Options are contracts that give the buyer the right, but not the obligation, to buy (call option) or sell (put option) the underlying asset at a specified price on or before a specific date. They are a type of derivative since their value is dependent upon the price of the underlying asset.
Just like other derivatives, a trader can use options for hedging, speculative, and arbitrage purposes. But the thing that makes options trading much more attractive than trading other securities is that they provide the trader a plethora of options to express his/ her opinion of the markets and make money.
Options are divided into three groups, on the basis of their moneyness. Options’ Moneyness is a metric that determines if an option contract can profit if it is exercised immediately:
In The Money (ITM) Options: If the underlying security’s price is higher than the strike price, the call option is in the money. A put option, on the other hand, is in the money if the underlying security’s price is less than the strike price.
At The Money (ATM) Options: Both call and put options are at the money if the strike price and the underlying security’s price are equal.
Out of The Money (OTM) Options: If the underlying security’s price is lower than the strike price, a call option is out-of-the-money. A put option, on the other hand, is out-of-the-money if the underlying security’s price is higher than the strike price.
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A trader can bet on neutral positions along with bearish and bullish positions using options. This essentially means that a trader or a speculator can bet on the sideways movement of the markets. The markets don’t need to be trading in a direction for the trader to make money.
Not just this, using options, a trader can also express the extent of the bullishness and bearishness of the trader. A moderately bullish trader can resort to a different strategy than a highly bullish trader and make money accordingly.
If a trader expects a one-sided move due to, let’s say, an event like results or budget upcoming, he can use an options strategy to profit even if he is not sure of the direction of the potential move.
Even though options provide alternatives, they are much riskier than other asset classes. Therefore, it is vital to understand the various option trading strategies that have predefined risk to avoid mishaps while using options
We’ll discuss a few widely-used option trading strategies in this blog. We look at bullish strategies- ideal for traders who see the market going up, bearish strategies- ideal for traders expecting the underlying security to go down, and neutral strategies- ideal for traders expecting the underlying security to remain in a range.
Before we continue, certain clarifications:
As an example, all the strategies are based on Nifty 50. They can however be used on any stock/ index.
The analysis was done on 2nd May 2021, Sunday. Therefore, the closing price of Nifty on 30th April which is 14,631, is taken as the current market price for the examples.
The expiry date taken for the options is 27th May 2021, which is the monthly expiry for the May series. The monthly expiry is always on the last Thursday of the month.
Opstra website is used to make the payoff charts of all the examples discussed below.
View on the underlying asset: Very bullish
Strategy: Buy call option
Risk: Limited to premium paid
Reward: Unlimited
Breakeven: Strike price + premium paid
Criteria for profit: Close of the underlying asset on the expiry date is greater than strike price + premium paid
Example:
Buy 14600 CE @Rs. 398.4
View on the underlying asset: Bullish
Strategy: Sell a put option
Risk: Unlimited
Reward: Limited to the premium received
Breakeven: Strike price - premium received
Criteria for profit: Close of the underlying asset on the expiry date is not less than strike price - premium or the option expires unexercised
Example:
Sell 14600 PE @Rs. 334.95
View on the underlying asset: Moderately bullish
Strategy: Buy ITM call option and sell OTM call option
Risk: Limited to the net premium paid
Reward: Limited to the difference between the two strikes minus the net premium paid
Breakeven: Strike price of purchased call + net premium paid
Criteria for max profit: Both the options are exercised
Criteria for max loss: Both the options are unexercised
Example:
Buy 14400CE @Rs. 524.35, Sell 14800CE @Rs. 290
View on the underlying asset: Moderately bullish
Strategy: Sell OTM put option and buy further OTM put option
Risk: Limited to the difference between the two strikes minus net premium received
Reward: Limited to the net premium received
Breakeven: Strike price of sold put - net premium received
Criteria for max profit: Both the options are unexercised
Criteria for max loss: Both the options are exercised
Example:
Sell 14600PE @Rs. 334.95, Buy 14500PE @Rs. 290.05
View on the underlying asset: Very bearish
Strategy: Buy put option
Risk: Limited to premium
Reward: Unlimited
Breakeven: Strike price - premium paid
Criteria for profit: Close of the underlying asset on the expiry date is less than strike price - premium paid
Example:
Buy 14600 PE @Rs. 334.95
View on the underlying asset: Bearish
Strategy: Sell call option
Risk: Unlimited
Reward: Limited to the premium received
Breakeven: Strike price + premium received
Criteria for max profit: Close of the underlying asset on the expiry date is not more than strike price + premium and the option expires unexercised
Criteria for loss: Close of the underlying asset on the expiry date is more than strike price + premium and the option expires exercised
Example:
Sell 14600 CE @Rs. 398.4
View on the underlying asset: Moderately bearish
Strategy: Sell ITM call option and Buy OTM call option
Risk: Limited to the difference between the two strikes minus the net premium received
Reward: Limited to the net premium received
Breakeven: Strike price of sold call + net premium received
Criteria for max profit: Both the options are unexercised
Criteria for max loss: Both the options are exercised
Example:
Sell 14500CE @Rs. 457.34, Buy 14700CE @Rs. 342.35
View on the underlying asset: Moderately bearish
Strategy: Buy ITM Put option and Sell OTM Put option
Risk: Limited to the net premium paid
Reward: Limited to the difference between the two strikes minus net premium paid
Breakeven: Strike price of bought put - Net premium paid
Criteria for max profit: Both the options are exercised
Criteria for max loss: Both the options are unexercised
Example:
Buy 14700PE @Rs. 377.65, Sell 14500PE @Rs. 290.05
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View on the underlying asset: Significant volatility
Strategy: Buy a call option and a put option of the same strike price
Risk: Limited to premium paid
Reward: Unlimited
Breakeven: Upper breakeven: strike price of call bought + net premium paid, lower breakeven: strike price of put bought - net premium paid
Criteria for profit: One of the options is exercised
Criteria for max loss: Both the options are unexercised
Example:
Buy 14600 CE @Rs. 398.4, Buy 14600 PE @Rs. 334.95
View on the underlying asset: Little volatility
Strategy: Sell call and put option of the same strike price
Risk: Unlimited
Reward: Limited to the premium received
Breakeven: Upper breakeven: strike price of call sold + net premium received, lower breakeven: strike price of put sold - net premium received
Criteria for max profit: Both the options are unexercised
Criteria for loss: One of the options is exercised
Example:
Sell 14600 CE @Rs. 398.4, Sell 14600 PE @Rs. 334.95
View on the underlying asset: Significant volatility
Strategy: Buy OTM Call and Put option
Risk: Limited to the premium paid
Reward: Unlimited
Breakeven: Upper breakeven: strike price of call + net premium paid, lower breakeven: strike price of put - net premium paid
Criteria for profit: One of the options is exercised
Criteria for max loss: Both the options are unexercised
Example:
Buy 14700CE @Rs. 342.35, Buy 14500PE @Rs. 290.05
View on the underlying asset: Little volatility
Strategy: Sell OTM call and put option
Risk: Unlimited
Reward: Limited to the net premium received
Breakeven: Upper breakeven: strike price of call + net premium received, lower breakeven: strike price of put - net premium received
Criteria for max profit: Both the options are unexercised
Criteria for max loss: One of the options is exercised
Example:
Buy 14700CE @Rs. 342.35, Buy 14500PE @Rs. 290.05
In this blog, we went through some of the option trading strategies used by traders all over the world to make profits in all types of market conditions.
Multiple other option trading strategies can be made to tweak the conditions as per one’s expectations of the future market movement. Options are used along with other financial securities like stocks, futures, and bonds to form multiple other types of option trading strategies as well.
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