STRATEGY 8 : PROTECTIVE CALL / SYNTHETIC LONG PUT: SHORT STOCK + BUY OTM*/ATM* CALL
*OUT-OF-THE MONEY
*AT-THE- MONEY
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. The net effect of this is that the investor creates a pay-off like a Long Put, but instead of having a net debit (paying premium) for a Long Put, he creates a net credit (receives money on shorting the stock). In case the stock price falls the investor gains in the downward fall in the price. However, in case there is an unexpected rise in the price of the stock the loss is limited. The pay-off from the Long Call will increase thereby compensating for the loss in value of the short stock position. This strategy hedges the upside in the stock position while retaining downside profit potential.
When to Use: If the investor is of the view that the markets will go down (bearish) but wants to protect against any unexpected rise in the price of the stock.
Risk: Limited. Maximum Risk is Call Strike Price – Stock Price + Premium
Reward: Maximum is Stock Price – Call Premium
Breakeven: Stock Price – Call Premium
Example :
Suppose NIFTY is trading at Rs. 5920.70 in Oct expiry 2010. An investor Mr. A buys a Rs 6000 Oct 2010 expiry call for Rs. 95.85 while shorting the stock at Rs. 5920.70. The net credit to the investor is Rs. 5824.85 (Rs. 5920.70 – Rs. 95.85).
Strategy : Short Stock + Buy Call Option
Sells Stock (Mr. A receives) Current Market Price (Rs.) 5920.70
Buys Call Strike Price (Rs.) 6000
Mr. A pays Premium (Rs.) 95.85
Break Even Point (Rs.) (Stock Price – Call Premium) 5824.85
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