STRATEGY 5 : SYNTHETIC LONG CALL: BUY STOCK + BUY OTM* PUT
*OUT-OF- THE MONEY
In this strategy, 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) or slightly below (OTM strike price).
In case the price of the stock rises you get the full benefit of the price rise. In case the price of the stock falls, exercise the Put Option (remember Put is a right to sell). You have capped your loss in this manner because the Put option stops your further losses. It is a strategy with a limited loss and (after subtracting the Put premium) unlimited profit (from the stock price rise). The result of this strategy looks like a Call Option Buy strategy and therefore is called a Synthetic Call!
But the strategy is not Buy Call Option. Here you have taken an exposure to an underlying stock with the aim of holding it and reaping the benefits of price rise, dividends, bonus rights etc. and at the same time insuring against an adverse price movement. In simple buying of a Call Option, there is no underlying position in the stock but is entered into only to take advantage of price movement in the underlying stock.
When to use: When ownership is desired of stock yet investor is concerned about near-term downside risk. The outlook is conservatively bullish.
Risk: Losses limited to Stock price + Put Premium – Put Strike price
Reward: Profit potential is unlimited.
Break-even Point: Put Strike Price + Put Premium + Stock Price – Put Strike Price
Example
Mr. XYZ is bullish about NIFTY/ STOCK. He buys NIFTY/ STOCK. at current market price of Rs. 5861.50 on 15th sept 2010. To protect against fall in the price of NIFTY/STOCK. (his risk), he buys an NIFTY/STOCK. Put option with a strike price Rs. 5800 (OTM) at a premium of Rs. 56.90 expiring on 30th sept 2010.
Strategy : Buy Stock + Buy Put Option
Buy Stock (Mr. XYZ pays) Current Market Price of NIFTY. (Rs.) 5861.50
Buy Put with Strike Price of 5800 @ Premium (Rs.) 56.90
Break Even Point (Rs.) (Put Strike Price + Put Premium + Stock Price – Put Strike Price)* 5918.4
* Break Even is from the point of view of Mr. XYZ. He has to recover the cost of the Put Option purchase price + the stock price to break even.
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.
STRATEGY 10. COLLAR: BUY STOCK + BUY ATM* PUT + SELL OTM* CALL
*OUT-OF- THE MONEY
*IN-THE MONEY
A Collar is similar to Covered Call (Strategy 6) but involves another leg – buying a Put tov insure against the fall in the price of the stock. It is a Covered Call with a limited risk. So a Collar is buying a stock, insuring against the downside by buying a Put and then financing (partly) the Put by selling a Call. The put generally is ATM and the call is OTM having the same expiration month and must be equal in number of shares. This is a low risk strategy since the Put prevents downside risk. However, do not expect unlimited rewards since the Call prevents that. It is a strategy to be adopted when the investor is conservatively bullish. The following example should make Collar easier to understand.
When to Use: The collar is a good strategy to use if the investor is writing covered calls to earn premiums but wishes to protect himself from an unexpected sharp drop in the price of the underlying security.
Risk: Limited
Reward: Limited
Breakeven: Purchase Price of Underlying – Call Premium + Put Premium
Example
Suppose an investor Mr. A buys or is holding NIFTY. currently trading at Rs. 5861.50. He decides to establish a collar by writing a Call of strike price Rs. 6000 for Rs. 22.65 while simultaneously purchasing a Rs. 5800 strike price Put for Rs. 56.90. Since he pays Rs. 5861.50 for the NIFTY., another Rs. 56.90 for the Put but receives Rs. 22.65 for selling the Call option, his total investment is Rs. 5895.75.
Strategy : Buy Stock + Buy Put + Sell Call
NIFTY Current Market Price (Rs.) 5861.50
Sell Call Option Strike Price (Rs.) 6000
Mr. A Receives Premium (Rs.) 22.65
Buy Put Option Strike Price (Rs.) 5800
Mr. A Pays Premium (Rs.) 56.90
Break Even Point (Rs.) 5895.75
No comments:
Post a Comment