Option Strategies in a Nutshell

1. Long Protective Calls: -

A long call option gives the buyer the right, but not the obligation, to purchase stock for a fixed price over a given amount of time.  It is the call buyer that has the right to purchase stock; the short call seller has the obligation to sell stock if the long position holder exercises his option i.e. if he has been assigned.

The long call strategy is applied when investor is bullish, so the value of the call rises with increases in the underlying stock.  Long call options provide leverage, that is, they cost far less to control shares of stock as compared to an outright purchase. Long Calls also provide protection by limiting the downside risk.

Example: -

If you are bullish on Nifty, then purchase the three-month Nifty 1250 call option. As the spot Nifty rises, the call option becomes in-the-money. If upon expiration, Nifty closes above the strike of 1250, the buyer would exercise his option and profit to the extent of the difference between the Nifty-close and strike price that would become his maximum profit. The profits possible on this option are potentially unlimited . However if Nifty falls below the strike of 1250, buyer lets the option expire and his losses are limited to the extent of the premium he paid for buying the option.

Maximum gain: - Unlimited (Spot price of Nifty - Strike Price)

Maximum Loss: - Rs. 60 (Premium Paid)

Break Even Point: - 1310 (1250+60)

2. Long Protective Puts: -

A Put option gives the buyer the right, but not the obligation, to sell stock for a fixed price over a given amount of time.  The short put seller, on the other side of the trade, has the obligation to purchase stock if the long position exercises their option i.e. if the seller has been assigned.

The long put strategy is applied when investor is bearish, as the value of the put rises with decrease in the underlying stock. If upon expiration, the spot price is below the strike price, he makes a profit. Lower the spot price more is the profit he makes.

Example: -

If you are bearish on Nifty, then purchase the three-month Nifty 1250 Put option. As the spot Nifty falls, the put option is in-the-money. If upon expiration, Nifty closes below the strike of 1250, the buyer would exercise his option and profit to the extent of the difference between the strike price and Nifty close. The profits possible on this option can be as high as the strike price. However if Nifty rises above the strike of 1250, he lets the option expire. His losses are limited to the extent of the premium he paid for buying the option.

Maximum Gain: - Strike Price - Nifty Close

Maximum loss: - Premium paid (Rs. 60)

Break Even Point: - Rs. 1190 (1250-60)

3. Naked Calls: -

A call option gives the buyer the right to buy the underlying asset at the strike price specified in the option. When selling naked (uncovered) calls, the investor takes in the premium, and in exchange is willing to assume the upside risk of the stock. The strategy behind the naked (or uncovered) short call is neutral to bearish.  The investor is betting that the stock will either fall or sit still. Whatever is the buyer's profit is the seller's loss. Hence as the spot price increases the writer of the option starts making losses. Higher the spot price, more is the loss he makes. If upon expiration the spot price of the underlying is less than the strike price, the buyer lets his option expires unexercised and writer gets to keep the premium.

Example: -

If you are bearish on Nifty then sell the three month Nifty 1250 calls. As the spot Nifty rises, the call option is in-the-money and you (writer) start making losses. If upon expiration, Nifty closes above the strike of 1250, the buyer would exercise his option on you and would suffer the loss to the extent of the difference between Nifty-close and strike price. The loss to you (writer) is potentially unlimited, whereas the maximum profit is limited to the extent of upfront payment of option premium Rs. 60 charged by you.

Maximum Gain: - Rs. 60 (Margin Payment received)

Maximum Loss: - Unlimited (Nifty Close - 1250)

Break Even Point: - Rs. 1310 (Strike Price + Premium)

4. Naked Puts: -

A Put option gives the right to sell the underlying asset at the strike price specified in the option. For selling the option, the writer of the option charges a premium. Whatever is the buyer's profit is the seller's loss. The strategy behind the naked (or uncovered) put is neutral to bullish.  The investor is betting that the stock will either rise or sit still. 

If upon expiration, the spot price happens to be below the strike price, the buyer will exercise the option on the writer. If upon expiration the spot price of the underlying is more than strike price, the buyer lets his option expire un-exercised and the writer gets to keep the premium.

Example: -

If you are bullish on Nifty, you write a Put option on three month Nifty at 1250. As the spot Nifty falls, the Put option is in-the-money and the writer starts making losses. If upon expiration, Nifty closes below the strike of 1250, the buyer would exercise his option on you (writer). You would suffer a loss to the extent of the difference between the Strike price and the Nifty-close. The maximum loss that can be incurred is to the extent of Strike price (Assuming asset price falls to Zero in worst case). While maximum gain is limited to the extent of upfront option premium received on writing the option.

Maximum Gain: - Rs. 60 (Premium received)

Maximum Loss: - To the extent of Strike price

Break Even Point: - 1190 (Strike price - Option Premium)

5. Buy Write / Covered Write: -

A covered call (also called a covered write) is a strategy where the investor buys stock and then sells a call against it. By selling the call, he is giving somebody else the right to buy the stock at a fixed price.

The reason this strategy is called "covered" is because he is not at risk if the stock moves higher. With covered writing, the upside risk is removed; he will always be able to deliver the shares no matter how high the stock is trading.  The short call is "covered" by the long stock.

The investor will take in some money for doing so, which in effect, provides a small downside hedge -- it lowers the break-even point.  However, the investor also gives up some of the upside potential in the stock.

Example: -

Assuming investor is buying a stock of Reliance at Rs. 500. Adding the Covered call, the investor sells a Rs. 550 call against the stock for a premium of Rs. 25. By selling the Rs. 550 call, the investor has sold the rights to the person who bought the call. But the investor also reduces the downside risk in exchange.

Maximum Gain: - Rs. 75 (550-500 + 25). This is limited to Rs. 75 irrespective of appreciation in the price of the long stock since we have entered into an agreement to sell it for Rs. 550.

Maximum Loss: - To the Extent of Strike Price

Break Even Point: - Rs. 475 [550 - (550-500 + 25)]

6. Sell Write: -

In sell-write, the investor simultaneously shorts the stock (sells it) and then writes the put.  The resulting position is a covered put;

So, if the stock falls, he may be assigned on the short put and be forced to buy the stock. He can profitably cover the short stock position through the assignment of the put.  The short option position is considered "covered" because the risk of the short put -- the downside -- is covered by the short stock.  This does not mean this strategy is risk-free; the trader has unlimited liability to the upside .  The short put just provides a little upside hedge. The sell-write is just a method of executing the two trades together to avoid execution risk.

Example: -

Assuming MUL is trading at Rs. 400. Investor is selling a stock of MUL at Rs. 390. Adding the Covered put, the investor sells a Rs. 385 put against the stock for a premium of Rs. 20. If the traders were just shorting the stock, he or she would only receive Rs. 390 but instead, with the sell-write, receives Rs. 410. 

The sell-write gives a higher credit . Because of this higher credit, the sell-write provides a little upside hedge for the trader.  If the trader is wrong about the direction of the stock, he or she can afford for the stock to now move up Rs. 20-- the premium received for the put -- to a level of Rs. 410 before heading into losses.  The trader who only shorts the stock will be exposed to losses for any price above 390.

Maximum Profit: - Rs. 25 (410-385)

Maximum Loss: - Potentially Unlimited

Break even Point: -Rs. 410 {Rs. 385 + [(390-385) +20]}

7. Bull Spread using Calls: -

Spreads are strategies where the investor buys one option and sells another.  Spreads get their name because one, in fact, spreads the risk when he enters into one of these transactions.  One of the positions, either the long or the short, acts as a hedge and either makes the position cheaper or acts as protection from a runaway stock. Bull spread strategy involves the purchase of a lower strike call and the sale (equal number of contracts) of a higher strike call with all other factors remaining the same (i.e., same underlying stock or index and time to expiration). 

The lower strike call will always be more expensive than the higher strike; hence this trade will result in a net debit.  In order to make up for this debit, the trader will need the stock to move higher, hence the name Bull spread.  This spread is also known as a Debit spread, Price spread or Vertical spread .

Example: -

Assuming investor is purchasing a Call on Reliance at Rs.550 June for Rs. 25 and sells a Call on Reliance at Rs. 600 June and receives premium of Rs. 15 with equal number of contracts.

Buy Reliance Jun Rs. 550 Call = Rs. 25
Sell Reliance Jun Rs. 600 Call = Rs. 15
Net Debit                           = Rs. 10

Maximum Profit: - Rs. 35 (Difference between the strike Minus Net initial cost)

Maximum Loss: - Rs. 10 (Net Initial Debit)

Break Even Point: - Rs. 560 (Lower Strike Price + Net Initial Debit), If Stock is trading at Rs. 560 then long call will worth Rs. 10 and short call expires worthless.

8. Bull spread using Puts: -

A Bull spread with Puts is a strategy where the trader buys a low strike put and sells a higher strike put in equal quantities.  Because a higher strike put will always be worth more this trade will result in a credit to the account.

This spread is also known as a Credit spread, Vertical spread, or Price spread .

Example: -

Assuming investor is purchasing a Put on MUL at Rs.450 June for Rs. 30 and sells a Put on MUL at Rs. 500 June and receive premium of Rs. 40 with equal number of contracts.

Buy MUL Jun Rs. 450 Put  = Rs. 30
Sell MUL Jun Rs. 500 Put  = Rs. 40
Net Credit                         = Rs. 1

If the stock of MUL closes above Rs. 500, then both the Put option become worthless and investor will get credit in his account to the extent of Rs. 10.

Maximum Profit: - Limited to the extent of Rs. 10 (Net Initial Credit)

Maximum Loss: -Rs. 40 (Difference between the strike Minus Net Initial Credit)

Break Even Point: - Rs. 490 (Higher strike Put minus Net Initial Credit). If MUL is trading at Rs. 490 then Rs. 500 Put is worth negative to the investor to the extent of Rs. 10 and the long Put expires worthless and investor just breaks even.

9. Bear Spread using Call: -

A bear spread, as the name implies, desires the stock or index to fall. This strategy involves the purchase of a high strike Call and the sale of a lower strike Call with all other factors the same. Because Investor is selling the lower strike Call, it will always be worth more and result in a credit.  In order for the trade to make money, the stock must fall.

Example: -

Assuming investor is purchasing a Call on Reliance at Rs.550 June for Rs. 25 and sells a Call on Reliance at Rs. 500 June and receives premium of Rs. 35 with equal number of contracts.

Buy Reliance Jun Rs. 550 Call  = Rs. 25
Sell Reliance Jun Rs. 500 Call  = Rs. 35
Net Credit                          = Rs. 10

Maximum Gain: - Rs. 10 (Net Initial Credit)

Maximum Loss: - Rs. 40 (Difference between the Strikes Minus Initial Credit)

Break Even Point: - Rs. 510 (Lower Strike call + Net Initial credit). In order to break even the trader can afford the lower strike call to move against him by 10 points to close at Rs. 510, at this point he owes Rs. 10 to the short position which is exactly offset by the initial premium received by him.

10. Bear spread using Puts: -

This strategy involves the purchase of a high strike put and the sale of a lower strike put with all other factors the same. Because investor is buying the higher strike put, it will always be worth more and result in a debit.  In order for the trade to make money, the stock must fall.

Example: -

Assuming investor is purchasing a Put on MUL at Rs500 June for Rs. 45 and sells a Put on MUL at Rs. 450 June and receives premium of Rs 35 with equal number of contracts.

Buy MUL Jun Rs. 500 Put  = Rs. 45
Sell MUL Jun Rs. 450 Put  = Rs. 35
Net Debit                          = Rs. 10

Maximum Gain: - Rs. 40 (Difference between strike Minus Initial Debit)

Maximum Loss: - Rs.10 (Net Initial Debit)

Break Even Point: - Rs. 490. In order to break even the stock should move favorably so if stock is trading below the higher strike put at Rs. 490 then trader breaks even since he is able to recover his initial debit.

11. Long Calendar Spread: -

A calendar spread is any spread where the trader buys a particular month, and then sells the same strike of a different month.  Since the trader is spreading months, it is known as calendar spread.  Also, because months represent time, these are equally known as time spreads or horizontal spreads . With a calendar spread, the trader is expecting the stock to sit flat -- this trade is actually a play on time-decay and volatility as opposed to direction.

In Long Calendar Spread the trade results into Net Debit.

Example: -

In Calendar spread trader expects the stock to sit still.

Buy Tisco March Rs. 400 for Rs.30 and short Jan Rs. 20 for a net debit of Rs. 10.  Because the trader is long the spread, he will want the spread to widen so that he may close it for a profit. So if the stock sits still, as we approach January expiration. Both options will lose money as time goes by, but the short January option will lose far more than the long March option.  The January will be nearly worthless, while the March will still have significant time remaining.  For instance, the January option may be trading for Rs. 2 while the March, with over two months remaining, may be worth Rs. 25.  The trader paid Rs. 10 and can close it for a net credit of Rs. 23 for a Rs. 13 gain

Indian derivatives market is very illiquid and, hence, we do not find Calendar spread strategies apparent in Indian Financial market.

12. Short Calendar Spread: -

A Short calendar spread wants the stock to move, either up or down by a large amount. If trader is bullish or bearish on a particular stock and entering into a calendar spread, he wants to short the spread -- he wants the spread to narrow.  In other words, if he shorts the spread, he will receive a credit.  If the stock moves way up or way down, the spread will narrow and he can purchase it back for a profit.

Example: -

Same example of Tisco as in the case of Long Calendar Spread.

Indian derivatives market is very illiquid hence we do not find Calendar spread strategies apparent in Indian Financial market.

13. Call Ratio Spread: -

In theory, Ratio spreads probably the perfect trade as they provide for buying the valuable options and selling off higher amounts of the "worthless" options to finance the long position.  But they do come with great risks to the tune of unlimited losses at an accelerated rate if the stock moves above the strike of the short position.

A call ratio spread consists of buying a lower strike call and then selling a higher number of contracts of a higher strike price.

Example: -

Currently Reliance is trading at Rs. 490. The trader is of the view that Reliance will go above Rs. 500 but not above Rs. 550. Then call ratio spread is a perfect strategy, which looks like this

Buy 1 Jun Rs. 500 call =  Rs. 30
Sell 2 Jun Rs. 550 calls =  Rs. 10
Net debit                    =   Rs. 10

Maximum Gain: - Rs. 40 (Difference in strike Minus Net Debit)

Maximum Loss: - Unlimited if the Stock rises above Rs. 550 (Upside Risk)

Break Even point: - Downside break even point is Rs. 510. If the Reliance is trading at Rs. 510 then it is enough to cover the initial debit being paid for the position and hence will Break Even.

Upside break even point is Rs. 610. This can be calculated (Spot- Rs. 500) so that we will have intrinsic value on long position and our expenses will be 2* (Spot - Rs. 550) - Rs. 10 and then equate the two equation together and solve it. Spot - 500 = 2*(Spot - 550)-10 which gives us the upside break even point as Rs. 610.

14. Put Ratio Spread: -

To establish a ratio spread with puts, the trader will buy one higher strike price and sell a higher number of contracts of a lower strike price.

A put ratio spread allows the investor to play the downside for much less money than either a long position or regular spread position.

Assuming trader is bearish on MUL, he takes the following position.

Buy 1 Dec Rs. 400 put = Rs. 40
Sell 2 Dec Rs. 350 puts = Rs . 15
Net debit                          Rs. 10

Maximum Gain: - Rs. 40 (Difference between Strike Minus Net Debit)

Maximum Loss: - Unlimited (To the extent of Strike Price) if the stock price falls below Rs. 350 and if stock moves up than maximum, a trader loses Rs. 10 (Initial debit)

Break Even Point: - Downside break even point is at Rs. 310 if the stock is trading below Rs. 350.

15. Christmas Tree using Calls:-

A Christmas tree strategy is similar to a ratio spread. The idea behind this strategy is that the trader lowers the cost basis of the long position by selling two options against it, thereby accelerating the rate of return on investment.  However, unlike the ratio spread where multiple calls of a single higher strike are sold against the long position, the trader instead sells multiple strikes.  It is a lower risk, lower reward strategy relative to the ratio spread.

Example: -

Investor bullish on Reliance trading at Rs. 500 enters a Christmas tree and buys the Rs. 500, sells the Rs.550 and sells the Rs. 600 for a net credit of Rs. 10 as follows:

Buy Rs. 500 =    Rs. 40
Sell Rs. 550 =    Rs. 30
Sell Rs. 600 =     Rs. 20
Net credit     Rs. 10

Maximum Gain: - Rs. 60 (Difference in Strike Plus Net Credit)

Maximum Loss: - Unlimited Upside risk once the stock crosses Rs. 660 limit

Break Even Point: - Rs. 660 (Rs. 600 + Difference in Strike Plus Net Credit)

16. Christmas Tree using Puts: -

The Christmas tree with puts is used for the opposite reasons as Christmas tree with Calls. The trader is bearish and wants to buy puts but sell two additional lower strikes to offset the cost.

Example: -

Investor is bearish on MUL and hence enters a Christmas tree and buys the Rs. 400 put, and sells the Rs. 350 puts and Rs. 300 puts for a credit of Rs. 5

Buy Rs. 400 put =    Rs. 55
Sell Rs. 350 put =    Rs. 35
Sell Rs. 300 put =     Rs. 25    
Net credit             Rs. 5

Maximum Gain: - Rs. 55 (Difference in Strike Price + Initial Credit)

Maximum Loss: - Unlimited downside risk (To the extent of strike Price) once it reaches the break even point of Rs. 255

Break even Point: - Rs 255. (Rs. 300 - Difference in strike price Minus Net Credit)

17. Backspread using Calls: -

The backspread is similar to a ratio spread, except that it has unlimited profit instead of unlimited loss on the profit and loss diagram.  It is the mirror image of the ratio spread.  The backspread is often called a long ratio spread .

If a trader is bullish on a stock yet fears a market turndown, then both sides of the market can be played with a backspread. 

A call backspread involves the sale of a low strike price call and the purchase of a higher number of contracts at a higher price.

Example: -

Investor is bullish on Reliance but fears market turndown so he positioned as:

Sells 1 Rs. 500 call June for Rs.20

Buys 2 Rs. 550 calls June for Rs. 5

Net Credit Rs. 10

Maximum Gain: - Unlimited upside Profit Potential once it crosses break even of Rs. 590

Maximum Loss: - Rs. 40 (Difference in strike price - Initial Net Credit) at strike price of Rs. 550

Break Even Point: -

Upside Break even point is Rs. 590 (Rs. 550 + Loss (Rs. 40)).

Downside Break even point is Rs. 510 (Lower Strike price + Net Initial Credit)

Or (Higher strike price - Loss)

18. Backspread using Puts: -

To enter a put backspread, the trader will sell a high strike put and buy a higher number of a lower strike put. 

With puts Backspread the trader is bearish. He is betting more on the downside, but he fears the upside risk.  A put backspread allows him to capture both possibilities while favoring the position to the downside.

Example: -

Trader is bearish on MUL but fears market upturn movement so enters into following transaction:

Sells 1 the Rs. 400 put Jun for Rs. 40

Buys 2 the Rs. 350 puts Jun for Rs.15

Net Credit Rs. 10 

Maximum Gain: - Unlimited profit potential once it crosses the break even point of Rs. 310 (Strike Price - Closing price of MUL)

Maximum Loss: - Rs. 40 (Difference in strike - Initial Net Credit)

Break Even Point: -

Downside break even: Rs.310 (Rs. 350 - Difference in strike Minus Initial Net credit)

Upside break even: Rs. 390 (Lower strike price + Loss) or (Higher strike price - Net credit)

  19. Box Spread: -

A box spread is a relatively simple strategy.  To enter into a long box position, all trader needs to do is to buy the bull spread and buy the bear spread with the same strikes and all other factors remaining the same. For example, say a stock is trading at Rs. 200.  A trader could buy the Jan Rs. 200 call and sell the Jan Rs. 220 call (bull spread), and also buy the Jan Rs. 220 put and sell the Jan Rs. 200 put (bear spread.). This trade will result in a debit for both spreads.  What is interesting about this position is that it is now guaranteed to be worth Rs. 20 (the difference in strikes). No matter where the stock closes, either the Rs. 200 call or the Rs. 220 put will be in-the-money. Because these are the two long positions of the box spread, the trader who buys the box spread is guaranteed to have a position worth Rs. 20 at expiration.

If stock price goes up say it is trading currently at Rs. 205,then long call would be worth Rs. 5 and long put worth Rs. 15 for total of Rs. 20 and short 200 call and short 220 put will expire worthless.

If stock price moves out of the range of Rs. 200 and Rs. 220 and trading at Rs. 150 than long put is worth Rs. 70 while short put is now of value Rs. 50 but being short on this its an obligation on trader's part, so net gain comes to +Rs. 70 - Rs. 50 = Rs. 20, thus, guaranteed value.

The box spread is very effective method of hedging the position. The box spread is effectively a way for market makers to borrow or lend money.  If a market maker sells a box spread, they are effectively borrowing money.  They receive a credit and must pay back the value of the box at expiration.  Similarly, if they buy a box spread, they are loaning money.  They will pay money but receive a guaranteed return at expiration.

 20. Long Straddle: -

A long straddle is a strategy where the investor buys a call and buys a put with the same strike and time to expiration.

The most common use of the strategy is when the trader expects a large move but is unsure about which direction. The strategy attempts to play both sides of the market hoping that the move in the underlying stock, whether up or down, is sufficient to cover the cost of the losing option. A better use of the straddle is to buy them if trader expects increases in volatility.  Increased volatility will increase the price of both calls and puts.  So, if trader is faced with a big announcement or news, he should buy the straddle only if he thinks the market has underestimated the volatility.

Example: -

A trader buys a March Rs. 500 call on Reliance for Rs. 30, and a March Rs. 500 put on Reliance for Rs.20 for a total of Rs. 50. 

Maximum Gain: - Unlimited on upside as well as on downside if the stock moves sharply and crosses the break even point on both the sides.

Maximum Loss: - Rs. 50 (Premium paid on both the options)

Break even point: -

Downside Break even: Rs. 450 (Strike price Minus both the premiums) i.e. [Rs. 500 - Rs. 50]

Upside Break even: Rs. 550 (Strike price Plus both the premiums) i.e. [Rs. 500 + Rs. 50]

21. Short Straddle: -

When trader thinks the underlying index or stock will fluctuate in a narrow range and neither rise nor fall, Short Straddle is the best strategy. It involves Selling a call and put option at the same strike price.

Example: -

A trader sells a March Rs. 300 call on MUL for Rs. 30, and a March Rs. 300 put on MUL for Rs.20 for a total of Rs. 50. 

Maximum Gain: - Maximum gain is when underlying price is equal to spot price. Maximum gain is Rs. 50 i.e. (Premium received on both the options)

Maximum Loss: - Unlimited on upside as well as on downside if the stock moves sharply and crosses the break even point on both the sides.

Break even point: -

Downside Break even: Rs. 250 (Strike price Minus both the premiums) i.e. [Rs. 300 - Rs. 50]

Upside Break even: Rs. 350 (Strike price Plus both the premiums) i.e. [Rs. 300 + Rs. 50]

22. Long Strangle: -

When trader thinks the underlying index or stock will rise or fall in a big way but not sure of the direction, Long Strangle is the best strategy. The idea behind straddles and strangles is the same in that the investor is looking for a large move in one direction or another.  The strangle differs in that the strike prices are different.  The expiration months are the same.

Example: -

Buy out-of-the-money call and put options.

A trader buys a March Rs. 500 call on Reliance for Rs. 20, and a March Rs. 450 put on Reliance for Rs.15 for a total of Rs. 35.

Maximum Gain: - Unlimited on upside as well as on downside if the stock moves sharply and crosses the break even point on both the sides.

Maximum Loss: - Rs. 35 (Premium paid on both the options).

Maximum loss occurs if the underlying price is between the lower and higher

strike price at expiry of the options.

Break even point: -

Downside Break even: Rs. 415 (Lower Strike price Minus both the premiums) i.e. [Rs. 450 - Rs. 35]

Upside Break even: Rs. 535 (Higher Strike price Plus both the premiums) i.e. [Rs. 500 + Rs. 35]

23. Short Strangle: -

When trader thinks the underlying index or stock will fluctuate in a broader range, Short Strangle is the best strategy. It involves selling a call and put out of the money option of different strike price of the same expiry.

Example: - A trader sells a March Rs. 300 call on MUL for Rs. 20, and a March Rs. 250 put on MUL for Rs.15 for a total of Rs. 35.

 

Maximum Gain: - Rs. 35 i.e. the profit is limited to the extent of premium received. The maximum profit is realized when underlying is between the lower and higher strike option at the expiry.

Maximum Loss: - Unlimited on upside as well as on downside if the stock moves sharply and crosses the break even point on both the sides.

Break even point: -

Downside Break even: Rs. 215 (Lower Strike price Minus both the premiums) i.e. [Rs. 250 - Rs. 35]

Upside Break even: Rs. 335 (Higher Strike price Plus both the premiums) i.e. [Rs. 300 + Rs. 35].

This is the better deal for most investors simply for the fact that the break-even points are stretched so wide.

 25. Strips: -

A strip is a strategy where the trader buys one call and two puts with the same strike and expiration dates. This strategy is similar to long straddle. With a strip, though, the investor is unsure about the direction, but is putting a little more emphasis on the downside move. So the trader is buying the Strip, which is one long, one call and two long put with the same strikes and expiration dates.

Example: -

A trader buys 1 March Rs. 500 call on Reliance for Rs. 30, and 2 March Rs. 500 put on Reliance for Rs.20 for a total of Rs. 70.

 

Maximum Gain: - Unlimited on upside as well as on downside if the stock moves sharply and crosses the break even point on both the sides.

Maximum Loss: - Rs. 70 (Premium paid on both the options)

Break even point: -

Downside Break even: Rs. 430 (Strike price Minus both the premiums) i.e. [Rs. 500 - Rs. 70]

Upside Break even: Rs. 570 (Strike price Plus both the premiums) i.e. [Rs. 500 + Rs. 70]

Strip costs more than the straddle because trader is buying an additional put for the strip.  Because of this additional cost, a bigger rise in the stock will be necessary before break-even is achieved to the upside with the strip as compared to the straddle.  Conversely, the strip will show a profit quicker as compared to the straddle if the stock should fall.

25. Straps: -

A strap is basically the opposite of the strip:  the investor buys two calls but only one put.  In this strategy, the investor is betting that there is a higher chance the stock will rise but is still uncertain so wants to play the downside as well.

Example: -

A trader buys 2 March Rs. 500 call on Reliance for Rs. 30, and 1 March Rs. 500 put on Reliance for Rs.20 for a total of Rs. 80.

 

Maximum Gain: - Unlimited on upside as well as on downside if the stock moves sharply and crosses the break even point on both the sides.

Maximum Loss: - Rs. 80 (Premium paid on both the options)

Break even point: -

Downside Break even: Rs. 420 (Strike price Minus both the premiums) i.e. [Rs. 500 - Rs. 80]

Upside Break even: Rs. 580 (Strike price Plus both the premiums) i.e. [Rs. 500 + Rs. 80]

If the stock rises, as the trader believes, he will profit at a much greater pace.  However, if the stock falls, he will still profit but will have a much lower break-even point as compared to the straddle.

 Conversion: -

Conversion is the same as Equity collar with only difference that call is sold and put is purchased at the same strike price.

Example: -

Assuming Gail is trading at Rs. 150; investor is buying the stock and then selling a call at Rs. 155 Jun for Rs. 15 and buying a put at Rs. 155 Jun for Rs. 20 resulting into net debit of Rs. 5. The most that the trader gains is Rs. 5 if the stock is trading above Rs. 155 but Rs. 5 is also spend on establishing the position so there is no net gain and position is effectively locked at Rs. 155.

This investor is guaranteed to receive Rs. 155 at expiration in three months.  If the stock is above Rs. 155, he will be assigned on the short calls and receive Rs. 155; if it closes below Rs. 155, he will exercise the puts and receive Rs. 155. Since the investor is Long and Short on the same stock hence he would not gain or lose anything from the conversion.

 

Maximum Gain: - Zero. If stock is trading above Rs. 150 lets say at Rs. 155 then trader will get Rs. 5 on assignment of short call position but net effect is zero since he has spend Rs. 5 on establishing conversion position.

Maximum Loss: - Zero. If stock is trading below Rs. 150 say at Rs. 145 than trader will exercise the long put option and sells the stock at Rs. 155 so the gain of Rs. 5 is offset by net debit of Rs. 5 that he paid in setting the collar position.

Break Even Point: - Rs. 155 where there is no profit and no loss.

26. Reversal: -

Reversal is also known as Reverse conversin. Reversal is the three-sided position used primarily by market makers to hedge risk.  A position of short stock, short put and long call is a reversal.  Both options must have the same strike price and expiration.  The reversal grows to a guaranteed payment at expiration. 

Example: -

Assuming MUL is trading at Rs. 350; investor is selling the stock at Rs. 350 and then buying a call at Rs. 345 Jun for Rs. 20 and selling a put at Rs. 345 Jun for Rs. 15 resulting into net debit of Rs. 5. The most that the trader gain is Rs. 5 if the stock is trading below Rs. 345 but Rs. 5 is also spending on establishing the position so there is no net gain and position is effectively locked at Rs. 345.

This investor is guaranteed to receive Rs. 345 at expiration in three months.  If the stock is below Rs. 345, say at Rs. 340 then he will be assigned to short put position hence he will buy the stock from the buyer of put option at Rs. 345 incurring profit of Rs. 5 since he is purchasing the stock at only Rs. 345 but this gain position is offset by the net debit of Rs. 5 hence he would not gain or lose anything from the reversal.

Maximum Gain: - Zero. If stock is trading below Rs. 350 lets say at Rs. 345 than trader gains Rs. 5 on assignment of Short Put but net effect is zero since the gain of Rs. 5 is offset by Net Initial debit of Rs. 5 of Reversal Position.

Maximum Loss: - Zero. If stock is trading above Rs. 350 say at Rs. 355 than trader will exercise the long Call option and purchases the stock at Rs. 345 so the gain of Rs. 5 is offset by net debit of Rs. 5 that he paid in setting the Reversal position.

Break Even Point: - Rs. 345 where there is no profit and no loss.

27.  Long Butterfly: -

The butterfly spread is one of many strategies that belong to a family collectively known as "wing spreads"; they get this name, from the shape of their profit and loss diagrams. The butterfly spread is designed for traders to take advantage of pricing discrepancies between spreads. 

For the long butterfly, the trader will buy 1 low strike, sell 2 medium strikes, and buy 1 high strike all with the same expiration dates.  The butterfly can be executed with either calls or puts (or a combination).  The high and low strikes must be the same distance from the medium option.

Example: -

Assuming Reliance is trading Rs. 500 and trader wants to enter into a long butterfly position. So enters into following transaction:

Buy 1 June Call at Rs. 450 for Rs. 30

Sell 2 June Calls at Rs. 500 for Rs. 20

Buy 1 June Call at Rs. 550 for Rs. 10

 

Maximum Profit: - Rs. 50. Maximum profit can be achieved at Rs. 500 (Difference between Lower and Middle strike prices - Initial Debit).

Maximum Loss: - Zero (Net Initial Debit). In this case we are having Net initial debit for bull spread as Rs. 10 (Buy one at lower Rs. 450 and sell one at higher Rs. 500) and also Net initial credit of Rs. 10 on bear spread (Sell one at lower Rs. 550 and buy one higher Rs. 550) which offset the position to Zero.

Break Even Point: -

Downside Break Even: Rs. 450 (Lower strike price + Initial Debit)

Upside Break Even: Rs. 550 (Higher Strike Price - Initial Debit)

28. Short Butterfly: -

When trader is not so sure that the underlying index or stock will rise or fall sharply and are not certain about the direction, Short Butterfly is the best strategy. This strategy involves selling one in the money call (Lower strike price), buy two at the money calls (Middle strike price) and selling one out of the money call (Higher strike price).

Example: -

Assuming Reliance is trading Rs. 500 and trader wants to enter into a short butterfly position. So enters into following transaction:

Sell 1 June Call at Rs. 450 for Rs. 30

Buy 2 June Calls at Rs. 500 for Rs. 20

Sell 1 June Call at Rs. 550 for Rs. 10

 

Maximum Profit: - Zero (Limited to Initial credit Received)

Maximum Loss: - Rs. 50 (Difference between the lower and middle strike price Minus Net initial Credit)

Break Even Point: -

Downside Break Even: Rs. 450 (Lower strike price + Initial Credit)

Upside Break Even: Rs. 550 (Higher Strike Price - Initial Credit)

29. Condor Spread: -

Condor Spread is similar to Butterfly spread and is used by traders to take advantage of small price discrepancies that appear in the market. The condor spread is a strategy involving four strikes and can be made up of calls, puts or a combination of both.  The basic condor spreads are usually constructed with either calls or puts. 

The condor is the same basic pattern except the trader is splitting the two medium strikes of the butterfly into two separate strikes.  This action creates a wider profit area relative to the butterfly.  The trader is hoping for a relatively stable stock price.

Example: -

Assuming Reliance is trading Rs. 500 and trader wants to enter into a long Condor spread. So he enters into following transaction:

Buy 1 June Call at Rs. 450 for Rs. 30

Sell 1 June Call at Rs. 500 for Rs. 18

Sell 1 June Call at Rs. 550 for Rs. 12

Buy 1 June Call at Rs. 600 for Rs. 10

Net Debit Rs. 10

 

Maximum Gain: - Limited to Rs. 40 (Difference between strike price Minus Net debit). The profit is highest at two middle strike price and thereby creating wider profit area.

Maximum Loss: - Restricted to Rs. 10 (Net Initial Debit)

Break Even Point: - Downside = Rs. 460 (Lower Strike + Net Initial Debit)

Upside = Rs. 590 (Higher strike price - Net Initial Debit)

30. Albatross Spread: -

The basic long albatross is a strategy utilizing four strikes just as the condor.  However, the trader skips a strike in the middle. 

Albatross has a wider but lower profit zone relative to the condor.  This reflects the relative risks of the two strategies.  All else equal, traders would prefer to have wider ranges of profit so will bid this strategy higher relative to the condor. 

Example: -

Assuming Reliance is trading Rs. 500 and trader wants to enter into a long Albatross spread. So he enters into following transaction:

Buy 1 June Call at Rs. 450 for Rs. 30

Sell 1 June Call at Rs. 500 for Rs. 15

Sell 1 June Call at Rs. 600 for Rs. 10

Buy 1 June Call at Rs. 650 for Rs. 08

Net Debit Rs. 13

 

Maximum Gain: - Limited to Rs. 37 (Difference between strike price Minus Net debit). The profit is highest at two middle strike price and thereby creating wider profit area more than even Condor Spread, stretched across 500 to 600.

Maximum Loss: - Restricted to Rs. 13 (Net Initial Debit)

Break Even Point: -

Downside Break Even = Rs. 463 (Lower Strike + Net Initial Debit)

Upside Break Even = Rs. 637 (Higher strike price - Net Initial Debit)

31. Pterodactyl Spread: -

Pterodactyl spread is same as Condor spread. It still involves four strike prices but, this time, two strikes are skipped in the middle.

The Pterodactyl trader has an even lower, but wider, range of profits compared to the albatross. 

Example: -

Assuming Reliance is trading Rs. 500 and trader wants to enter into a long Albatross spread. So he enters into following transaction:

Buy 1 June Call at Rs. 450 for Rs. 30

Sell 1 June Call at Rs. 500 for Rs. 15

Sell 1 June Call at Rs. 650 for Rs. 08

Buy 1 June Call at Rs. 700 for Rs. 07

Net Debit Rs. 14

 

Maximum Gain: - Limited to Rs. 36 (Difference between strike price Minus Net debit). The profit is highest at two middle strike price and thereby creating wider profit area more than even Albatross Spread, stretched across 500 to 650.

Maximum Loss: - Restricted to Rs. 14 (Net Initial Debit)

Break Even Point: -

Downside Break Even = Rs. 464 (Lower Strike + Net Initial Debit)

Upside Break Even = Rs. 686 (Higher strike price - Net Initial Debit)

32. Jelly Roll: -

Jelly roll is a conversion in one month and a reversal in another.

A strategy using a long call and short put (synthetic long position) and a short call and long put (synthetic long position) at another date with all options represent the same underlying.  If the position is initiated for a debit (credit) it is a long (short) jelly roll. 

Conversions (long stock, long puts and short calls) in one month and reversals (short stock, short puts and long calls) in the another are ways for market makers to lock in profits.

Example: - Say a market maker has the following Reversal for March expiration on MUL:

Short 1 share at Rs. 350
Long 1 Rs. 350 call
Short 1 Rs. 350 put

And also has the following Conversion for June expiration:

Long 1 share at Rs. 350
Long 1 Rs. 350 put
Short 1 Rs. 350 call

March Reversal	June Conversion
Long 1 Rs. 350 calls	Long 1 Rs.350 puts
Short 1 Rs. 350 puts	Short 1Rs.350 calls
(Synthetic Long Position)	(Synthetic Short Position)

 

Notice the market maker is short 1share in the reversal and long 1share in the conversion -- a net zero position.

The trader is forced to buy the stock at Rs. 350 in March and sell the stock at Rs. 350 in June. Thus trader is not losing anything on principal as he is buying and selling at same price. So the value of a jelly roll is the cost of carry between months less the present value of dividends received.

33.  Option Repair Strategy: -

If trader is buying stocks for any length of time, he is probably been in the situation every investor dreads -- seeing the stock down twenty or more percent from the purchase price. 

The repair strategy has a couple of assumptions.  First, trader must be at least moderately bullish on the stock over the short term.  If he thinks the stock is heading south, he is probably best selling at a loss or buying protective puts as a full or partial hedge.  Second, he is assumed to be trying to get out of the position by just breaking even (or close to it).  In other words, this strategy is not used as a high profit one; it is designed to get you out of a bad situation for nearly break-even.

Example: -

Buy 1 shares of stock at Rs. 500 and it is now trading for Rs. 400 -- down 20%. Trader is bullish that stock will rise to Rs. 450 but not beyond that. The repair strategy is designed by writing a ratio call spread.

Buy 1 Rs. 400 call for Rs. 20 = Rs. 20
Sell 2 Rs. 450 calls for Rs. 10 = Rs. 10
Net cost                                       Rs. 0

Normally, a ratio writer is subjected to unlimited upside risk.  However, because he has already bought share, he can cover 1 of the short Rs. 450 calls with the stock purchased and the remaining 1 contract with the Rs. 400 call. 

Now, if stock moves to Rs. 450 at expiration, the long shares worth atleast Rs. 450 (the short call Rs. 450 expires worthless) and Rs. 400/450 call spread worth atleast Rs. 50 for a total of Rs. 500 and thus breaking even. Any stock price above Rs. 450 expiration will result into total position being worth Rs. 500.

 34. Synthetic Short Stock: -

Synthetic option equation is Stock + Put - Call =? We want synthetic of short stock which is - Stock = + Put - Call i.e. Long Put and Short Call = Short Stock.

With synthetic short sales trader is buying puts, and that gives him the right to sell the stock which, will appreciate as the stock falls -- just like a short stock position.  However, puts can be very expensive, so in order to pay for the puts, investors will sell calls and use the proceeds to buy the puts.

Example: -

Long Rs. 500 Put June Reliance for Rs. 30

Short Rs. 500 Call June Reliance for Rs. 30

We can see from the diagram that it looks exactly like short stock position at expiration, the investor gains point-for-point if the stock falls, and loses point-for-point if it rises.  The synthetic position, at expiration, is behaving exactly like short stock.

Maximum gain: - Potentially unlimited (To the extent of Strike Price)

Maximum Loss: - Potentially unlimited on downside

Break Even Point: - Rs. 500

In Synthetic short position both the trades are placed simultaneously in order to avoid the execution risk i.e. the risk of an unfavorable market move while executing two separate orders.

 35.  Semifuture Strategy: -

The related strategy that has a little less risk called a semifuture .  The strategy can be used as a long or short position.  If trader wants a synthetic short position with a little less risk, he can split the strike prices, such as buy the Rs. 500 put and sell the Rs. 550 call.  The more the distance between the strikes the less is upside risk.

Example: -

Long Rs. 500 Put June Reliance for Rs. 30

Short Rs. 550 Call June Reliance for Rs. 30

 

 From the diagram it is evident that the flat area between Rs. 500 and Rs. 550 creates less risk to the upside.  In other words, with synthetic stock at Rs. 500, the trader is exposed to losses for any stock price above Rs. 500 but with the semifuture , the trader is not exposed to losses until the stock is above Rs. 550.

Maximum Gain: - Potentially unlimited (to the extent of strike price)

Maximum Loss: - Unlimited once the stock crosses the limit of Rs. 550.

Break Even Point: - Ranges anywhere between Rs. 500 and Rs. 550.

36. Buy Vertical Spread Plus one: -

The purpose of this strategy is to allow a trader to make a directional play on a given security which affords three key advantages:

1) Unlimited Profit Potential

2) Limited Risk

3) A much higher probability of profit than simply buying naked calls or puts

Option.

This strategy involves (for example) buying 3 call (or put) options of a given strike for a particular month and simultaneously selling 3 call (or put) options of the same month using a further out strike price

This strategy is most useful as a replacement for buying naked calls and puts, which generally has a very low probability of profit and requires exact market timing in order to generate a profit. Like naked option buying, this strategy enjoys unlimited potential and limited risk. However, unlike naked option buying, this strategy can allow a trader to profit even if the underlying fails to move in the predicted direction.

The Buy Vertical Spread Plus One can be used at anytime, regardless of the implied volatility level of the underlying security. However, this strategy is an outstanding replacement to buying naked options when volatility is extremely high. If trader buys a naked option when volatility is extremely high and volatility subsequently falls, he can be left with almost no chance of making money, barring a huge price movement by the underlying in the anticipated direction. Conversely, the Buy Vertical Spread Plus One strategy will actually benefit from a decline in volatility prior to option expiration (because the option which was sold when establishing this spread will suffer time decay much more quickly than the option that was purchased).

 

Impact of Greeks

 

An option's price can be influenced by a number of factors, each of which can either help or hurt depending on the type of option position established.

"Greeks" - a set of risk measures that indicate how exposed an option is to price influences, principally time-value decay, implied volatility, and changes in the underlying price of the commodity.

Major influences of the above mentioned factors on both a call and put option's price are listed below. The plus or minus sign indicates an option's price direction resulting from a change in one of the price variables.

Options	Increase in Volatility	Decrease in Volatility	Increase in Time to Expiration	Decrease in Time to Expiration	Increase in the Underlying	Decrease in the Underlying
Calls	+	-	+	-	+	-
Puts	+	-	+	-	-	+

The impact of the above factors also differs depending upon the Long and Short Position. If one is long a call option, a rise in implied volatility will be favorable since rising implied volatility typically gets priced into the option premium. But if one has established a short call option position, a rise in implied volatility would have an inverse (or negative sign) effect. The writer of a naked option, be it a put or call, would therefore not benefit from a rise in volatility since writers desire the price of the option to decline.

Following table represents the impact of the factors on the long and short Call/Put position.

Call Options	Increase in Volatility	Decrease in Volatility	Increase in Time to Expiration	Decrease in Time to Expiration	Increase in the Underlying	Decrease in the Underlying
Long	+	-	+	-	+	-
Short	-	+	-	+	-	+

Decrease in implied volatility, a reduced time to expiration, and a fall in the price of the underlying will benefit the short call holder. At the same time, an increase in volatility, a greater time remaining on the option, and a rise in the underlying will benefit the long call holder.

Put Options	Increase in Volatility	Decrease in Volatility	Increase in Time to Expiration	Decrease in Time to Expiration	Increase in the Underlying	Decrease in the Underlying
Long	+	-	+	-	-	+
Short	-	+	-	+	+	-

It is evident from the above illustration that a short put holder benefits from a decrease in implied volatility, a reduced time remaining until expiration, and a rise in the price of the underlying. Meanwhile, an increase in implied volatility, a greater time remaining until expiration, and a decrease in the price of the underlying will benefit the long put holder.

Delta, Gamma, Theta, Vega and Rho are the important Greeks.

Delta: -

Delta is a measure of the change in an option's price (premium of an option) resulting from a change in the underlying security (i.e., stock). The value of Delta ranges from -1 to 0 for puts and 0 to 1 for calls. Puts have a negative delta because they have a "negative relationship" to the underlying: put premiums rise when the underlying decreases, and vice versa. Call options, on the other hand, have a positive relationship to the price of the underlying: if the underlying rises, so does the premium on the call, provided there are no changes in other variables like implied volatility and time remaining until expiration. And if the price of the underlying falls, the premium on a call option, provided all other things remains constant, will decline. An at-the-money option has Delta a value of approximately 0.5, which means the premium will rise or fall by half a point with a 1 point move up or down in the underlying.

As the option gets deep in the money, Delta approaches +1 on a call and -1 on a put, which means that at these extremes there is a one-for-one relationship between changes in the option price and changes in the price of the underlying. In effect, at Delta values of -1 and +1, the option behaves like the underlying in terms of price changes. This occurs with little or no time-value, as most of the value of the option is intrinsic.

Three things to keep in mind with Delta:

(1) Delta tends to increase closer to expiration for near or at-the-money options; (2) Delta is not a constant, and

(3) Delta is subject to change given changes in implied volatility

Gamma: -

Gamma, also known as the first derivative of delta, measures the Rate of change of Delta . When call options are far out of the money, they generally have a small Delta. This is because changes in the underlying bring about only tiny changes in the price of the option. But as the call option gets closer to the money, resulting from a continued rise in the price of the underlying, the Delta gets larger.

Points to keep in mind about Gamma:

(1) Gamma is smallest for far out-of-the-money and deep in-the money options; (2) Gamma is highest when the option gets near the money; and

(3) Gamma is positive for long options and negative for short options.

Theta: -

Theta is an important conceptual dimension. Theta measures the rate of decline of time-premium resulting from the passage of time. In other words, an option premium that is not intrinsic value will decline at an increasing rate as expiration nears.

Points to be considered when trading:

•  Theta can be very high for out-of-the- money options if they contain a lot of implied volatility;

•  Theta is typically highest for at the money options; and

•  Theta will increase sharply in the last few weeks of trading and can severely undermine a long option holder's position, especially if implied volatility is on the decline at the same time.

Vega: -

Vega quantifies risk exposure to implied volatility changes. It tells approximately how much an option price will increase or decrease given an increase or decrease in the level of implied volatility. Option sellers benefit from a fall in implied volatility, and option buyers benefit with rise in implied volatility. The value of Vega itself indicates by how much the position will gain.

For Vega following points need to keep in mind:

•  Vega can increase or decrease even without price changes of the underlying because implied volatility is the level of expected volatility;

•  Vega can increase from quick moves of the underlying, especially if there is a big drop in the stock market and

•  Vega falls, as the option gets closer to expiration.

 

Criteria for Selection of Strategies

 

We are tracking position on few scrips. These scrips are Infosys, Nifty index, Reliance, Satyam and Wipro. Different Strategies chosen for the mentioned scrips are based on certain parameters and prevailing market condition during the particular time period.

For the purpose of deciding strategies, Optionpro software is used. Certain adjustments are made in the particular software, like Trade filter was set at minimum volume of 5 contracts to ensure the liquidity so any contract below 5 would not be accepted in the system and options price below Rs.1 and above Rs. 9999 would not be accepted.

Strategies are based on following parameters: -

•  We are considering Option pro stocks - volatility ratio graph of 6 day to 100 day implied volatility. If graph shows value below 50 than we should be bullish on the particular stock and if the value is above 150 than bearish. If the value falls between 90 and 100 than we need to take Standard Deviation as zero and strategy should be Neutral (Butterfly spread and related strategies can be chosen as Neutral Strategies).

•  Second parameter to consider is of Volatility Ranking. If the volatility ranking of the stock is below 5 than we should chose Buy Premium strategy with Standard Deviation set as +1. Value of Volatility ranking above 5 suggests us to choose Sell Premium strategies with Standard Deviation Set either to Zero or to -1.

Various strategies applicable to different stocks based on above parameters are found with the help of Trade Finders in Optionpro software. Out of the suggested strategies we are tracking only few of them doing special study on the suggested stocks. The strategies chosen are as follows: -

•  Infosys: -

On February 19, 2004, Infosys was trading at Rs. 4959 and volatility rank was 4 because of which price of stock might go up and hence buy premium strategies is the viable strategy. Out of the suggested strategies Bear spread created using calls for Infosys scrip is considered.

•  Nifty: -

Nifty index's position was also taken on February 19, 2004. It was trading at 1853.2 and volatility rank was 8, which suggest taking sell premium strategy since the market is expected to go down in the near future. Out of the suggested strategies Put Ratio Spread on Nifty is taken for analysis.

•  Reliance: -

Position on Reliance was created on February 27, 2004 when it was trading at Rs. 555.60. Volatility rank was 7 and Volatility ratio stood between 90 and 100 which suggested being Neutral on strategies. Based on the parameter Sell Premium strategy was considered. Out of the suggested trade Sell Naked and Condor Spread are to be looked at.

•  Satyam: -

On March 1, 2004 Satyam position was taken. Satyam was trading at Rs.310; volatility rank was 6 suggested to be Sell Premium. Out of the suggested trade, Sell Vertical spread strategy was tracked.

•  Wipro: -

Wipro's position was taken on March 1, 2004. Volatility ratio was 54.13 which was near to 50 and volatility rank was 2 (Standard Deviation set to +1) which recommended Bullish + Buy premium strategy. Out of the suggested trade Buy Vertical + 1 strategy was considered for analysis.

Volatility Impact on Option Price and Position

 

In determining the option price various factors are considered like:

•  Stock Price

•  Strike Price

•  Risk free interest rate

•  Time to expiration and

•  Volatility

Out of the five factors Volatility is the only unknown variable hence it has major impact on determining the option price. It is a measure of the rate and magnitude of the change of prices (up or down) of the underlying. If volatility is high, the premium on the option will be relatively high, and vice versa.

Nifty: -

The position taken on Nifty was as follows applying Ratio spread Strategy.

Long/Short	No. Of contracts	Expiry	Strike Price	Call/Put	Premium
Short	6	Mar-04	1840	Puts	45.5
Long	1	Mar-04	1850	Put	55.05

During the course of observation Nifty has seen high amount of volatility, which is clearly evident from the following table.

Date	Nifty	Net Gain/(Loss) in Rs.	Put Option price at strike price of 1840
20 Feb '04	1853.2	41579	45.5
24 Feb '04	1822.95	-21370	66
27 Feb '04	1804.8	-53300	94
5 Mar '04	1874.75	16330	28.45
8 Mar '04	1885.6	22500	22.35
9 Mar '04	1862	14420	30.5
10 Mar '04	1838.9	4610	40.5
11 Mar '04	1803.1	-11520	57.15
12 Mar '04	1812.45	-5710	50.95
15 Mar '04	1759	-48100	93
16 Mar '04	1745.65	-51670	98
17 Mar '04	1751.85	-61530	105
18 Mar '04	1717.3	-56320	106
19 Mar '04	1727.25	-57410	105
22 Mar '04	1687.45	-114430	159
23 Mar '04	1696.55	-128940	169
24 Mar '04	1694.05	-116810	160

In determining the option price various factors are considered like:

•  Stock Price

•  Strike Price

•  Risk free interest rate

•  Time to expiration and

•  Volatility

Out of the five factors Volatility is the only unknown variable hence it has major impact on determining the option price. It is a measure of the rate and magnitude of the change of prices (up or down) of the underlying. If volatility is high, the premium on the option will be relatively high, and vice versa.

Nifty: -

The position taken on Nifty was as follows applying Ratio spread Strategy.

Long/Short	No. Of contracts	Expiry	Strike Price	Call/Put	Premium
Short	6	Mar-04	1840	Puts	45.5
Long	1	Mar-04	1850	Put	55.05

During the course of observation Nifty has seen high amount of volatility, which is clearly evident from the following table.

Date	Nifty	Net Gain/(Loss) in Rs.	Put Option price at strike price of 1840
20 Feb '04	1853.2	41579	45.5
24 Feb '04	1822.95	-21370	66
27 Feb '04	1804.8	-53300	94
5 Mar '04	1874.75	16330	28.45
8 Mar '04	1885.6	22500	22.35
9 Mar '04	1862	14420	30.5
10 Mar '04	1838.9	4610	40.5
11 Mar '04	1803.1	-11520	57.15
12 Mar '04	1812.45	-5710	50.95
15 Mar '04	1759	-48100	93
16 Mar '04	1745.65	-51670	98
17 Mar '04	1751.85	-61530	105
18 Mar '04	1717.3	-56320	106
19 Mar '04	1727.25	-57410	105
22 Mar '04	1687.45	-114430	159
23 Mar '04	1696.55	-128940	169
24 Mar '04	1694.05	-116810	160

Ratio spread position with Put on Nifty consists of two strike price; lower strike price is 1840 while higher strike price is at 1850. In order to study the impact of Volatility seen on Nifty on Option Price we have consider Option price on lower strike of 1840. From the above illustration it is evident that Put option price on far out of the money option is very less. This trend was seen from 5 th March to 10 th March where option premium was ranging between Rs. 28 to Rs. 40. As Nifty went down below 1840, option on put started to be in the money. As a result of which option price went up and touch the high of Rs. 169 just two days ahead of expiry on March 25.

Profit and loss position on Nifty can be tracked easily from the following graph.

Ratio spread strategy was with one contract on long put at 1840 and 6 short contract on put at 1850 with March expiry. As the Nifty headed southward, the position started making losses because of high number of contracts on short position. Since Nifty went down the buyer of the Put option must have exercised the contract as result of which the trader on short side have to purchase the put contracts at designated price, which was higher than the market hence it resulted into loss. The loss touched the nadir to Rs. 128940 just ahead of two days before expiry when Nifty was at 1696.55. The position saw the profit only for few days when Nifty was trading in the range of 1838 to 1875.

Infosys: -

Buy premium strategy on Infosys is taken with Bear spread on Calls. The position taken on Infosys on March 1 st 2004 looks as follows:

Long/Short	No. Of contracts	Expiry	Strike Price	Call/Put	Premium
Short	81	March-04	5000	Calls	226.8
Long	81	March-04	5100	Calls	183

Whereby we are short on strike price of Rs. 5000 and long on higher strike price of Rs. 5100 on calls with equal number of contracts.

The following table shows the observation made during the course of observation till the expiry of the option contract.

Date	Infosys	Net Gain/Loss	Call Option price at Strike of 5000
3 Mar '04	5205.15	-144180	300
4 Mar '04	5290	-122715	360
5 Mar '04	5235.1	-292815	330
8 Mar '04	5102.15	-81810	249
9 Mar '04	4980	-405	181
10 Mar '04	4854	76140	137
11 Mar '04	4846.1	114240	125
12 Mar '04	5090.05	-68445	182
15 Mar '04	4900	32197	226
16 Mar '04	4917.7	44347	113.7
17 Mar '04	5000.05	-14985	146.9
18 Mar '04	4930	33615	79.35
19 Mar '04	5182	-121905	210.4
22 Mar '04	5100	-70673	128.1
23 Mar '04	5180	-174758	203.7
24 Mar '04	5037	43132	76.45

Infosys has seen greater amount of ups and downs in the course of observation with high point touching at Rs. 5290 and low at Rs. 4846.1. This high amount of volatility has directly impacted the option price on calls. It is clearly evident from the graph that option price has linearly followed the movement in price of Infosys. With increase in price of the Infosys above Rs. 5000, clearly the option becomes more valuable, with option price touching high of Rs. 360 when Infosys was trading Rs. 5290. Decrease in price of the Infosys below Rs. 5000 clearly made it more valuable for the option seller, with price of the option touching as low as Rs. 76.45.

Following graph depicts the net gain/ loss on position taken on Infosys with the help of Bear spread using calls.

With the Short call at Rs. 5000, the option becomes more valuable with the increase in price of the stock. Since we are short on 5000 calls it becomes more valuable if the price of the stock goes below Rs. 5000 which is clearly evident from the graph which shows highest amount of profit when the price of Infosys reached to its lowest before the expiry on 25 th March 2004. The graph clearly depicts that Profit and loss position on Bear spread is symmetric to movement in the Infosys. Gain on the position was recorded only when the Infosys traded below Rs. 5000, since we are short on call at strike price of Rs. 5000 which becomes more valuable to us below Rs. 5000, as we are getting paid the premium for writing the option and buyer of the option lets his option expires as it is trading below Rs. 5000. We will let the Long Position on Call option expires if the stock is trading below Rs. 5100 and the difference between the option premium paid and option premium received is our net gain.

Satyam: -

For Satyam, Sell Vertical Spread is the strategy chosen. The strategy's composition was as follows.

Long/Short	No. Of contracts	Expiry	Strike Price	Call/Put	Premium
Short	64	March-04	320	Calls	13.7
Long	64	March-04	330	Calls	9.85

The position was tracked till the expiry of the option and net gain/loss of the strategic position was as follows:

Date	Satyam	Net Gain/Loss (Rs.)
27 Feb '04	310	269816
3 Mar '04	311.04	23040
4 Mar '04	311.9	11520
5 Mar '04	308	30720
8 Mar '04	302.75	53760
9 Mar '04	296	130560
10 Mar '04	293.7	130560
11 Mar '04	292.85	165120
12 Mar '04	304.7	92160
15 Mar '04	286.8	184320
16 Mar '04	299.8	145920
17 Mar '04	303.25	126720
18 Mar '04	292	21880
19 Mar '04	305.45	115200
22 Mar '04	294.7	234240
23 Mar '04	299.2	264960
24 Mar '04	299.75	284160

The strategy suggested for Satyam is perfect since it has not incurred any loss till the expiry, which depicts that movement in Satyam was favourable for the position. Till the Expiry Satyam moved in the range of 286.8 to 311.9. On every move position has made the profit since adverse movement in the stock was absent. Trader has shorted 320 Calls, the premium received on which is higher than the premium paid for buying 330 Calls and the movement in Satyam was observed below the lower strike price. This made the Short call option worthless for the buyer and trader gets the higher premium to be kept. Trader lets his long option expires worthless for which he has paid premium less than the lower strike price and hence net results into gain.

The above chart shows the trend in the Profit of the position with the movement in the stock of Satyam recording the highest profit at a day ahead of the expiry. The lowest profit was recorded when the stock was trading at 311.

Wipro: -

Directional play on Wipro was made with the help of Buy vertical +1 strategy. This strategy is much superior than buying naked calls or puts and this guarantees the profit. The position taken on Wipro looks like as follows:

Long/Short	No. Of contracts	Expiry	Strike Price	Call/Put	Premium
Short	116	March-04	1500	Calls	43
Long	117	March-04	1470	Calls	44

Following table shows the guaranteed profit potential of the strategy.

Date	Wipro	Net Gain/Loss (Rs.)
3 Mar '04	1524.9	402600
4 Mar '04	1511	800000
5 Mar '04	1479.9	632640
8 Mar '04	1431	341080
9 Mar '04	1422.15	221920
10 Mar '04	1446.1	66080
11 Mar '04	1459.95	35880
12 Mar '04	1468	326000
15 Mar '04	1416	88000
16 Mar '04	1460	165280
17 Mar '04	1461	440000
18 Mar '04	1415.15	84750
19 Mar '04	1422	322010
22 Mar '04	1375.25	5270
23 Mar '04	1395	97000
24 Mar '04	1392	-43500

Wipro has seen high amount of volatility during the course of observation with price ranging from as low as 1375.25 to as high as 1524.9. Irrespective of any directional move by the security the position has made the profit.

The following graph depicts the trend in the profit made by the position with the movement in Wipro.

Wipro price movement was not consistent sometimes it moved in unfavourable direction but because of the strategy's unique structure it always made profit and crossed the border only on a day ahead of expiry. The profit potential is attributable to the unique strategy of buying one extra which ensures that if price moves in a favourable range i.e. in the case of Wipro higher than Rs. 1470 than the trader always makes more than the normal because of buying additional one contract. The profit went up as high as Rs. 800000 when actually Wipro went down from its previous close.

Reliance: -

Reliance position was taken on March 1 st , 2004; the volatility rank was 7 hence we chose sell premium strategy in which we have concentrated only on Sell Naked Option strategy. It was also being observed that volatility ratio vary from 90 to 100 which suggested taking Neutral strategy hence we have considered Condor Spread also.

Naked Option

Long/Short	No. Of contracts	Expiry	Strike Price	Call/Put	Premium
Short	7	March-04	500	Calls	65

Following table shows the Net gain and loss of the Naked position taken on Reliance. This strategy is very dangerous as unlimited amount of loss can be incurred if the price moves in unfavourable direction.

Date	Reliance	Net Gain/Loss (Rs.)	Call Option Price
3 Mar '04	580.7	-84000	85
4 Mar '04	575.05	-46200	76
5 Mar '04	586.35	-81900	84.5
8 Mar '04	598.95	-135240	97.2
9 Mar '04	581.65	-87570	85.85
10 Mar '04	571.7	-43470	75.35
12 Mar '04	564.1	18900	60.5
15 Mar '04	541	75600	47
16 Mar '04	541.7	73500	47.5
18 Mar '04	517.05	178500	22.5
19 Mar '04	523	147420	29.9
22 Mar '04	508.6	217770	13.15
23 Mar '04	511.6	213360	41.2
24 Mar '04	513.25	213570	14.15

The following graph depicts the direct impact of Movement in Reliance on Net Gain/Loss of the naked position. Before Expiry the position has seen high profit of Rs. 217770 when Stock was trading near to strike price. As stock price headed upward position started making losses and seen the maximum loss of Rs. 135240 when the stock was trading at its high of Rs. 598.95.

Graph clearly indicates that the naked position is very dangerous. The profit and loss position is the side mirror replica of the movement in Reliance. As the price of Reliance headed southward, the net profit and loss position started recovering from the losses and headed towards north. This particular strategy has unlimited profit potential provided the price of the stock moves in favourable direction. The risk on the position is also unlimited. If Reliance had continued to move above Rs. 580, unlimited amount of losses would have incurred.

The trend in stock movement was clearly reflected in Call Option price as evident from the following graph.

Condor Spread

Condor spread is a neutral strategy. Profit earned is less but it is extended over the time period between the two strike prices.

Volatility ratio suggests taking Condor spread on Reliance. The position of Reliance Condor spread looks as follows:

Long/Short	No. Of contracts	Expiry	Strike Price	Call/Put	Premium
Long	31	March-04	560	Puts	20.6
Short	31	March-04	540	Puts	11.9
Short	31	March-04	520	Puts	6.75
Long	31	March-04	500	Puts	3.7

Following table shows the net gain and loss position on Condor spread.

Date	Reliance	Net Gain/Loss (Rs.)
3 Mar '04	580.7	-23250
4 Mar '04	575.05	5580
5 Mar '04	586.35	-69750
8 Mar '04	598.95	-59520
9 Mar '04	581.65	-66960
10 Mar '04	571.7	-54870
12 Mar '04	564.1	-34410
15 Mar '04	541	39990
16 Mar '04	541.7	36270
18 Mar '04	517.05	89280
19 Mar '04	523	193440
22 Mar '04	508.6	92070
23 Mar '04	511.6	112530
24 Mar '04	513.25	106950

Condor Spread is the hedging strategy of Butterfly family. Instead of having high amount of profit only at one strike price, the profit potential is stretched across two price ranges. This makes the profit available for the longer time duration. In the case of Reliance the profit potential is stretched between the strike prices of Rs. 520 and Rs. 540. This is clearly evident from the enumerated table also where the highest amount of profit was seen when Reliance was trading at Rs. 523.

Condor spread on Reliance was built with the help of Put option. Put option becomes valuable as the stock price of the underlying decreases from the strike price. The graph clearly depicts that as Reliance moved southward, the position clearly started heading upward and reached high of Rs. 1,93,400.