WHEN NIFTY IS VERY BEARISH - STRATEGY 2: SHORT CALL

STRATEGY 2 : SHORT CALL: SELL ITM* CALL

*IN-THE- MONEY

When you buy a Call you are hoping that the underlying stock / index would rise. When you expect the underlying stock / index to fall you do the opposite. When an investor is very bearish about a stock / index and expects the prices to fall, he can sell Call options. This position offers limited profit potential and the possibility of large losses on big advances in underlying prices. Although easy to execute it is a risky strategy since the seller of the Call is exposed to unlimited risk.

A Call option means an Option to buy. Buying a Call option means an investor expects the underlying price of a stock / index to rise in future. Selling a Call option is just the opposite of buying a Call option. Here the seller of the option feels the underlying price of a stock / index is set to fall in the future.

When to use: Investor is very aggressive and he is very bearish about the stock / index.

Risk: Unlimited

Reward: Limited to the amount of premium

Break-even Point: Strike Price + Premium

Example:

Mr. XYZ is bearish about Nifty and expects it to fall. He sells a Call option with a strike price of Rs.5500 at a premium of Rs. 401.90 of Nov 2011 expiry, when the current Nifty is at 5812. If the Nifty stays at 5500 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. 401.90.

Strategy : Sell Call Option

Current Nifty index 5812

Call Option Strike Price (Rs.) 5500 of Nov 2011 expiry

Mr. XYZ receives Premium (Rs.) 401.90

Break Even Point (Rs.) (Strike Price + Premium)* 5901.9

* Breakeven Point is from the point of Call Option Buyer.

ANALYSIS: This strategy is used when an investor is very aggressive and has a strong

expectation of a price fall (and certainly not a price rise). This is a risky strategy since as the stock price / index rises, the short call loses money more and more quickly and losses can be significant if the stock price / index falls below the strike price. Since the investor does not own the underlying stock that he is shorting this strategy is also called Short Naked Call.