A Note On Investment Strategies Involving Options

INVESTMENT STRATEGIES INVOLVING OPTIONS Contd..

Example:

An investor buys one June call option on a share of Reliance at a premium of Rs. 25 and a strike price of Rs.240 (X) and sells a March call option at a premium of Rs. 15 at a strike price of Rs. 240 (X). The payoff diagram of a calendar spread using calls is given below:

Investors make profit if the stock price at the expiration of the short maturity option is close to the exercise price. However, a loss is incurred if the stock price is lower or higher than the exercise price.

Option Combinations

Options can be used in combinations to design investment strategies that suit the risk-return profile of investors. It involves taking position in both calls and puts on the same stock. By using various combinations of options, one can develop straddles, strangles, strips and straps. These have been explained below:

Straddles

A Straddle strategy involves buying a call and a put option at same strike price and with the same expiration date. A long straddle involves buying a call and a put option at the same exercise price, for the same period and with the same underlying terms. A short straddle is the reverse of a long straddle and involves selling a call and a put option at the same exercise price and on the same expiration date.

Example:

An investor buys one March call option on a share of ABB at a premium of Rs. 21 per share at a strike price of Rs.310 (Xt). He/she buys one put option on a share of ABB at a premium of Rs. 42 at a strike price of Rs. 310 (Xt). The payoff table (Refer Table 10) shows the fluctuations of net profit with a change in the spot price.