F&O Trading Strategies - Himanshu Ahire

Future & Option Trading Strategies

Assignment One

Himanshu Ahire 13 Executive Full Time PGDM ( 2009-2010 ) Trimester 4 Symbiosis Institute of Management Studies

1

F&O Trading Strategies - Himanshu Ahire

Introduction

Hedgers

Speculators

Arbitrageurs

4

4 5 5

Market Players

The Exchanges

Financial Institution

Market Makers

Day traders

Premium Sellers

Spread Traders

Theoretical Traders

6

6 6 6

7 7 7 7

Future & option Trading Strategies

Long & Short Futures

Long position

Short position

8

8

8 9

Options In-the-money, At-the-money, Out-of-the-money

At-the-money

In-the-money

out-of-the-money

10

10 10 10

Trading Strategies

Bullish Strategies

Long call

Covered Calls

Protective Put

Bull Call Spread

Bull Put Spread

Call Back Spread

11

11

11 12 13 14 15 16

2

F&O Trading Strategies - Himanshu Ahire Naked Put

17

Bearish Strategies

Long Put

Naked Put

Put Back-spread

Bear call spread

Bear put spread

18

18 19 20 21 22

Neutral Strategies

Reversal

Conversion

23

23 24

The Collar

Long Straddle

Short Straddle

Long Strangle

Short Strangle

The Butterﬂy

Ratio Spread

Condor

Calendar Spread

25

26 27 28 29 30 31 32 33

Bibliography

34

3

F&O Trading Strategies - Himanshu Ahire

Introduction

Derivatives are ﬁnancial instruments which derives their value from underlying asset. These underlying assets can be Shares, Bonds, Interest Rates, Market Volatility, currencies & Commodities. Derivatives market can be OTC or Exchange Traded. Primary goal of derivatives trading is to transfer underlying price risk from one party to another. Hence derivatives helps mitigating risk from future uncertainties. Although main objective of derivatives is to mitigate risk it can be used for proﬁt making. Hence Derivatives traders can be classiﬁed as • • • Hedgers Speculators Arbitrageurs

Hedgers Generally hedgers have substantial interest ( exposure ) in spot market. Hence they participate in derivatives market to mitigate adverse price movement risk in spot market. hedgers can take various positions in derivatives market based on their exposure in spot market. Generally they take opposite position in derivatives market compare to spot market. Hedging can also be used to protect existing future or options positions. For Example following are option positions & their respective possible future/options hedge positions. Option Position Hedge Position

Long Call : Increases in value as the underlying Short Underlying increases in value Short Call Long Put Short Call :Decreases in value as the underlying Long Underlying increases in value Long Call Short Put Long Put : Decreases in value as the underlying Long Underlying increases in value Short Put Long Call Short Put : Increases in value as the underlying Short Underlying decreases in value Long Put Short Call

4

F&O Trading Strategies - Himanshu Ahire

Speculators Speculators have proﬁt motive. They tried to get beneﬁt from market movement. They bets on derivative position based on personal view. Generally they have high risk appetite. Their main objective is to make quick gain by market movement. Because of their one sided view there is possibility of large proﬁt or Large loss.

Arbitrageurs Arbitrageurs want to make risk-less proﬁt. They tend to exploit market inefﬁciencies. Generally In the market, future & options prices are closely related to respective underlying spot market. For Example When the Underlying Security... The Long Call will The Short Call will The Long Put will The Short Put will Increase in Value Increase in Value Decrease in Value Decrease in Value Increase in Value Decrease in Value Decrease in Value Increase in Value Increase in Value Decrease in Value

But sometimes due to market inefﬁciencies there is some difference between spot market & derivative markets.They can utilized these differences between spot market & Derivatives market to make proﬁt.

5

F&O Trading Strategies - Himanshu Ahire

Market Players

With the possible exception of futures contracts, option trading is not a zero-sum game. In other words, for every winner there doesn't have to be a loser. Therefore, because there are so many different combinations and ways options can be hedged against each other. The main defferance between spot & Derivatives market is that in derivatives trading there are more players and multiple agendas. In the derivatives markets, the players fall into four categories: • • • • The Exchanges Financial Institution Market Makers Individual (Retail) Investors

The Exchanges The exchange is a place where market makers and traders gather to buy and sell stocks, options, bonds, futures, and other ﬁnancial instruments. Financial Institution Financial institutions are professional investment management companies that typically fall into several main categories: mutual funds, hedge funds, insurance companies, stock funds. In each case, these money managers control large portfolios of stocks, options, and other ﬁnancial instruments. Market Makers Market makers are the traders on the ﬂoor of the exchanges who create liquidity by providing two-sided markets. In each counter, the competition between market makers keeps the spread between the bid and the offer relatively narrow. Nevertheless, it's the spread that partially compensates market makers for the risk of willingly taking either side of a trade. In general, there are four trading techniques that characterize how different market makers trade options. Any or all of these techniques may be employed by the same market maker depending on trading conditions. • • • • Day Traders Premium Sellers Spread Traders Theoretical Traders

6

F&O Trading Strategies - Himanshu Ahire

Day traders Day traders, on or off the trading screen, tend to use small positions to capitalize on intraday market movement. Since their objective is not to hold a position for extended periods, day traders generally don't hedge options with the underlying stock. At the same time, they tend to be less concerned about delta, gamma, and other highly analytical aspects of option pricing.

Premium Sellers Just like the name implies, premium sellers tend to focus their efforts selling high priced options and taking advantage of the time decay factor by buying them later at a lower price. This strategy works well in the absence of large, unexpected price swings but can be extremely risky when volatility skyrockets. Spread Traders Like other market makers, spread traders often end up with large positions but they get there by focusing on spreads. In this way, even the largest of positions will be somewhat naturally hedged. Spread traders employ a variety of strategies buying certain options and selling others to offset the risk. Some of these strategies like reversals, conversions, and boxes are primarily used by ﬂoor traders because they take advantage of minor price discrepancies that often only exist for seconds. However, spread traders will use strategies like butterﬂies, condors, call spreads, and put spreads that can be used quite effectively by individual investors. Theoretical Traders By readily making two-sided markets, market makers often ﬁnd themselves with substantial option positions across a variety of months and strike prices. The same thing happens to theoretical traders who use complex mathematical models to sell options that are overpriced and buy options that are relatively underpriced. Of the four groups, theoretical traders are often the most analytical in that they are constantly evaluating their position to determine the effects of changes in price, volatility, and time.

7

F&O Trading Strategies - Himanshu Ahire

Future & option Trading Strategies

Long & Short Futures The Pay-off of a futures contract on maturity depends on the spot price of the underlying asset at the time of maturity and the price at which the contract was initially traded. There are two positions that could be taken in a futures contract: Long position one who buys the asset at the futures price takes the long position. The pay-off for a long position in a futures contract on one unit of an asset is: Long Pay-off = Future Price at Expiry – Future Purchase price

• • • • • • •

Maximum Proﬁt = Unlimited Proﬁt Achieved When Market Price of Futures > Purchase Price of Futures Proﬁt = (Market Price of Futures - Purchase Price of Futures) x Contract Size Maximum Loss = Unlimited Loss Occurs When Market Price of Futures < Purchase Price of Futures Loss = (Purchase Price of Futures - Market Price of Futures) x Contract Size + Commissions Paid Breakeven Point = Purchase Price of Futures Contract

8

F&O Trading Strategies - Himanshu Ahire

Short position one who sells the asset at the futures price takes the short position. Short Pay-off = Future short position price - Future short position at Expiry

• • • • • • •

Maximum Proﬁt = Unlimited Proﬁt Achieved When Market Price of Futures < Selling Price of Futures Proﬁt = (Selling Price of Futures - Market Price of Futures) x Contract Size Maximum Loss = Unlimited Loss Occurs When Market Price of Futures > Selling Price of Futures Loss = (Market Price of Futures - Selling Price of Futures) x Contract Size + Commissions Paid Breakeven Point = Selling Price of Futures Contract

9

F&O Trading Strategies - Himanshu Ahire

Options In-the-money, At-the-money, Out-of-the-money

In-the-money

Call Option

Put Option

Strike Price less than Spot Strike Price greater than Price of underlying asset Spot Price of underlying asset Strike Price equal to Spot Strike Price equal to Spot Price of underlying asset Price of underlying asset Strike Price greater than Strike Price less than Spot Spot Price of underlying Price of underlying asset asset

At-the-money

Out-of-the-money

At-the-money An option is said to be 'at-the-money', when the option's strike price is equal to the underlying asset price. This is true for both puts and calls. In-the-money A call option is said to be in-the-money when the strike price of the option is less than the underlying asset price. For example, a Sensex call option with strike of 3900 is 'in-themoney', when the spot Sensex is at 4100 as the call option has value. The call holder has the right to buy a Sensex at 3900, no matter how much the spot market price has risen. And with the current price at 4100, a proﬁt can be made by selling Sensex at this higher price. out-of-the-money On the other hand, a call option is out-of-the-money when the strike price is greater than the underlying asset price. Using the earlier example of Sensex call option, if the Sensex falls to 3700, the call option no longer has positive exercise value. The call holder will not exercise the option to buy Sensex at 3900 when the current price is at 3700. (Please see table)

10

F&O Trading Strategies - Himanshu Ahire

Trading Strategies

Bullish Strategies Long call For aggressive investors who are bullish about the short-term prospects for a stock, buying calls can be an excellent way to capture the upside potential with limited inside risk.

• • • • • •

Maximum Proﬁt = Unlimited Proﬁt Achieved When Price of Underlying >= Strike Price of Long Call + Premium Paid Proﬁt = Price of Underlying - Strike Price of Long Call - Premium Paid Max Loss = Premium Paid + Commissions Paid Max Loss Occurs When Price of Underlying <= Strike Price of Long Call Breakeven Point = Strike Price of Long Call + Premium Paid

11

F&O Trading Strategies - Himanshu Ahire

Covered Calls For conservative investors, selling calls against a long stock position can be an excellent way to generate income without assuming the risks associated with uncovered calls. In this case, investors would sell one call contract for each 100 shares of stock they own.

• • • • •

Proﬁt Potential: Limited Loss Potential: Unlimited Upside Proﬁt at Expiration If Assigned: Premium Received + Difference (if any) Between Strike Price and Stock Purchase Price Upside Proﬁt at Expiration If Not Assigned: Any Gains in Stock Value + Premium Received BEP: Stock Purchase Price - Premium Received

12

F&O Trading Strategies - Himanshu Ahire

Protective Put For investors who want to protect the stocks in their portfolio from falling prices, protective puts provide a relatively low-cost form of portfolio insurance. In this case, investors would purchase one put contract for each 100 shares of stock they own.

• • • • • •

Maximum Proﬁt = Unlimited Proﬁt Achieved When Price of Underlying > Purchase Price of Underlying + Premium Paid Proﬁt = Price of Underlying - Purchase Price of Underlying - Premium Paid Max Loss = Premium Paid + Purchase Price of Underlying - Put Strike + Commissions Paid Max Loss Occurs When Price of Underlying <= Strike Price of Long Put Breakeven Point = Purchase Price of Underlying + Premium Paid

13

F&O Trading Strategies - Himanshu Ahire

Bull Call Spread For bullish investors who want to a nice low risk, limited return strategy without buying or selling the underlying stock, bull call spreads are a great alternative. This strategy involves buying and selling the same number of calls at different strike prices to minimize both the cash outlay and the overall risk.

• • • • •

Max Proﬁt = Strike Price of Short Call - Strike Price of Long Call - Net Premium Paid Commissions Paid Max Proﬁt Achieved When Price of Underlying >= Strike Price of Short Call Max Loss = Net Premium Paid + Commissions Paid Max Loss Occurs When Price of Underlying <= Strike Price of Long Call Breakeven Point = Strike Price of Long Call + Net Premium Paid

14

F&O Trading Strategies - Himanshu Ahire

Bull Put Spread For bullish investors who want a nice low risk, limited return strategy, bull put spreads are another alternative. Like the bull call spread, the bull put spread involves buying and selling the same number of put options at different strike prices. Since puts with the higher strike are sold, the trade is initiated for a credit.

• • • • •

Max Proﬁt = Net Premium Received - Commissions Paid Max Proﬁt Achieved When Price of Underlying >= Strike Price of Short Put Max Loss = Strike Price of Short Put - Strike Price of Long Put Net Premium Received + Commissions Paid Max Loss Occurs When Price of Underlying <= Strike Price of Long Put Breakeven Point = Strike Price of Short Put - Net Premium Received

15

F&O Trading Strategies - Himanshu Ahire

Call Back Spread For bullish investors who expect big moves in already volatile stocks, call back spreads are a great limited risk, unlimited reward strategy. The trade itself involves selling a call (or calls) at a lower strike and buying a greater number of calls at a higher strike price.

• • • • • • •

Maximum Proﬁt = Unlimited Proﬁt Achieved When Price of Underlying >= 2 x Strike Price of Long Call - Strike Price of Short Call +/- Net Premium Paid/Received Proﬁt = Price of Underlying - Strike Price of Long Call - Max Loss Max Loss = Strike Price of Long Call - Strike Price of Short Call +/- Net Premium Paid/ Received + Commissions Paid Max Loss Occurs When Strike Price of Long Call Upper Breakeven Point = Strike Price of Long Call + Points of Maximum Loss Lower Breakeven Point = Strike Price of Short Call

16

F&O Trading Strategies - Himanshu Ahire

Naked Put For bullish investors who are interested in buying a stock at a price below the current market price, selling naked puts can be an excellent strategy. In this case, however, the risk is substantial because the writer of the option is obligated to purchase the stock at the strike price regardless of where the stock is trading.

• • • • • •

Max Proﬁt = Premium Received - Commissions Paid Max Proﬁt Achieved When Price of Underlying >= Strike Price of Short Put Maximum Loss = Unlimited Loss Occurs When Price of Underlying < Strike Price of Short Put - Premium Received Loss = Strike Price of Short Put - Price of Underlying - Premium Received + Commissions Paid Breakeven Point = Strike Price of Short Put - Premium Received

17

F&O Trading Strategies - Himanshu Ahire

Bearish Strategies Long Put For aggressive investors who have a strong feeling that a particular stock is about to move lower, long puts are an excellent low risk, high reward strategy. While risk is limited to the initial investment, the proﬁt potential is unlimited.

• • • • • •

Maximum Proﬁt = Unlimited Proﬁt Achieved When Price of Underlying = 0 Proﬁt = Strike Price of Long Put - Premium Paid Max Loss = Premium Paid + Commissions Paid Max Loss Occurs When Price of Underlying >= Strike Price of Long Put Breakeven Point = Strike Price of Long Put - Premium Paid

18

F&O Trading Strategies - Himanshu Ahire

Naked Put Selling naked calls is a very risky strategy which should be utilized with extreme caution. By selling calls without owning the underlying stock, you collect the option premium and hope the stock either stays steady or declines in value. If the stock increases in value this strategy has unlimited risk.

• • • •

Maximum Loss = Unlimited Loss Occurs When Price of Underlying < Strike Price of Short Put - Premium Received Loss = Strike Price of Short Put - Price of Underlying - Premium Received + Commissions Paid Breakeven Point = Strike Price of Short Put - Premium Received

19

F&O Trading Strategies - Himanshu Ahire

Put Back-spread For aggressive investors who expect big downward moves in already volatile stocks, backspreads are great strategies. The trade itself involves selling a put at a higher strike and buying a greater number of puts at a lower strike price. As the stock price moves lower, the proﬁt potential is unlimited.

• • • • • • •

Maximum Proﬁt = Unlimited Proﬁt Achieved When Price of Underlying < 2 x Strike Price of Long Put - Strike Price of Short Put + Net Premium Received Proﬁt = Strike Price of Long Put - Price of Underlying - Max Loss Max Loss = Strike Price of Short Put - Strike Price of Long Put - Net Premium Received + Commissions Paid Max Loss Occurs When Price of Underlying = Strike Price of Long Put Upper Breakeven Point = Strike Price of Short Put Lower Breakeven Point = Strike Price of Long Put - Points of Maximum Loss

20

F&O Trading Strategies - Himanshu Ahire

Bear call spread For investors who maintain a generally negative feeling about a stock, bear spreads are a nice low risk, low reward strategies. This trade involves selling a lower strike call, usually at or near the current stock price, and buying a higher strike, out-of-the-money call. This spread proﬁts when the stock price decreases and both calls expire worthless.

• • • • • •

Max Proﬁt = Net Premium Received - Commissions Paid Max Proﬁt Achieved When Price of Underlying <= Strike Price of Short Call Max Loss = Strike Price of Long Call - Strike Price of Short Call - Net Premium Received + Commissions Paid Max Loss Occurs When Price of Underlying >= Strike Price of Long Call Breakeven Point = Strike Price of Short Call + Net Premium Received

21

F&O Trading Strategies - Himanshu Ahire

Bear put spread For investors who maintain a generally negative feeling about a stock, bear spreads are another nice low risk, low reward strategy. This trade involves buying a put at a higher strike and selling another put at a lower strike. Like bear call spreads, bear put spreads proﬁt when the price of the underlying stock decreases.

• • • • •

Max Proﬁt = Strike Price of Long Put - Strike Price of Short Put - Net Premium Paid Commissions Paid Max Proﬁt Achieved When Price of Underlying <= Strike Price of Short Put Max Loss = Net Premium Paid + Commissions Paid Max Loss Occurs When Price of Underlying >= Strike Price of Long Put Breakeven Point = Strike Price of Long Put - Net Premium Paid

22

F&O Trading Strategies - Himanshu Ahire

Neutral Strategies Reversal Primarily used by ﬂoor traders, a reversal is an arbitrage strategy that allows traders to proﬁt when options are underpriced. To put on a reversal, a trader would sell stock and use options to buy an equivalent position that offsets the short stock.

•

Proﬁt = Sale Price of Underlying - Strike Price of Call/Put + Put Premium - Call Premium

23

F&O Trading Strategies - Himanshu Ahire

Conversion Primarily used by ﬂoor traders, a conversion is an arbitrage strategy that allows traders to proﬁt when options are overpriced. To put on a conversion, a trader would buy stock and use options to sell an equivalent position that offsets the long stock.

•

Proﬁt = Strike Price of Call/Put - Purchase Price of Underlying + Call Premium - Put Premium

24

F&O Trading Strategies - Himanshu Ahire

The Collar For bullish investors who want to nice low risk, limited return strategy to use in conjunction with a long stock position, collars are a great alternative. In this case, the collar is created by combining covered calls protective puts.

• • • • •

Max Proﬁt = Strike Price of Short Call - Purchase Price of Underlying + Net Premium Received - Commissions Paid Max Proﬁt Achieved When Price of Underlying >= Strike Price of Short Call Max Loss = Purchase Price of Underlying - Strike Price of Long Put - Net Premium Received + Commissions Paid Max Loss Occurs When Price of Underlying <= Strike Price of Long Put Breakeven Point = Purchase Price of Underlying + Net Premium Paid

25

F&O Trading Strategies - Himanshu Ahire

Long Straddle For aggressive investors who expect short-term volatility yet have no bias up or down (i.e., a neutral bias), the long straddle is an excellent strategy. This position involves buying both a put and a call with the same strike price, expiration, and underlying. The potential loss is limited to the initial investment. The potential proﬁt is unlimited as the stock moves up or down.

• • • • • • •

Maximum Proﬁt = Unlimited Proﬁt Achieved When Price of Underlying > Strike Price of Long Call + Net Premium Paid OR Price of Underlying < Strike Price of Long Put - Net Premium Paid Proﬁt = Price of Underlying - Strike Price of Long Call - Net Premium Paid OR Strike Price of Long Put - Price of Underlying - Net Premium Paid Max Loss = Net Premium Paid + Commissions Paid Max Loss Occurs When Price of Underlying = Strike Price of Long Call/Put Upper Breakeven Point = Strike Price of Long Call + Net Premium Paid Lower Breakeven Point = Strike Price of Long Put - Net Premium Paid

26

F&O Trading Strategies - Himanshu Ahire

Short Straddle For aggressive investors who don't expect much short-term volatility, the short straddle can be a risky, but proﬁtable strategy. This strategy involves selling a put and a call with the same strike price, expiration, and underlying. In this case, the proﬁt is limited to the initial credit received by selling options. The potential loss is unlimited as the market moves up or down.

• • • • • • • •

Max Proﬁt = Net Premium Received - Commissions Paid Max Proﬁt Achieved When Price of Underlying = Strike Price of Short Call/Put Maximum Loss = Unlimited Loss Occurs When Price of Underlying > Strike Price of Short Call + Net Premium Received OR Price of Underlying < Strike Price of Short Put - Net Premium Received Loss = Price of Underlying - Strike Price of Short Call - Net Premium Received OR Strike Price of Short Put - Price of Underlying - Net Premium Received + Commissions Paid Upper Breakeven Point = Strike Price of Short Call + Net Premium Received Lower Breakeven Point = Strike Price of Short Put - Net Premium Received

27

F&O Trading Strategies - Himanshu Ahire

Long Strangle For aggressive investors who expect short-term volatility yet have no bias up or down (i.e., a neutral bias), the long strangle is another excellent strategy. This strategy typically involves buying out-of-the-money calls and puts with the same strike price, expiration, and underlying. The potential loss is limited to the initial investment while the potential proﬁt is unlimited as the market moves up or down.

• • • • • • • •

Maximum Proﬁt = Unlimited Proﬁt Achieved When Price of Underlying > Strike Price of Long Call + Net Premium Paid OR Price of Underlying < Strike Price of Long Put - Net Premium Paid Proﬁt = Price of Underlying - Strike Price of Long Call - Net Premium Paid OR Strike Price of Long Put - Price of Underlying - Net Premium Paid Max Loss = Net Premium Paid + Commissions Paid Max Loss Occurs When Price of Underlying is in between Strike Price of Long Call and Strike Price of Long Put Upper Breakeven Point = Strike Price of Long Call + Net Premium Paid Lower Breakeven Point = Strike Price of Long Put - Net Premium Paid

28

F&O Trading Strategies - Himanshu Ahire

Short Strangle For aggressive investors who don't expect much short-term volatility, the short strangle can be a risky, but proﬁtable strategy. This strategy typically involves selling out-of-themoney puts and calls with the same strike price, expiration, and underlying. The proﬁt is limited to the credit received by selling options. The potential loss is unlimited as the market moves up or down.

• • • • • • •

Max Proﬁt = Net Premium Received - Commissions Paid Max Proﬁt Achieved When Price of Underlying is in between the Strike Price of the Short Call and the Strike Price of the Short Put Maximum Loss = Unlimited Loss Occurs When Price of Underlying > Strike Price of Short Call + Net Premium Received OR Price of Underlying < Strike Price of Short Put - Net Premium Received Loss = Price of Underlying - Strike Price of Short Call - Net Premium Received OR Strike Price of Short Put - Price of Underlying - Net Premium Received + Commissions Paid Upper Breakeven Point = Strike Price of Short Call + Net Premium Received Lower Breakeven Point = Strike Price of Short Put - Net Premium Received

29

F&O Trading Strategies - Himanshu Ahire

The Butterﬂy Ideal for investors who prefer limited risk, limited reward strategies. When investors expect stable prices, they can buy the butterﬂy by selling two options at the middle strike and buying one option at the higher and lower strikes. The options, which must be all calls or all puts, must also have the same expiration and underlying.

• • • • • • •

Max Proﬁt = Strike Price of Short Call - Strike Price of Lower Strike Long Call - Net Premium Paid - Commissions Paid Max Proﬁt Achieved When Price of Underlying = Strike Price of Short Calls Max Loss = Net Premium Paid + Commissions Paid Max Loss Occurs When Price of Underlying <= Strike Price of Lower Strike Long Call OR Price of Underlying >= Strike Price of Higher Strike Long Call 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

30

F&O Trading Strategies - Himanshu Ahire

Ratio Spread For aggressive investors who don't expect much short-term volatility, ratio spreads are a limited reward, unlimited risk strategy. Put ratio spreads, which involve buying puts at a higher strike and selling a greater number of puts at a lower strike, are neutral in the sense that they are hurt by market movement.

• • • • • • •

Max Proﬁt = Strike Price of Short Call - Strike Price of Long Call + Net Premium Received - Commissions Paid Max Proﬁt Achieved When Price of Underlying = Strike Price of Short Calls Maximum Loss = Unlimited Loss Occurs When Price of Underlying > Strike Price of Short Calls + ((Strike Price of Short Call - Strike Price of Long Call + Net Premium Received) / Number of Uncovered Calls) Loss = Price of Underlying - Strike Price of Short Calls - Max Proﬁt + Commissions Paid Upper Breakeven Point = Strike Price of Short Calls + (Points of Maximum Proﬁt / Number of Uncovered Calls) Lower Breakeven Point = Strike Price of Long Call +/- Net Premium Paid or Received

31

F&O Trading Strategies - Himanshu Ahire

Condor Ideal for investors who prefer limited risk, limited reward strategies. The condor takes the body of the butterﬂy - two options at the middle strike - and splits between two middle strikes. In this sense, the condor is basically a butterﬂy stretched over four strike prices instead of three.

• • • • • •

Max Proﬁt = Strike Price of Lower Strike Short Call - Strike Price of Lower Strike Long Call - Net Premium Paid - Commissions Paid Max Proﬁt Achieved When Price of Underlying is in between the Strike Prices of the 2 Short Calls Max Loss = Net Premium Paid + Commissions Paid Max Loss Occurs When Price of Underlying <= Strike Price of Lower Strike Long Call OR Price of Underlying >= Strike Price of Higher Strike Long Call Upper Breakeven Point = Strike Price of Highest Strike Long Call - Net Premium Received Lower Breakeven Point = Strike Price of Lowest Strike Long Call + Net Premium Received

32

F&O Trading Strategies - Himanshu Ahire

Calendar Spread Calendar spreads are also known as time or horizontal spreads because they involve options with different expiration months. Because they are not exceptionally proﬁtable on their own, calendar spreads are often used by traders who maintain large positions. Typically, a long calendar spread involves buying an option with a long-term expiration and selling an option with the same strike price and a short-term expiration.

The maximum possible proﬁt for the neutral calendar spread is limited to the premiums collected from the sale of the near month options minus any time decay of the longer term options. This happens if the underlying stock price remains unchanged on expiration of the near month options. The maximum possible loss for the neutral calendar spread is limited to the initial debit taken to put on the spread. It occurs when the stock price goes down and stays down until expiration of the longer term options.

33

F&O Trading Strategies - Himanshu Ahire

Bibliography

NCFM derivatives module www.nseindia.com http://www.theoptionsguide.com/ http://en.wikipedia.org/wiki/Main_Page

34

Future & Option Trading Strategies

Assignment One

Himanshu Ahire 13 Executive Full Time PGDM ( 2009-2010 ) Trimester 4 Symbiosis Institute of Management Studies

1

F&O Trading Strategies - Himanshu Ahire

Introduction

Hedgers

Speculators

Arbitrageurs

4

4 5 5

Market Players

The Exchanges

Financial Institution

Market Makers

Day traders

Premium Sellers

Spread Traders

Theoretical Traders

6

6 6 6

7 7 7 7

Future & option Trading Strategies

Long & Short Futures

Long position

Short position

8

8

8 9

Options In-the-money, At-the-money, Out-of-the-money

At-the-money

In-the-money

out-of-the-money

10

10 10 10

Trading Strategies

Bullish Strategies

Long call

Covered Calls

Protective Put

Bull Call Spread

Bull Put Spread

Call Back Spread

11

11

11 12 13 14 15 16

2

F&O Trading Strategies - Himanshu Ahire Naked Put

17

Bearish Strategies

Long Put

Naked Put

Put Back-spread

Bear call spread

Bear put spread

18

18 19 20 21 22

Neutral Strategies

Reversal

Conversion

23

23 24

The Collar

Long Straddle

Short Straddle

Long Strangle

Short Strangle

The Butterﬂy

Ratio Spread

Condor

Calendar Spread

25

26 27 28 29 30 31 32 33

Bibliography

34

3

F&O Trading Strategies - Himanshu Ahire

Introduction

Derivatives are ﬁnancial instruments which derives their value from underlying asset. These underlying assets can be Shares, Bonds, Interest Rates, Market Volatility, currencies & Commodities. Derivatives market can be OTC or Exchange Traded. Primary goal of derivatives trading is to transfer underlying price risk from one party to another. Hence derivatives helps mitigating risk from future uncertainties. Although main objective of derivatives is to mitigate risk it can be used for proﬁt making. Hence Derivatives traders can be classiﬁed as • • • Hedgers Speculators Arbitrageurs

Hedgers Generally hedgers have substantial interest ( exposure ) in spot market. Hence they participate in derivatives market to mitigate adverse price movement risk in spot market. hedgers can take various positions in derivatives market based on their exposure in spot market. Generally they take opposite position in derivatives market compare to spot market. Hedging can also be used to protect existing future or options positions. For Example following are option positions & their respective possible future/options hedge positions. Option Position Hedge Position

Long Call : Increases in value as the underlying Short Underlying increases in value Short Call Long Put Short Call :Decreases in value as the underlying Long Underlying increases in value Long Call Short Put Long Put : Decreases in value as the underlying Long Underlying increases in value Short Put Long Call Short Put : Increases in value as the underlying Short Underlying decreases in value Long Put Short Call

4

F&O Trading Strategies - Himanshu Ahire

Speculators Speculators have proﬁt motive. They tried to get beneﬁt from market movement. They bets on derivative position based on personal view. Generally they have high risk appetite. Their main objective is to make quick gain by market movement. Because of their one sided view there is possibility of large proﬁt or Large loss.

Arbitrageurs Arbitrageurs want to make risk-less proﬁt. They tend to exploit market inefﬁciencies. Generally In the market, future & options prices are closely related to respective underlying spot market. For Example When the Underlying Security... The Long Call will The Short Call will The Long Put will The Short Put will Increase in Value Increase in Value Decrease in Value Decrease in Value Increase in Value Decrease in Value Decrease in Value Increase in Value Increase in Value Decrease in Value

But sometimes due to market inefﬁciencies there is some difference between spot market & derivative markets.They can utilized these differences between spot market & Derivatives market to make proﬁt.

5

F&O Trading Strategies - Himanshu Ahire

Market Players

With the possible exception of futures contracts, option trading is not a zero-sum game. In other words, for every winner there doesn't have to be a loser. Therefore, because there are so many different combinations and ways options can be hedged against each other. The main defferance between spot & Derivatives market is that in derivatives trading there are more players and multiple agendas. In the derivatives markets, the players fall into four categories: • • • • The Exchanges Financial Institution Market Makers Individual (Retail) Investors

The Exchanges The exchange is a place where market makers and traders gather to buy and sell stocks, options, bonds, futures, and other ﬁnancial instruments. Financial Institution Financial institutions are professional investment management companies that typically fall into several main categories: mutual funds, hedge funds, insurance companies, stock funds. In each case, these money managers control large portfolios of stocks, options, and other ﬁnancial instruments. Market Makers Market makers are the traders on the ﬂoor of the exchanges who create liquidity by providing two-sided markets. In each counter, the competition between market makers keeps the spread between the bid and the offer relatively narrow. Nevertheless, it's the spread that partially compensates market makers for the risk of willingly taking either side of a trade. In general, there are four trading techniques that characterize how different market makers trade options. Any or all of these techniques may be employed by the same market maker depending on trading conditions. • • • • Day Traders Premium Sellers Spread Traders Theoretical Traders

6

F&O Trading Strategies - Himanshu Ahire

Day traders Day traders, on or off the trading screen, tend to use small positions to capitalize on intraday market movement. Since their objective is not to hold a position for extended periods, day traders generally don't hedge options with the underlying stock. At the same time, they tend to be less concerned about delta, gamma, and other highly analytical aspects of option pricing.

Premium Sellers Just like the name implies, premium sellers tend to focus their efforts selling high priced options and taking advantage of the time decay factor by buying them later at a lower price. This strategy works well in the absence of large, unexpected price swings but can be extremely risky when volatility skyrockets. Spread Traders Like other market makers, spread traders often end up with large positions but they get there by focusing on spreads. In this way, even the largest of positions will be somewhat naturally hedged. Spread traders employ a variety of strategies buying certain options and selling others to offset the risk. Some of these strategies like reversals, conversions, and boxes are primarily used by ﬂoor traders because they take advantage of minor price discrepancies that often only exist for seconds. However, spread traders will use strategies like butterﬂies, condors, call spreads, and put spreads that can be used quite effectively by individual investors. Theoretical Traders By readily making two-sided markets, market makers often ﬁnd themselves with substantial option positions across a variety of months and strike prices. The same thing happens to theoretical traders who use complex mathematical models to sell options that are overpriced and buy options that are relatively underpriced. Of the four groups, theoretical traders are often the most analytical in that they are constantly evaluating their position to determine the effects of changes in price, volatility, and time.

7

F&O Trading Strategies - Himanshu Ahire

Future & option Trading Strategies

Long & Short Futures The Pay-off of a futures contract on maturity depends on the spot price of the underlying asset at the time of maturity and the price at which the contract was initially traded. There are two positions that could be taken in a futures contract: Long position one who buys the asset at the futures price takes the long position. The pay-off for a long position in a futures contract on one unit of an asset is: Long Pay-off = Future Price at Expiry – Future Purchase price

• • • • • • •

Maximum Proﬁt = Unlimited Proﬁt Achieved When Market Price of Futures > Purchase Price of Futures Proﬁt = (Market Price of Futures - Purchase Price of Futures) x Contract Size Maximum Loss = Unlimited Loss Occurs When Market Price of Futures < Purchase Price of Futures Loss = (Purchase Price of Futures - Market Price of Futures) x Contract Size + Commissions Paid Breakeven Point = Purchase Price of Futures Contract

8

F&O Trading Strategies - Himanshu Ahire

Short position one who sells the asset at the futures price takes the short position. Short Pay-off = Future short position price - Future short position at Expiry

• • • • • • •

Maximum Proﬁt = Unlimited Proﬁt Achieved When Market Price of Futures < Selling Price of Futures Proﬁt = (Selling Price of Futures - Market Price of Futures) x Contract Size Maximum Loss = Unlimited Loss Occurs When Market Price of Futures > Selling Price of Futures Loss = (Market Price of Futures - Selling Price of Futures) x Contract Size + Commissions Paid Breakeven Point = Selling Price of Futures Contract

9

F&O Trading Strategies - Himanshu Ahire

Options In-the-money, At-the-money, Out-of-the-money

In-the-money

Call Option

Put Option

Strike Price less than Spot Strike Price greater than Price of underlying asset Spot Price of underlying asset Strike Price equal to Spot Strike Price equal to Spot Price of underlying asset Price of underlying asset Strike Price greater than Strike Price less than Spot Spot Price of underlying Price of underlying asset asset

At-the-money

Out-of-the-money

At-the-money An option is said to be 'at-the-money', when the option's strike price is equal to the underlying asset price. This is true for both puts and calls. In-the-money A call option is said to be in-the-money when the strike price of the option is less than the underlying asset price. For example, a Sensex call option with strike of 3900 is 'in-themoney', when the spot Sensex is at 4100 as the call option has value. The call holder has the right to buy a Sensex at 3900, no matter how much the spot market price has risen. And with the current price at 4100, a proﬁt can be made by selling Sensex at this higher price. out-of-the-money On the other hand, a call option is out-of-the-money when the strike price is greater than the underlying asset price. Using the earlier example of Sensex call option, if the Sensex falls to 3700, the call option no longer has positive exercise value. The call holder will not exercise the option to buy Sensex at 3900 when the current price is at 3700. (Please see table)

10

F&O Trading Strategies - Himanshu Ahire

Trading Strategies

Bullish Strategies Long call For aggressive investors who are bullish about the short-term prospects for a stock, buying calls can be an excellent way to capture the upside potential with limited inside risk.

• • • • • •

Maximum Proﬁt = Unlimited Proﬁt Achieved When Price of Underlying >= Strike Price of Long Call + Premium Paid Proﬁt = Price of Underlying - Strike Price of Long Call - Premium Paid Max Loss = Premium Paid + Commissions Paid Max Loss Occurs When Price of Underlying <= Strike Price of Long Call Breakeven Point = Strike Price of Long Call + Premium Paid

11

F&O Trading Strategies - Himanshu Ahire

Covered Calls For conservative investors, selling calls against a long stock position can be an excellent way to generate income without assuming the risks associated with uncovered calls. In this case, investors would sell one call contract for each 100 shares of stock they own.

• • • • •

Proﬁt Potential: Limited Loss Potential: Unlimited Upside Proﬁt at Expiration If Assigned: Premium Received + Difference (if any) Between Strike Price and Stock Purchase Price Upside Proﬁt at Expiration If Not Assigned: Any Gains in Stock Value + Premium Received BEP: Stock Purchase Price - Premium Received

12

F&O Trading Strategies - Himanshu Ahire

Protective Put For investors who want to protect the stocks in their portfolio from falling prices, protective puts provide a relatively low-cost form of portfolio insurance. In this case, investors would purchase one put contract for each 100 shares of stock they own.

• • • • • •

Maximum Proﬁt = Unlimited Proﬁt Achieved When Price of Underlying > Purchase Price of Underlying + Premium Paid Proﬁt = Price of Underlying - Purchase Price of Underlying - Premium Paid Max Loss = Premium Paid + Purchase Price of Underlying - Put Strike + Commissions Paid Max Loss Occurs When Price of Underlying <= Strike Price of Long Put Breakeven Point = Purchase Price of Underlying + Premium Paid

13

F&O Trading Strategies - Himanshu Ahire

Bull Call Spread For bullish investors who want to a nice low risk, limited return strategy without buying or selling the underlying stock, bull call spreads are a great alternative. This strategy involves buying and selling the same number of calls at different strike prices to minimize both the cash outlay and the overall risk.

• • • • •

Max Proﬁt = Strike Price of Short Call - Strike Price of Long Call - Net Premium Paid Commissions Paid Max Proﬁt Achieved When Price of Underlying >= Strike Price of Short Call Max Loss = Net Premium Paid + Commissions Paid Max Loss Occurs When Price of Underlying <= Strike Price of Long Call Breakeven Point = Strike Price of Long Call + Net Premium Paid

14

F&O Trading Strategies - Himanshu Ahire

Bull Put Spread For bullish investors who want a nice low risk, limited return strategy, bull put spreads are another alternative. Like the bull call spread, the bull put spread involves buying and selling the same number of put options at different strike prices. Since puts with the higher strike are sold, the trade is initiated for a credit.

• • • • •

Max Proﬁt = Net Premium Received - Commissions Paid Max Proﬁt Achieved When Price of Underlying >= Strike Price of Short Put Max Loss = Strike Price of Short Put - Strike Price of Long Put Net Premium Received + Commissions Paid Max Loss Occurs When Price of Underlying <= Strike Price of Long Put Breakeven Point = Strike Price of Short Put - Net Premium Received

15

F&O Trading Strategies - Himanshu Ahire

Call Back Spread For bullish investors who expect big moves in already volatile stocks, call back spreads are a great limited risk, unlimited reward strategy. The trade itself involves selling a call (or calls) at a lower strike and buying a greater number of calls at a higher strike price.

• • • • • • •

Maximum Proﬁt = Unlimited Proﬁt Achieved When Price of Underlying >= 2 x Strike Price of Long Call - Strike Price of Short Call +/- Net Premium Paid/Received Proﬁt = Price of Underlying - Strike Price of Long Call - Max Loss Max Loss = Strike Price of Long Call - Strike Price of Short Call +/- Net Premium Paid/ Received + Commissions Paid Max Loss Occurs When Strike Price of Long Call Upper Breakeven Point = Strike Price of Long Call + Points of Maximum Loss Lower Breakeven Point = Strike Price of Short Call

16

F&O Trading Strategies - Himanshu Ahire

Naked Put For bullish investors who are interested in buying a stock at a price below the current market price, selling naked puts can be an excellent strategy. In this case, however, the risk is substantial because the writer of the option is obligated to purchase the stock at the strike price regardless of where the stock is trading.

• • • • • •

Max Proﬁt = Premium Received - Commissions Paid Max Proﬁt Achieved When Price of Underlying >= Strike Price of Short Put Maximum Loss = Unlimited Loss Occurs When Price of Underlying < Strike Price of Short Put - Premium Received Loss = Strike Price of Short Put - Price of Underlying - Premium Received + Commissions Paid Breakeven Point = Strike Price of Short Put - Premium Received

17

F&O Trading Strategies - Himanshu Ahire

Bearish Strategies Long Put For aggressive investors who have a strong feeling that a particular stock is about to move lower, long puts are an excellent low risk, high reward strategy. While risk is limited to the initial investment, the proﬁt potential is unlimited.

• • • • • •

Maximum Proﬁt = Unlimited Proﬁt Achieved When Price of Underlying = 0 Proﬁt = Strike Price of Long Put - Premium Paid Max Loss = Premium Paid + Commissions Paid Max Loss Occurs When Price of Underlying >= Strike Price of Long Put Breakeven Point = Strike Price of Long Put - Premium Paid

18

F&O Trading Strategies - Himanshu Ahire

Naked Put Selling naked calls is a very risky strategy which should be utilized with extreme caution. By selling calls without owning the underlying stock, you collect the option premium and hope the stock either stays steady or declines in value. If the stock increases in value this strategy has unlimited risk.

• • • •

Maximum Loss = Unlimited Loss Occurs When Price of Underlying < Strike Price of Short Put - Premium Received Loss = Strike Price of Short Put - Price of Underlying - Premium Received + Commissions Paid Breakeven Point = Strike Price of Short Put - Premium Received

19

F&O Trading Strategies - Himanshu Ahire

Put Back-spread For aggressive investors who expect big downward moves in already volatile stocks, backspreads are great strategies. The trade itself involves selling a put at a higher strike and buying a greater number of puts at a lower strike price. As the stock price moves lower, the proﬁt potential is unlimited.

• • • • • • •

Maximum Proﬁt = Unlimited Proﬁt Achieved When Price of Underlying < 2 x Strike Price of Long Put - Strike Price of Short Put + Net Premium Received Proﬁt = Strike Price of Long Put - Price of Underlying - Max Loss Max Loss = Strike Price of Short Put - Strike Price of Long Put - Net Premium Received + Commissions Paid Max Loss Occurs When Price of Underlying = Strike Price of Long Put Upper Breakeven Point = Strike Price of Short Put Lower Breakeven Point = Strike Price of Long Put - Points of Maximum Loss

20

F&O Trading Strategies - Himanshu Ahire

Bear call spread For investors who maintain a generally negative feeling about a stock, bear spreads are a nice low risk, low reward strategies. This trade involves selling a lower strike call, usually at or near the current stock price, and buying a higher strike, out-of-the-money call. This spread proﬁts when the stock price decreases and both calls expire worthless.

• • • • • •

Max Proﬁt = Net Premium Received - Commissions Paid Max Proﬁt Achieved When Price of Underlying <= Strike Price of Short Call Max Loss = Strike Price of Long Call - Strike Price of Short Call - Net Premium Received + Commissions Paid Max Loss Occurs When Price of Underlying >= Strike Price of Long Call Breakeven Point = Strike Price of Short Call + Net Premium Received

21

F&O Trading Strategies - Himanshu Ahire

Bear put spread For investors who maintain a generally negative feeling about a stock, bear spreads are another nice low risk, low reward strategy. This trade involves buying a put at a higher strike and selling another put at a lower strike. Like bear call spreads, bear put spreads proﬁt when the price of the underlying stock decreases.

• • • • •

Max Proﬁt = Strike Price of Long Put - Strike Price of Short Put - Net Premium Paid Commissions Paid Max Proﬁt Achieved When Price of Underlying <= Strike Price of Short Put Max Loss = Net Premium Paid + Commissions Paid Max Loss Occurs When Price of Underlying >= Strike Price of Long Put Breakeven Point = Strike Price of Long Put - Net Premium Paid

22

F&O Trading Strategies - Himanshu Ahire

Neutral Strategies Reversal Primarily used by ﬂoor traders, a reversal is an arbitrage strategy that allows traders to proﬁt when options are underpriced. To put on a reversal, a trader would sell stock and use options to buy an equivalent position that offsets the short stock.

•

Proﬁt = Sale Price of Underlying - Strike Price of Call/Put + Put Premium - Call Premium

23

F&O Trading Strategies - Himanshu Ahire

Conversion Primarily used by ﬂoor traders, a conversion is an arbitrage strategy that allows traders to proﬁt when options are overpriced. To put on a conversion, a trader would buy stock and use options to sell an equivalent position that offsets the long stock.

•

Proﬁt = Strike Price of Call/Put - Purchase Price of Underlying + Call Premium - Put Premium

24

F&O Trading Strategies - Himanshu Ahire

The Collar For bullish investors who want to nice low risk, limited return strategy to use in conjunction with a long stock position, collars are a great alternative. In this case, the collar is created by combining covered calls protective puts.

• • • • •

Max Proﬁt = Strike Price of Short Call - Purchase Price of Underlying + Net Premium Received - Commissions Paid Max Proﬁt Achieved When Price of Underlying >= Strike Price of Short Call Max Loss = Purchase Price of Underlying - Strike Price of Long Put - Net Premium Received + Commissions Paid Max Loss Occurs When Price of Underlying <= Strike Price of Long Put Breakeven Point = Purchase Price of Underlying + Net Premium Paid

25

F&O Trading Strategies - Himanshu Ahire

Long Straddle For aggressive investors who expect short-term volatility yet have no bias up or down (i.e., a neutral bias), the long straddle is an excellent strategy. This position involves buying both a put and a call with the same strike price, expiration, and underlying. The potential loss is limited to the initial investment. The potential proﬁt is unlimited as the stock moves up or down.

• • • • • • •

Maximum Proﬁt = Unlimited Proﬁt Achieved When Price of Underlying > Strike Price of Long Call + Net Premium Paid OR Price of Underlying < Strike Price of Long Put - Net Premium Paid Proﬁt = Price of Underlying - Strike Price of Long Call - Net Premium Paid OR Strike Price of Long Put - Price of Underlying - Net Premium Paid Max Loss = Net Premium Paid + Commissions Paid Max Loss Occurs When Price of Underlying = Strike Price of Long Call/Put Upper Breakeven Point = Strike Price of Long Call + Net Premium Paid Lower Breakeven Point = Strike Price of Long Put - Net Premium Paid

26

F&O Trading Strategies - Himanshu Ahire

Short Straddle For aggressive investors who don't expect much short-term volatility, the short straddle can be a risky, but proﬁtable strategy. This strategy involves selling a put and a call with the same strike price, expiration, and underlying. In this case, the proﬁt is limited to the initial credit received by selling options. The potential loss is unlimited as the market moves up or down.

• • • • • • • •

Max Proﬁt = Net Premium Received - Commissions Paid Max Proﬁt Achieved When Price of Underlying = Strike Price of Short Call/Put Maximum Loss = Unlimited Loss Occurs When Price of Underlying > Strike Price of Short Call + Net Premium Received OR Price of Underlying < Strike Price of Short Put - Net Premium Received Loss = Price of Underlying - Strike Price of Short Call - Net Premium Received OR Strike Price of Short Put - Price of Underlying - Net Premium Received + Commissions Paid Upper Breakeven Point = Strike Price of Short Call + Net Premium Received Lower Breakeven Point = Strike Price of Short Put - Net Premium Received

27

F&O Trading Strategies - Himanshu Ahire

Long Strangle For aggressive investors who expect short-term volatility yet have no bias up or down (i.e., a neutral bias), the long strangle is another excellent strategy. This strategy typically involves buying out-of-the-money calls and puts with the same strike price, expiration, and underlying. The potential loss is limited to the initial investment while the potential proﬁt is unlimited as the market moves up or down.

• • • • • • • •

Maximum Proﬁt = Unlimited Proﬁt Achieved When Price of Underlying > Strike Price of Long Call + Net Premium Paid OR Price of Underlying < Strike Price of Long Put - Net Premium Paid Proﬁt = Price of Underlying - Strike Price of Long Call - Net Premium Paid OR Strike Price of Long Put - Price of Underlying - Net Premium Paid Max Loss = Net Premium Paid + Commissions Paid Max Loss Occurs When Price of Underlying is in between Strike Price of Long Call and Strike Price of Long Put Upper Breakeven Point = Strike Price of Long Call + Net Premium Paid Lower Breakeven Point = Strike Price of Long Put - Net Premium Paid

28

F&O Trading Strategies - Himanshu Ahire

Short Strangle For aggressive investors who don't expect much short-term volatility, the short strangle can be a risky, but proﬁtable strategy. This strategy typically involves selling out-of-themoney puts and calls with the same strike price, expiration, and underlying. The proﬁt is limited to the credit received by selling options. The potential loss is unlimited as the market moves up or down.

• • • • • • •

Max Proﬁt = Net Premium Received - Commissions Paid Max Proﬁt Achieved When Price of Underlying is in between the Strike Price of the Short Call and the Strike Price of the Short Put Maximum Loss = Unlimited Loss Occurs When Price of Underlying > Strike Price of Short Call + Net Premium Received OR Price of Underlying < Strike Price of Short Put - Net Premium Received Loss = Price of Underlying - Strike Price of Short Call - Net Premium Received OR Strike Price of Short Put - Price of Underlying - Net Premium Received + Commissions Paid Upper Breakeven Point = Strike Price of Short Call + Net Premium Received Lower Breakeven Point = Strike Price of Short Put - Net Premium Received

29

F&O Trading Strategies - Himanshu Ahire

The Butterﬂy Ideal for investors who prefer limited risk, limited reward strategies. When investors expect stable prices, they can buy the butterﬂy by selling two options at the middle strike and buying one option at the higher and lower strikes. The options, which must be all calls or all puts, must also have the same expiration and underlying.

• • • • • • •

Max Proﬁt = Strike Price of Short Call - Strike Price of Lower Strike Long Call - Net Premium Paid - Commissions Paid Max Proﬁt Achieved When Price of Underlying = Strike Price of Short Calls Max Loss = Net Premium Paid + Commissions Paid Max Loss Occurs When Price of Underlying <= Strike Price of Lower Strike Long Call OR Price of Underlying >= Strike Price of Higher Strike Long Call 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

30

F&O Trading Strategies - Himanshu Ahire

Ratio Spread For aggressive investors who don't expect much short-term volatility, ratio spreads are a limited reward, unlimited risk strategy. Put ratio spreads, which involve buying puts at a higher strike and selling a greater number of puts at a lower strike, are neutral in the sense that they are hurt by market movement.

• • • • • • •

Max Proﬁt = Strike Price of Short Call - Strike Price of Long Call + Net Premium Received - Commissions Paid Max Proﬁt Achieved When Price of Underlying = Strike Price of Short Calls Maximum Loss = Unlimited Loss Occurs When Price of Underlying > Strike Price of Short Calls + ((Strike Price of Short Call - Strike Price of Long Call + Net Premium Received) / Number of Uncovered Calls) Loss = Price of Underlying - Strike Price of Short Calls - Max Proﬁt + Commissions Paid Upper Breakeven Point = Strike Price of Short Calls + (Points of Maximum Proﬁt / Number of Uncovered Calls) Lower Breakeven Point = Strike Price of Long Call +/- Net Premium Paid or Received

31

F&O Trading Strategies - Himanshu Ahire

Condor Ideal for investors who prefer limited risk, limited reward strategies. The condor takes the body of the butterﬂy - two options at the middle strike - and splits between two middle strikes. In this sense, the condor is basically a butterﬂy stretched over four strike prices instead of three.

• • • • • •

Max Proﬁt = Strike Price of Lower Strike Short Call - Strike Price of Lower Strike Long Call - Net Premium Paid - Commissions Paid Max Proﬁt Achieved When Price of Underlying is in between the Strike Prices of the 2 Short Calls Max Loss = Net Premium Paid + Commissions Paid Max Loss Occurs When Price of Underlying <= Strike Price of Lower Strike Long Call OR Price of Underlying >= Strike Price of Higher Strike Long Call Upper Breakeven Point = Strike Price of Highest Strike Long Call - Net Premium Received Lower Breakeven Point = Strike Price of Lowest Strike Long Call + Net Premium Received

32

F&O Trading Strategies - Himanshu Ahire

Calendar Spread Calendar spreads are also known as time or horizontal spreads because they involve options with different expiration months. Because they are not exceptionally proﬁtable on their own, calendar spreads are often used by traders who maintain large positions. Typically, a long calendar spread involves buying an option with a long-term expiration and selling an option with the same strike price and a short-term expiration.

The maximum possible proﬁt for the neutral calendar spread is limited to the premiums collected from the sale of the near month options minus any time decay of the longer term options. This happens if the underlying stock price remains unchanged on expiration of the near month options. The maximum possible loss for the neutral calendar spread is limited to the initial debit taken to put on the spread. It occurs when the stock price goes down and stays down until expiration of the longer term options.

33

F&O Trading Strategies - Himanshu Ahire

Bibliography

NCFM derivatives module www.nseindia.com http://www.theoptionsguide.com/ http://en.wikipedia.org/wiki/Main_Page

34