Investing

The long put options trading technique grants the right to sell an underlying stock at the set price, point A, as shown on the graph. When a put option is purchased, the investor is betting that the stock will fall below the strike price before the expiration date.

Using a put instead of shorting the stock decreases the investor’s risk because they can only lose the cost of the put, as opposed to the limitless risk of shorting the stock.

• If the stock increases, the long put option will expire worthless, leaving the holder with merely the option’s cost. Similarly, an investor who shorted the stock will continue to lose money as the company rises in value.

• When purchasing puts, especially short term, there is a need for investors to be careful. If an investor buys many put contracts, their risk also increases. This is because the options can expire worthless, whereby the investor would lose the entire investment.

When Should You Purchase Put Options?

• Put option contracts can be purchased for a variety of reasons, including speculation (the investor believes a stock’s price will decline).

• A long put can also be used as a hedge against existing stock to protect an asset against a rapid drop in value, often known as a protective put.

If the stock that is already held suddenly drops in value, owning a put option would increase in value, offsetting the stock’s losses.

Purchasing a Put Versus Shorting the Stock

Shorting the stock and purchasing put option contracts are the most popular tactics for investors who want to take a bearish position in the firm.

Shorting a stock is a risky endeavour because a stock’s price might climb indefinitely, resulting in endless risk. Buying a put is an alternate bearish approach because an investor can only lose the cost of the put, therefore the risk is restricted.

However, purchasing a put option allows you to profit from a stock’s downward movement while limiting your risk to the premium paid for the option contract.

Profit/Loss

Maximum Loss = Net Premium Paid

The maximum gain for a long put strategy is limitless because the stock can continue to fall in value until it reaches zero.

Breakeven

• A long put option’s breakeven point is derived by subtracting the premium from the strike price.

• If a stock is now selling at Rs.100 and an investor wishes to purchase a 90-strike price put for Rs.2.0, the breakeven point is Rs.88.00.

Example

If stock XYZ is trading at Rs.100 and the investor believes it will fall, he may purchase a Rs.2 put option with a strike price of 90.

If the price falls to Rs.85, they will make Rs.5 on the 90 put, but because the option cost Rs.2, their net gain will be Rs.3.

However, if the stock continues to rise or never falls below Rs.90, they would lose their Rs.2 investment.

Conclusion

The long put is an investment strategy that allows the investor to bet on the stock’s decline. The investor must be prepared to lose the entire premium if they are incorrect.

When the underlying price falls, traders can make far more through put ownership than through short-selling. The dangers associated with short-selling are unbounded because the stock price has the potential to climb indefinitely.

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The short call option strategy, also known as the uncovered or naked call, entails selling a call without owning the underlying stock. Short call options should be avoided by those who are new to options because they are a high-risk strategy with limited profits.

More advanced traders use a short call to profit from unique situations where they receive a premium for taking on risk. Let’s take a more in-depth look at the short call option strategy.

When the forecast for the underlying asset is negative to neutral, investors initiate the short call strategy. If the buyer of the short call exercises the option, the trader is obligated to sell the stock at the strike price.

• This is not to be confused with a short put option, in which the seller is obligated to purchase the stock at the strike price. In the chart above, the trader begins to lose money if the stock advances past strike price A.

• Wait until the strike price is one standard deviation out of the money (the stock price is lower than the strike price) before implementing this option strategy.

• With a short call, the trader wants the implied volatility (IV) to decrease as this will reduce the price of the options they’re short.

Here, if the investor decides to close the position before the expiration date, the trade will cost them less to buy back. Similarly, decreasing time to expiration is also a positive factor with this strategy because the less time to expiration, the lower the value of the call option, enabling the investor to close the position for less.

When Should You Use a Short Call?

The other alternative is to purchase put option contracts. In exchange for a premium, the seller of a call option bets that the stock will not rise over a certain price (strike price) before the option expires.

• This type of bear market trade is frequently entered when a stock has already had a significant run to the upside, particularly in a short period of time, and technical indicators, such as RSI or Percent-R, indicate that it is overbought.

• By selling a short call, the trader becomes bound to the option’s buyer, ensuring that they will deliver the stock to the call option’s buyer if the stock rises above the strike price.

• If the stock price remains below the strike price, the holder of the short call option keeps the entire premium as profit.

If the stock price rises above the strike price, the long call holder will exercise the option, forcing the short call holder to buy the shares at the current market price and deliver it to them at the lower price.

Profit/Loss

Maximum Profit = Net Premium Received

The greatest loss for a short call strategy is infinite because the stock can continue to rise indefinitely.

Breakeven

A short call option’s breakeven is computed by adding the premium to the strike price.

If a company is selling at Rs.100 and an investor wants to sell a call with a strike price of Rs.110 for Rs.2.00, the breakeven point is Rs.112.00.

Example

If the stock moves up to Rs.115, they will be required to buy the shares at Rs.115 and then return it to the call buyer at Rs.110, losing Rs.5.

However, because the option seller paid Rs.2 for selling the call, their net loss is Rs.3. If, on the other hand, the stock continues to fall or never hits Rs.110, the trader retains the Rs.2 premium as profit.

Conclusion

The short call option strategy is ideal for experienced investors who wish to profit by selling volatility when markets are overbought. The premium received decays over time, allowing investors to keep the entire premium or repurchase it later at a cheaper price.

• Aside from individual companies, some investors like to sell call index options. One justification for trading index options is that they are thought to be less volatile than individual stocks.

• Profitability with this method is restricted owing to the unlimited risk involved if the stock continues to rise. Traders prefer to sell calls because the potential reward is considerable if the option is far out of the money and the trade is properly timed.

If an investor expects a stock to fall in price, he or she might consider a bear call spread. This allows the investor to earn by selling at a premium while also allowing them to lose money if their analysis is incorrect.

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An advanced options strategy that has three legs and a total of six options is called a Christmas tree spread with puts. Buying one put at strike price D, bypassing strike price C, selling three puts at strike price B, and then buying two puts at strike price A are the steps in the option strategy. Similar to a butterfly spread, but with more room for the stock price to fall, making it a more bearish option strategy, the desired result is a pin at the short middle strikes.

Additionally, costs are higher compared to a typical butterfly spread since the long upper legged strike price is farther from the short middle strikes. The stock must decrease in price in order for the position to become profitable because it was opened at a higher cost. Losses are capped at the opening price in the event that the stock moves against the trader, even though the likelihood of a loss is higher.

Profit/Loss

The difference between the highest strike price and the three short middle put strike prices is used to determine the maximum profit, which is then subtracted from the trade’s cost. For instance, the maximum profit would be Rs 7.50 if the distance between point D and point B was Rs 10 and the deal cost Rs 2.50.

With the identical scenario, the maximum loss would be Rs 2.50 since the cost of the deal would be the maximum loss.

Breakeven

There are two points where things break even. By deducting the cost of the deal from the top strike price (point D), the upper breakeven point can be determined. Therefore, if trading cost Rs 2.50 and point D was an option with a strike price of 110, the upper breakeven would be Rs 107.50.

The lowest strike price (point A) plus one-half of the net debit would be used to determine the lower breakeven point. Therefore, if the cost of the trade was Rs 2.50 and the point A strike price was Rs 95 the lower breakeven would be Rs 96.25 (95 + 2.50 / 2).

Example

A trader might execute a 110/100/95 Christmas tree spread by purchasing one put with a strike price of 110, selling three puts with a strike price of 100, and purchasing two puts with a strike price of 95 for the following prices:

• For Rs 8, purchase 1 XYZ 110-strike price put.
• Sell three XYZ puts with a 100 strike price for Rs 6.90 (Rs 2.30 apiece).
• Invest Rs 1.40 (Rs .70 per) to purchase two XYZ 95-strike price puts.
• Total expense: Rs 2.50

The investor will have lost the whole Rs 2.50 and all holdings will be eliminated from his account if the stock increases in value over the ensuing three months.

The trader will profit Rs 10 on the market movement and the 110-strike price option if the stock goes down to Rs 100 at expiration, while the remaining options expire worthless. Their net profit would be Rs 7.50 because they spent Rs 2.50 to make the trade.

The investor would profit Rs 20 on the Rs 110 put if the stock fell to Rs 90. The short middle 100-puts lose Rs 10 X 3 for a total loss of Rs 30. Gain Rs 5 twice for a total of Rs 10 on the long lower 95-puts.

The investor paid Rs 2.50 for the trade, therefore their net loss is Rs 2.50. The final result would be Rs 20 – Rs 30 + Rs 10, meaning all profits are lost.

Conclusion

The more bearish a Christmas tree spread grows, while also lowering the cost of the deal, the lower a trader sets the strike prices. However, the likelihood of success decreases when strike prices are lowered.

The implied volatility is sensitive to variations in this kind of spread. Inversely correlated with changes in implied volatility is the spread’s net price, which decreases when implied volatility increases and rises when implied volatility decreases. The trader who places this order hopes implied volatility would decrease.

Only seasoned traders should implement a Christmas tree spread options strategy; it is not advised for beginners.

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An advanced options strategy with three legs and four total options is called a long butterfly spread with calls. One call is purchased at strike price A, two calls are sold at strike price B, and one call is subsequently purchased at strike price C. The set up results from an investor linking the beginning of a short call spread with the end of a long call spread at strike price B.

An investor who opens this position is making a wager that the stock will pin or almost pin at strike price B. The investor would keep the profits from option A if the stock did really pin at the short strikes, but options B and C would expire worthless.

Although it can be difficult to secure that pinning strike, this method has a modest entrance cost, which means decreased risk if things go south. The long butterfly spread works well in low-volatility situations where there is a good chance that the price will pin. Due to its limited loss, it can also be a wise decision in volatile markets, but traders should watch the trade carefully and exit it as the stock goes near the short strikes.

Profit/Loss

The difference between the lowest and middle strike prices is subtracted from the cost of the trade to determine the maximum profit. For instance, the maximum profit would be Rs 4.30 if the distance between points A and B were Rs 5 and the deal cost Rs 0.70.

The maximum loss would be equal to the cost of the deal, or Rs 0.70 in the same scenario.

Breakeven

There are two points where things break even. By taking the lower strike price (point A) and adding the trade’s cost, one can get the lower breakeven point. So, if transaction cost Rs 0.70 and point A had a strike price of 100, the lower breakeven would be Rs 100.70.

The highest strike price (point C) would be used to determine the higher breakeven point, and the net debit would be subtracted. Therefore, our higher breakeven would be Rs 109.30 if the point C strike price was Rs 110 and the transaction cost was Rs 0.70.

Example

A trader might execute a 100/105/110 butterfly spread by purchasing one call with a strike price of 100, selling two calls with a strike price of 105, and purchasing one call with a strike price of 110 at the prices listed below:

• Purchase one (Rs 5.00) XYZ 100-strike price call.
• For Rs 5.40 (Rs 2.70 each), sell two XYZ 105-strike price calls.
• Purchase 1 110-strike price call for XYZ for Rs 1.10.
• Cost in whole is Rs 0.70 debit.

The investor will have lost the full Rs 0.70 if the stock declines during the next 45 days, and all positions will expire worthless and be taken out of the account.

The trader will profit Rs 5 if the stock moves up slightly to Rs 105 at expiration, capitalising on the 100-strike price option while the other options expire worthless. Their net gain would be Rs 4.30 because they spent Rs 0.70 on the trade.

The investor would profit Rs 10 on the 100 call if the stock reached a price of Rs 110. The 110 call expired worthless, resulting in a loss of Rs 10 (Rs 5 X 2 losses on the short middle 105-calls). The investor paid Rs 0.70 for the trade, therefore their net loss is Rs 0.70. The final result would be Rs 10 – Rs 10, meaning all profits are lost.

Conclusion

A butterfly spread with calls becomes more bullish and less expensive to trade the higher the strike prices are set by the trader. However, the likelihood of winning decreases when strike prices are raised.

The implied volatility is sensitive to variations in this kind of spread. Inversely correlated with changes in implied volatility is the spread’s net price, which decreases when implied volatility increases and rises when implied volatility decreases. The trader who places this order hopes implied volatility would decrease.

The long butterfly spread with calls is a technique that should only be used by seasoned options traders.

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An advanced options strategy with three legs and four total options is called a long butterfly spread with puts. One put is purchased at strike price A, two puts are sold at strike price B, and one put is then purchased at strike price C. The setup results from an investor combining the beginning of a short put spread with the end of a long put spread at strike price B.

An investor who opens this position is making a wager that the stock will pin or almost pin at strike price B. The investor would keep the profits from option C if the stock did really pin at the short strikes, but options B and A would expire worthless.

Although it can be difficult to secure that pinning strike, this method has a modest entrance cost, which means decreased risk if things go south. In low-volatility situations where there is a strong likelihood of price pinning, the long butterfly spread with puts is a suitable option. Due to its limited loss, it can also be a wise decision in volatile markets, but traders should watch the trade carefully and exit it as the stock goes near the short strikes.

Profit/Loss

The difference between the higher strike price and the middle strike price is subtracted from the cost of the trade to determine the maximum profit. For instance, the maximum profit would be Rs 4.30 if the distance between points C and B were Rs 5 and the deal cost Rs 0.70.

The maximum loss would be equal to the cost of the deal, or Rs 0.70 in the same scenario.

Breakeven

There are two points where things break even. The highest strike price (point C) would be used to determine the upper breakeven threshold, and the cost of the trade would be subtracted. Therefore, the lower breakeven would be Rs 109.30 if point C had an option with a strike price of 110 and the trade cost Rs 0.70.

By adding the net debit to the lowest strike price (point A), the lower breakeven point can be determined. Therefore, our lower breakeven would be Rs 100.70 if the point A strike price was equal to Rs 100 and the trade’s cost was Rs 0.70.

Example

A trader might execute a 100/105/110 butterfly spread with options if XYZ is trading at Rs 107 and it is anticipated that it will trade flat to slightly lower over the next 45 days by purchasing one 110-strike price put, selling two 105-strike price puts, and purchasing one 100-strike price put for the following prices:

• Purchase one (Rs 5.00) XYZ 110-strike price put.
• For Rs 5.40 (Rs 2.70 apiece), sell 2 XYZ 105-strike price puts.
• For Rs 1.10, purchase 1 XYZ 100-strike price put.
• Cost in whole is Rs 0.70 debit.

The investor will have lost the full Rs 0.70 and all positions will expire worthless and be deleted from the account if the stock trades higher than Rs 110 over the next 45 days.

The trader will profit Rs 5 from the market movement, utilising the 110-strike price option, while the remaining options expire worthless if the stock trades somewhat lower to Rs 105 at expiration. Their net gain would be Rs 4.30 because they spent Rs 0.70 on the trade.

The investor would profit Rs 10 on the 110 put if the stock fell to Rs 100. The 100 put lost all of its value, and you lost Rs 5 X 2 on the short middle 105-puts for a total loss of Rs 10. The investor paid Rs 0.70 for the trade, therefore their net loss is Rs 0.70. The final result would be Rs 10 – Rs 10, meaning all profits are lost.

Conclusion

The more bearish a butterfly spread with puts becomes, while also lowering the cost of the transaction, the lower the trader sets the strike prices. However, the likelihood of success decreases when strike prices are lowered.

The implied volatility is sensitive to variations in this kind of spread. Inversely correlated with changes in implied volatility is the spread’s net price, which decreases when implied volatility increases and rises when implied volatility decreases. The trader who places this order hopes implied volatility would decrease.

A seasoned options trader should use the long butterfly spread with puts instead of a newbie.

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An advanced options strategy known as an iron butterfly spread has three legs and four total choices. Joining a bull put spread with a bear call spread at strike price B constitutes the transaction. An iron butterfly can also be viewed as an iron condor, with the difference being that the short strikes, for both calls and puts, are at the same strike price as opposed to being spread apart. The investor is short both the put and the call spread, therefore the trade is set up for a total net credit.

An investor who opens this position is making a wager that the stock will pin or almost pin at strike price B. All of the options would expire worthless and the investor would keep the whole premium amount if the stock did pin at the short strikes.

The stock’s position in relation to the short strikes at the time the trade is opened can make it slightly bullish or bearish, however generally speaking this trade is a natural direction approach. If the stock is trading below strike price B, it is bullish; if it is trading above strike price B, it is bearish.

Profit/Loss

The maximum profit would be equal to the credit obtained for opening the trade, or Rs 3.40 in this example. This profit would be realised if the stock remained at the short strike prices on the expiration date.

The difference between the lower strike price and the intermediate strike price is subtracted from the credit of the trade to determine the maximum loss. For instance, the maximum loss would be Rs 1.60 if the distance between points A and B was Rs 5 and the premium received was Rs 3.40.

Breakeven

There are two points where things break even. By adding the premium obtained for the trade to the short strike price (point B), the higher breakeven point can be determined. Therefore, the higher breakeven would be Rs 103.40 if point B had a 100-strike price option and the credit earned was Rs 3.40.

By subtracting the premium earned for the trade from the short strike price (point B), one can determine the lower breakeven point. Because of this, if point B represented a 100-strike price option and the credit received was Rs 3.40, the lower breakeven would be Rs 96.60.

Example

A trader could execute a 95/100/105 iron butterfly spread by purchasing one 95-strike price put, selling one 100-strike price put, purchasing one 105-strike price call, and XYZ is trading at Rs 100 and is predicted to trade sideways over the next 45 days.

• For Rs 0.50, purchase 1 XYZ 95-strike price put.
• For Rs 2.20, sell 1 XYZ 100-strike price put.
• For Rs 2.20, sell 1 XYZ 100-strike price call.
• Purchase 1 105-strike price call for XYZ for Rs 0.50.
• Total premium equals Rs 3.40 in credit.

The investor will keep the Rs 3.40 credit if the stock reaches Rs 100 at expiration, but all positions will expire worthless and be deleted from the account.

The trader will lose Rs 5 on the short 100 put if the stock moves lower than Rs 95 at expiration, while all other options expire worthless. The trader’s net loss would be Rs 1.60 because they were given a credit of Rs 3.40.

The investor would lose Rs 2 on the 100-strike call if the stock reached Rs 102 and all other options would expire worthless. The trader’s net profit would be Rs 1.40 because they were given a credit of Rs 3.40.

Conclusion

The implied volatility is sensitive to variations in this kind of spread. When implied volatility grows, the spread’s net price rises, and when implied volatility declines, the price lowers. The trader who places this order hopes that implied volatility will decline since it will enable them to repurchase the trade at a lower cost.

This transaction is frequently made just before earnings, when implied volatility is high. Once the earnings report is released and implied volatility decreases, the spread’s value decreases, allowing the investor to repurchase it at a lower price. However, if there is a sizable earnings gap, a huge price fluctuation might quickly turn this strategy into a loser. Due to its great profitability and low risk, it is a preferred investment among traders.

The iron butterfly spread is a strategy for seasoned options traders only; it is not advised for beginners.

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A collar is an options strategy in which the stock is purchased or acquire. Or followed by the purchase of a put option at strike price A and the sale of a call option at strike price B. When using this method, an options trader hopes that the stock will trend higher. Also, be called away at the call strike price B. However, they also want to be covered in the event that the stock price drops below strike price A. allowing them to sell the stock and execute their option if that happens.

In essence, a collar option is what would occur if a trader wanted to simultaneously run a covered call and a protected put. When an investor wants downside protection but does not willing to pay for it. they typically use this method. They therefore cap their exposure to the downside in return for limiting their upside potential in order to meet their costs. Both short-term and long-term positions can use this tactic.

When to Use a Collar

If an investor is positive on the stock over the long term but is worried about short-term downward volatility. They should think considering utilizing a collar. A pandemic, unclear profitability, or any other short-term market. Uncertainty are a few examples of such things.

When a stock has made large gains that the investor doesn’t want to risk losing. They may also utilise a collar. In this situation, an investor can use a collar option strategy to safeguard their prior gains.

The investor buys an out-of-the-money put option that guards against a decline.Also, in stock price in order to apply the collar.

In a turbulent market, the collar is a very helpful technique since it protects the investor for little to no money. Allowing them to limit their possible loss if the stock moves lower while restricting their potential profit. The call option is sold above the stock price. Which allows the investor to still make a profit while allaying their concerns about the stock falling in value.

Profit/Loss

The difference between the stock price and the short call is used to determine the maximum profit, from which the cost of the collar (if it was purchased with borrowed money) is subtracted or the premium earned (if the position was opened with credit) is added. The maximum profit, in this case, would be Rs 5.30 if the stock was trading at Rs 100 and the trader bought a 95/105 collar for a Rs 0.30 credit.

The maximum loss is determined by removing the premium earned if the long put was opened for a credit. Adding the collar cost to the difference between the stock price and the long put. The maximum loss. For instance, would be Rs 4.70 if the stock was trading at Rs 100 and the purchaser purchased a 95/105 collar for a Rs 0.30 credit.

Breakeven

The breakeven point for the collar option is the same. But it is determined differently depending on whether the collar was purchased for a credit or a debit.

When buying a collar on credit, the breakeven point is determined by deducting the premium from the stock price.

If the collar is purchased on credit, the breakeven point would be determined by multiplying the purchase price by the stock price.

Example

A trader might execute a 95/105 collar by purchasing the stock. So, purchasing one put at the strike price of 95. Selling one call at the strike price of 105 for the following prices. If XYZ is trading at Rs 100 and is anticipated to trade lower during the following three months.

• 100 shares of XYZ stock are purchased for Rs 100.
• For Rs 1.50, purchase 1 XYZ 95-strike price put.
• 1 XYZ 105-strike price call being sold for Rs 1.80.
• The total premium is equal to Rs 0.30.

The call will be exercised and the investor will be required to sell the XYZ stock in their inventory for Rs 105. If the stock trades up to Rs 107 at expiration. As a result, they will earn a Rs 0.30 credit in addition to a Rs 5.00 profit on the stock, for a total gain of Rs 5.30.

The trader will execute the 95-strike price put and sell the stock at Rs 95 if the stock trades lower than Rs 91 at expiration. This would indicate that they suffered a loss of Rs 5.00 on the stock. But since they were able to sell the collar for a credit of Rs 0.30. Their actual loss was only Rs 4.70. Losses are never desirable. But in this case, having the collar on would be far better than if they had to bear the entire Rs 9.00 loss.

Conclusion

There is just one justification for entering a collar. To keep downside risk to a minimum while leaving room for upside possibilities. Option strategies of this kind might be purchased concurrently with stock purchases or added to existing stock positions. The fact that the trader is aware of the trade’s maximum gains and losses as soon as they enter the collar is one of its strongest features. Here, the trader limits their losses in exchange for the chance for large rewards.

Since it is long one option and short another, balancing the volatility effect. It is only very little sensitive to fluctuations in implied volatility.
The collar is a great trading technique for a newbie. Since it enables the trader to profit from price increases while keeping them relatively secure. In case their bullish forecast is incorrect.

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A defensive put strategy, often referred to as a synthetic long call or married put, is purchasing the stock first, followed by one put at strike price A. When an investor uses this technique, they hope the stock will trade upward but also want to be protected in case it drops below strike price A, which would give them the option to sell the shares.

This tactic is typically used when a trader wants to protect their downside while still having the opportunity to gain on their upside because they are concerned about the market. In the event that a stock price declines further, the protective put functions as a price floor, limiting the amount an investor can lose. The investor is shielded from further losses after the stock drops below the protective put’s strike price.

How to Use the Protective Put

An investor who already owns stock runs the risk of suffering losses if the stock falls lower. However, by purchasing a protective put option, an investor is ensuring that if the stock continues to decline, they will be able to sell it at a set price, so limiting their losses.

The investor is establishing a price floor that safeguards their asset since they have a contract in place to sell a stock at a specific price, should they choose to do so.

The protective put functions as asset insurance, and like all forms of insurance, a premium must be paid in exchange for this security. The premium is determined by the investor’s desired price floor as well as volatility, which measures the risk that the stock price will continue to decline. Additionally, the insurance has a time limit; the longer the investor wants the insurance to last, the more expensive the protective put purchase price will be.

Strike Prices for Protection

An investor has a number of options when executing a protective put, including the level strike price to use and the expiration date. Typically, investors choose a put option that is out of the money. When the strike price is less than the stock’s current price, this occurs. As is the price difference between the current stock price and the level where the protective put adds insurance, this does not offer full protection. However, there is a lower premium for this defensive put.

Investors may also purchase at the money put if they are more concerned about a decline in stock price. The increased premium required for this level of insurance results in 100% protection from any losses thanks to the more active protective put.
Higher premiums are also a result of long-term protective puts.

Profit/Loss

The potential profit is limitless because the investor can keep making money as long as the stock trades at a higher price by owning the shares.

The maximum loss is determined by subtracting the stock price from the long put and then adding the put’s purchase price. The maximum loss, for instance, would be Rs 6.50 if the stock was trading at Rs 100 and the investor bought a 95-strike put for Rs 1.50.

Breakeven

The stock price plus the put price represents the protective put’s breakeven point. For instance, if the stock price is Rs 100 and the put price is Rs 1.50, the stock would need to increase by Rs 1.50 to break even, or Rs 101.50.

Example

If XYZ is trading at Rs 100 and is anticipated to rise in value during the following three months, a trader might purchase the stock and a put option with a 95-strike price for the sum of:

• 100 shares of XYZ stock are purchased for Rs 100.
• For Rs 1.50, purchase 1 XYZ 95-strike price put.

The investor will make Rs 5.00 on the shares if the stock trades up to Rs 105 at expiration, but because they spent Rs 1.50 on the put, they will only make Rs 3.50 overall.

The trader will execute the 95-strike price put and sell the stock at Rs 95 if the stock price falls to Rs 91 by expiration. As a result, they would have suffered a loss of Rs 5.00 on the stock and a loss of Rs 6.50 overall because they paid Rs 1.50 for the protective put.

Conclusion

When purchasing a stock or adding a protective put to an existing stock position, the only reason to acquire one is to reduce potential downside losses.

The value of the put grows along with an increase in implied volatility, therefore an investor who is long a put benefits from an increase in implied volatility. The put would lose value and damage the investment if implied volatility fell.

For a novice who wishes to get insurance for their long stock position, this is a great technique. It is crucial to comprehend every facet of the trade and how it may effect the position’s profit or loss before engaging in any options strategy.

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Purchasing a call and selling a put in the same month and at the same strike price creates a synthetic long stock position. If the investor uses this method and holds the position until expiration, they will purchase the shares at strike price A. The investor will want to exercise the call option if the stock price rises over strike price A, and the investor will be assigned on the put if the stock falls below strike price A, so they will ultimately own the stock at price A.

Most investors, however, do not want to keep the position until expiration because it resembles a long stock position.

Profit/Loss

The potential profit is limitless because the investor can keep making money as long as the stock trades at a higher price by owning the shares.

As the price of the stock declines, losses continue to accumulate and the maximum loss is likewise limitless, at least down to zero.

Breakeven

Regardless of whether it was purchased for a credit or a debit, the synthetic long stock has a single breakeven point that is computed differently.

The breakeven point would be determined by deducting the premium received from the strike price if the synthetic long stock had been purchased with credit.

The breakeven point would be determined by multiplying the purchase price of the synthetic long stock by the strike price if it were acquired on a debit.

Example

A trader might purchase a call with a strike price of 100 and sell a put with a strike price of 100 for the following exchange rate if XYZ is trading at Rs 100 and is anticipated to trade higher over the following three months:

• Purchase one (Rs 4) XYZ 100-strike price call.
• For Rs 3.50, sell 1 XYZ 100-strike price put.
• Total premium = a debit of Rs 0.50

The investor will profit Rs 5.00 on the stock if it goes up to Rs 105 at expiration, but because they invested Rs 0.50 on the synthetic long stock, their net gain will only be Rs 4.50.

A 100-strike price put will be assigned to the trader, who will then purchase the shares for Rs 100 if the stock trades lower than Rs 95 at expiration. This would indicate that they suffered a Rs 5.00 loss on the put, but because they paid Rs 0.50 for the synthetic long stock, their overall loss would be Rs 5.50.

Conclusion

The only justification for purchasing a synthetic long stock option would be to have the same position as a stock without paying the high stock prices. Of course, the trader’s investment bank and margin requirements play a role in this. Because they don’t want their money to be tied down, most investors don’t hold their positions until they expire, which is why they initially utilised a synthetic long stock option call.

Due to the fact that this form of strategy is long one option and short another, it is not extremely sensitive to fluctuations in implied volatility.

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Purchasing an out-of-the-money call option and selling an out-of-the-money put option in the same expiration month is the risk-reversal options trading method. This is a very bullish trade that, depending on where the strikes are in regard to the stock, can be executed for a debit or a credit.

The investor that engages in a risk reversal seeks to gain by holding call options while covering the cost of the call by selling put options. This trade setting avoids the danger of the market moving sideways, but it carries a significant risk if the stock moves downward.

When to Use a Risk Reversal

When compared to a collar option strategy, the risk reversal has the opposite effect. When an investor is short the underlying asset. However it can shield them from a rising stock price. An investor can buy an upside call and then sell a downside put to cover the cost. And if they are concerned that the stock price of a short stock position will increase. One risk reversal option contract should be executed for every 100 shares the investor is short in the trade, or one-to-one. The upside long call option would protect the investor if the stock rose in price. The investor would be compelled to purchase the shares at the short put’s lower price point if the stock traded at a lower price.

An aggressive bull trade can also be employed as a risk reversal. The investor is essentially doing a bull trade at little to no cost or even a credit because they are purchasing a call option with a higher strike price and financing the premium by selling a put option that is out of the money. And If the investor is right and the stock price rises more. And the short put will lose all of its value and the long call will gain more, resulting in a sizable profit.

If the investor predicts the stock movement incorrectly, they will be compelled to purchase the shares at the short put strike price. Although there is a high potential for loss and this is exceedingly dangerous. Even if the investor is compelled to buy the stock at a lower price than where they opened the risk reversal, this is still a better result than if they had bought the stock right away.

Profit/Loss

The potential profit is limitless because holding an upward call enables the investor to keep profiting as the stock rises in value.

As the stock’s price declines, losses from the short put keep piling up, and the maximum loss is also limitless, at least all the way to zero.

Breakeven

If a risk reversal was done for a credit or a debit, the breakeven point is the same, but the calculation is different.

The breakeven would be determined by deducting the premium received from the put’s strike price if the risk reversal was purchased for a credit.

The breakeven would be computed by adding the amount paid to the call’s strike price if the risk reversal was purchased for a debit.

Example

A trader might purchase a call with a 120-strike price and sell a put with an 80-strike price for the following price if XYZ is trading at Rs 100 and is anticipated to trade higher over the following year:

• For Rs 6, purchase 1 XYZ 120-strike price call.
• For Rs 7.00, sell 1 XYZ 100-strike price put.
• Total premiums equal a Rs 1 credit.

The investor will make no money if the stock rises up to Rs 105 at expiration because it has not yet hit the strike price, but they will make money because they received a Rs 1.00 credit on the risk reversal.

The investor will profit Rs 10.00 from the call if the stock rises to Rs 130 at expiration because it is now Rs 10 above the 120-strike price. However, the investor will have a net gain of Rs 11.00 because they earned a credit of Rs 1.00 for the risk reversal.

The trader will be assigned on the 80-strike price put and compelled to buy the shares at Rs 80 if the stock trades lower than Rs 70 at expiration. This would indicate that they suffered a loss of Rs 10.00 on the put, but since they were given a credit of Rs 1.00 for the risk reversal, their actual loss would be Rs 9.00.

Conclusion

If handled properly, the risk reversal position offers a very high potential for profits, but if done incorrectly, it can result in huge losses for an investor.

Due to the fact that this form of strategy is long one option and short another, it is not extremely sensitive to fluctuations in implied volatility.

Risk reversals are not recommended for new investors because they might result in significant losses if the transaction moves against them. Only experienced options traders should use it.

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