In addition to the strategies explained above, other
investment strategies involving options include the protective
put, the married put, the covered call, the collar option and
the box spread.
Protective Put
A protective put strategy involves purchasing a put option by an
investor on shares already owned by him. Investors who adopt
this strategy continue to enjoy the benefit of stock ownership
such as dividends, voting rights and more. Investors adopt this
strategy when they are worried about a significant fall in stock
prices and want to limit their downside risk, but do not want to
lose out in case the market rises. A protective put is usually
created by buying an ‘out of money'put option on stock already
held.
Married Put
A married put strategy involves purchasing of put options by an
investor along with an equivalent number of shares of the
underlying stock. This strategy also provides the investor the
benefits of stock ownership entitling him to dividends, voting
rights and more, while at the same time insuring the investor
from a significant fall in the price of the underlying stock.
The upside potential in this strategy is unlimited while the
downside risk is limited to the difference between the stock
purchase price and the strike price plus the premium paid.
Covered Call
A call is said to be covered when an investor at the time of
selling a call option owns an equivalent number of shares of the
underlying stock. This strategy is generally employed when an
investor while being bullish on the underlying stock feels that
the stock prices will not rally much during the life of the call
contract and wishes to earn additional income over and above
dividends from shares of the underlying stock.
The upside potential in this strategy is limited, with the
maximum profit that could be realized being limited to the
premium received plus the difference between the strike price (Xt)
and the stock purchase price. However, the downside risk could
be substantial, with the risk being maximum if the stock price
falls to zero.
Example:
A buys 100 shares of Electrolux at Rs 40 per share and sells
Electrolux one March call option contract on 100 shares at Rs
45. The option premium is Rs. 3.50 per share, thus giving the
following cash flows:
Buy 100 shares at Rs. 40 = Rs. (4000)
Sell March Rs. 45 call option contract
on 100 Shares at Rs. 3.50 per share = Rs. 350
Max. Profit = Rs. (500 + 350) = 850
Max. Loss = Rs. 4000 – 350 = 3650 |
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