A Note On Investment Strategies Involving Options

INVESTMENT STRATEGIES INVOLVING OPTIONS Contd..

Table 12: Payoff using Strips

Payoff when S  Xt, 2 (Xt – S)
Payoff when S > Xt, (S – Xt)
Net Profit = Payoff minus (C+P)

In a strip, the investor expects that there will be major stock price movement and the movement is more likely to be in the downward direction. By employing this strategy an investor will make profit in both the rise and fall of stock prices but the amount of profit will be greater when the prices fall sharply. The downside risk is limited to the amount of premium paid.

Straps

A strap consists of buying two calls and one put at the same strike price and with the same expiration date. A strap is like a strip, the only difference being that the investor expects volatility in the movement of stock prices and the chances of prices rising are greater.

Example:

An investor buys two October call options on shares of Knoll Pharma at a premium of Rs. 18 per share at a strike price is Rs.325 (Xt). He also buys one October put option on one share of Knoll at a premium of Rs. 38 per share and a strike price of Rs. 325 (Xt). The payoff (Refer Table 13) of an investor-using strap would be:

2010, ICMR (IBS Center for Management Research).All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, used in a spreadsheet, or transmitted in any form or by any means - electronic or mechanical, without permission.

To order copies, call +91- 8417- 236667 or write to ICMR,
Survey No. 156/157, Dontanapalli Village, Shankerpalli Mandal,
Ranga Reddy District,
Hyderabad-501504. Andhra Pradesh, INDIA. Mob: +91- 9640901313, Ph: +91- 8417- 236667,
Fax: +91- 8417- 236668
E-mail: info@icmrindia.org
Website: www.icmrindia.org