STRATEGY 3 : LONG PUT: BUY OTM* PUT
*OUT-OF-THE MONEY
Buying a Put is the opposite of buying a Call. When you buy a Call you are bullish about the stock / index. When an investor is bearish, he can buy a Put option. A Put Option gives the buyer of the Put a right to sell the stock (to the Put seller) at a pre-specified price and thereby limit his risk.
A long Put is a
Bearish strategy. To
take advantage of a
falling market an
investor can buy Put
options.
Example:
Mr. XYZ is bearish on Nifty on 15th sept 2010, when the
Nifty is at 5861.50. He buys a Put option with a strike
price Rs. 5800 at a premium of Rs. 56.90, expiring on
30th sept 2010. If the Nifty goes below 5743.10, Mr. XYZ will
make a profit on exercising the option. In case the
Nifty rises above 5800, he can forego the option (it
will expire worthless) with a maximum loss of the
premium.
When to use:
Investor is bearish
about the stock /
index.
Risk: Limited to the
amount of Premium
paid. (Maximum loss if
stock / index expires
at or above the option
strike price).
Reward: Unlimited
Break-even Point:
Stock Price - Premium.
Strategy : Buy Put Option
Current Nifty index 5861.50
Put Option Strike Price (Rs.) 5800
Mr. XYZ Pays Premium (Rs.) 56.90
Break Even Point (Rs.)
(Strike Price - Premium) 5743.10
ANALYSIS: A bearish investor can profit from declining stock price by buying Puts. He
limits his risk to the amount of premium paid but his profit potential remains unlimited. This
is one of the widely used strategy when an investor is bearish.
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