Option strategies


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Option Strategies by FCA Kapil Agrawal

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Option strategies

  1. 1. For Optimization of Investor’s Wealth Author FCA Kapil Agrawal Financial Derivative Consultant
  2. 2. <ul><li>AFTER having identified a GOOD MANAGEMENT, WORTHY PERFORMANCE stock, an investor takes a position on the stock. </li></ul><ul><li>Thus, when you buy Reliance Industries, you have bet on its superior price performance. </li></ul>
  3. 3. <ul><li>The price goes up as you had expected. </li></ul><ul><li>You are overjoyed, news starts pouring that Reliance shall gain further ground. </li></ul><ul><li>You distribute the news of your success to your friends and few of them also join the party. </li></ul><ul><li>You wait for more profits and see sweet dreams while asleep at night. </li></ul>
  4. 4. <ul><li>And then, an event occurs which is not at all connected with the company’s performance. </li></ul><ul><li>The oil & petroleum minister, who is considered very close to the management, is promoted & transferred to defence. </li></ul><ul><li>Unknowingly, the price of Reliance dives and before you can recover, you are counting losses and so are your friends. </li></ul><ul><li>After all, this is stock market, my friend </li></ul>
  5. 5. <ul><li>Now, if you had bought the stock in delivery, had made full payment, you need not worry, it shall be just a matter of time and the share shall recover its lost ground. </li></ul><ul><li>An afterthought: </li></ul><ul><li>Had I booked profits when the share was riding high ! </li></ul>
  6. 6. <ul><li>Alternately, had you taken position in Futures , be ready to cough the mark to market losses apart from the increasing SPAN margins, which generally escalates when the speculator is caught unaware. </li></ul><ul><li>You grow PANICKY: You have already spoilt your sleep </li></ul>
  7. 7. <ul><li>For the normal investor, I have a strategy: </li></ul><ul><li>Mr. Investor is bullish on Reliance, he buys the scrip at Rs 900. </li></ul><ul><li>He decides that if the share gives 5% profits in one month, he shall exit but he knows that at 950, he shall not be able to sell because Mr. GREED shall occupy the driver’s seat. </li></ul><ul><li>So, he immediately WRITES a CALL OPTION 950 CA , one month expiry and gets additional credit of the premium (a nearly 2% fair premium of Rs. 18 for a one month commitment ). </li></ul>
  8. 8. <ul><li>Coming back to the Original scenario, the share climbs to 940, nosedives on minister’s news and at the monthly expiration, settles at, say 885. </li></ul><ul><li>He is a happy man: his Rs. 15 loss is offset by Rs. 18 premium that he earns. </li></ul><ul><li>He ends in a plus. </li></ul><ul><li>If the shares ends more in the red, he is still compensated by Rs. 18 and has a chance of recovering his money faster. </li></ul>
  9. 9. <ul><li>On the other hand, the market refuses to go down, climbs to 965 at the month end expiry, he need not be sad, his delivery shall get sold at 950 (committed price at 950 CA) + he shall take home Rs. 18 premium. </li></ul><ul><li>Profit is Rs. 68………….. Hurray to the bank </li></ul>
  10. 10. <ul><li>What if the market climbs to 985. </li></ul><ul><li>That’s his luck: he is satisfied with his </li></ul><ul><li>Rs. 68 or 7% profits for that month and has to forego Rs. 17 for other players to benefit. </li></ul><ul><li>He is a winner in all situations </li></ul>
  11. 11. <ul><li>WIN WIN Situation he is in, still…………… </li></ul><ul><li>Back home, he feels cheated. </li></ul><ul><li>His marriage with Reliance has resulted in a compulsory Divorce & he has been forced to part with the share which, he feels would have gone places. </li></ul><ul><li>This is another stock market psychology: ONE IS NEVER SATISFIED. </li></ul>
  12. 12. <ul><li>We have a solution here too </li></ul><ul><li>WRITE a 950 PUT for the next month @ 27 OR better still a 900 PUT @ 10. </li></ul><ul><li>If the market does not budge, this premium is all yours. </li></ul><ul><li>After all, any business is worth only when you earn profits </li></ul>
  13. 13. <ul><li>The best scene of this story now occurs: The petroleum minister is now shifted . </li></ul><ul><li>( Remember, you can never time the market ) </li></ul><ul><li>Reliance plunges to 885 this expiry. </li></ul><ul><li>He has all the chance in the world to remarry the share at 885 . </li></ul><ul><li>Considering the premium earned Rs 10 and the loss of Rs. 15 on 900 PUT, his effective purchase price would be 890. </li></ul>
  14. 14. <ul><li>His two month Balance Sheet would read: </li></ul><ul><li>BOT at 900, SOLD at 968, BOT again at 890. </li></ul><ul><li>HAPPY TRADING PROFITS </li></ul>
  15. 15. <ul><li>Stock markets are Volatile. </li></ul><ul><li>They follow a SPIRAL movement. </li></ul><ul><li>We can take advantage of this Spiral movement and enhance our returns on our investment. </li></ul><ul><li>Basic OPTION WRITING can give us excellent returns in any type of market, if done in a strategic, disciplined manner. </li></ul>
  16. 16. <ul><li>For novice investors, selling an option can be too risky . </li></ul><ul><li>While it can earn you limited strategic profits but at the same time, there can be UNLIMITED LOSSES involved. </li></ul><ul><li>There is a fear but this is because of lack of awareness and practice. </li></ul><ul><li>Still, it is advisable that option writing must be done under expert professional guidance only. </li></ul>
  17. 17. <ul><li>There are various option strategies for investors, which can be used to make profits ,under different situations. </li></ul><ul><li>Options can be bought, spreads can be traded, straddle or strangle can be created or butterfly can be traded. </li></ul><ul><li>I repeat , initially OPTION trading should be done under expert guidance only. </li></ul>
  18. 18. <ul><li>One last question? </li></ul><ul><li>After having BOT back Reliance at 890, what should be this investor’s next step? </li></ul><ul><li>No marks for guessing the correct answer. </li></ul>
  19. 19. <ul><li>by </li></ul><ul><li>FCA Kapil Agrawal </li></ul><ul><li>Financial Derivative Consultant </li></ul><ul><li>[email_address] </li></ul>