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Infosys option strategy, April 2012


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Infosys Technologies 4th quarter results are to be announced on 13th April 2012. …

Infosys Technologies 4th quarter results are to be announced on 13th April 2012.
Please find enclosed a document on an "option spread strategy" that can applied in Infosys for a decent return,,just before the company announces its 4th quarter results.

Caution: Risk of loss in trading in can be substantial. You should carefully consider whether trading is appropriate for you in light of your experience objectives, financial resources and other relevant circumstances.

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  • 1. OPTION STRATEGY IN INFOSYS APRIL 2012Marwah Financial Services
  • 2. OPTION STRATEGY IN INFOSYSThe document consists of an option spread strategy wherein it explains the option strategy in details followed by an analysisand recommended application of the strategy in one of the index stocks i.e. Infosys Technologies. thApplication of Option Strategy in Infosys before 4 Quarter Results in April 2012With reference to the observations noted from Table A(below on Pg No. 5) and the option strategy explained below(at Pg No. th th3), we can apply Long Strangle strategy in the Infosys stock , before it announces its 4 quarter results on 13 April 2012.Based on the past data and current stock price following are the key points important to the application of the strategy. Stock lot size: 125 shares Approximate capital outflow in the strategy would be Rs 20000-25000 One can expect (post transaction charges) gains/returns of 7-12% from this strategy One can trade this strategy with a decent risk reward ration of 1:2 or 1:3 on/before the Infosys result date The strategy is not direction biased and should be applied on the premise of volatility the stocks witnesses on the result day. The strategy is to be applied for a maximum period of 2-3 days. PAST 2 QUARTERS OPTION STRATEGY PAYOFF Strategy Entry Strategy Payoff Closing Price Daily Date Volatility th 11 January 2012 Long Strangle Long and 2800 Total Premium at closing on 11/01/2012 th PE@72 12 January 2012 was Rs 210 Rs 2826 Total premium Money Earned Rs 26500 8.5% outflow Rs 167 Return 25 % 12/01/2012 Money Invested Rs Rs 2588 21000 th11 October 2011 Long Straddle Long 2500 CE @98 Total Premium at closing on 11/10/2011- th and 2500 PE @ 87 12 October 2011-Rs 220 Rs 2504 Total Premium Money Earned Rs 27500 7.0% Outflow 185 Return 19% 12/10/2011- Money Invested Rs Rs 2679 23125 2
  • 3. OPTION STRATEGY EXPLAINED: LONG STRANGLE Strategy Market Opinion When to Use Benefits Risk vs. RewardLONG STRANGLE Buying call and a put Large Price Earnings Good Profits Limited loss on the same Movements in Announcements when Volatility Unlimited underlying asset the underlying Unsure of the supersedes Profits with similar expiry asset Direction Time Value Non Directional Any specific event LONG STRANGLE The long strangle is simply the simultaneous purchase of a long call and a long put on the same underlying security with both options having the same expiration but where the put strike price is lower than the call strike price. Because the position includes both a long call and a long put, the investor using long strangle should have a complete understanding of the risks and rewards associated with both long calls and long puts. The long strangle is similar to the long straddle. However, while the straddle uses the same strike price for the call and the put, the strangle uses different strikes. In the case of strangle, the put strike is below the call strike. As a result, whereas the straddle expires worthless only if the stock price equals the strike price, the long strangle expires worthless if the underlying price is at or between the strike prices at expiration. The strangle will generally provide more leverage when compared to a straddle as it is normally less expensive to purchase a strangle than a straddle. Market opinion Increasing volatility and extremely large price swings in the underlying security. Potentially profit from a large move, either up or down, in the underlying price during the life of the options. When to Use Purchasing only long calls or only long puts is primarily a directional strategy. The long strangle however, consisting of both long calls and long puts is a not a directional strategy, rather one where the investor feels extremely large price swings are forthcoming but is unsure of the direction. This strategy may prove beneficial when the investor feels large price movement, either up or down, is about to happen but uncertain of the direction. An instance of when a strangle may be considered is when an earnings announcement is forthcoming. The investor feels the projected announcement will introduce large price swings in the underlying. If the earnings announcement and future outlook is positive, this may positively impact the price of the security. If the earnings announcement and outlook is negative, or fails to impress investors, the stock could decline considerably. The risk is the stock remains stable or between the strike price of the call and strike price of the put until expiration. Another risk is that the stocks move does not produce a corresponding option price increase that is enough to cover the two premiums paid for the position. Declining implied volatility will also negatively impact this strategy. 3
  • 4. BenefitA long strangle benefits when the price of the underlying moves above or below the break even points. If a large pricemovement occurs outside of this range, significant profits can be realized. If an increase in the implied volatility of the optionsoutpaces time value erosion, likewise the position could realize a profit.Risk v/s RewardMaximum Profit: Theoretically unlimited to the upside; limited profits on the down side as the stock can only decline to zero.Maximum Loss: Limited and predetermined, but potentially significant, equal to the sum of the two premiums paid (callpremium plus put premium). Maximum loss occurs if the underlying price is between the strike price of the call and putoptions at expiration.Upside Profit at Expiration: (Stock Price at expiration – total premium paid) – call strike price.Assuming Stock Price above BEP at expiration.Downside Profit at Expiration: Put strike price - (Stock price at expiration + total premium paid).Assuming stock price is below BEP at expiration.The maximum profit on the upside is theoretically unlimited as there is no theoretical limit on how high a stock price can rise.The maximum downside profit is limited by the stocks potential decrease to no less than zero. Though the potential loss ispredetermined and limited in dollar amount, it can be as much as 100% of the premiums initially paid for the strangle.Whatever your motivation for purchasing the strangle is, weigh the potential reward against the potential loss of the entirepremium paid.Break-Even-Point (BEP)BEP: Two break-even prices:Call strike price + sum of call premium and put premiumPut strike price sum of call premium and put premiumVolatilityIf Volatility Increases: Positive EffectIf Volatility Decreases: Negative EffectAny effect of volatility on the options total premium is on the time value portion. 4
  • 5. Time Decay Passage of Time: Negative Effect The time value portion of an options premium, which the option holder has "purchased" when paying for the options, generally decreases, or decays, with the passage of time. This decrease accelerates as the option contract approaches expiration. A market observer will notice that time decay for puts occurs at a slightly slower rate than with calls. INFOSYS LAST 16 QUARTERS PRICE VOLATILITY TABLE: TABLE A Prev Next 1 Day 2 Day Highest Lowest Result Day Open High Low Last Close Day Volatility Volatility Volatility Volatility Date Close Price Price Price Price Price Close (%) (%) (%) (%) 15-Apr-08 1421.9 1440 1525 1420 1511.1 1510.4 1600 6.2 12.5 7.3 0.1 11-Jul-08 1805.25 1845 1874.65 1641.5 1667 1676.85 1555 -7.1 -13.9 3.8 9.1 10-Oct-08 1254.25 1200 1280 1040 1220 1225.2 1318 -2.3 5.1 2.1 17.1 13-Jan-09 1159.7 1180 1242.4 1119 1232 1228.15 1304 5.9 12.4 7.1 3.5 15-Apr-09 1409.3 1348 1382 1300.15 1369 1370.6 1345 -2.7 -4.6 -1.9 7.7 10-Jul-09 1677.55 1700 1769.8 1665 1717 1721.15 1770 2.6 5.5 5.5 0.7 9-Oct-09 2210.8 2230 2276.8 2166.6 2181.05 2177.6 2240 -1.5 1.3 3.0 2.0 12-Jan-10 2489.65 2500 2594 2500 2581.5 2586.95 2684 3.9 7.8 4.2 -0.4 13-Apr-10 2683.1 2690 2793.85 2635 2777 2781.9 2802 3.7 4.4 4.1 1.8 13-Jul-10 2895.9 2870 2875.05 2781 2790 2796.75 2743 -3.4 -5.3 -0.7 4.0 15-Oct-10 3185.25 3200 3238 3061.15 3085 3076.3 3107 -3.4 -2.5 1.7 3.9 13-Jan-11 3377.3 3293 3299 3195 3203.2 3205.2 3205 -5.1 -5.1 -2.3 5.4 15-Apr-11 3306.2 3296 3298.6 2977.5 2980.7 2989.5 2906 -9.6 -12.1 -0.2 9.9 12-Jul-11 2921.15 2850 2850 2746.8 2786.1 2791.55 2778 -4.4 -4.9 -2.4 6.0 12-Oct-11 2504.55 2595 2688 2595 2681 2679.35 2697 7.0 7.7 7.3 -3.6 12-Jan-12 2826.6 2750 2750 2578.05 2590.25 2588.25 2585 -8.4 -8.5 -2.7 8.8Stock Price Data Source: The above table consists of the daily price movements in the price of Infosys on the day its quarterly results are announced. The price movements on the result day have been compared with the previous day closing price and the result day’s high and low price. 5
  • 6. INFOSYS VOLATILITY TABLE OBSERVATIONS: • On the result day, the stock price has seen, price volatility of minimum 1.5% and maximum 9.6% when compared to the previous day’s close price. • Highest and the lowest price volatility seen in the stock price on the result date when compared to the previous day closing price has been 7.3% and 0.7% respectively. (This volatility has been calculated with respect to the day’s high/low on the result date) • The Stock has witnessed a daily volatility of less 3% in 4 out of the last 16 quarters as shown in red colour in the table above • The stock witnessed reverse volatility(i.e. the price moved in the reverse direction from the previous day close) on the 2nd day of the result announcement in October 2008 and October 2009.This can be some kind of a coincidence that the stock saw reverse price movements on the 2nd day of the result announcement • The stock generally witnesses large price movements on its result day quarter on quarter because of the management future guidance for the upcoming quarters. • The above strategy if applied a day before Infosys announces its 4th quarter results can provide good trading gains with a limited downside. One can trade this strategy with a decent risk reward ration of 1:2 or 1:3 on the Infosys result date. • One can expect (post transaction charges) gains/returns of 6-12% from this strategy • 5% volatility in the price of Infosys stock is approximately a change of Rs 130-150 in absolute terms.Caution:Risk of loss in trading in can be substantial. You should carefully consider whether trading is appropriate for you in light of yourexperience objectives, financial resources and other relevant circumstances 6