This document provides an overview of options strategies. It defines derivatives and describes how they derive value from underlying assets. Common types of derivatives are discussed including futures and options. Basic option positions like calls and puts are explained. Popular options strategies like bull call spreads, bear put spreads, and butterfly spreads are defined and examples are provided to illustrate how the payoffs work. Long straddles and short straddles are also introduced as strategies used when volatility is expected to increase or decrease. Key option terms are defined throughout like premium, strike price, expiration date, and different option types.
3. Used by
Banks,
Securities firm,
Companies,
Investors,
Housewives, ETC.
4. But why
To hedge risk
To gain access to cheaper money
To make profit
5. Types of Derivatives
ᵴFuture:
The owner of a future has the obligation to sell or
buy something in the future at a predetermined
price. A future contract has standardized
conditions.
ᵴOptions:
The owner of an option has the option to buy or
sell something at a predetermined price on or
before a predetermined date.
6. Types of Options
ᵴCall
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.
ᵴ Puts
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.
7. Options are Contracts
The option contract specifies:
The
The
The
The
underlying instrument
quantity to be delivered
price at which delivery occurs
date that the contract expires
Three parties to each contract
The Buyer
The Writer (seller)
The Clearinghouse
8. Core Concepts
Index options: These options have the index as the underlying.
In India, they have a European style settlement. E.g. Nifty options,
Mini Nifty options etc.
Stock options: Stock options are options on individual stocks. A
stock option contract gives the holder the right to buy or sell the
underlying shares at the specified price. They have an American
style settlement.
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 / seller of an option: The writer / seller 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.
9. Continued….
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. Premium of an option = Option's intrinsic value + Options
time value
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.
American options: American options are options that can be
exercised at any time up to the expiration date.
European options: European options are options that can be
exercised only on the expiration date itself.
10. Continued….
In-the-money option: A call option is in-the-money if the
strike price is less than the market price of the underlying security.
A put option is in-the-money if the strike price is greater than the
market price of the underlying security.
At-the-money option: When the price of the underlying
security is equal to the strike price, an option is at-the-money.
Out-of-the-money option: A call option is out-of-the-money if
the strike price is greater than the market price of the underlying
security. A put option is out-of-the money if the strike price is less
than the market price of the underlying security
12. Position of Call option buyer
Trader’s rights- Buy underlying at strike price.
Trader’s obligations- Nil.
Premium paid or received - Paid.
Risk profile - Limited, to the extent of the premium paid.
Profit potential - Unlimited, if prices go up.
Breakeven point - Strike price + Premium.
13. Position of Call option seller
Trader’s rights- Nil.
Trader’s obligations- Sell underlying at strike price.
Premium paid or received - Received.
Risk profile - Unlimited, if prices go up.
Profit potential - Limited , to the extent of the premium
received.
Breakeven point - Strike price + Premium.
15. Position of Put option buyer
Trader’s rights- Sell underlying at strike price.
Trader’s obligations- Nil.
Premium paid or received - Paid.
Risk profile - Limited, to the extent of the premium paid.
Profit potential - Unlimited*, if prices go down (BEP = Strike price Premium).
Practically, Put option buyer’s profit is limited as the price of the
asset can not go below zero (Max. profit = Strike price – Premium
paid)
16. Position of Put option seller
Trader’s rights- Nil.
Trader’s obligations- Buy underlying at strike price.
Premium paid or received - Received.
Risk profile - Unlimited*, if prices go down.
Profit potential - Limited, to the extent of the premium
received (BEP = Strike price - Premium)
Practically, Put option seller’s risk is limited as the price of
the asset can not go below zero (Maximum loss = Strike
price – Premium received)
19. Option strategies
Option Strategies are calculated ways of using options singly or in
combination in order to profit from one or more market movements.
Option Strategies are a direct alternative to traditional buying and
selling of stocks and offers greater profit potential with limited risk.
Option strategies are merely the means through which you transform
your "prediction" of future stock movement into money through option
trading.
Option Strategies give options traders the versatility to profit from
any opinions that they have on an underlying stock and to limit risk
even if that opinion moves against them.
The creative use of Options Strategies makes stock options the most
versatile financial instrument in the world today.
20. Bull call spread
When to use: investor is moderately bullish.
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 striker above.
Break-even-point (BEP): strike price of purchased call+ net debit
paid.
Strategy : buy a call with a lower strike (ITM) +sell a call with a
higher strike (OTM).
23. Bull put spread
When to use: when the investor is moderately bullish.
Risk: Risk is 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
24. Example:
SPOT PRICE
Buy put
strike price
premium paid
Breakeven
5050
Sell put
5000 strike price
premium
50 received
lot size
5100
100
5050
50
NIFTY @expiry
4900
4950
5000
5050
5100
5150
5200
Net Payoff
-2500
-2500
-2500
0
2500
2500
2500
26. Bear call spread
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
29. Bear put spread
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
30. Example
SPOT PRICE
5050
SELL PUT
strike price
premium received
BUY PUT
5000
strike price 5100
50 premium paid 100
Breakeven
5050
lot size
50
NIFTY @expiry
4900
4950
5000
5050
5100
5150
5200
Net Payoff
-2500
-2500
-2500
0
2500
2500
2500
32. Long call butterfly
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
36. SHORT CALL BUTTERFLY
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
40. LONG STRADDLE
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
41. Example
SPOT PRICE
5050
BUY CALL
BUY PUT
strike price
5050
strike price 5050
premium received
50 premium paid
25
Breakeven
LOWER BEP
5025
UPPER BEP
5075
lot size
50
NET PREMIUM
25
44. SHORT STRADDLE
When to Use: The investor thinks that the underlying stock / index
will experience very 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
45. Example
SPOT PRICE
SELL CALL
strike price
premium received
5050
SELL PUT
5100 strike price
50 premium paid
Breakeven
LOWER BEP
UPPER BEP
5100
25
5075
5125
lot size
NET PREMIUM
50
25
47. 2000
1000
0
4950 4975 5000 5025 5050 5075 5100 5125 5150 5175 5200 5225 5250
-1000
-2000
Net Payoff
-3000
-4000
-5000
-6000
-7000
Conclusion : So Here Profits Are Limited And Losses Are Unlimited
48. Conclusion
Option strategies are the simultaneous, and often
mixed, buying or selling of one or more options that differ in
one or more of the options' variables. This is often done to gain
exposure to a specific type of opportunity or risk while
eliminating other risks as part of a trading strategy. A very
straight forward strategy might simply be the buying or selling
of a single option, however option strategies often refer to a
combination of simultaneous buying and or selling of options.