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Option Strategies
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In our  blogs Series, we gave a brief introduction as to what options are & Working of Options.

To Read the first Blog (Introduction to options) in this Series Click here

To Read the Second Blog (Working of Options) in this Series Click here.

Straddle is one of the frequently used strategies of options trading.

It can be entered into by an investor in the following ways –

(i)     Simultaneously holding both call and put options with same strike price and same expiry period, or

(ii)    Simultaneously writing both call and put options with same strike price and same expiry period.

 Let us take an example.

Suppose, the current share price of stock Y is Rs 150, and it is expected to be Rs 200 in one month time. An investor enters a call option at a premium of Rs 3 per share for a strike price of Rs 165 per share.

After one month, if the market price is more than Rs 165 (say Rs 175), he will exercise the option and make a net profit of Rs 175-165-3= Rs 7 per share. However, if the price happens to be Rs 165 or less, then he will allow the option to lapse. His loss in such a situation would be the premium paid, i.e., Rs 3 per share. So, by entering into a call option, he can make profit only when the actual price on the expiry day happens to be more than the strike price. However, he can ensure profit even if the price falls below the strike price by simultaneously buying a put option at the same strike price for the same expiry period. In case, the market price happens to be less than the strike price, he will let the call option expire but exercise the put option thus, making profit. So, the investor will be able to make profit whether the market price is more or less than the strike price.

A straddle position is called long straddle when an investor buys a call option as well as a put option at the same strike price. Maximum loss (premium paid for both the options) for long straddle occurs when the underlying stock price on expiration date is trading at the strike price of the options bought.

Option Strategies

It is called short straddle when an investor sells (writes) both a call option and put option at the same strike price. Maximum loss for short straddle is unlimited and maximum gain is limited to the premiums received.

Considering the same example as above, let us suppose an investor has sold a call and a put option at strike price of Rs 165 and premium of Rs 3 (for call and put each, the payoffs would be as shown in the chart below:

Option Strategies

 References:

 Rustagi, Dr. R.P., Investment Management: Theory and Practice (2008)

 

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