It is important to understand that a trader must have an
overview of the underlying assets before initiating an options strategy. Many
options traders trade with the goal of getting rich overnight! However, as you
know, there is no shortcut to success and this is true in options trading as
well. So, in this article, we are going to talk about options strategies
(two-legged strategies) that have the potential to generate decent returns by
keeping risk under control.
Before we begin, 0
So, let's start with strategy construction.
In case our view is moderately bullish, we may use this strategy:
If a trader is expecting that there would be a moderately
bullish view on the underlying stock’s price during the options’ term, he/she
may initiate a Bull Put Spread Option Strategy.
What is Bull Put Spread? It is a two-leg option strategy and as the name suggests, it is constructed by using only Put options. It involves shorting one Put option with a higher strike price (in-the-money) and buying one Put option with a lower strike price (out-of-the-money) of the same expiration date. Strike selection should be based on a broad view of the stock or index and its winning probability.
Is it a
debit or credit spread strategy? It is a credit strategy as
sold premium is more than the bought premium. So, we receive a net
credit.
Example
for the construction of this strategy: Let’s say a stock i.e.
TATAMOTORS is trading at Rs 335. We executed a Bull Put Spread by shorting 340
strike price put (in-the-money) at Rs 16 and subsequently, buying (long) 320
strike price put (out-of-the-money) at Rs 6. Assuming a lot size of stock
TATAMOTORS is 1,750 shares. Net credit for this strategy is Rs 10 per share (Rs
16-Rs 6), where Rs 16 has been received by selling an in-the-money option of
340 strike price, and Rs 6 is outflow as we had bought out-of-the-money Put of
strike 320.
Maximum
profit potential: The trader would get maximum profit on this strategy when
the stock price expires above the short put strike price (340 strike price).
The maximum profit potential is limited up to the net premium received. In the
above example, it would be Rs 10 (per share) *1,750 (lot size) = Rs 17,500.
Maximum
loss for this strategy: A trader would incur a maximum
loss in case the stock expires below the long-put strike price (320 strike
price). Here is a formula to calculate maximum loss: Strike price of short put
strike (340) - strike price of long put strike price (320) – net credit
received at the time of initiating a trade (10) = Rs 10 * 1,750 (lot size) = Rs
17,500.
Break-even
point of this strategy: Break-even point= Strike price of short put
(340) – net premium received (10) = Rs 330.
In case the view is moderately bearish, one may use this
strategy:
If a trader is having a moderate bearish view of the underlying
stock’s price during the options’ term, he/she may initiate a Bear Call Spread Option
Strategy.
What is
Bear Call Spread? It is a two-leg strategy, which is constructed by buying
one out-of-the-money (OTM) Call option and selling one in-the-money (ITM) Call
option of the same underlying asset of the same expiration date.
Is it a
debit or credit spread strategy? It is a credit strategy as
sold premium is more than the bought premium. So, we received a net
credit.
Example
for construction of this strategy: Let’s say a stock i.e.
RELIANCE is trading at Rs 2500. One can execute a Bear Call Spread
by buying 2550 call strike prices call at Rs 20 and subsequently,
selling a 2450 strike price call option at Rs 50. Net credit for this strategy
is Rs 30 per share (Rs 50 - Rs 20). The lot size for this stock is 250.
Maximum
profit potential: Maximum potential profit is limited to the net premium
received.
Maximum
loss for this strategy: Maximum loss in the above example
would be the difference between the strike prices i.e. 100 (2550 -2450) and net
credit received, which is 30 per share.
Break-even point of this strategy: Break-even point=Strike price of short call (2450) + net premium received (30) = Rs 2480.
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