naresh acl2 proj

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PROJECT REPORT

ON OPTIONS THEORY

AT

CENTRUM

IN PARTIAL FULFILLMENT OF THE AWARD OF PDBM SUBMITTED TO

WLCI COLLEGE

BY ACL-2

M.NARESH REDDY

06120071

WLCI COLLEGE

HYDERABAD


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ACKNOWLEDGEMENT


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I take this opportunity to express my deep and sincere gratitude to the

Management of CENTRUM for their gesture of allowing me to undertake this project

and its various employees who lent their hand towards the completion of this study.

The Co-operation I received from the wide cross-section of employee of

CENTRUM makes it difficult to style out individuals for acknowledgment. However,

I am particularly indebted to Mr. R D RAJAN, Project Manager for allowing me to

carry out my project work in the organization.

M.NARESH REDDY


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INTRODUCTION:

A Derivative is a security whose value depends on the value of to gather more

basic underlying variable. These are also known as contingent claims. Derivative

securities have been very successful innovation in capital market.

Derivative is a product whose value is derived from the value of one or more

basic variables, called bases (underlying asset, index, or reference rate), in a

contractual manner.

The underlying asset can be equity, forex, commodity or any other asset.

In the Indian context the Securities Contracts (Regulation) Act, 1956

(SC(R) A) defines "derivative" to include:

A security derived from a debt instrument, share, loan whether

secured or unsecured, risk instrument or contract for differences or any other

form of security.

A contract which derives its value from the prices, or index of prices, of

underlying securities.

Derivatives are securities under the SC(R) A and hence the trading of

derivatives is governed by the regulatory framework under the SC(R) A.

Introduction to Derivatives:

The emergence of the market for derivative products, most notably forwards,

futures and options, can be traced back to the willingness of risk-averse economic

agents to guard themselves against uncertainties arising out of fluctuations in asset

prices. By their very nature, the financial markets are marked by a very high degree of

volatility. Through the use of derivative products, it is possible to partially or fully

transfer price risks by locking-in asset prices. As instruments of risk management,


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these generally do not influence the fluctuations in the underlying asset prices.

However, by locking in asset prices, derivative products minimize the impact of

fluctuations in asset prices on the profitability and cash flow situation of risk-averse

investors.

Emergence of financial derivative products:

Derivative products initially emerged as hedging devices against fluctuations

in commodity prices, and commodity-linked derivatives remained the sole form of

such products for almost three hundred years. Financial derivatives came into

spotlight in the post-1970 period due to growing instability in the financial markets.

However, since their emergence, these products have become very popular and by

1990s, they accounted for about two-thirds of total transactions in derivative products.

In recent years, the market for financial derivatives has grown tremendously in terms

of variety of instruments available, their complexity and also turnover. In the class of

equity derivatives the world over, futures and options on stock indices have gained

more popularity than on individual stocks, specially among institutional investors,

who are major users of index-linked derivatives. Even small investors find these

useful due to high correlation of the popular indexes with various portfolios and ease

of use.


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Factors Driving the Growth of Derivatives:

Over the last three decades, the derivatives market has seen a phenomenal

growth. A large variety of derivative contracts have been launched at exchanges

across the world.

Some of the factors driving the growth of financial derivatives are:

Increased volatility in asset prices in financial markets,

Increased integration of national financial markets with the international

markets,

Marked improvement in communication facilities and sharp decline in their

costs,

Development of more sophisticated risk management tools, providing

economic agents a wider choice of risk management strategies, and

Innovations in the derivatives markets, which optimally combine the risks and

returns over a large number of financial assets leading to higher returns, reduced risk

as well as transactions costs as compared to individual financial assets.

OBJECTIVES OF STUDY:

To study various trends in derivative market.

1. Comparison of the profits/losses in cash market and derivative market.

2. To find out profit/losses position of the option writer and option

holder.

3. To study in detail the role of the options


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4. To study the role of derivatives in Indian financial market.

5. To seek the knowledge in Derives

6. To know about the Options Trading Procedure

7. To know the Methods/Strategies/Styles in Options Trading

8. To know to whom it is useful

9. To know the players in Options World

SCOPE OF THE STUDY:

The study is limited to derivatives with special reference to options in the

Indian context the study is not based on the international perspective of derivative

markets.

LIMITATIONS OF THE STUDY:

As the information related to option strategies are very confidential in nature

because these are the techniques that the investor will use the strategies to get profit

by exercising the options. So, I did analysis of option strategies only two common

strategies that are used by the investors regularly i.e., LONG PUT and LONG

COMBO.


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Company profile

Centrum

Centrum is jointly promoted by Mr. Chandir Gidwani, a Chartered

Accountant, having more than a decade of experience in the financial services

industry & The Cassinath Group, promoted by late Mr. Khushroo P. Byramjee.

Centrum was incorporated in 1977. It is a SEBI registered Category I

Merchant Banker, listed on The Stock Exchange, Mumbai (BSE). Over the last two

decades, it has expanded into a full-service investment banking company. Today its

primary role is that of a responsible intermediary with a strong professional base. Its

forte is providing advisory and innovatively structured financial solutions in the area

of fund raising, infrastructure development, government borrowing, corporate

restructuring and money market intermediation. Centrum has the experience of raising

over Rs.8,05,000 million (US $ 17,300 million) through equity, bonds and creditsyndication in the last 5 years. This can be attributed to its excellent relationship

across a wide spectrum of private and public sector banks, FIs, provident funds,

charitable organizations and institutional investors across India.

Centrum Capital Ltd. and its group subsidiaries, FCH CentrumDirect Ltd,

Centrum Broking Pvt. Ltd., FCH Centrum Wealth Managers Limited and CentrumInfrastructure & Realty Ltd. provide value added products and services to corporates

and individuals across the country in both the Private and the Public sector.

Centrum Services comprise investment banking, wealth management,

portfolio management, stock broking, foreign exchange, travel services and

infrastructure & real estate advisory services. As a leading financial services firm it


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strives to promote a corporate culture promoting world-class banking services for our

clients and value for our shareholders.

Centrum Group of Companies:

Centrum Capital Ltd. (CCL) is a leading investment bank offering

comprehensive financial services comprising fund raising by way of equity and debt

for corporates, Government undertakings and state entities.

CentrumDirect Ltd. (CDL) is amongst the top retail money changers in the

country authorized by the Reserve bank of India. It does money changing for retail

and corporate travelers and is also involved in wholesale foreign exchange business

like export of currency.

Centrum Broking Private Ltd. (CBPL) is an associate of CCL, has set-up an

integrated stock broking business in the last few years. The Company is a member of

BSE and National Exchange (NSE) on both cash and derivatives segments. It is also a

Depository Participant under Central Depository Services Limited (CDSL) and a

Portfolio Manager registered with Securities Exchange Board of India (SEBI).

Your window to the Stock Market

Centrum is a full-service Broking House having memberships in the Cash and

F&O segments of the Bombay Stock Exchange Limited (BSE), the National Stock

Exchange of India Ltd (NSE) and the NCDEX, offering comprehensive personal

financial solutions to a cross-section of clients comprising of High Net Worth

Individuals, Corporates, NRIs, FIIs, Mutual Funds, Insurance Companies, Banks

and other Financial Institutions. Centrum is also a Depository participant with CDSL

and a SEBI registered Portfolio Manager.


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Minimizing Risks, Maximizing Returns

Centrum is dedicated to creating growth-oriented investment solutions tailored

to suit your individual financial needs and goals. It is committed to minimizing the

risks involved in investing in the stock markets through careful fundamental,

quantitative and technical analysis of the various investment options available and

selecting the ones that optimize client returns.

Centrums adherence to high ethical standards along with its credible

relationships with major leading banks and financial institutions has made it the most

preferred broker with many clients for institutional trading and derivatives. It also has

a dedicated team focusing on hedging and arbitrage strategies for investors with

special needs.

Moreover, Centrums dedicated HNI Cell offers research-based advice to

affluent individuals and families to help them manage and multiply their wealth. The products and services covered are mutual funds, IPOs, insurance, forex, fixed

income, discretionary and non-discretionary PMS, equity and commodities trading in

India and Dubai.

Centrum Wealth Managers Ltd. (CWML) is the Retail broking,

Distribution, Insurance & Portfolio management arm of CCL.

Centrum Infrastructure & Realty Ltd. (CIRL) it offers infrastructure and real

estate advisory services to facilitate investment, development and setting up of

infrastructure facilities including real estate projects.

Casby Logistics Pvt. Ltd. (CLPL) is a firm incorporated in 1857, is one of the

largest Stevedores of the Bombay Port. The business interests of the firm span


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transportation, clearing & forwarding, couriers, logistics and supply chain

management services. They are the local partner for P&O Ports, Australia.

Our mission

To become the first-choice investment banker

To provide uniquely tailored solutions for 100% of the financial services

needs of both corporate and individuals

To challenge the obvious solutions and provide financial consultancy and

syndicated products, which deliver value beyond customer expectations

To this end Centrum has over the years built a very strong foundation by

investing heavily for the future. It has invested in high quality talent, technology that

drives business and state- of-the art infrastructure to extend its reach further.

Centrum today is not only amongst Indias top 10 fund mobilisers but also has

the distinction of being amongst the top 3 retail money changers in the country. It is

also one of the fastest growing wealth managers in the country. Centrum has reached

the position of being a unique financial services company that draws strength from

each one of its business units and builds on it.

Centrum products & services

Centrum broking

A full-service broking house, Centrum offers comprehensive financial

solutions to a cross-section of clients comprising high net-worth individuals,

corporates, NRIs, FIIs, Mutual Funds, Insurance Companies, Banks and other

financial institutions.


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Its research-based advice on potential investment options ensures the best

possible returns on investments. Moreover, through its dedicated HNI Cell, Centrum

provides both, discretionary and non-discretionary Portfolio Management Services to

investors.

Its association with various stock exchanges and organizations facilitate their

operations:

Cash and F&O segments of the Bombay Stock Exchange Limited (BSE) and

the National Stock Exchange of India Limited (NSE). Depository participant with CSDL.

SEBI registered portfolio manager.

Membership on NCDEX.

In a nutshell, Centrum is a one-stop shop for all your stock market needs:

stock broking, portfolio management and depository services.

Centrum capital

Equity

Centrum provides complete financial solutions to companies in high-growth

markets on their capitalization/re-capitalization strategies. It has raised funds for both,

public and private corporates and is adept in dealing with the issues specific to each of

these environments. From advising on capital structuring, to raising equity,

preparation of the prospectus to post-issue assistance, Centrum provides

comprehensive services that has made it one of the most preferred financial services

providers.


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Suggesting an optimal mix of debt and equity

Advising on capital structuring

Advising on the best options to raise equity and the instrument

Public Issues (IPOs), Follow on Offerings and Right Issues

Private Placement of Equity

Corporate Advisory Services

Share Buyback and Open Offers

Credit syndicate

Centrum has been instrumental in arranging loans for Corporate, PSUs, State

Finance Corporations, etc. across India with the principal focus being infrastructure

funding. Over the last 5 years, it has successfully syndicated over Rs. 1, 20,000

million (US$ 2600 million) for blue chip clients.

Empowered by a team of experienced management professionals spreadacross seven major states, Centrum has syndicated loans across diverse sectors, which

include Power, Roadways, Irrigation, Urban Development, Processed Foods,

Specialty Chemicals, Renewable Energy, FMCG, Mining, Pharmaceuticals,

Entertainment and Media.

Fixed income

Centrums core expertise lies in arranging resources for clients comprising

major Public and Private Banks, PSUs, Government Undertakings, and Private Sector

Corporate. In the last 5 years, it has successfully structured, distributed and placed

public and private debts of over Rs. 6,50,000 million (US$ 14,000 million) and is

ranked the 4th highest mobilize of funds on all-India basis for the FY 2005-2006

(Source: League Tables - Prime Database).


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Centrums team of management professionals helps its clients to structure

their debts to meet short and long term financial objectives. Reputable and long-

standing relationships with the investing community: Banks, Mutual Funds, Provident

funds, etc., enables Centrum to raise debts on competitive terms in record time,

irrespective of its size.

Centrum direct

Forex

Centrum is one of the leading RBI authorised moneychangers in India. With

its team of highly trained and experienced professionals, Centrum serves leading

Multinationals, PSUs, Government establishments and Banks and large Tour

Operators across the country through its branches located in all major cities. It

serviced over 300,000 clients in FY 2005-06 resulting in a turnover of US$ 187

million.

Centrum, with its presence at Airports, has positioned its branches in all major

tourist destinations to provide encashment facilities to inbound travellers.

It understands the needs of outbound travellers and is the countrys largest

retailer of Co-branded Prepaid Travel Cards. At the same time, Centrum provides

option to the travellers for the American Express Traveller Cheques in 6 destination

currencies: USD, GBP, EURO, JPY, AUD and CAD.

Investments

Centrum understands the needs of customized investment solutions for its

affluent clients, their families and businesses. Through its dedicated HNI Cell, it

assiduously analyzes clients financial objectives and creates a customized strategy to


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meet those targets. The process draws on its effective research capabilities that are

resilient to changing market conditions.

Centrums investment discipline recognizes the importance of strategic asset

allocation and the flexibility to select from diverse investment strategies to achieve

short and long term financial goals. Relying on this principle, its team of experienced

professionals, which includes MBAs, CAs and CFAs, determine an ideal investment

plan that achieves: the best possible returns, an acceptable level of risk, and sufficient

financial freedom to accommodate ones future growth plans.

Insurance

Insurance is now emerging as an integral part of any investment plan. It not

only protects you from the uncertainties of life but also gives you competitive

stipulated returns.

Centrum offers insurance advisory services that help its clients to balance risk

as well as achieve their financial goals in the event of an unexpected occurrence.

After analyzing the risk profile, expected cover, and anticipated returns, Centrum

designs an ideal insurance plan that provides a simple, cost-effective solution to a

wide range of business needs, from risk management and compensation to business

continuation. It combines long-term stability with the flexibility to respond as theneeds change.

Life Insurance

Unit Linked Insurance Plans (ULIP): Unique combination of security from life

insurance and earnings from investments.


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Money Back Plans: Periodic payment of certain percentage of sum assured is

made at regular intervals.

Endowment Plans: Covers life for a predetermined amount i.e. the sum

assured.

Whole-life plans: Provides insurance cover till 100 years of age or death

whichever is earlier.

Pension Plans: Regular pension comes to policyholder after retirement till

his/her death.

Children Plans: Designed to secure your childs future by giving your child

(the beneficiary) a guaranteed lump sum, on maturity or in case of unfortunate

demise of the policy-holder.

Term Plans: Offers high death benefit at low premium but no maturity

benefit.


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Derivative Products:

Derivative contracts have several variants. The most common variants are

forwards, futures, options and swaps. We take a brief look at various derivatives

contracts that have come to be used.

Forwards:

A forward contract is a customized contract between two entities, where

settlement takes place on a specific date in the future at today's pre-agreed price.

Futures:

A futures contract is an agreement between two parties to buy or sell an asset

at a certain time in the future at a certain price. Futures contracts are special types of

forward contracts in the sense that the former are standardized exchange-traded

contracts.

Options:

Options are of two types - calls and puts. Calls give the buyer the right but not

the obligation to buy a given quantity of the underlying asset, at a given price on or

before a given future date. Puts give the buyer the right, but not the obligation to sell a

given quantity of the underlying asset at a given price on or before a given date.

Warrants:

Options generally have lives of upto one year; the majority of options traded

on options exchanges having a maximum maturity of nine months. Longer-dated

options are called warrants and are generally traded over-the-counter.

LEAPS:

The acronym LEAPS means Long-Term Equity Anticipation Securities. These

are options having a maturity of upto three years.


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Baskets:

Basket options are options on portfolios of underlying assets. The underlying

asset is usually a moving average of a basket of assets. Equity index options are a

form of basket options.

Swaps:

Swaps are private agreements between two parties to exchange cash flows in

the future according to a prearranged formula. They can be regarded as portfolios of

forward contracts.

Interest rate swaps: These entail swapping only the interest related cash

flows between the parties in the same currency.

Currency swaps: These entail swapping both principal and interest between

the parties, with the cash flows in one direction being in a different currency

than those in the opposite direction.

Swaptions:

Swaptions are options to buy or sell a swap that will become operative at the

expiry of the options. Thus a swaption is an option on a forward swap. Rather than

have calls and puts, the swaptions market has receiver swaptions and payer swaptions.

A receiver swaption is an option to receive fixed and pay floating. A payer swaption

is an option to pay fixed and receive floating.

Participants in the Derivatives Markets:

The following three broad categories of participants:

Hedgers,

Speculators, and

Arbitrageurs.


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HEDGERS:

Hedgers face risk associated with the price of an asset. They use futures or

options markets to reduce or eliminate this risk.

SPECULATORS:

Speculators wish to bet on future movements in the price of an asset. Futures

and options contracts can give them an extra leverage; that is, they can increase both

the potential gains and potential losses in a speculative venture.

ARBITRAGEURS:

Arbitrageurs are in business to take advantage of a discrepancy between prices

in two different markets. If, for example, they see the futures price of an asset getting

out of line with the cash price, they will take offsetting positions in the two markets to

lock in a profit.

NSE'S Derivatives Market:

The derivatives trading on the NSE commenced with S&P CNX Nifty Index

futures on June 12, 2000. The trading in index options commenced on June 4, 2001

and trading in options on individual securities commenced on July 2, 2001. Single

stock futures were launched on November 9, 2001. Today, both in terms of volume

and turnover, NSE is the largest derivatives exchange in India. Currently, the

derivatives contracts have a maximum of 3-month expiration cycles. Three contracts

are available for trading, with 1 month, 2 months and 3 months expiry. A new

contract is introduced on the next trading day following the expiry of the near month

contract...


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Forward Contracts:

A forward contract is an agreement to buy or sell an asset on a specified date

for a specified price. One of the parties to the contract assumes a long position and

agrees to buy the underlying asset on a certain specified future date for a certain

specified price. The other party assumes a short position and agrees to sell the asset on

the same date for the same price. Other contract details like delivery date, price and

quantity are negotiated bilaterally by the parties to the contract. The forward contracts

are normally traded outside the exchanges.

The salient features of forward contracts are:

They are bilateral contracts and hence exposed to counter-party risk.

Each contract is custom designed, and hence is unique in terms of contract

size, expiration date and the asset type and quality.

The contract price is generally not available in public domain.

On the expiration date, the contract has to be settled by delivery of the asset.

Forward markets world-wide are afflicted by several problems:

Lack of centralization of trading,

Illiquidity, and

Counterparty risk

In the first two of these, the basic problem is that of too much flexibility and

generality. The forward market is like a real estate market in that any two consenting

adults can form contracts against each other. This often makes them design terms of

the deal which are very convenient in that specific situation, but makes the contracts

non-tradable.

Counterparty risk arises from the possibility of default by any one party to the

transaction. When one of the two sides to the transaction declares bankruptcy, the


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other suffers. Even when forward markets trade standardized contracts, and hence

avoid the problem of illiquidity, still the counterparty risk remains a very serious

issue.


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Introduction to Futures:

Futures markets were designed to solve the problems that exist in forward

markets. A futures contract is an agreement between two parties to buy or sell an asset

at a certain time in the future at a certain price. But unlike forward contracts, the

futures contracts are standardized and exchange traded. To facilitate liquidity in the

futures contracts, the exchange specifies certain standard features of the contract. It is

a standardized contract with standard underlying instrument, a standard quantity and

quality of the underlying instrument that can be delivered, (or which can be used for

reference purposes in settlement) and a standard timing of such settlement. A futures

contract may be offset prior to maturity by entering into an equal and opposite

transaction. More than 99% of futures transactions are offset this way.

The standardized items in a futures contract are:

Quantity of the underlying

Quality of the underlying

The date and the month of delivery

The units of price quotation and minimum price change

Location of settlement


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Introduction To Options:

Options are fundamentally different from forward and futures contracts. An

option gives the holder of the option the right to do something. The holder does not

have to exercise this right. In contrast, in a forward or futures contract, the two parties

have committed themselves to doing something. Whereas it costs nothing (except

margin requirements) to enter into a futures contract, the purchase of an option

requires an up-front payment.

Option Terminology:

Index options :

These options have the index as the underlying. Some options are European

while others are American. Like index futures contracts, index options contracts are

also cash settled.

Stock options:

Stock options are options on individual stocks. Options currently trade on over

500 stocks in the United States. A contract gives the holder the right to buy or sell

shares at the specified price.

Buyer of an option:

The buyer of an option is the one who by paying the option premium buys the

right but not the obligation to exercise his option on the seller/writer.

Writer of an option :

The writer of a call/put option is the one who receives the option premium

and is thereby obliged to sell/buy the asset if the buyer exercises on him.

Types of Options :

Call Options and

Put Options.


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Call option :

A call option gives the holder the right but not the obligation to buy an asset

by a certain date for a certain price.

Put option:

A put option gives the holder the right but not the obligation to sell an asset by

a certain date for a certain price.

Option Styles:

American options:

American options are options that can be exercised at any time up to

the expiration date. Most exchange-traded options are American.

European options:

European options are options that can be exercised only on the

expiration date itself. European options are easier to analyze than American

options, and properties of an American option are frequently deduced from

those of its European counterpart.

Option price/premium:

Option price is the price which the option buyer pays to the option seller. It is

also referred to as the option premium.

Expiration date :

The date specified in the options contract is known as the expiration date, the

exercise date, the strike date or the maturity.

Strike price:

The price specified in the options contract is known as the strike price or the

exercise price.


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In-the-money option:

An in-the-money (ITM) option is an option that would lead to a positive cash

flow to the holder if it were exercised immediately. A call option on the index is said

to be in-the-money when the current index stands at a level higher than the strike

price (i.e. spot price > strike price). If the index is much higher than the strike price,

the call is said to be deep ITM. In the case of a put, the put is ITM if the index is

below the strike price.

At-the-money option:

An at-the-money (ATM) option is an option that would lead to zero cash flow

if it were exercised immediately. An option on the index is at-the-money when the

current index equals the strike price (i.e. spot price = strike price).

Out-of-the-money option:

An out-of-the-money (OTM) option is an option that would lead to a negative

cash flow if it were exercised immediately. A call option on the index is out-of-the-

money when the current index stands at a level which is less than the strike price (i.e.

spot price < strike price). If the index is much lower than the strike price, the call is

said to be deep OTM. In the case of a put, the put is OTM if the index is above the

strike price.

Intrinsic value of an option:

The option premium can be broken down into two components - intrinsic

value and time value. The intrinsic value of a call is the amount the option is ITM, if it

is ITM. If the call is OTM, its intrinsic value is zero. Putting it another way, the

intrinsic value of a call is Max [0, (St K)] which means the intrinsic value of a call

is the greater of 0 or (St K). Similarly, the intrinsic value of a put is Max [0, K

St ], i.e.


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The greater of 0 or (K St). K is the strike price and St is the spot price.

Time value of an option:

The time value of an option is the difference between its premium and its

intrinsic value. Both calls and puts have time value. An option that is OTM or ATM

has only time value. Usually, the maximum time value exists when the option is

ATM. The longer the time to expiration, the greater is an option's time value, all else

equal. At expiration, an option should have no time value.


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Option Strategy:

In finance an option strategy is the purchase and/or sale of one or

various option positions and possibly an underlying position.

Options strategies can favor movements in the underlying that are bullish,

bearish or neutral. In the case of neutral strategies, they can be further classified into

those that are bullish on volatility and those that are bearish on volatility. The option

positions used can be long and/or short positions in calls and/or puts at various strikes .

Bullish strategies

Bullish options strategies are employed when the options trader expects the

underlying stock price to move upwards. It is necessary to assess how high the stock

price can go and the time frame in which the rally will occur in order to select the

optimum trading strategy.

Bearish strategies

Bearish options strategies are the mirror image of bullish strategies. They are

employed when the options trader expects the underlying stock price to move

downwards. It is necessary to assess how low the stock price can go and the time

frame in which the decline will happen in order to select the optimum trading

strategy.
http://en.wikipedia.org/wiki/Financehttp://en.wikipedia.org/wiki/Option_(finance)http://en.wikipedia.org/wiki/Underlyinghttp://en.wikipedia.org/wiki/Long_(finance)http://en.wikipedia.org/wiki/Short_(finance)http://en.wikipedia.org/wiki/Call_optionhttp://en.wikipedia.org/wiki/Put_optionhttp://en.wikipedia.org/wiki/Strike_(finance)http://en.wikipedia.org/wiki/Financehttp://en.wikipedia.org/wiki/Option_(finance)http://en.wikipedia.org/wiki/Underlyinghttp://en.wikipedia.org/wiki/Long_(finance)http://en.wikipedia.org/wiki/Short_(finance)http://en.wikipedia.org/wiki/Call_optionhttp://en.wikipedia.org/wiki/Put_optionhttp://en.wikipedia.org/wiki/Strike_(finance)


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Option Strategies:

There are 22 option strategies dealing with options they are as follows:

STRATEGY 1 : LONG CALL

STRATEGY 2 : SHORT CALL

STRATEGY 3 : SYNTHETIC LONG CALL

STRATEGY 4 : LONG PUT

STRATEGY 5 : SHORT PUT

STRATEGY 6 : COVERED CALL

STRATEGY 7 : LONG COMBO

STRATEGY 8 : PROTECTIVE CALL

STRATEGY 9 : COVERED PUT

STRATEGY 10 : LONG STRADDLE

STRATEGY 11 : SHORT STRADDLE

STRATEGY 12 : LONG STRANGLE

STRATEGY 13. SHORT STRANGLE

STRATEGY 14. COLLAR

STRATEGY 15. BULL CALL SPREAD STRATEGY

STRATEGY 16. BULL PUT SPREAD STRATEGY

STRATEGY 17 : BEAR CALL SPREAD STRATEGY

STRATEGY 18 : BEAR PUT SPREAD STRATEGY

STRATEGY 19: LONG CALL BUTTERFLY

STRATEGY 20 : SHORT CALL BUTTERFLY

STRATEGY 21: LONG CALL CONDOR

STRATEGY 22 : SHORT CALL CONDOR


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1. Long Call strategy:

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

2. Short Call

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


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3: SYNTHETIC LONG CALL: BUY STOCK, BUY PUT:

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

4: Long Put Strategy :

A long Put is a Bearish strategy. To take advantage of a falling market an

investor can buy Put options.

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

5: Short put

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


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6: Covered Call:

When to Use: This is often employed when an investor has a short-term neutral to

moderately bullish view on the stock he holds. He takes a short position on the Call

option to generate income from the option premium. Since the stock is purchased

simultaneously with writing (selling) the Call, the strategy is commonly referred to as

buy-write.

Risk: If the Stock Price falls to zero, the investor loses the entire value of the Stock

but retains the premium, since the Call will not be exercised against him.

So maximum risk = Stock Price Paid Call Premium

Upside capped at the Strike price plus the Premium received. So if the Stock rises

beyond the Strike price the investor (Call seller) gives up all the gains on the stock.

Reward: Limited to (Call Strike Price Stock Price paid) + Premium received

Breakeven: Stock Price paid - Premium Received

Strategy: 7: Long Combo: Sell a put and buy a call :

A Long Combo is a Bullish strategy. If an investor is expecting the price of a

stock to move up he can do a Long Combo strategy. It involves selling an OTM

(lower strike) Put and buying an OTM (higher strike) Call. This strategy simulates the

action of buying a stock (or futures) but at a fraction of the stock price. It is an

inexpensive trade, similar in pay-off to

Long Stock, except there is a gap between the strikes (please see the payoff

diagram). As the stock price rises the strategy starts making profits.

When to Use: Investor is Bullish on the stock.


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Risk: Unlimited (Lower Strike+ net debit)

Reward: Unlimited

Breakeven: Higher strike + net debit

Strategy 8: Protective Call / Synthetic Long Put

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, incase 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

Strategy 9: Covered Put:

This strategy is opposite to a Covered Call. A Covered Call is a neutral to

bullish strategy, whereas a Covered Put is a neutral to Bearish strategy. You do this

strategy when you feel the price of a stock / index is going to remain range bound or


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move down. Covered Put writing involves a short in a stock / index along with a short

Put on the options on the stock / index.

The Put that is sold is generally an OTM Put. The investor shorts a stock

because he is bearish about it, but does not mind buying it back once the price reaches

(falls to) a target price. This target price is the price at which the investor shorts the

Put (Put strike price). Selling a Put means, buying the stock at the strike price if

exercised. If the stock falls below the Put strike, the investor will be exercised and

will have to buy the stock at the strike price (which is anyway his target price to

repurchase the stock). The investor makes a profit because he has shorted the stock

and purchasing it at the strike price simply closes the short stock position at a profit.

And the investor keeps the Premium on the Put sold. The investor is covered here

because he shorted the stock in the first place.

When to Use: If the investor is of the view that the markets are moderately bearish.

Risk: Unlimited if the price of the stock rises substantially

Reward: Maximum is (Sale Price of the Stock Strike Price) + Put Premium

Breakeven: Sale Price of Stock + Put Premium

Strategy 10: Long Straddle

A Straddle is a volatility strategy and is used when the stock price / index is

expected to

show large movements. This strategy involves buying a call as well as put on the

same stock / index for the same maturity and strike price, to take advantage of a

movement in either direction, a soaring or plummeting value of the stock / index. If

the price of the stock / index increases, the call is exercised while the put expires

worthless and if the price of the stock / index decreases, the put is exercised, the call


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expires worthless. Either way if the stock / index shows volatility to cover the cost of

the trade, profits are to be made. With Straddles, the investor is direction neutral. All

that he is looking out for is the stock / index to break out exponentially in either

direction.

When to Use: The investor thinks that the underlying stock / index will experience

significant volatility in the near term.

Risk: Limited to the initial premium paid.

Reward: Unlimited

Breakeven:

Upper Breakeven Point = Strike Price of Long Call + Net Premium Paid

Lower Breakeven Point = Strike Price of Long Put - Net Premium Paid

Strategy 11: Short straddle:

A Short Straddle is the opposite of Long Straddle. It is a strategy to be adopted

when the investor feels the market will not show much movement. He sells a Call and

a Put on the same stock / index for the same maturity and strike price. It creates a net

income for the investor. If the stock / index does not move much in either direction,

the investor retains the Premium as neither the Call nor the Put will be exercised.

However, incase the stock / index moves in either direction, up or down significantly,the investors losses can be significant. So this is a risky strategy and should be

carefully adopted and only when the expected volatility in the market is limited. If the

stock / index value stays close to the strike price on expiry of the contracts, maximum

gain, which is the Premium received is made.


very little volatility in the near term.


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Risk: Unlimited

Reward: Limited to the premium received

Breakeven:

Upper Breakeven Point = Strike Price of Short Call + Net Premium Received

Lower Breakeven Point = Strike Price of Short Put - Net Premium Received

Strategy 12: Long Strangle :

A Strangle is a slight modification to the Straddle to make it cheaper to

execute. This strategy involves the simultaneous buying of a slightly out-of-the-

money (OTM) put and a slightly out-of-the-money (OTM) call of the same underlying

stock / index and expiration date. Here again the investor is directional neutral but is

looking for an increased volatility in the stock / index and the prices moving

significantly in either direction. Since OTM options are purchased for both Calls and

Puts it makes the cost of executing a Strangle cheaper as compared to a Straddle,

where generally ATM strikes are purchased. Since the initial cost of a Strangle is

cheaper than a Straddle, the returns could potentially be higher. However, for a

Strangle to make money, it would require greater movement on the upside or

downside for the stock / index than it would for a Straddle. As with a Straddle, the

strategy has a limited downside (i.e. the Call and the Put premium) and unlimited

upside potential.


very high levels of volatility in the near term.


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Risk: Limited to the initial premium paid

Reward: Unlimited

Breakeven:

Upper Breakeven Point = Strike Price of Long Call + Net Premium Paid

Lower Breakeven Point = Strike Price of Long Put - Net Premium Paid

Strategy 13: Short strangle

A Short Strangle is a slight modification to the Short Straddle. It tries to

improve the profitability of the trade for the Seller of the options by widening the

breakeven points so that there is a much greater movement required in the underlying

stock / index, for the Call and Put option to be worth exercising. This strategy

involves the simultaneous selling of a slightly out-of-the-money (OTM) put and a

slightly out-of-the-money (OTM) call of the same underlying stock and expiration

date. This typically means that since OTM call and put are sold, the net credit

received by the seller is less as compared to a Short Straddle, but the break even

points are also widened. The underlying stock has to move significantly for the Call

and the Put to be worth exercising. If the underlying stock does not show much of a

movement, the seller of the Strangle gets to keep the Premium.

When to Use: This options trading strategy is taken when the options investor thinksthat the underlying stock will experience little volatility in the near term.

Risk: Unlimited

Reward: Limited to the premium received

Breakeven:

Upper Breakeven Point = Strike Price of Short Call + Net Premium Received

Lower Breakeven Point = Strike Price of Short Put - Net Premium Received


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Strategy 14: Collar:

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.

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

Strategy 15: Bull call spread strategy:

In this strategy the investor will Buy call option, sell call option

A bull call spread is constructed by buying an in-the-money (ITM) call option,

and selling another out-of-the-money (OTM) call option. Often the call with the lower

strike price will be in-the-money while the Call with the higher strike price is out-of-

the-money. Both calls must have the same underlying security and expiration month.

When to Use: Investor is moderately bullish.


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Risk: Limited to any initial premium paid in establishing the position. Maximum loss

occurs where the underlying falls to the level of the lower strike or below.

Reward: Limited to the difference between the two strikes minus net premium cost.

Maximum profit occurs where the underlying rises to the level of the higher strike or

above

Break-Even-Point (BEP): Strike Price of Purchased call + Net Debit Paid

Strategy 16: Bull put spread strategy:

In this strategy the investor will Sell put option, buy put option

A bull put spread can be profitable when the stock / index is either range

bound or rising. The concept is to protect the downside of a Put sold by buying a

lower strike Put, which acts as an insurance for the Put sold. The lower strike Put

purchased is further OTM than the higher strike Put sold ensuring that the investor

receives a net credit, because the Put purchased (further OTM) is cheaper than the Put

sold.

When to Use: When the investor is moderately bullish.

Risk: Limited. Maximum loss occurs where the underlying falls to the level of the

lower strike or below

Reward: Limited to the net premium credit Maximum profit occurs where underlying

rises to the level of the higher strike or above.

Breakeven: Strike Price of Short Put - Net Premium Received


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Strategy 17: Bear Call Spread Strategy:

In this the investor will sell ITM call, buy OTM call

The Bear Call Spread strategy can be adopted when the investor feels that the

stock / index is either range bound or falling. The concept is to protect the downside

of a Call Sold by buying a Call of a higher strike price to insure the Call sold. In this

strategy the investor receives a net credit because the Call he buys is of a higher strike

price than the Call sold. The strategy requires the investor to buy out-of-the-money

(OTM) call options while simultaneously selling in-the-money (ITM) call options on

the same underlying stock index.

This strategy can also be done with both OTM calls with the Call purchased

being higher OTM strike than the Call sold. If the stock / index falls both Calls will

expire worthless and the investor can retain the net credit. If the stock / index rises

then the breakeven is the lower strike plus the net credit. Provided the stock remains

below that level, the investor makes a profit. Otherwise he could make a loss. The

maximum loss is the difference in strikes less the net credit received.

When to use : When the investor is mildly bearish on market.

Risk : Limited to the difference between the two strikes minus the net premium.

Reward : Limited to the net premium received for the position i.e., premium received

for the short call minus the premium paid for the long call.

Break Even Point: Lower Strike + Net credit

Strategy 18: Bear Put Spread Strategy:

In this strategy the investor will Buy Put, Sell Put

This strategy requires the investor to buy an in-the-money (higher) put option

and sell an out-of-the-money (lower) put option on the same stock with the same


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expiration date. This strategy creates a net debit for the investor. The net effect of the

strategy is to bring down the cost and raise the breakeven on buying a Put (Long Put).

The strategy needs a Bearish outlook since the investor will make money only when

the stock price / index falls. The bought Puts will have the effect of capping the

investors downside. While the Puts sold will reduce the investors costs, risk and raise

breakeven point (from Put exercise point of view). If the stock price closes below the

out-of-the-money (lower) put option strike price on the expiration date, then the

investor reaches maximum profits. If the stock price increases above the in-the-money

(higher) put option strike price at the expiration date, then the investor has a

maximum loss potential of the net debit.

When to use: When you are moderately bearish on market direction

Risk: Limited to the net amount paid for the spread. i.e. the premium paid for long

position less premium received for short position.

Reward: Limited to the difference between the two strike prices minus the net

premium paid for the position.

Break Even Point: Strike Price of Long Put Net Premium Paid

Strategy 19: long call butterfly:

In this strategy the investor sell 2 ATM call options, buy 1 ITM call Option

and buy 1 OTM call option.

A Long Call Butterfly is to be adopted when the investor is expecting very

little movement in the stock price / index. The investor is looking to gain from low

volatility at a low cost. The strategy offers a good risk / reward ratio, together with

low cost. A long butterfly is similar to a Short Straddle except your losses are limited.

The strategy can be done by selling 2 ATM Calls, buying 1 ITM Call, and buying 1


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OTM Call options (there should be equidistance between the strike prices). The result

is positive incase the stock / index remains range bound. The maximum reward in this

strategy is however restricted and takes place when the stock / index is at the middle

strike at expiration. The maximum losses are also limited.

When to use : When the investor is neutral on market direction and bearish on

volatility .

Risk Net debit paid.

Reward Difference between adjacent strikes minus net debit

Break Even Point :

Upper Breakeven Point = Strike Price of Higher Strike Long Call Net

Premium Paid

Lower Breakeven Point = Strike Price of Lower Strike Long Call + Net

Premium Paid

Strategy 20: short call butterfly:

In this strategy the investor buy 2 ATM call options, sell 1 ITM call option

and sell 1 OTM call option.

A Short Call Butterfly is a strategy for volatile markets. It is the opposite of

Long Call Butterfly, which is a range bound strategy. The Short Call Butterfly can be

constructed by Selling one lower striking in-the-money Call, buying two at-the-

money Calls and selling another higher strike out-of-the-money Call, giving the

investor a net credit (therefore it is an income strategy). There should be equal

distance between each strike. The resulting position will be profitable in case there is

a big move in the stock / index. The maximum risk occurs if the stock / index is at the

middle strike at expiration. The maximum profit occurs if the stock finishes on either


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side of the upper and lower strike prices at expiration. However, this strategy offers

very small returns when compared to straddles, strangles with only slightly less risk.

When to use : You are neutral on market direction and bullish on volatility .

Neutral means that you expect the market to move in either direction - i.e. bullish and

bearish.

Risk Limited to the net difference between the adjacent strikes (Rs. 100 in this

example) less the premium received for the position.

Reward Limited to the net premium received for the option spread.

Break Even Point :

Upper Breakeven Point = Strike Price of Highest Strike Short Call - Net

Premium Received

Lower Breakeven Point = Strike Price of Lowest Strike Short Call + Net

Premium Received

Strategy 21: long call condor:

In this strategy the investor will buy 1 ITM Call option (lower strike), sell 1

ITM call Option (lower Middle), sell 1 OTM call Option (higher middle), buy 1

OTM call Option (higher strike)

The strategy is suitable in a range bound market. The Long Call Condor involves buying ITM Call (lower strike), selling 1 ITM Call (lower middle) , selling 1

OTM call (higher middle) and buying 1 OTM Call (higher strike). The long options at

the outside strikes ensure that the risk is capped on both the sides. The resulting

position is profitable if the stock / index remains range bound and shows very little

volatility. The maximum profits occur if the stock finishes between the middle strike

prices at expiration.


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When to Use: When an investor believes that the underlying market will trade in a

range with low volatility until the options expire.

Risk Limited to the minimum of the difference between the lower strike call spread

less the higher call spread less the total premium paid for the condor.

Reward Limited. The maximum profit of a long condor will be realized when the

stock is trading between the two middle strike prices.

Break Even Point:

Upper Breakeven Point = Highest Strike Net Debit

Lower Breakeven Point = Lowest Strike + Net Debit

Strategy 22: short call condor:

In this strategy the investor will short 1 ITM call option (lower strike), long

1 ITM Call option (lower middle), long 1 OTM call Option (higher middle), short

1 OTM call Option (higher strike).

The strategy is suitable in a volatile market. The Short Call Condor involves

selling 1 ITM Call (lower strike), buying 1 ITM Call (lower middle) , buying 1 OTM

call (higher middle) and selling 1 OTM Call (higher strike). The resulting position is

profitable if the stock / index shows very high volatility and there is a big move in the

stock / index. The maximum profits occur if the stock / index finishes on either side of

the upper or lower strike prices at expiration.

When to Use: When an investor believes that the underlying market will break out of

a trading range but is not sure in which direction.


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Risk Limited. The maximum loss of a short condor occurs at the center of the option

spread.

Reward Limited. The maximum profit of a short condor occurs when the underlying

stock / index is trading past the upper or lower strike prices.

Break Even Point:

Upper Break even Point = Highest Strike Net Credit

Lower Break Even Point = Lowest Strike + Net Credit


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LONG CALL OPTION:

LONG CALL strategy (BUY CALL OPTION):

When the investor is bullish in the Market/Sector/Stock in the

Market/Sector/Stock then investor will use this strategy and enjoys the unlimited

profits and at the same time there may be chance of limited risk. The investor will pay

the premium on call option.

If the market goes beyond the BEP then investor will starts making profits and

if market falls below the BEP then the investor will lose only the premium.

In the current scenario the investor is bullish in the index / stock in future to

purchase put option.

When the investor is bullish in INDEX the investor will enter into the contract.

When the buyer of the call option is bullish and expect the underlying stock/index to

rise in future then the investor will use this strategy.

BEP: Strike price + premium;

Risk: limited

Reward: unlimited;

INDEX Spot price: Rs.5225 as on 2010, Jan 1st

.

Strike price: Rs.5200

Call Option Premium: Rs.134.70 /-

In this case investor is always expecting to rise the INDEX price by assuming

this the investor bought one call option at Rs. 134.70/- with strike price Rs.5200/-.


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BEP= Strike Price + Premium.

BEP=5200(Strike price) + 134.7/-(Premium).

BEP= 5334.70.

If the price of INDEX falls below 5334.70 then investor will lose only the

premium and if the price of INDEX moves above 5334.70 then investor will starts

making profits.

SPOT STRIKE PREMIUM PAY OUT LOT SIZE TOTAL


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PRICE PRICE PER UNIT PAYOUT

4500 5200 134.7 (134.7) 50 (6735)

4800 5200 134.7 (134.7) 50 (6735)

4850 5200 134.7 (134.7) 50 (6735)

5200 5200 134.7 (134.7) 50 (6735)

5335 5200 134.7 0.30 50 15

5800 5200 134.7 465.3 50 23265

6000 5200 134.7 665.3 50 33265

BEP POINT

STRIKE

SPOTUNLIMITED PROFITS

LOSS LIMITED TO

PREMIUM

SPOT


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ASSUMPTIONS:

CASE I:





Risk: limited

Reward: unlimited;

INDEX Spot price: Rs.5225 as on 2010, Jan 1 st.



Closing date: 2010, jan 28 th. Market price: 4850

Lot size: 50

BEP: 5334.70

If the INDEX falls to 4500 then what will be net payout amount for the

Investor?

Call Option: The spot INDEX on Expiry date is below the strike price then the

investor will not exercise the transaction.

Net payout/pay-in: In this case the market price on the expiry date is less than strike

price of call option so, the investor of the call option will loss only the premium. The

net loss of call option: Rs.134.7

Therefore total net loss = 134.7*50(lot size) = 6735.


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In this diagram strike price is Rs.5200 and BEP is Rs.5334.7 and current

marketing price is Rs.4500 and marketing price is less than BEP therefore the investor

of the call option will lose only the premium that means his loss is limited to loss. So,

the investor will get losses so in graph the line A B determines that investor is

making losses.

Strike price: 5200

Spot price: 4500

LOSS IS LIMITED TO PREMIUM

BEP: 5334.7

A

B


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CASE II:





Risk: limited

Reward: unlimited;





Lot size: 50

BEP: 5334.70

If the INDEX Moves to 4800 then what will be net payout amount for the

Investor?








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making losses.

Strike price: 5200

Spot price: 4800


BEP: 5334.7

A

B


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CASE III:





Risk: limited

Reward: unlimited;





Lot size: 50

BEP: 5334.70


Investor?








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making losses.

Strike price: 5200

Spot price: 4850


BEP: 5334.7

A

B


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CASE IV:





Risk: limited

Reward: unlimited;





Lot size: 50

BEP: 5334.70


Investor?


investor will exercise the transaction based on the investors choice.

Net payout/pay-in Call Option= 5200 5200 = 0

In this case the investor as the market price is equal to the strike price so there

is no loss but the investor is already paid a premium so, the investor loss is limited to

the premium only i.e., Rs.134.70/-



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making losses.

Strike price & spot price: 5200LOSS IS LIMITED TO PREMIUM

BEP: 5334.7

A

B


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CASE V:





Risk: limited

Reward: unlimited;





Lot size: 50

BEP: 5334.70


Investor?

Call Option: The spot INDEX on Expiry date is above the strike price then the

investor will exercise the transaction.

Net payout/pay-in Call Option= 5335 5200 = 135 will be the actual profit in call

option.

In this case he makes actual profit of Rs.135 but initially he paid a premium

for call option i.e., Rs.134.7 therefore net profit is Rs.0.3

Therefore total net profit = 0.3*50(lot size) = 15.


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marketing price is Rs.5335 and marketing price is more than BEP therefore the

investor of the call option will get profits. So, the investor will get profits so in graph

the line from A determines that investor is making unlimited profits.

Strike price: 5200

BEP:5334.7

Spot price: 5335

UNLIMITED PROFITS

A


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CASE VI:





Risk: limited

Reward: unlimited;





Lot size: 50

BEP: 5334.70


Investor?



Net payout/pay-in Call Option=5800 5200 = 600 will be the actual profit in call

option.





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Strike price: 5200

BEP:5334.7

Spot price: 5800 UNLIMITED PROFITS

A


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CASE VII:





Risk: limited

Reward: unlimited;





Lot size: 50

BEP: 5334.70


Investor?



Net payout/pay-in Call Option=6000 5200 = 800 will be the actual profit in call

option.





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Strike price: 5200

BEP:5334.7

Spot price: 5800 UNLIMITED PROFITS

A


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SHORT CALL

SHORT CALL strategy (SALE CALL):

When the investor is very aggressive and bearish in the Market/Sector/Stock

in the Market/Sector/Stock then investor will use this strategy and enjoys the limited

profits up to the premium and at the same time there may be chance to bear unlimited

risk. The seller of the call option will receive the premium on put option by entering

into the contract with buyer of the call option.

If the market goes beyond the BEP then seller of the call option will lose

entire premium and if market falls below the BEP then the seller of the call option

will starts gain up to the premium only.

In the current scenario the investor is bearish in the index / stock in future to

sale the call option.

When the investor is bearish in INDEX/STOCK the investor will enter into the

contract. When the investor of the call option is bearish and expect the underlying

stock/index to fall in future then the investor will use this strategy.


Risk: unlimited

Reward: limited;

RELIANCE Spot price: Rs.1075 as on 2010, Jan 5 th.

Strike price: Rs.1110/-

Call Option Premium: Rs.25 /-


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In this case seller is always expecting to fall the RELIANCE Stock price by

assuming this the investor sold one call option at Rs. 25/- with strike price Rs.1110/-.

BEP= Strike Price + Premium.

BEP=1110(Strike price) + 25/-(Premium).

BEP= 1135/-

If the price of RELIANCE Stock falls below 1135/- then seller gain only up to

the premium and if the price of RELIANCE Stock moves above 1135/- then seller

will starts making losses.


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SPOT

PRICE

STRIKE

PRICE

PREMIUM NET PAY OUT

PER UNIT

LOT SIZE TOTAL

1100 1110 25 25 1000 25000

1000 1110 25 25 1000 25000

900 1110 25 25 1000 25000

1135 1110 25 0 1000 0

1200 1110 25 (65) 1000 (65000)

1300 1110 25 (165) 1000 (165000)1550 1110 25 (415) 1000 (415000)

SPOT

STRIKE

SPOT

UNLIMITED LOSSES

BEP PROFIT LIMITED TO PREMIUM


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Net payout/pay-in

In this case the market price on the closing date is less than strike price of the call

option so, the seller will receive the profit which is limited to the premium only.i.e.

Rs.25 which is received during entering into the transaction.

Therefore total net profit =25*1000 (lot size) = 25000/-

1110

1100

Profit is limited topremium

BEP:1135


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CASE II:

When the investor is bearish in RELIANCE Stock then seller will enter into

the contract. When the seller of the call option is bullish and expect the underlying

stock/index to rise in future then the investor will use this strategy.


Risk: unlimited

Reward: limited to the premium;

INDEX Spot price: Rs.1075 as on 2010, Jan 5 th



Closing date: 2010, jan 28 th. Market price 1120/-

Lot size: 1000

BEP: 1135/-

If the INDEX falls to 1000 then what will be net payout amount for the

Investor?

Call Option: The spot RELIANCE Stock on Expiry date is below the strike price then

the seller will exercise the transaction.

Net payout/pay-in

In this case the market price on the closing date is less than strike price of the

call option so, the seller will receive the profit which is limited to the premium

only.i.e. Rs.25 which is received during entering into the transaction.



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1110

1000


BEP:1135


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CASE III:





Risk: unlimited






Lot size: 1000

BEP: 1135/-


Investor?



Net payout/pay-in

In this case the market price on the closing date is less than strike price of the





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1110

1000


BEP:1135


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CASE IV:

When the investor is bearish in RELIANCE Stock then seller will enter

into the contract. When the seller of the call option is bullish and expect the

underlying stock/index to rise in future then the investor will use this strategy.


Risk: unlimited






Lot size: 1000

BEP: 1135/-


Investor?



Net payout/pay-in

In this case the market price on the closing date is equal to strike price of the





78/86

1110

1000


BEP:1135


79/86

CASE V:





Risk: unlimited






Lot size: 1000

BEP: 1135/-


Investor?




80/86

Net payout/pay-in

Call Option=1200-1110 = 90 will be the actual loss in call option.

In this case when the market price is more than strike price then the seller of

the call option start making losses here the seller made actual loss of Rs.90 and seller

received a premium only i.e., Rs.25 during entering into the transaction therefore the

net profit is 90(net loss in the call option) 25(premium received) = 65

Therefore total loss = 65*1000 (lot size) =65000/-

1200

1110

BEP: 1135

Unlimited loss


81/86

CASE VI:





Risk: unlimited






Lot size: 1000

BEP: 1135/-

If the INDEX Moves to 1300 hen what will be net payout amount for the

Investor?




82/86

Net payout/pay-in

Call Option=1300 -1110 = 190 will be the actual loss in call option.





Therefore total loss =165*1000 (lot size) =165000

1300

1110

BEP: 1135

Unlimited loss


83/86

CASE VII:





Risk: unlimited






Lot size: 1000

BEP: 1135/-


Investor?




84/86

Net payout/pay-in

Call Option=1550-1110 = 440 will be the actual loss in call option.





Therefore total loss = 415*1000 (lot size) =415000/-

1550

1110

BEP: 1135

Unlimited loss


85/86

Conclusions:

Options are useful to only Speculators and Speculators can take the risk to

increase the profits:

High Risk: High Returns

Investor may loose entire premium amount if their assumptions are go wrong

Risk is limited in case of Buyer of the Call Options and Buyer of the Put

options and at the same time they may get unlimited profits with their limited

Premium/Investment.

Risk is unlimited in case of Seller of the Call Options and Seller of the Put

Options and at the same time they may get unlimited losses if their

assumptions are go wrong.

Buyer of the Call Option/Put Option = Risk is limited to premium

Reward is unlimited if the market moves with their assumptions

Seller of the Call Options/Put Options = Reward is limited to premium which

received from the buyers

Risk is unlimited if the markets moves opposite directions to their

assumptions.


86/86

Recommendations:

It is advisable to trade speculators

It is not advisable for long-term investors and small investor

The investor may loose the entire principle amount in Options

The Options life expires in one month i.e. expiry date.

Investors can not rollover/extend the contract to next month, that means buyer

as well as seller needs to excise the contract on expiry date and it is depend on

the buyer of the call options.

naresh acl2 proj

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