A Note On Investment Strategies Involving Options

INVESTMENT STRATEGIES INVOLVING OPTIONS Contd..

Table 4: Payoff from Buying of Put Option (Rs.)

The payoff for the put buyer is Max (Xt - S, 0)
The payoff for a put writer is Min (S - Xt, 0)

Example:

B sells a European put option on one share of BPL Engineering at a premium of Rs. 3 per share on January 01, 2002. The strike price is Rs.70 and the contract matures on June 30, 2002. The payoff table (Refer Table 5) shows the fluctuations of profit with a change in the spot price.

Table 5: Payoff from selling a Put Option

Payoff: Min (S – Xt, 0) Net Profit = Payoff plus ‘P,'since ‘P'is the Cash Inflow i.e. option premium received on writing a put. Investors adopt this strategy when they are certain that the market will not fall. If they expect the market to be very bullish, they will sell a put, which is in the money. The four option trading strategies mentioned above (long a call, short a call, long a put and short a put) can be used independently, together, or in combination with other financial instruments to develop a number of option-trading strategies. Using options one can design unique investment strategies and take the advantage of the market fluctuations. The other investment strategies involving options include spreads, straddles, strips, straps, and strangles.

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