EQUITY RESEARCH LAB: BULLISH STRATEGIS

STOCK FUTURE TIPS

Introduction to Options

 An Option is a financial derivative instrument which gives the right but not the obligation to the option holder to either sell or buy an underlying asset at a pre-specified date i.e. expiry date and at a pre-specific price i.e. the strike price. The option seller has the obligation to fulfill the transaction as and when the option holder demands (exercise or not to exercise decision rests with the option holder). The option writer receives a reward, for sale of this right to the option buyer, known as ‘Premium’.

types of Option:

1. Call Option

A Call Option gives an option buyer (then holder) the right but not the obligation to buy the underlying asset (stock, commodity, currency, etc.) at a pre-specific price (strike price) and at a pre-specified date (expiry date).

2. Put Option

A Put Option gives an option buyer (then holder) the right but not the obligation to sell the underlying asset (stock, commodity, currency, etc.) at a pre-specific price (strike price) and at a pre-specified date (expiry date).

Duration of an Option:

In India, options can be traded for 3 months:

1. Near Month
January (current on-going month)

2. Next Month
February (next month)

3. Far Month
March (next to next month)

Moneyness of an Option:
Comparing the spot price with the strike price at expiry date, Options will be classified under 3 categories:


Call Option Moneyness Put Option

Strike Price < Spot Price In The Money Strike Price > Spot Price
Strike Price = Spot Price At The Money Strike Price = Spot Price
Strike Price > Spot Price Out of the Money Strike Price < Spot Price

Strategy 1: Long Call

Explanation

This is one of the basic strategies as it involves entering into one position i.e. buying the Call Option only. Any investor who buys the Call Option will be bullish in nature and would be expecting the market to give decent returns in the near future.

 

Risk: The risk of the buyer is the amount paid by him to buy the Call Option i.e. the premium value.
Reward: The reward will be unlimited as the underlying asset value can rise up to any value until the expiry. Break-Even Point: The break-even point for the Call Option Holder will be ‘Strike Price + Premium.’

Construction

Buy 1 Call Option

Payoff Chart

Example

Currently NIFTY is trading around 5300 levels, and Mr. X is bullish on NIFTY and buys one 5200 Call Option (ITM) for Rs. 200 premium. Lot size is 50. The investment amount will be Rs. 10000. (200*50)
Case 1: NIFTY closes at 5500 levels; Mr. X will make a profit of Rs. 5000. [(300-200)*50]
Case 2: NIFTY dips to 5100 levels; Mr. X will incur a loss of Rs. 10000 (200*50) which is the premium he paid for buying one lot of 5200 Call Option.

Strategy 2: Synthetic Long Call

Explanation

A trader is bullish in nature for short term, but also fearful about the downside risk associated with it. Here, a trader wants to hold an underlying asset either in physical form like in case of commodities or demat (electronic) form in case of stocks. But he is always exposed to downside risk and in order to mitigate his losses, he will buy 1 ATM or OTM Put Option since ITM Put option will carry more premium than ATM & OTM Put options which are relatively cheap.

Case 1: If the prices rise as per his calculations, he will make unlimited profits on his long position in spot/cash market.

Case 2: If the prices fall, then his loss is covered by the Put Option. The loss incurred will be the premium amount paid to buy Put option.

The net position created from Synthetic Call strategy is similar to Call Option buy strategy. A major difference exists between buying a Call Option and Synthetic Call strategy. In a plain Vanilla Call Option you do not hold the underlying asset, whereas in Synthetic Call you will hold the underlying asset and reap the benefits of dividends, bonus issues, etc. (only in case if the underlying asset is a stock)

Construction

Buy 250 RIL Shares
Buy 1 Put Option of RIL

Payoff Chart

Example

RIL is trading at Rs. 720 levels, Mr. X isbullish in the long term, but wants to hedge himself from the fall in cash strategy goes wrong. He will buy 250 shares of RIL from the cash market @ Rs. 720 and buy 1 700 Put Option @ Rs. 10 as premium. The lot size of RIL is 250. His net investment will be Rs. 180000. [(250*720) + Rs. 2500(250*10) = Rs. 182500]

Reward: The gains will be unlimited since it’s a long position. His maximum loss will be Rs. 2500 assuming he will hold his cash position irrespective of the price. Break-Even Point for the net position will be Rs. 730. (720+10)

Case 1: If RIL dips to Rs. 690, then his net loss payoff will be Rs. 7500. [{(690-720) + (10-10)}*250]
Case 2: If RIL closes at Rs. 720, then his net loss payoff will be Rs. 2500. [{(720-720)-(10)}*250]
Case 3: If RIL rises up to Rs. 750, then his net profit payoff will be Rs. 5000. [{(750-720)-(10)}*250]

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