option with a strike price Rs. 5100 at

a premium of Rs. 52, expiring on 31st July. If the
Nifty goes below 5048, Mr.

XYZ will make a profit on exercising the option. In

case the Nifty rises above 5100, he can forego the
option (it will expire worthless) with a maximum
loss of the Premium paid by him.
Payoff for a put seller ( short put)

Anticipations
An upward move in the underlying asset is
anticipated.
Maximum Profit / Loss - short Call
Limited profit / unlimited loss.
Max profit - limited to the net credit
received.
Max loss – unlimited.
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 lose the premium and
more depending on the extent of the fall in Nifty.
 Pay off Diagram of synthetic call
Synthetic Long Call

We purchase a stock since we feel bullish

about it. But what 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).

Max Loss = Premium Paid + Commissions

A synthetic long call is created when long stock Paid
position is combined with a long put of the Max Loss Occurs When Price of Underlying
same series. It is so named because the <= Strike Price of Long Put.
established position has the same profit
potential as a long call. Maximum Profit = Unlimited
(Profit Achieved When Price of Underlying >
Synthetic Long Call Construction Purchase Price of Underlying + Premium
Paid)
Long 100 Shares Profit = (Price of Underlying - Purchase Price
of Underlying - Premium Paid)

Buy 1 ATM Put

Example Synthetic Long Call

Example:
ABC Ltd. is trading at Rs.4000 on 4th July. Buy 100 shares of the Stock at Rs.4000 and buy 100 QTY July
Put Options with a Strike Price of Rs.3900 at a premium of Rs.143.80 per put

Maximum Loss:
Maximum Loss = Stock Price + Put Premium – Put Strike
=Rs.4000 + Rs.143.80 – Rs.3900
=Rs.24,380

Maximum Profit:
As the stock price rises, profit potential is unlimited.

Breakeven Point:
Breakeven = Put Premium + Stock Price
=Rs.143.80 + Rs.4000
= Rs.4143.80

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 when you buy a stock for medium or long term, with the aim of protecting any
downside risk. The pay-off resembles a Call Option buy and is therefore called as Synthetic
Long Call.
Covered Call strategy
Anticipations A downward move in the underlying asset.

You own shares in a company which you feel may rise but not much in the near term (or
at best stay sideways). You would still like to earn an income from the shares. The
covered call is a strategy in which an investor Sells a Call option on a stock he owns
(netting him a premium). The Call Option which is sold in usually an OTM Call. The Call
would not get exercised unless the stock price increases above the strike price.

Maximum Profit / Loss - short Call

Max profit - limited.
Max loss - unlimited.

Creating
Sell call option and buy underlying security.

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.
 Example
Mr. A have shares of XYZ Ltd. at Rs 3850 and he anticipated that the price of the stock will come down
and at the same time it may not go above Rs 4000.

What Mr. A will do ?

To cover the loss (in case stock value downgraded) he will go and sell a call of 4000 strike

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.

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. And the loss will be upset from stock price.

Break Even Point (Rs.) (Stock Price paid – Premium Received)

=3850-80
=3770
 Exercise

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?

a) Sell the Stock in the market at : Rs. 4100

b) Pay Rs. 100 to the Call Options buyer : - Rs. 100

c) Pay Off (a – b) received : Rs. 4000 (This was Mr. A’s target price)
d) Premium received on Selling Call Option : Rs. 80
e) Net payment (c + d) received by Mr. A : Rs. 4080

f) Purchase price of XYZ Ltd. : Rs. 3850

g) Net profit : Rs. 4080 – Rs. 3850= Rs. 230

h) Return (%) : (Rs. 4080 – Rs. 3850) X 100

Rs. 3850
= 5.97%
LONG COMBO : SELL A PUT, BUY A CALL

A Long Combo is a Bullish strategy. If an investor is expecting the price of a stock to move
up he can do a Long Combo strategy. It involves selling an OTM (lower strike) Put and
buying an OTM (higher strike) Call. This strategy simulates the action of buying a stock (or
a futures) but at a fraction of the stock price. It is an inexpensive trade, similar in pay-off to
Long Stock, except there is a gap between the strikes (please see the payoff diagram). As
the stock price rises the strategy starts making profits.

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 (net debit) is Rs. 1.

Explanation

ABC Ltd. Current Market Price (Rs.) 450

Sells Put Strike Price (Rs.) 400
Mr. XYZ receives Premium (Rs.) 1.00
Buys Call Strike Price (Rs.) 500
Mr. XYZ pays Premium (Rs.) 2.00
Net Debit (Rs.) 1.00
Break Even Point (Rs.) (Higher Strike + Net Debit) Rs. 501
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. An investor shorts a stock and buys an
ATM or slightly OTM Call. In case the stock price falls the investor
gains in the downward fall in the price. However, incase there is an unexpected rise in the
price of the stock the loss is limited.
When to use
Often times the position is established due to
an adjustment to a long Call position. By selling
XYZ short, the investor turns a bullish position
(long Call) into a bearish position (synthetic
long Put).
Risk/Reward Characteristics
Profit potential is limited only by the fact that
XYZ cannot decline below zero. Losses are
limited as long as the Call option is owned.
Break-even Point Selling price of XYZ stock -
premium paid for Call.
 Example

Suppose ABC Ltd. is trading at Rs. 4457 in June. An investor Mr. A buys a Rs 4500 call
for Rs. 100 while shorting the stock at Rs. 4457. The net credit to the investor is Rs.
4357 (Rs. 4457 – Rs. 100).

Explanation Strategy : Short Stock + Buy Call Option

Sells Stock Current Market 4457

(Mr. A receives) Price (Rs.)
Buys Call Strike Price (Rs.) 4500
Mr. A pays Premium (Rs.) 100

Break Even Point (Rs.) (Stock Price 4357

– Call Premium)
Covered Put strategy

The covered put strategy is just the opposite of the covered call strategy. 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 range bound or move
down.

Covered Put Construction

Short stocks
Sell same quantity of OTM Put

Profit and Loss

Limited profits with no downside risk (Profit for the covered put option strategy is
limited and maximum gain is equal to the premiums received for the option sold.

Unlimited upside risk As the writer is short on the stock, he is subjected to much risk if
the price of the underlying stock rises dramatically. In theory, maximum loss for the
covered put options strategy is unlimited since there is no limit to how high the stock
price can be at expiration.

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.

Explanation Strategy : Short Stock + Short Put Option

Sells Stock Current Market 4500

(Mr. A Price (Rs.)
receives)
Sells Put Strike Price (Rs.) 4300
Mr. A receives Premium (Rs.) 24
Break Even Point (Rs.) (Sale price of 4524
Stock + Put Premium)
LONG STRADDLE
A Straddle is a volatility strategy and is used when the stock price / index is expected to
show large movements. A long straddle is a combination of buying a call and buying
a put, both with the same strike price and expiration. Together, they produce a
position that should profit if the stock makes a big move either up or down.

LONG STRADDLE Construction

Buy 1 ATM Call
Buy 1 ATM Put

Unlimited Profit Potential

By having long positions in both call and put
options, straddles can achieve large profits no Max Loss = Net Premium Paid
matter which way the underlying stock price
heads, provided the move is strong enough.

Limited Risk
Maximum loss for long straddles occurs when the underlying stock price on expiration
date is trading at the strike price of the options bought. At this price, both options
expire worthless and the options trader loses the entire initial debit taken to enter the
trade.
 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.

Explanation Strategy : Buy Put + Buy Call

Nifty index Current Value 4450

Call and Put Strike Price (Rs.) 4500
Mr. A pays Total Premium (Call + Put) (Rs.) Rs (85+122)= Rs 207

Breakeven ( There are two breakeven points)

· Upper Breakeven Point = Strike Price of Long Call + Net Premium Paid = 4500+207 =4707

· Lower Breakeven Point = Strike Price of Long Put - Net Premium Paid =4500 -207 =4293
 SHORT STRADDLE
The Opposite strategy to the long straddle is the short straddle. Short straddles are used
when little movement is expected of the underlying stock price. 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.

SHORT STRADDLE Construction

Sell 1 ATM Call
Sell 1 ATM Put

Limited Profit
In short straddle the profit potential is limited up
to the premium received by the investor .

Unlimited Risk
Large losses for the short straddle can be
incurred when the underlying stock price makes a
strong move either upwards or downwards at
expiration, causing the short call or the short put
to expire deep in the money.
 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.

Explanation

Nifty index Current Value 4450

Call and Put Strike Price (Rs.) 4500
Mr. A receive Total Premium (Call + Put) Rs (85+122)= Rs 207

Breakeven (There are 2 break-even points for the short straddle position. We can calculate
the BEP by using following formula)

Upper Breakeven Point = Strike Price of Short Call + Net Premium Received = 4500+207 =4707
Lower Breakeven Point = Strike Price of Short Put - Net Premium Received =4500 -207 =4293
 Looking for sharp move in underlying stock,
LONG STRANGLE either up or down, during the life of the options
The long strangle, also known as buy strangle or simply "strangle", is a neutral strategy in
options trading that involve the simultaneous buying of a slightly out-of-the-money put and
a slightly out-of-the-money call of the same underlying stock and expiration date.

How to construct a Long Strangle.

Buy 1 out-of-the-money put
Buy 1 out-of-the-money call

Max Loss
The maximum loss is limited. The maximum loss occurs if
the underlying stock remains between the strike prices
until expiration. If at expiration the stock's price is
between the strikes, both options will expire worthless
and the entire premium paid will have been lost.
Max Gain
The maximum gain is unlimited. The maximum gain occurs if the underlying stock goes to infinity, and a
very substantial gain would occur if the stock became worthless. The gross profit at expiration would be
the difference between the stock's price and either (a) the call strike price if the stock price is higher or
(b) the put strike price if the stock price is lower. The net profit is the gross profit less the premium paid
for the options. There is no limit to the upside potential and the downside potential is limited only
because the stock price cannot go below zero
 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 maximum possible loss.

Explanation

Nifty index Current Value 4500

Buy Call Option Strike Price (Rs.) 4700
Mr. A pays Premium (Rs.) 43
Break Even Point (Rs.) 4766 (4700+66 (premium received))
Buy Put Option Strike Price (Rs.) 4300
Mr. A pays Premium (Rs.) 23
Break Even Point (Rs.) 4234( 4300 - 66(premium received))

Upper Breakeven Point = Strike Price of Long Call + Net Premium Paid
Lower Breakeven Point = Strike Price of Long Put - Net Premium Paid
SHORT STRANGLE
A Short Strangle is a slight modification to the Short Straddle. This strategy involves the
simultaneous selling of a slightly out-of-the-money put and a slightly out-of-the-money
call of the same underlying stock and expiration date.

How to construct a Short Strangle.

Sell 1 out-of-the-money put
Sell 1 out-of-the-money call

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.

Maximum profit loss.

Max profit - limited to the net credits received.
Max loss - unlimited. (Large losses for the short strangle
can be experienced when the underlying stock price makes a
strong move either upwards or downwards at expiration)
 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.

Explanation

Nifty index Current Value 4500

Sell Call Option Strike Price (Rs.) 4700
Mr. A receives Premium (Rs.) 43
Break Even Point (Rs.) 4766 (4700+66 (premium received))
Sell Put Option Strike Price (Rs.) 4300
Mr. A receives Premium (Rs.) 23
Break Even Point (Rs.) 4234( 4300 - 66(premium received))

Upper Breakeven Point = Strike Price of Short Call + Net Premium Received
Lower Breakeven Point = Strike Price of Short Put - Net Premium Received
COLLAR STRATEGY

A collar is an options trading strategy that is constructed by holding shares of the underlying
stock , insuring against the downside by buying a Put and then financing (partly) the Put by
selling a Call.

How to construct a Short Strangle.

Long on Shares/ Having underlying stock
Sell OTM Call
Buy OTM Put

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 (Strike Price of Short Call - Purchase Price of Underlying + Net Premium Received)

Reward =Limited (Purchase Price of Underlying - Strike Price of Long Put - Net Premium Received)
 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.

Explanation Strategy : Buy Stock + Buy Put + Sell Call

ABC Ltd. Current Market Price(Rs.) 4758

Sell Call Option Strike Price (Rs.) 5000
Mr. A Receives Premium (Rs.) 39
Buy Put Option Strike Price (Rs.) 4700
Mr. A Pays Premium (Rs.) 27
Net Premium Received(Rs.) 12
Break Even Point (Rs.) 4746

Breakeven Point = Purchase Price of Underlying + Net Premium Paid

Exercise

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.
 BULL CALL SPREAD STRATEGY
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. Both calls must have the same underlying
security and expiration month.

When to Use - The bull call spread option trading strategy is employed when the options
trader thinks that the price of the underlying asset will go up moderately in the near
term.

How to construct ?
Buy an in-the-money (ITM)
Sell out-of-the-money (OTM)

Limited Profit.
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

Limited Risk.
The bull call spread strategy will result in a loss if the stock price declines at expiration. Maximum loss
cannot be more than the initial debit taken to enter the spread position.
 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.

Nifty index Current Value 4191.10

Buy ITM Call Option Strike Price (Rs.) 4100
Mr. XYZ Pays Premium (Rs.) 170.45
Sell OTM Call Option Strike Price (Rs.) 4400
Mr. XYZ Receives Premium (Rs.) 35.40
Net Premium Paid (Rs.) 135.05
Break Even Point (Rs.) 4235.05

Breakeven Point = Strike Price of Long Call + Net Premium Paid

= 4100+135.05
= 4235.05
BULL PUT SPREAD STRATEGY
A bull put spread involves being short a put option and long another put option for same expiration but with a
lower strike. The short put generates income, whereas the long put's main purpose is to offset assignment risk.
Because of the relationship between the two strike prices, the investor will always be paid a premium (credit)
when initiating this position.
When to Use - When the investor is moderately bullish. when the options trader thinks
that the price of the underlying asset will go up moderately in the near term.

How to construct ?
Buy out-of-the-money (OTM) put
Sell In the money (ITM) put

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. MAXIMUM GAIN = Net premium received
MAXIMUM LOSS = High strike - low strike - net
premium received
Breakeven = short put strike - net credit 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.

Nifty index Current Value 4191.10

Sell Put Option Strike Price (Rs.) 4000
Mr. XYZ Receives Premium (Rs.) 21.45
Buy Put Option Strike Price (Rs.) 3800
Mr. XYZ Pays Premium (Rs.) 3.00
Net Premium Received (Rs.) 18.45
Break Even Point (Rs.) 3981.55

Breakeven: Strike Price of Short Put - Net Premium Received

BEAR CALL SPREAD STRATEGY

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.

How to construct ?
Buy out-of-the-money (OTM) call
Sell In the money (ITM) call

Max Loss
The maximum loss is limited. The maximum loss is
the difference between the two strikes, but it is
reduced by the net credit received at the outset.

Max Gain
The maximum gain is limited. The best that can happen at expiration is for the stock to
be below both strike prices. In that case, both the short and long call options expire
worthless, and the investor pockets the credit received when putting on the position
 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.

Nifty index Current Value 2694

Sell ITM Call Option Strike Price (Rs.) 2600
Mr. XYZ receives Premium (Rs.) 154
Buy OTM Call Option Strike Price (Rs.) 2800
Mr. XYZ pays Premium (Rs.) 49
Net premium received (Rs.) 105
Break Even Point (Rs.) 2705
BEAR PUT SPREAD STRATEGY
It consists of buying one put in hopes of profiting from a decline in the underlying stock,
and writing another put with the same expiration, but with a lower strike price, as a way to
offset some of the cost. Because of the way the strike prices are selected, this strategy
requires a net cash outlay (net debit) at the outset.

How to construct ?
Buy In the money (ITM) put
Sell Out of the money put

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.
 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.

Nifty index Current Value 2694

Buy ITM Put Option Strike Price (Rs.) 2800
Mr. XYZ pays Premium (Rs.) 132
Sell OTM Put Option Strike Price (Rs.) 2600
Mr. XYZ receives Premium (Rs.) 52
Net Premium Paid (Rs.) 80
Break Even Point (Rs.) 2720
LONG CALL BUTTERFLY
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).
 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.

Nifty index Current Value 3200

Sell 2 ATM Call Option Strike Price (Rs.) 3200
Mr. XYZ receives Premium (Rs.) 195.80
Buy 1 ITM Call Option Strike Price (Rs.) 3100
Mr. XYZ pays Premium (Rs.) 141.55
Buy 1 OTM Call Option Strike Price (Rs.) 3300
Mr. XYZ pays Premium (Rs.) 64
Break Even Point (upper) (Rs.) 3290.25
Break Even Point (Lower) (Rs.) 3109.75

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
SHORT CALL BUTTERFLY

A Short Call Butterfly is a 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 (therefore it is an income strategy). There should
be equal distance between each strike. The maximum risk occurs if the stock / index is at the
middle strike at expiration.
 Example
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 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.

Nifty index Current Value 3200

Buy 2 ATM Call Option Strike Price (Rs.) 3200
Mr. XYZ pays Premium (Rs.) 195.80
Sells 1 ITM Call Option Strike Price (Rs.) 3100
Mr. XYZ receives Premium (Rs.) 141.55
Sells 1 OTM Call Option Strike Price (Rs.) 3300
Mr. XYZ receives Premium (Rs.) 64
Break Even Point (upper) (Rs.) 3290.25
Break Even Point (Lower) (Rs.) 3109.75

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
 LONG PUT BUTTERFLY

( SELL 2 ATM PUT + BUY 1 ITM PUT + BUY 1 OTM PUT)

A Long Put 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 / profit ratio, together with low
cost. The strategy cab be done by Selling 2 ATM Puts , Buying 1 ITM Put and Buying 1
OTM Put Options.

Market Strategy : When the investor is Neutral on Market direction and Bearish on
Volatility.

Risk : Net Premium Paid

Profit : Limited ( Difference between Strikes – Net Debit)
Upper BEP = Strike Price of Higher Strike Long Put – Net Premium Paid

Lower BEP : Strike Price of Lower Strike Long Put + Net Premium Paid
 Spot = 5000

Buy 1 ITM Put ( Strike 5100) = Premium Rs. 224

Sell 2 ATM Put ( Strike 5000) = Premium Rs. 168*2= 236
Buy 1 OTM Put ( Strike 4900) = Premium Rs. 121

Upper BEP = 5100- 9 = 5091

Lower BEP = 4900 + 9 = 4909
 SHORT PUT BUTTERFLY
( Buy 2 ATM Put, Sell 1 ITM Put, Sell 1 OTM Put)

A Short Put Butterfly is a Strategy for Volatile Markets. It is the Opposite of Long Put
Butterfly, which is a range bound strategy. The Short Put Butterfly can be by Selling 1
Lower Strike ITM Put, Buying 2 ATM
Put and Selling 1 higher Strike OTM Put, giving the investor a net credit. There should
be equal distance between each strike.

Market Strategy : Neutral on Market direction and Bullish on Volality.

Risk : Limited ( Net difference between strikes ( Rs. 100 Premium in this example)

Profit : Limited to the Net Premium Received

Upper BEP : Strike Price of Highest Strike Short Put – Net Premium Received
Lower BEP : Strike Price of Lowest Strike Long Put + Net Premium Received
 SPOT = 5000

SELL 1 ITM PUT (STRIKE 5100) = PREMIUM RS. 121

BUY 2 ATM PUT ( STRIKE 5000 ) = PREMIUM RS. 80*2 = 160

SELL 1 OTM PUT ( STRIKE 4900 ) = PREMIUM RS. 42

UPPER BEP = 5100 - 3 = 5097

LOWER BEP = 4900 + 3 = 4903

 LONG CALL CONDOR

The strategy is suitable in a range bound market. The long call condor
involves buying 1 ITM Call ( lower strike price) , selling 1 ITM Call ( lower
middle strike ), selling 1 OTM Call (higher middle strike) and buying 1 OTM
Call ( higher strike).

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 long condor will be realized when
the stock is trading between the two middle strike prices.

Breakeven :

Upper Breakeven Point = Highest Strike –Net Debit

Lower Breakeven Point = Lowest Strike + Net Debit

 Nifty Index Current Value = 3600
Buy 1 ITM Call ( Strike 3400) pays Premium = Rs. 41.25
Sell 1 ITM Call ( Strike 3500) receives Premium = 26
Sell 1 OTM Call ( Strike 3700) receives Premium = 9.80
Buy 1 OTM Call ( Strike 3800) pays Premium = 6

Net Debit is Rs. 11.45 ( The maximum possible Loss)

Upper Breakeven Point = Highest Strike –Net Debit

Upper Break Even Point = 3788.55

Lower Breakeven Point = Lowest Strike + Net Debit Lower

Break Even Point = 3411.45

 SHORT CALL CONDOR

The strategy is suitable in a volatile market. The short call condor involves selling 1
ITM Call ( lower strike price) , buying 1 ITM Call ( lower middle strike ), buying 1
OTM Call (higher middle strike) and selling 1 OTM Call ( higher strike).

When an investor believes that the market will break out of a trading range but is
not sure in which direction.

Risk : Limited, the maximum loss of a short condor at the center of the option
spread.

Reward : Limited, the maximum profit of short condor when the stock / index is
trading the upper or lower strike prices.

Breakeven :
Upper Breakeven Point = Highest Strike –Net Credit

Lower Breakeven Point = Lowest Strike + Net credit

 Nifty Index Current Value = 3600
Sell 1 ITM Call ( Strike 3400) pays Premium = Rs. 41.25
Buy 1 ITM Call ( Strike 3500) receives Premium = 26
Buy 1 OTM Call ( Strike 3700) receives Premium = 9.80
Sell 1 OTM Call ( Strike 3800) pays Premium = 6

Net Credit is Rs. 11.45

Upper Breakeven Point = Highest Strike –Net Debit

Upper Break Even Point = 3788.55

Lower Breakeven Point = Lowest Strike + Net Debit Lower

Break Even Point = 3411.45

 Call-Put Parity

It is an option pricing concept. According to Call-Put

parity the price of underlying, call option, put option
and future should be in equilibrium. If they are not in
equilibrium then Call-Put parity exits and we can take
arbitrage opportunities.
 Nifty Future at EOD is = 5110.
5100 CE =148
5100 PE =152

Value of call/put= Intrinsic Value + Time Value

For call Intrinsic Value (IV)=5110-5100= Rs. 10

Value of call= 10+Time value

time value to Rs 138.

Value of Put
152= 0 + 152.
Note here future is greater than strike price of put 5100 so we will say that Intrinsic
value of
5100 put is Zero, and rest is purely time value. That means for the same strike
market is valuing call =138 and put=152. So logic is that market is overvaluing put, it
may or may not be bearish indicator. Our purpose is to make a sure shot gain by this

concept.
 compare the time value of both the options.
Between 138 - 152 the difference is of Rs 14 and that is our sure shot gain.

Short Future, Short Put (sell the put) and buy call. (Note gains only on expiry/ or if valuations are

good then you can reverse your positions.

Put-Call Parity

Nifty Spot/Future + Put - Call = Exercise/Strike Price.

Future +Put=Strike-call.

5110+152=5100+148

5262 is not equal to 5248, so difference is our gain to be made .

Short the greater side, i.e short future, short put.
and long the lesser side which is 5100 call.

Now check your payoffs at any Nifty points there will always be gain of 14 Rs and you
will never
make loss.
 Ratio Spread

The ratio spread is a neutral strategy. It is a limited profit, unlimited

risk options, taking strategy that is taken when the options trader
thinks that the underlying stock will experience little volatility in the
near term.

Buy 1 ITM Call

Sell 2 OTM Call

Market Scenario : Neutral

Risk : Unlimited
Reward : Limited
Maximum Profit = Strike Price of Call – Strike Price of Long Call + Net
Premium Received
BEP = Strike Price of Short Calls + ( Maximum Profit/ Number of
Uncovered Calls)
 Spot Nifty : 5000
Buy 1 ITM Call for Strike 4900 @ Rs. 221
Sell 2 OTM Call for Strike 5100 @ Rs. 124

Net Premium Received = Rs. 248 – Rs. 221 = Rs. 27

Maximum Profit = Strike Price of Short Call – Strike Price of
Long Call + Net Premium Received

5100 – 4900 + 27 = 227

BEP = Strike Price of Short Calls + ( Maximum Profit/ Number of

Uncovered Calls)

= 5100 + (227 / 1) = 5327

 CALENDAR SPREAD

It Spread over the Calendar Month, hence it is known as Calendar Spread. The
logic behind Calendar Spread is, near Month Options Price will fluctuate more
than Far Month. So, in Calendar Spread we take benefit out of this.

SELL NEAR MONTH OPTION

BUY FAR MONTH OPTION

If it has made using Call Option it is called Calendar Call Spread, for Put it is known
as Calendar Put Spread. If the Calendar Spread is made of different Months Expiry
and the Same Strike Price is called Horizontal Calendar Spread.
If the Calendar Spread is made of different Months Expiry with different Strike
Price is known as Vertical Calendar Spread.
 Strategy = Neutral
Risk = Limited
Profit = Limited

Horizontal Calendar Spread

Using Different Months Expiry with Same Strike Price Options

SPOT = 5000
STRIKE = 5100
If Current Month is Oct., than Selling the Option of Nov. ( Near Month) and
Buying the Option of Dec. ( Far Month).
 OPTION GREEKS

Option Greeks measure the options sensitivity to various risk

components to the price of an option.
These measure include the speed of the underlying Index /
Stocks price movement, time decay of an option, volatility and
interest rate change.
The value of each Option Greek has its own importance . There
are five Greeks used for hedging portfolios of options with
underlying assets (Index or Individual Stocks). These are denoted
by Delta, Theta, Gamma, Vega and Rho.
 The Delta of an option is measure the sensitive of an option
value with respect to change in the price of underlying

The gamma of an option is the rate of change in Delta with

respect to change the price of the underlying .

The Vega of the option price is the rate of change of the

option price with respect to the volatility of underlying.

It measures the change in the value of the option with respect

to the passage of time.