STRATEGY 1 : LONG CALL (BUY OTM* CALL)
*OUT-OF- THE MONEY
For aggressive investors who are very bullish about the prospects for a stock / index, buying calls can be an excellent way to capture the upside potential with limited downside risk.
Buying a call is the most basic of all options strategies. It constitutes the first options trade for someone already familiar with buying / selling stocks and would now want to trade options.
Buying a call is an easy strategy to understand. When you buy it means you are bullish. Buying a Call means you are very bullish and expect the underlying stock / index to rise in future.
When to Use: Investor is very bullish on the stock / index.
Risk: Limited to the Premium. (Maximum loss if market expires at or below the option strike price).
Reward: Unlimited
Breakeven: Strike Price + Premium
Example
Mr. XYZ is bullish on Nifty on 14th sept, when the Nifty is at 5812.00. He buys a call option with a strike price of Rs. 5900 at a premium of Rs. 36.40, expiring on 30th Spet. If the Nifty goes above 5936.40, Mr. XYZ will make a net profit (after deducting the premium) on exercising the option. In case the Nifty stays at or falls below 5900, he can forego the option (it will expire worthless) with a maximum loss of the premium.
Strategy : Buy Call Option
Current Nifty index 5812
Call Option Strike Price (Rs.) 5900
Mr. XYZ Pays Premium (Rs.) 36.40
Break Even Point (Rs.) (Strike Price + Premium) 5936.40.
ANALYSIS: This strategy limits the downside risk to the extent of premium paid by Mr.
XYZ (Rs. 36.40). But the potential return is unlimited in case of rise in Nifty. A long call
option is the simplest way to benefit if you believe that the market will make an upward
move and is the most common choice among first time investors in Options. As the stock
price / index rises the long Call moves into profit more and more quickly.
STRATEGY 4 : SHORT PUT (SELL OTM* PUT)
*OUT -OF- THE MONEY
Selling a Put is opposite of buying a Put. An investor buys Put when he is bearish on a
stock. An investor Sells Put when he is Bullish about the stock – expects the stock price to rise or stay sideways at the minimum.
When you sell a Put, you earn a Premium (from the buyer of the Put). You have sold someone the right to sell you the stock at the strike price. If the stock price increases beyond the strike price, the short put position will make a profit for the seller by the amount of the premium, since the buyer will not exercise the Put option and the Put seller can retain the Premium (which is his maximum profit). But, if the stock price decreases below the strike price, by more than the amount of the premium, the Put seller will lose money. The potential loss being unlimited (until the stock price fall to zero).
When to Use: Investor is very Bullish on the stock / index. The main idea is to make a short term income.
Risk: Put Strike Price – Put Premium.
Reward: Limited to the amount of Premium received.
Breakeven: Put Strike Price - Premium
Example
Mr. XYZ is bullish on Nifty when it is at 5812 on 14th sept 2010. He sells a Put option with a strike price of Rs. 5700 at a premium of Rs. 41.35 expiring on 30th sept 2010. If the Nifty index stays above 5700, he will gain the amount of premium as the Put buyer won’t exercise his option. In case the Nifty falls below 5700, Put buyer will exercise the option and the Mr. XYZ will start losing money. If the Nifty falls below 5658.65, which is the breakeven point, Mr. XYZ will lose the premium and more depending on the extent of the fall in Nifty.
Strategy : Sell Put Option
Current Nifty index 5812
Put Option Strike Price (Rs.) 5700
Mr. XYZ receives Premium (Rs.) 41.35
Break Even Point (Rs.) (Strike Price - Premium)* 5658.65
* Breakeven Point is from the point of Put Option Buyer.
ANALYSIS: Selling Puts can lead to regular income in a rising or range bound markets. But it should be done carefully since the potential losses can be significant in case the price of the stock / index falls. This strategy can be considered as an income generating strategy.
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