5paisa Derivatives

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Introduction To Derivatives | 5paisa

3-4 minutes
Derivatives
Derivatives are contracts whose value is derived from the value of an ‘underlying’ asset.
Derivative contracts are available on a wide range of ‘underlying’ assets, such as metals,
energy resources, Agri-commodities, and financial assets.
Reasons to trade in derivatives market

The benefits of trading in Derivatives are:
 Transfer risk to the person who is willing to accept it

 Opportunity to make profits with minimal amount of risk capital
 Lower transaction costs
 Provision for liquidity
Participants in the derivative market

There are generally three types of participants in the derivative market:
Hedgers
Hedgers use derivatives to reduce the risk associated with the prices of underlying assets.
Corporations, investing institutions and banks use derivative products to hedge or reduce
their exposures to market variables, such as interest rates, share values, bond prices, currency
exchange rates and commodity prices.
Speculators/Traders
Speculators try to predict the future movements in prices of underlying assets. Based on the
predictive view, they take positions in derivative contracts. Derivatives are preferred over
underlying assets for trading purpose, as they offer leverage, are less expensive, and are faster
to execute in size, owing to their high volume market.
Arbitrageurs
Arbitrage is a deal that produces profit by exploiting the difference in price of a product in
two different markets. Arbitrage originates when you purchase an asset cheaply in one
location and simultaneously arrange to sell it at a higher price in another location. Such
opportunities are unlikely to persist for very long, since other arbitrageurs would rush in, thus
closing the price gap.
Risks Faced by Participants in Derivative market

You should understand that derivatives, being leveraged instruments, are significantly more
risky than investing directly in the underlying real assets. Risks include Counter-party Risk
i.e. default by counter-party; Price Risk i.e. loss on position because of price move; Legal or
Regulatory Risk i.e. enforceability of contracts; and Operational Risk i.e. fraud, inadequate
documentation, improper execution, etc.
It may not be an appropriate avenue for someone of limited resources, trading experience and
low risk tolerance. You should carefully read the Model Risk Disclosure Document, given by
the broker at the time of signing the agreement.
Key Takeaways
 Derivatives are contracts that derive their value from underlying assets.
 Derivatives offer a number of benefits to the participants willing to trade in the
product.
 Three main participants in the derivative market, hedgers, speculators and
arbitrageurs.
 Since derivative is a leveraged instrument it can act as a double edged sword in some
cases.
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Different Types Of Derivatives | 5paisa

3 minutes
Forward contract
A forwards contract is a customized contract between two parties to buy or sell an asset at a
specified price on a future date. Since forward contracts are not traded on a centralized
exchange, they are regarded as over the counter instruments, which also give rise to counter
party default risks. A forward contract settlement can occur in cash or on delivery basis.
Since forward contracts are non-standardized, it is of interest to those who wish to hedge by
customizing the contract to any commodity, amount or delivery date.
Futures contract
This is a standardized contract between two parties to buy or sell an asset at a specified time
in the future at a specified price. Futures are standardized exchange traded contracts. Futures’
trading is of interest to those who wish to:
 Speculate by taking a view on the market and buying or selling accordingly

 Prefer Price Risk Transfer through hedging
 Take advantage of the leverage offered by paying a small fraction of the total contract
as margin
Options
There are two basic types of Options - Call and Put. Call Option gives the buyer the right but
not the obligation to buy a specified amount of an underlying security at a specified price
within a specified time. On the other hand, a Put Option gives the buyer the right, but not the
obligations to sell a specified amount of an underlying security at a specified price within a
specified time. Option trading is of interest to those who wish to:
 Participate in the market without trading or holding a large quantity of stock

 Protect their portfolio by paying small premium amount
Future and Option Products Available in Indian Markets

Futures and Options contracts are traded on indices and on individual stocks. Popular indices
products available on the Indian stock exchanges are Nifty 50, CNX IT Index, Bank Nifty
Index, CNX Nifty Junior, CNX 100, Nifty Midcap 50, Mini Nifty and Long dated Options
contracts on Nifty 50.
Key Takeaways
 Forwards are customized contracts which can lead to counter party default.
 Futures were introduced to eliminate counter party default by standardizing the
contract.
 Options are of two types - call and put.
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Future Contracts - Significance & Future

Scope | 5paisa
11-14 minutes
Significance of Future Contract
This is an agreement made through an organized exchange to buy or sell a fixed amount of a
commodity or a financial asset, on a future date, at an agreed price. The clearing house,
associated with the exchange, guarantees settlement of these trades.
You can choose either to be a trader who buys futures contract and takes a long position, or a
trader who sells futures and takes a short position. The words buy and sell are figurative only
because no money or underlying asset changes hand, between buyer and seller, when the deal
is signed.
Scope of Futures in the Indian Market

NSE and BSE are the two main exchanges that offer future trading. Contracts are available
for different tenures (expiry). Typically, contracts are available for one, two or three months.
You can choose any of the three contracts, provided there is liquidity of the same underlying.
Remember the Following
 Last working Thursday is the date of expiry for the contracts of that particular month.
If the last Thursday is a holiday, the expiry is advanced by one day, i.e. Wednesday.
 Buyers and Sellers do not take or give delivery of the underlying.
 Profit and Losses are settled in cash.
 Since there is no delivery of underlying, you can trade in broad indices like NIFTY.
 You may choose to open a trade in future by paying a small portion (%) of the
contract value as Margin.
 The contract size and margin percentages are set by exchanges. In cash trading, the
settlement cycle is T+2 days; while in F &O, the trades are settled on T+1 day. If
trade is opened with a buy, such position is called as Long and if a trade is opened
with a sell, such position is called as Short.
Quotes Given on the NSE Website for Nifty Futures on Aug 28, 2017
Key Takeaways
Each futures contract has the following features-
Spot Price
This is the price at which an asset trades in the cash market. Underlying value of Nifty on
Aug 28, 2017, was Rs. 9,913.4.
Equity Derivatives Watch

Futures Price
This is the price of the futures contract in the futures market. Nifty Future Price, on Aug 28
2017, was 9,919.15.
Expiration Day
This refers to the day on which a derivative contract ceases to exist. It is the last trading day
of the contract. On expiry date, all the contracts are compulsorily settled.
Contract Cycle
It is a period over which a contract trades. Futures contracts have a maximum of three-month
trading cycle - the near month (one), the next month (two) and the far month (three). New
contracts are introduced on the trading day following the expiry of the near month contracts.
The new contracts are introduced for three month duration. At any point in time, there will be
three contracts available for trading in the market i.e., one near month, one mid month and
one far month duration respectively.
Tick Size
It is the minimum move allowed in the price quotations. Exchanges decide the tick sizes on
traded contracts as part of contract specification. Tick size for Nifty futures is 5 paisa.
Contract Size and Contract Value

Futures contracts are traded in lots. To arrive at the contract value, we have to multiply the
price with contract multiplier/lot size/contract size.
Basis
The difference between the spot price and the futures price is called Basis. If the futures price
is greater than spot price, basis for the asset is considered to be negative. Similarly, if the spot
price is greater than futures price, basis for the asset is considered to be positive. Whatever
the basis is—positive or negative—it turns to zero, at maturity of the futures contract. This
means that there should not be any difference between futures price and spot price at the time
of maturity/expiry of contract.

On Aug 28, 2017, Nifty Spot Price was 9,913.4 and Nifty Aug Future Price was 9,919.5.
Therefore, current basis of Nifty is negative. But on Aug 31, 2017 i.e. expire day Nifty basis
will be zero.
Cost of Carry
Cost of Carry is the relationship between futures prices and spot prices. It measures the
storage cost (in commodity markets) plus the interest that is paid to finance or ‘carry’ the
asset till delivery. It does not include the income earned on the asset during the holding
period. For equity derivatives, cost of carry is the interest paid to finance the purchase, minus
the dividend earned. It is important to note that cost of carry will be different for different
participants.
Contract Specifications
Contract specifications include the salient features of a derivative contract like contract
maturity and contract multiplier, also known as lot size, contract size, tick size, etc.
Price Band
Price Band is essentially the price range within which a contract is permitted to trade during a
day. The band is calculated with regard to previous day’s closing price of a specific contract.
For example, previous day’s closing price of a contract is Rs. 100 and price band for the
contract is 10%, then the contract can trade between Rs. 90 and Rs. 110 for the next trading
day.
Long Position
Outstanding/unsettled buy position in a contract is called “Long Position”. For instance, if
Mr. X buys 5 contracts on Nifty futures, then he would be long 5 contracts. Similarly, if Mr.
Y buys 4 contracts on Pepper futures, then he would be long 4 contracts.
Short Position
Outstanding/unsettled sell position in a contract is called “Short Position”. For instance, if
Mr. X sells 5 contracts on Nifty futures, then he would be short 5 contracts on Nifty futures.
Similarly if Mr. Y sells 4 contracts on Pepper futures, then he would be short 4 contracts on
pepper.
Open Position
Outstanding/unsettled derivative contracts, either in long (buy) or short (sell) positions are
called “Open Positions”. For instance, if Mr. X shorts 5 contracts on Infosys futures and
longs 3 contracts on Reliance futures, he is said to be having open position, which is equal to
short on 5 contracts on Infosys and long on 3 contracts of Reliance. Next day, if he buys 2
Infosys contracts of same maturity, his open position would be short on 3 Infosys contracts
and long on 3 Reliance contracts.
Naked and Calendar Spread Positions

Naked position in futures market simply means a long or short position in any futures
contract, without having any position in the underlying asset. Calendar spread position is a
combination of two positions in futures on the same underlying, i.e. long on one maturity
contract and short on a different maturity contract. For instance, a short position in near
month contract coupled with a long position in far month contract is a calendar spread
position. Calendar spread position is computed with respect to the near month series and
becomes an open position once the near month contract expires or either of the offsetting
positions is closed. A calendar spread is always defined with regard to the relevant months.
Opening a Position
Opening a position means either buying or selling a contract, which increases a client’s open
position (long or short).
Closing a Position
A client is said to be closing a position if he sells a contract which he had bought before or he
buys a contract which he had sold earlier.
Initial Margin
This is the margin amount that a trader needs to pay to the Exchange to open a trade. Buyers
(long) and sellers (short) will be paying this margin. The margin percentage is specified by
the Exchange and these percentages could change within the tenure of the contract, in case of
high volatility.
Minimum Margin
Normally known as maintenance margin, it is the minimum margin that is blocked during the
life of the contract.
Convergence of Spot and Future Price

The logic for difference between spot and future is the time value of money and one of the
variables of time value is the number of days left in the contract. On the last day of the
contract, there is no time value left. Hence, the price of future contract and cash market will
be same. There could be many other market dynamics, which impact the prices during the
last day/few days of expiry.
Benefits of trading in Index Futures compared to any

other security
You can trade the ‘entire stock market’ by buying index futures instead of buying individual
securities with the efficiency of a mutual fund. The advantages of trading in Index Futures
are:
 The contracts are highly liquid

 Index Futures provide higher leverage than any other stocks
 It requires low initial capital requirement
 It has lower risk than buying and holding stocks
Pay-off for Buyer of Futures contract: Long Futures

Let us say that a person goes long in ABC stock futures contract at Rs. 100. This means that
he has agreed to buy the underlying ABC stock at Rs. 100, on expiry. Now, if on expiry, the
price of the underlying (ABC stock) is Rs. 150, then this person will buy at Rs. 100, as per
the ABC stock futures contract and will immediately be able to sell the underlying in the cash
market at Rs. 150, thereby making a profit of Rs. 50.
Similarly, if the price of the underlying (ABC stock) falls to Rs. 70 at expiry, he would have
to buy at Rs. 100, as per the ABC stock futures contract. If he sells the same in the cash
market, he would only receive Rs. 70, translating into a loss of Rs. 30. This potential
profit/loss at expiry, when expressed graphically, is known as a pay off chart.
Short Futures Pay Off

As one person goes long, some other person has to go short, otherwise a deal will not take
place. The profits and losses for the short futures position will be exactly opposite of the long
futures position.
A short futures position makes profits when prices fall. If prices fall to 60 at expiry, the
person who has shorted at Rs.100 will buy from the market at 60 on expiry and sell at 100,
thereby making a profit of Rs. 40. This is shown in the given chart.
Pricing of Futures
The Cost of Carry Model is used for Future Pricing. It is defined as: F=S+C.
Herein, F=Future Price, S=Spot Price, and C=Holding Costs or Carry Costs
If F < S+C or F > S+C, arbitrage opportunities would exist, i.e. whenever the futures price
moves away from the fair value, there would be chances for arbitrage.
If ABC stock is quoted at Rs. 1,000 per share and the three months futures of ABC stock is
Rs.1070, then one can purchase ABC stock at Rs. 1000, in Spot, by borrowing @12% annum
for three months and selling ABC stock futures for three months, at Rs. 1070. Here,
F=1000+36 = 1036.
Drawbacks of Trading in Futures

Futures carry the potential for unlimited risks and, hence, unlimited losses. In futures, there is
an obligation to honor the contract, irrespective of profit or loss.
Key Takeaways
 Futures are standardized contracts which are traded on the exchange platform.
 Through a futures contract we could either take a long position or a short position
based on our view.
 Margin- small portion of contract value you need to pay upfront.
 F &O trades are settled on T+1 day.
 Tick size for Nifty futures is 5 paisa.
 The difference between the spot price and the futures price is called Basis
 Outstanding/unsettled derivative contracts, either in long (buy) or short (sell)
positions are called Open Positions.
 Cost of Carry Model is used for Future Pricing. It is defined as: Future price = Spot
price + Cost of carry.
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Margins, Mark To Market & Settlements |

5paisa
6-8 minutes
Back to Chapter List
Margins
Two types of margins are determined daily: Initial Margin and Mark-to-Market Profit/Loss.
Initial margin on the future market is computed by using Value-at-Risk (VaR). Initial margin
amount, computed using VaR, is collected up-front from buyers and sellers.
At the time of initiating the futures position, margin is blocked in your trading account. The
initial margin is made up of two components i.e. SPAN margin and the Exposure Margin.
Initial Margin will be blocked in your trading account for the number of days you choose to
hold the futures trade. The value of initial margin varies daily as it depends on the futures
price volatility. Remember, Initial Margin = % of (Futures Price * Lot Size). Lot Size is
fixed, but the futures price varies every day.
Symbol NIFTY 31-Aug-17

Current Future Price 9,919
Lot Size 75
Contract Value (Future Price * Lot Size) 743,925
Initial Margin @ 5% 37,196
Exposure Margin @ 3% 22,317
Total Initial Margin (Rs) 59,513
Mark to Market
The daily settlement process is called Mark to Market. It provides for collection of losses that
have already occurred. The mark-to-market settlement is done in cash.
Mark to Market - Long Position

Assumption: Initial Margin is Rs. 59,500.
Beginning Funds Nifty Settlement Future Price Gain Ending

Day
Balance Deposited Close Price Change /Loss Balance
0 0 59,500 9900 742,500 0 0 59,500
1 59,500 0 9850 738,750 -50 -3,750 55,750
2 55,750 0 9750 731,250 -100 -7,500 48,250
3 48,250 0 9920 744,000 170 12,750 61,000
4 61,000 0 9945 745,875 25 1,875 62,875
5 62,875 0 9935 745,125 -10 -750 62,125
6 62,125 0 9950 746,250 15 1,125 63,250
Net Profit/ Loss From the trade = (63250-59500) = Rs. 3750
Mark to Market - Short Position

Assumption: Initial Margin is Rs. 59,500.
Beginning Funds Nifty Settlement Future Price Gain Ending

Day
Balance Deposited Close Price Change /Loss Balance
0 0 59,500 9900 742,500 0 0 59,500
1 59,500 0 9850 738,750 -50 3,750 63,250
2 63,250 0 9750 731,250 -100 -7,500 70,750
3 70,750 0 9920 744,000 +170 -12,750 58,000
4 58,000 0 9945 745,875 +25 -1,875 56,125
5 56,125 0 9935 745,125 -10 750 56,875
6 56,875 0 9950 746,250 +15 -1,125 55,750
Net Profit/Loss From the trade = (55,750- 59,500) = Rs. -3,750

Settlement of derivatives contracts
All the Futures and Options contracts are settled in cash on a daily basis and at the expiry or
exercise of the respective contracts as the case may be. As a trader, you can exit the future
position by taking an opposite position. Therefore, if you are a buyer, you have to sell the
same contract of the same quantity. On the other hand, if you are a seller, you need to buy the
same contract of same quantity. This process of exiting is also known as Square-off.
Once the position is squared off, you are free from all obligations and the contract ceases to
exist. If any position is not squared off, such positions are taken on the closing price of Stock
(not the future) of the expiry date. The closing price is the average price of the stock in the
last half an hour of trading.
Derivatives markets can be extremely volatile and there are no circuit breakers. Prices can
move up or down sharply, resulting in very favorable or unfavorable situations for you.
Hence, you need to monitor your positions regularly.
Key Takeaways
 Initial margin varies daily as it depends on the futures price volatility.
 Initial Margin = % of (Futures Price * Lot Size).
 Daily settlement process is called Mark to Market.
 Futures and Options contracts are settled in cash.
 Stock price movement in derivatives market can be extreme as there are no circuit
filters.
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Options In Derivatives | Types Of Options |

5paisa
19-24 minutes
Options
An Option is a contract that gives the right, but not the obligation, to buy or sell the
underlying asset on or before a stated date, at a stated price. The party taking a long position,
i.e. buying the option is called buyer/holder of the Option and the party taking a Short
position, i.e. selling the Option is called the seller/writer of the Option; the contract value and
lots size are similar to Futures.
Types of Options
There are two types of Options:
 Call Option
 Put Option
Options, which give you a right to buy the underlying asset, are called Call Options. On the
other hand, the Options that give you a right to sell the underlying asset are called Put
Options.
Key features
Index Option
These Options have Index as the underlying asset. For example, options on Nifty, Sensex,
Bank Nifty etc.
Stock Option
These Options have individual stocks as the underlying asset. Examples include Options on
ONGC, NTPC, etc.
Buyer of an Option
The buyer of an Option has a right but not the obligation in the contract. For owning this
right, you pay a price to the seller of this right, called ‘option premium’.
Writer of an Option
The writer of an Option receives the Option premium and is thereby obliged to sell the asset
if the buyer of Option exercises his right.
Option Price/Premium
It is the price which you, as an Option buyer, pay to the Option seller.
Lot Size
Lot size is the number of units of underlying asset in a contract.
Expiration Day
This is the day on which a derivative contract ceases to exist. It is the last trading date of the
contract. The expiration day of Nifty contracts is Aug 31, 2017 in the following example.
Spot Price
It is the price at which the underlying asset trades in the spot market. Underlying stock value
of Nifty option was 9912 as on Aug 28, 2017.
Strike Price or Exercise Price
Strike price is the price per share for which the underlying security may be purchased or sold
by the Option holder. For e.g. when underlying value of NIFTY is 9912, then prices of 9900
Call and 9900 Put is:
Underlying Expiry Date Option Type Strike Price Option Premium
NIFTY 31 Aug 2017 Call 9900 50.10
NIFTY 31 Aug 2017 Put 9900 33.15
Open Interest
As discussed in futures section, Open Interest is the total number of Option contracts
outstanding for an underlying asset.
Option Premium
Intrinsic Value
Option premium, consists of two components - intrinsic value and time value.
For an Option, intrinsic value refers to the amount by which an Option is in the money, i.e.
the amount an Option buyer will realize, before adjusting for premium paid, if he exercises
the Option instantly.
Therefore, only in-the-money Options have intrinsic value whereas at-the-money and out-of-
the-money Options have zero intrinsic value. The intrinsic value of an Option can never be
negative. Thus, for call Option, which is in-the-money, intrinsic value is the excess of spot
price (S) over the exercise price (X).
Intrinsic value of a Call Option can be calculated as S-X, with a possible minimum value of
zero because no one would like to exercise his right under no advantage condition. Similarly,
for Put Option which is in-the-money, intrinsic value is the excess of exercise price (X) over
the spot price (S). Thus, intrinsic value of Put Option can be calculated as X-S, with
minimum possible value of zero.
Time Value
It is the difference between premium and intrinsic value, if any, of an Option. ATM and
OTM Options will have only time value because the intrinsic value of such Options is zero.
Option Greeks
Delta
Delta measures the change in Option price for a unit change in the price of underlying. So if
my delta is 0.46, it shows that for each unit increase/decrease in underlying, Option price will
increase/decrease by 0.46.
Important points for Delta:
 Delta of Call Option is always positive and Delta of Put Option is always negative.
 When you buy Call Option, Delta is positive and when you sell Call Option, Delta is
negative.
 When you buy Put Option, Delta is negative and when you sell Put Option, Delta is
positive.
 Call Delta ranges from 0 to 1 and Put Delta ranges from 0 to -1
 Total of absolute value of call Delta and put Delta always comes to 1
Gamma
Gamma measures the change in Delta with respect to per unit change in underlying. If
Gamma value is 0.0008, it shows that the next move in Delta will be 0.0008 if underlying
changes by 1. So Gamma shows what will be the next change in Delta with respect of change
in underlying.
Important points for Gamma:
 Gamma of Option is always positive.

 Gamma of Call and Put Option is same.
 Gamma is highest at ATM & decreases as Underlying moves away.
 Call Delta ranges from 0 to 1 and Put Delta ranges from 0 to -1
 Gamma of Future is 0.
Vega
Vega measures the change in Options price per unit change in volatility. A Vega value of
6.87 shows that for every unit increase in volatility, Option price will increase by 6.87. Thus,
Vega shows effect of volatility on Option price.
Theta
Theta measures the change in Option price per day change in time to expiry. If Theta is -3.87,
it signifies that for each day passing towards expiry, the Options price will decrease by 3.87.
Rho
Rho measures the change in Option price per unit change in interest rate. A Rho value of 2
shows that for every unit increase in interest rate, Option price will change by 2. Rho is
inversely related to puts and directly related to calls.
In the Money (ITM) option
A Call Option is said to be ITM when spot price is higher than strike price. A Put Option is
said to be ITM when spot price is lower than strike price.
For example, last traded price of different ITM Calls and Puts, when underlying Nifty is
trading at 9912, are as follows:
Strike Price LTP of Calls
9900 51.8
9850 85.3
9800 128.9
9750 171.4
9700 217.75
9650 262.05
LTP of
Strike Price
Puts
9950 57.35
10000 92.55
10050 133.95
10100 179.75
10150 235.1
10200 279.35
At the Money (ATM) Option
At-The-Money is a situation where an Option’s strike price is same as the price of the
underlying security. Both the Call and Put Options are simultaneously At-The-Money. At-
The-Money Options have no intrinsic value, but it may still have time value.
Out of the Money (OTM) Option
Call Option is said to be OTM, when spot price is lower than strike price. And a Put Option is
said to be OTM when spot price is higher than strike price.
For example, last traded price of different OTM Calls and Puts, when underlying Nifty is
trading at 9912, are as follows:
Strike Price LTP of Calls
9950 28.65
10000 14.3
10050 6.45
10100 3.15
10150 1.6
10200 1
LTP of
Strike Price
Puts
9900 34.35
9850 20.25
9800 12.9
9750 7.9
9700 5.25
9650 3.05
Difference between ITM, ATM and OTM
Exercise of Options
In case of American option, buyers can exercise their Option any time before the maturity of
contract. All these Options are exercised with respect to the settlement value/closing price of
the stock on the day of exercise of Option.
Payoff Diagram
Long Call Payoff
On Aug 28, 2017, Nifty was trading at 9912. Assume that you buy a Call Option with strike
price of 9900 at a premium of Rs. 52 with expiry date Aug 31, 2017.
Scenario Analysis at various expiry levels:
Spot Closing at Expiry
Instrument Action Strike Premium No of Lots 9600 9700 9800 9900 10000 10100 10200
Call Buy 9900 52 1 -52 -52 -52 -52 48 148 248
Long Put Payoff
On Aug 28, 2017, Nifty is at 9912. Assume that you buy a Put Option with strike price of
9900 at a premium of Rs.34 with expiry date Aug 31, 2017.
Scenario Analysis at various expiry levels:
Spot Closing at Expiry
Instrument Action Premium Strike No of Lots 9600 9700 9800 9900 10000 10100 10200
Put Buy 9900 34 1 266 166 66 -34 -34 -34 -34
Opening a Position
An opening transaction is one that adds or creates a new trading position. It can be either a
purchase or a sale. With respect to an Option transaction, we will consider both:
 Opening purchase – This is done with the purchasing intention of creating or

increasing a long position in a given series of Options.
 Opening sale – This is done with the selling intention of creating or increasing a Short
position in a given series of Options.
Closing a Position
A Closing transaction is one that reduces or eliminates an existing position by an appropriate

offsetting purchase or sale. This is also known as “squaring off” your position. With respect
to an Option transaction:
 Closing purchase – This is done with the purchasing intention of reducing or

eliminating a short position in a given series of Options. This transaction is frequently
referred to as “covering” a short position.
 Closing sale – This is done with the selling intention of reducing or eliminating a long
position in a given series of Options.
You cannot close out a long call position by purchasing a Put or any other similar transaction.
A closing transaction for an Option involves the sale of an Option contract with the same
terms.
Leverage
You, as an Option buyer, pay a relatively small premium for market exposure in relation to
the contract value. This is known as Leverage. You can see large percentage gains from
comparatively small, favorable percentage moves in the underlying equity. Leverage also has
downside implications. If the underlying price does not rise/falls during the lifetime of the
Option, Leverage can magnify your percentage loss.
Risk Return
Long Premium paid Unlimited
Short Unlimited Premium received
A Long Option position has limited risk (premium paid) and unlimited profit potential. A
Short Option position has unlimited downside risk, but limited upside potential (to the extent
of premium received).
Option Trading Strategies

Option Strategies
Options trading, in particular, has many advantages and there are plenty of reasons why this
form of trading is worthy of consideration for anyone looking to trade in the market ,even if it
is slightly more complex subject to learn than direct equity trading.
We will look at some of the benefits of for trading in the options market and why it is can be
such a good idea.
Leverage
One of the primary reasons for trading in the options markets is the benefit of leverage that a
trader receives. It is possible to make significant profits without necessarily having large
sums of cash. In simple terms we can make use of leverage to get more trading power from
the capital we have.
Risk & Reward
Options trading can offer a much better risk versus reward ratio if the right trading strategies
are employed. Through the wide range of option strategies we place different orders and limit
our risk, which may not be possible by simply buying and selling stocks. As we learn about
the various options strategies in the following section we will understand the power of the
tool when it comes to handling risk.
Flexibility & Versatility
One of the most appealing elements of options is the flexibility that they offer. When we
trade in the cash market there are limitations involved, we can either buy the stock or sell its.
But in the options market there are trading strategies based on the prevailing situation and
trend in the market.
 Bullish Option Strategies

 Bearish Option Strategies
 Neutral Option Strategies
 Volatility Option Strategies
Key Takeaways
 There are two types of Options - Call Option and Put Option.
 Call Option is bought when view is bullish.
 Put Option is bought when view is bearish.
 Buyer of Option pays the Option premium.
 Writer of the Option receives the Option premium.
 Only ITM Options have intrinsic value.
 Time value is the difference between premium and intrinsic value.
 Delta measures the change in Option price for a unit change in the price of
underlying.
 Gamma measures the change in Delta with respect to per unit change in underlying.
 Vega measures the change in Options price per unit change in volatility.
 Theta measures the change in Option price per day change in time to expiry.
 Rho measures the change in Option price per unit change in interest rate.
 All option strategies use basic Call and Put Options.
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Bullish Option Strategies | 5paisa

53-68 minutes
Bullish Option Strategies
Bullish options trading strategies are used when options trader expects the underlying assets
to rise. It is very important to determine how much the underlying price will move higher and
the timeframe in which the rally will occur in order to select the best options strategy. The
simplest way to make profit from rising prices using options is to buy calls. However, buying
call is not necessarily the best way to make money in moderately or mildly bullish market.
Following are the most popular bullish strategies that can be used depend upon different
scenarios.
 Long Call Strategy

 Short Put Strategy
 Bull Put Spread
 Long Call Ladder Strategy
 Covered Call Strategy
 Call Back –Spread Strategy
 Stock Repair Strategy
 Call Ratio Spread
How to make profit using bullish option trading
strategies?
Long Call
When to initiate a Long call?
Long call is best used when you expect the underlying asset to increase significantly in a
relatively short period of time. It would still benefit if you expect the underlying asset to rise
slowly. However, one should be aware of the time decay factor, because the time value of
call will reduce over a period of time as you reach near to expiry.
Why to use the Long call
This is a good strategy to use because downside risk is limited only up to the premium/cost of
the call you pay, no matter how much the underlying asset drops. It also gives you the
flexibility to select risk to reward ratio by choosing the strike price of the options contract
you buy.
Strategy Buy/Long Call Option
Market Outlook Extremely Bullish
Breakeven at expiry Strike price + Premium paid
Risk Limited to premium paid
Reward Unlimited
Margin required No
Let’s try to understand with an Example:
Current ABC Ltd Price 8200
Strike price 8200
Premium Paid (per share) 60
BEP (strike Price + Premium paid) 8260
Lot size 75
Suppose the stock of ABC Ltd is trading at Rs. 8,200. A call option contract with a strike
price of Rs. 8,200 is trading at Rs. 60. If you expect that the price of ABC Ltd will rise
significantly in the coming weeks, and you paid Rs. 4,500 (75*60) to purchase single call
option covering 75 shares. So, as expected, if ABC Ltd rallies to Rs. 8,300 on options
expiration date, then you can sell immediately in the open market for Rs. 100 per share. As
each option contract covers 75 shares, the total amount you will receive is Rs. 7,500. Since
you had paid Rs. 4,500 to purchase the call option, your net profit for the entire trade is,
therefore Rs. 3,000. For the ease of understanding, we did not take into account commission
charges.
Analysis Of Long Call Strategy:
Long call strategy limits the downside risk to the premium paid which is coming around Rs.
60 per share in the above example, whereas potential return is unlimited if ABC Ltd moves
higher significantly. It is perfectly suitable for traders who don’t have a huge capital to invest
but could potentially make much bigger returns than investing the same amount directly in
the underlying security.
Short Put Options Trading Strategy

What is short put option strategy?
A short put is the opposite of buy put option. With this option trading strategy, you are
obliged to buy the underlying security at a fixed price in the future. This option trading
strategy has a low profit potential if the stock trades above the strike price and exposed to
high risk if stock goes down. It is also helpful when you expect implied volatility to fall, that
will decrease the price of the option you sold.
When to initiate a short put?
A short put is best used when you expect the underlying asset to rise moderately. It would
still benefit if the underlying asset remains at the same level, because the time decay factor
will always be in your favour as the time value of put will reduce over a period of time as you
reach near to expiry. This is a good option trading strategy to use because it gives you upfront
credit, which will help to somewhat offset the margin.
Strategy Short Put Option
Market Outlook Bullish or Neutral
Breakeven at expiry Strike price - Premium received
Risk Unlimited
Reward Limited to premium received
Margin required Yes
Current Nifty Price 8300
Strike price 8200
Premium received (per share) 80
BEP (strike Price - Premium paid) 8120
Lot size 75
Suppose Nifty is trading at Rs. 8300. A put option contract with a strike price of 8200 is
trading at Rs. 80. If you expect that the price of Nifty will surge in the coming weeks, so you
will sell 8200 strike and receive upfront profit of Rs.6,000 (75*80). This transaction will
result in net credit because you will receive the money in your broking account for writing
the put option. This will be the maximum amount that you will gain if the option expires
worthless. If the market moves against you, then you should have a stop loss based on your
risk appetite to avoid unlimited loss.
So, as expected, if Nifty Increases to 8400 or higher by expiration, the options will be out of
the money at expiration and therefore expire worthless. You will not have any further liability
and amount of Rs.6000 (75*80) will be your maximum profit. If Nifty goes against your
expectation and falls to 7800 then the loss would be amount to Rs.24000 (75*320). Following
is the payoff schedule assuming different scenarios of expiry. For the ease of understanding,
we did not take into account commission charges and Margin.
Analysis of Short Put Option Trading Strategy
A short put options trading strategy can help in generating regular income in a rising or
sideways market but it does carry significant risk and it is not suitable for beginner traders.
It’s also not a good strategy to use if you expect underlying assets to rise quickly in a short
period of time; instead one should try long call trade strategy.
Bull Put Spread

What is Bull Put Spread Option strategy?
A Bull Put Spread involves one short put with higher strike price and one long put with lower
strike price of the same expiration date. A Bull Put Spread is initiated with flat to positive
view in the underlying assets.
When to initiate Bull Put Spread
Bull Put Spread Option strategy is used when the option trader believes that the underlying
assets will rise moderately or hold steady in the near term. It consists of two put options –
short and long put. Short put’s main purpose is to generate income, whereas long put is
bought to limit the downside risk.
How to Construct the Bull Put Spread?
Bull Put Spread is implemented by selling At-the-Money (ATM) Put option and
simultaneously buying Out-the-Money (OTM) Put option of the same underlying security
with the same expiry. Strike price can be customized as per the convenience of the trader.
Probability of making money
A Bull Put Spread has a higher probability of making money as compared to Bull Call
Spread. The probability of making money is 67% because Bull Put Spread will be profitable
even if the underlying assets holds steady or rise. While, Bull Call Spread has probability of
only 33% because it will be profitable only when the underlying assets rise.
Strategy Sell 1 ATM Put and Buy 1 OTM Put
Market Outlook Neutral to Bullish
Motive Earn income with limited risk
Breakeven at expiry Strike Price of Short Put - Net Premium received
Risk Difference between two strikes - premium received
Margin required Yes
Let’s try to understand with an example:
Nifty Current spot price (Rs) 9300
Sell 1 ATM Put of strike price (Rs) 9300
Premium received (Rs) 105
Buy 1 OTM Put of strike price (Rs) 9200
Premium paid (Rs) 55
Break Even point (BEP) 9250
Lot Size 75
Net Premium Received (Rs) 50
Suppose Nifty is trading at Rs.9300. If Mr. A believes that price will rise above 9300 or hold
steady on or before the expiry, so he enters Bull Put Spread by selling 9300 Put strike price at
Rs.105 and simultaneously buying 9200 Put strike price at Rs.55. The net premium received
to initiate this trade is Rs.50. Maximum profit from the above example would be Rs.3750
(50*75). It would only occur when the underlying assets expires at or above 9300. In this
case, both long and short put options expire worthless and you can keep the net upfront credit
received that is Rs.3750 in the above example. Maximum loss would also be limited if it
breaches breakeven point on downside. However, loss would be limited to Rs.3750(50*75).
For the ease of understanding, we did not take in to account commission charges. Following
is the payoff chart and payoff schedule assuming different scenarios of expiry.
The Payoff Schedule:
On Expiry Nifty closes Payoff from Put Sold 9300 Payoff from Put Bought 9200 Net Payoff
at (Rs) (Rs) (Rs)
8800 -395 345 -50
8900 -295 245 -50
9000 -195 145 -50
9100 -95 45 -50
9200 5 -55 -50
9250 55 -55 0
9300 105 -55 50
9400 105 -55 50
9500 105 -55 50
9600 105 -55 50
9700 105 -55 50
Payoff diagram
Impact of Options Greeks:
Delta: Delta estimates how much the option price will change as the stock price changes. The
net Delta of Bull Put Spread would be positive, which indicates any downside movement
would result in loss.
Vega: Bull Put Spread has a negative Vega. Therefore, one should initiate this strategy when
the volatility is high and is expected to fall.
Theta: Time decay will benefit this strategy as ATM strike has higher Theta as compared to
OTM strike.
Gamma: This strategy will have a short Gamma position, so any downside movement in the
underline asset will have a negative impact on the strategy.
How to manage Risk?
A Bull Put Spread is exposed to limited risk; hence carrying overnight position is advisable.
Analysis of Bull Put Spread Options strategy:
A Bull Put Spread Options strategy is limited-risk, limited-reward strategy. This strategy is
best to use when an investor has neutral to Bullish view on the underlying assets. The key
benefit of this strategy is the probability of making money is higher as compared to Bull Call
Spread.
Long Call Ladder Options Strategy

A Long Call Ladder is the extension of bull call spread; the only difference is of an additional
higher strike sold. The purpose of selling the additional strike is to reduce the cost. It is
limited profit and unlimited risk strategy. It is implemented when the investor is expecting
upside movement in the underlying assets till the higher strike sold. The motive behind
initiating this strategy is to rightly predict the stock price till expiration and gain from time
value.
When to initiate a Long Call Ladder
A Long Call Ladder spread should be initiated when you are moderately bullish on the
underlying assets and if it expires in the range of strike price sold then you can earn from
time value factor. Also another instance is when the implied volatility of the underlying
assets increases unexpectedly and you expect volatility to come down then you can apply
Long Call Ladder strategy.
How to construct a Long Call Ladder?
A Long Call Ladder can be created by buying 1 ITM call, selling 1 ATM call and selling 1
OTM call of the same underlying security with the same expiry. Strike price can be
customized as per the convenience of the trader i.e. A trader can initiate the following trades
also: Buy 1 ATM Call, Sell 1 OTM Call and Sell 1 far OTM Call.
Strategy Buy 1 ITM Call, Sell 1 ATM Call and Sell 1 OTM Call
Market Outlook Moderately bullish
Upper Breakeven Total strike price of short call - Strike price of long call - Net premium paid
Lower Breakeven Strike price of long call + Net Premium Paid
Limited to premium paid if stock falls below lower breakeven.

Risk
Unlimited if stock surges above higher breakeven.
Reward Limited (expiry between upper and lower breakeven)
Margin required Yes
Buy 1 ITM call of strike price (Rs) 9000
Sell 1 ATM call of strike price (Rs) 9100
Sell 1 OTM call of strike price (Rs) 9200
Upper breakeven 9270
Lower breakeven 9030
Lot Size 75
Net Premium Paid (Rs) 30
Suppose Nifty is trading at 9100. An investor Mr. A thinks that Nifty will expire in the range
of 9100 and 9200 strikes, so he enters a Long Call Ladder by buying 9000 call strike price at
Rs.180, selling 9100 strike price at Rs.105 and selling 9200 call for Rs.45. The net premium
paid to initiate this trade is Rs.30. Maximum profit from the above example would be
Rs.5250 (70*75). It would only occur when the underlying assets expires in the range of
strikes sold. Maximum loss would be unlimited if it breaks higher breakeven point. However,
loss would be limited up to Rs.2250(30*75) if it drops below the lower breakeven point.
The Payoff chart:
The Payoff Schedule

Payoff from 1 ITM Call Payoff from 1 ATM Payoff from 1 OTM
On Expiry NIFTY Net Payoff
Bought Calls Sold Call Sold
closes at (Rs)
(9000) (Rs) (9100) (Rs) (9200) (Rs)
8600 -180 105 45 -30
8700 -180 105 45 -30
8800 -180 105 45 -30
8900 -180 105 45 -30

9000 -180 105 45 -30
9030 -150 105 45 0
9100 -80 105 45 70
9200 20 5 45 70
9270 90 -65 -25 0
9300 120 -95 -55 -30
9400 220 -195 -155 -130
9500 320 -295 -255 -230
9600 420 -395 -355 -330
9700 520 -495 -455 -430
9800 620 -595 -555 -530
Delta: At the time of initiating this strategy, we will have a short Delta position, which
indicates any significant upside movement, will lead to unlimited loss.
Vega: Long Call Ladder has a negative Vega. Therefore, one should buy Long Call Ladder
spread when the volatility is high and expects it to decline.
Theta: A Long Call Ladder will benefit from Theta if it moves steadily and expires in the
range of strikes sold.
Gamma: This strategy will have a short Gamma position, which indicates any significant
upside movement, will lead to unlimited loss.
How to manage Risk?
A Long Call Ladder is exposed to unlimited risk; it is advisable not to carry overnight
positions. Also, one should always strictly adhere to Stop Loss in order to restrict losses.
Analysis of Long Call Ladder Options strategy:
A Long Call Ladder spread is best to use when you are confident that an underlying security
will not move significantly and will stays in a range of strike price sold. Another scenario
wherein this strategy can give profit is when there is a decrease in implied volatility.
What Is Covered Call Options Trading Strategy?

A covered call options trading strategy is an Income generating strategy which can be
initiated by simultaneously purchasing a stock and selling a call option. It can also be used by
someone who is holding a stock and wants to earn income from that investment. Generally,
the call option which is sold will be out-the-money and it will not get exercised unless the
stock price increases above the strike price.
How should you use the covered call Options Trading strategy?
Choosing between strikes involves a trade-off between priorities. An investor can select
higher out-the-money strike price and preserve some more upside potential. However, more
out-the-money would generate less premium income, which means that there would be a
smaller downside protection in case ofstock decline. The expiration month reflects the time
horizon of his market view.
Strategy Buy Stock & Sell call option
Market Outlook Neutral to moderately bullish
Breakeven(Rs.) at expiry Stock price paid-premium received
Maximum Risk Stock price paid-call premium
Reward Limited
Margin required Yes
Let’s try to understand the Covered Call Options Trading Strategy with an Example:
Current ABC Ltd Price Rs. 8500
Strike price Rs. 8700
Premium Received (per share) Rs. 50
BEP (strike Price - Premium paid) Rs. 8450
Lot size (in units) 100
Let us consider the following scenario: Mr. X has purchased 100 shares of ABC Ltd. for
Rs.8500 and simultaneously sells a call option with a strike price of Rs.8700 for Rs.50 which
means that Mr. X does not think that price of ABC Ltd will rise above Rs.8700 till expiry.
Thus, the net outflow to Mr. X is (Rs.8500-Rs.50) Rs.8450.
The upside profit potential is limited to the premium received from the call option sold plus
the difference between the stock purchase price and its strike price.
In the above example, if stock price surges above the 8700 level, then the maximum profit
would be calculated as:(8700-8500 +50)*100 = (250*100) = Rs. 25,000. If the stock price
stays at or below Rs.8700, the call option will not get exercised and Mr. X can retain the
premium of Rs. 50, which is an extra income.
For the ease of understanding, concepts such as commission, dividend, margin, tax and other
transaction charges have not been included in the above example.
Any increase in volatility will have a neutral to negative impact as the option premium will
increase, while a decrease in volatility will have a positive effect. Time decay will have a
positive effect.
Analysis of Covered Call trading Strategy:
The covered call strategy is best used when an investor wishes to generate income in addition
to any dividends from shares of stocks he or she owns. However, it may not be a very
profitable strategy for an investor whose main interest is to gain substantial profit and who
wants to protect downside risk.
What is Call Backspread?

The Call Backspread is reverse of call ratio spread. It is bullish strategy that involves selling
options at lower strikes and buying higher number of options at higher strikes of the same
underlying stock. It is unlimited profit and limited risk strategy.
When to initiate the Call Backspread
The Call Backspread is used when an option trader thinks that the underlying asset will
experience significant upside movement in the near term.
How to construct the Call Backspread?
 Sell 1 ITM/ATM Call

 Buy 2 OTM Call
The Call Backspread is implemented by selling one In-the-Money (ITM) or At-the-Money

(ATM) call option and simultaneously buying two Out-the-Money (OTM) call options of the
same underlying asset with the same expiry. Strike price can be customized as per the
convenience of the trader.
Strategy Call Backspread
Market Outlook Significant upside movement
Upper Long call strikes + Difference between long and short strikes -/+ net premium
Breakeven received or paid
Lower
Strike price of Short call +/- net premium paid or received
Breakeven
Risk Limited
Reward Unlimited (when Underlying price > strike price of buy call)
Margin required Yes

NIFTY Current market Price Rs 9300
Sell ATM Call (Strike Price) Rs 9300
Premium Received (per share) Rs 140
Buy OTM Call (Strike Price) Rs 9400
Premium Paid (per lot) Rs 70
Net Premium Paid/Received 0
Upper BEP 9500
Lower BEP 9300
Lot Size 75
Suppose Nifty is trading at Rs.9300. If Mr. A believes that price will rise significantly above
Rs 9400 on or before expiry, then he initiates Call Backspread by selling one lot of 9300 call
strike price at Rs.140 and simultaneously buying two lot of 9400 call strike price at Rs.70.
The net premium paid/received to initiate this trade is zero. Maximum profit from the above
example would be unlimited if underlying assets break upper breakeven point. However,
maximum loss would be limited to Rs.7,500 (100*75) and it will only occur when Nifty
expires at 9400.
is the payoff schedule assuming different scenarios of expiry.

On Expiry NIFTY Net Payoff from 9300 Call Net Payoff from 9400 Call Bought Net Payoff
closes at Sold (Rs) (Rs) (2Lots) (Rs)
9000 140 -140 0
9100 140 -140 0
9200 140 -140 0
9300 140 -140 0
9350 90 -140 -50
9400 40 -140 -100
9450 -10 -40 -50
9500 -60 60 0
9600 -160 260 100
9700 -260 460 200
9800 -360 660 300
9900 -460 860 400
The Payoff Graph:

Delta: If the net premium is received from the Call Backspread, then the Delta would be
negative, which means even if the underlying assets falls below lower BEP, profit will be the
net premium received.
If the net premium is paid then the Delta would be positive which means any upside
movement will result into profit.
Vega: The Call Backspread has a positive Vega, which means an increase in implied
volatility will have a positive impact.
Theta: With the passage of time, Theta will have a negative impact on the strategy because
option premium will erode as the expiration dates draws nearer.
Gamma: The Call Backspread has a long Gamma position, which means any major upside
movement will benefit this strategy.
How to manage risk?
The Call Backspread is exposed to limited risk; hence one can carry overnight position.
Analysis of Call Backspread:
The Call Backspread is best to use when an investor is extremely bullish because investor
will make maximum profit only when stock price expires above higher (bought) strike.
What is Stock Repair strategy?

As the name suggests, the Stock Repair strategy is an alternative strategy to recover from loss
that a stock has suffered due to fall in price. The Stock Repair strategy helps in recovering
losses with just a moderate rise in the price of the underlying stock.
Why to Initiate Stock Repair strategy?
Stock Repair strategy is initiated to recover from the losses and exit from loss making
position at breakeven of the underlying stock.
Who can initiate Stock Repair strategy?
A Stock Repair strategy should be implemented by investors who are looking forward to
average their position by buying additional stocks in cash when the underlying stock price is
falling. Instead of buying additional stock in cash one can apply stock repair strategy.
Stock Repair strategy?
A Stock Repair strategy should be initiated only when the stock that you are holding in your
portfolio has corrected by 10-20% and only if you think that the underlying stock will rise
moderately in near term.
How to Construct the Stock Repair strategy?
 Buy 1 ATM call

 Sell 2 OTM calls
Stock Repair strategy is implemented by buying one At-the-Money (ATM) call option and
simultaneously selling two Out-the-Money (OTM) call options strikes, which should be
closest to the initial buying price of the same underlying stock with the same expiry.
Strategy Long Stock, Buy 1 ATM Call and Sell 2 OTM Call
Market Outlook Mildly Bullish
Motive Recover loss with limited risk
Break even (Strike price of buy call + strike of sell call + net premium paid)/2
Risk Net premium paid, Drop in price of holding stock
Reward Average of difference between strike price-net premium paid
Margin required Yes

DISHTV earlier Bought at Rs 100
Quantity bought 7000
DISHTV Current spot price (Rs) 90
Buy 1 ATM Call of strike price (Rs) 90
Premium paid (Rs) 5
Sell 2 OTM Call of strike price (Rs) 100
OTM call price per lot (Rs) 2
Premium received (Rs) (2*2) 4
Break even 95.5
Lot Size 7000
Net Premium paid (Rs) 1

For example, an investor Mr. A had bought 7000 shares of DISHTV at Rs.100 in April but
the price of DISHTV has declined to Rs.90, resulting in to notional loss of Rs.70,000. Mr. A
thinks that price will rise from this level so rather than doubling the quantity at current price,
here he can initiate the Stock Repair strategy. This can be initiated by buying one May 90 call
for Rs.5 and selling two May 100 call for Rs.2 each. The net debit paid to enter this spread is
Rs.1 amounting to Rs.7000, which will be the maximum loss from repair strategy that Mr. A
will face if DISHTV falls below Rs.90.
If DISHTV expires at 80 level then both the calls would expire worthless, resulting in loss of
the debit paid of Rs.7000 as the net cost to initiate Stock Repair strategy is Rs.1 per lot. Had
Mr A doubled his position at 90 level then he would have lost Rs.70,000 (10*7000). This
shows he is much better off by applying this strategy.
If DISHTV expires at 100 level then this would be the best case scenario where maximum
profit will be achieved. May 90 call bought would result in to profit of Rs.5 where as May
100 call sold will expire worthless resulting in to gain of Rs.4. Net gain would be Rs.63,000
(9*7000).
Followings are the two scenarios assuming Mr A has implemented the Stock Repair strategy
whereas Mr B has doubled his position at lower level. For the ease of understanding, we did
not take in to account commission charges.
Stock Repair Normal Averaging
Payoff from Payoff from Payoff from

DISHTV Net payoff Doubling down Net Payoff
stock holding at Repair stock holding at
expires at of Mr. A position payoff of Mr. B
Rs 100 Strategy Rs 100
70 (2,10,000) 7,000 (2,17,000) (2,10,000) (1,40,000) (3,50,000)
80 (1,40,000) 7,000 (1,47,000) (1,40,000) (70,000) (2,10,000)
90 (70,000) 7,000 (77,000) (70,000) 0 (70,000)
100 0 63,000 63,000 0 70,000 70,000
110 70,000 (7,000) 63,000 70,000 1,40,000 2,10,000
Comparison:
Mr. B Doubled his position at lower
Mr. A initiated stock repair strategy
level
Only margin money is required to initiate Full amount has to be paid in cash for
Margin
stock repair strategy taking delivery of stock
Interest Loss (1
1,50,000*0.08/12=1000 630000*0.08/12= 4200
month)
It involves high risk when the stock price

Risk Risk associated is limited
falls
Brokerage in Options is comparatively Brokerage paid to initiate position is
Brokerage
less. higher as compared to Options.
The Payoff chart:
Analysis of Stock Repair strategy:
The Stock Repair strategy is suitable for an investor who is holding a losing stock and wants
to reduce breakeven at very little or no cost. This strategy helps in minimizing the loss at very
low cost as compared to "Doubling Down" of position.
Call Ratio Spread Explained

What is Call Ratio Spread?
The Call Ratio Spread is a premium neutral strategy that involves buying options at lower
strikes and selling higher number of options at higher strikes of the same underlying stock.
When to initiate the Call Ratio Spread
The Call Ratio Spread is used when an option trader thinks that the underlying asset will rise
moderately in the near term only up to the sold strikes. This strategy is basically used to
reduce the upfront costs of premium paid and in some cases upfront credit can also be
received.
How to construct the Call Ratio Spread?
 Buy 1 ITM/ATM Call

 Sell 2 OTM Call
The Call Ratio Spread is implemented by buying one In-the-Money (ITM) or At-the-Money
(ATM) call option and simultaneously selling two Out-the-Money (OTM) call options of the
Strategy Call Ratio Spread
Market Outlook Moderately bullish with less volatility
Upper Difference between long and short strikes + short call strikes +/- premium
Lower
Strike price of long call +/- Net premium paid or received
Breakeven
Risk Unlimited
Reward Limited (when Underlying price = strike price of short call)
Margin required Yes

NIFTY Current market Price 9300
Buy ATM Call (Strike Price) 9300
Premium Paid (per share) 140
Sell OTM Call (Strike Price) 9400
Premium Received 70
Net Premium Paid/Received 0
Upper BEP 9500
Lower BEP 9300
Lot Size 75
Suppose Nifty is trading at Rs.9300. If Mr. A believes that price will rise to Rs.9400 on
expiry, then he enters Call Ratio Spread by buying one lot of 9300 call strike price at Rs.140
and simultaneously selling two lot of 9400 call strike price at Rs.70. The net premium
paid/received to initiate this trade is zero. Maximum profit from the above example would be
Rs.7500 (100*75). For this strategy to succeed the underlying asset has to expire at 9400. In
this case short call option strikes will expire worthless and 9300 strike will have some
intrinsic value in it. However, maximum loss would be unlimited if it breaches breakeven
point on upside.

On Expiry NIFTY Net Payoff from 9300 Call Net Payoff from 9400 Call Sold Net Payoff
closes at Bought (Rs) (Rs) (2Lots) (Rs)
8900 -140 140 0
9000 -140 140 0
9100 -140 140 0
9200 -140 140 0
9300 -140 140 0
9350 -90 140 50
9400 -40 140 100
9450 10 40 50
9500 60 -60 0
9600 160 -260 -100
9700 260 -460 -200
9800 360 -660 -300
9900 460 -860 -400

The Payoff Graph:
Delta: If the net premium is received from the Call Ratio Spread, then the Delta would be
negative, which means slight upside movement will result into loss and downside movement
will result into profit.
If the net premium is paid then the Delta would be positive which means any downside
movement will result into premium loss, whereas a big upside movement is required to incur
loss.
Vega: The Call Ratio Spread has a negative Vega. An increase in implied volatility will have
a negative impact.
Theta: With the passage of time, Theta will have a positive impact on the strategy because
Gamma: The Call Ratio Spread has short Gamma position, which means any major upside
movement will impact the profitability of the strategy.
How to manage risk?
The Call Ratio Spread is exposed to unlimited risk if underlying asset breaks higher
breakeven; hence one should follow strict stop loss to limit loses.
Analysis of Call Ratio Spread:
The Call Ratio Spread is best to use when an investor is moderately bullish because investor
will make maximum profit only when stock price expires at higher (sold) strike. Although
investor profits will be limited if the price does not rise higher than expected sold strike.
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Bearish Option Strategies | 5paisa

50-64 minutes
Bearish Option Strategies

Bearish Option Trading strategy is best used when an options trader expects the underlying
assets to fall. It is very important to determine how much the underlying price will move
lower and the timeframe in which the rally will occur in order to select the best option
strategy. The simplest way to make profit from falling prices using options is to buy put
options. Following are the most popular bearish strategies that can be used in different
scenarios.
 Long Put
 Short Call Strategy
 Put Ratio Strategy
 Bear Call Strategy
 Bear Put Strategy
 Put Back - spread Strategy
 Long Put Ladder Strategy
Bearish Options Trading strategies for Falling Markets

Long Put Options Trading
When should you initiate a Long Put Options Trade?
A Long Put strategy is best used when you expect the underlying asset to fall significantly in
a relatively short period of time. It would still benefit if you expect the underlying asset to fall
gradually. However, one should be aware of the time decay factor, because the time value of
put will reduce over a period of time as you reach near expiry.
Why should you use Long Put?
This is a good strategy to use because the downside risk is limited only up to the
premium/cost of the put you pay, no matter how much the underlying asset rises. It also gives
you the flexibility to select the risk to reward ratio by choosing the strike price of the options
contract you buy. In addition, Long Put can also be used as a hedging strategy if you want to
protect an asset owned by you from a possible reduction in price.
Strategy Buy/Long Put Option
Market Outlook Extremely Bearish
Breakeven at expiry Strike price - Premium paid
Risk Limited to premium paid
Reward Unlimited
Margin required No

Current Nifty Price Rs.8200
Strike price Rs.8200
Premium Paid (per share) Rs.60
BEP (Strike Price - Premium paid) Rs.8140
Suppose Nifty is trading at Rs.8200. A put option contract with a strike price of Rs 8200 is
trading at Rs.60. If you expect that the price of Nifty will fall significantly in the coming
weeks, and you paid Rs.4,500 (75*60) to purchase a single put option covering 75 shares.
As per expectation, if Nifty falls to Rs.8100 on options expiration date, then you can sell
immediately in the open market for Rs 100 per share. As each option contract covers 75
shares, the total amount you will receive is Rs 7,500 (100*75). Since, you had paid Rs.4,500
(60*75) to purchase the put option, your net profit for the entire trade is therefore Rs.3,000.
For the ease of understanding, we did not take into account commission
How to manage risk?
A Long Put is a limited risk and unlimited reward strategy. So carrying overnight position is
advisable but one can keep stop loss to restrict losses due to opposite movement in the
underlying assets and also time value of money can play spoil sports if underlying assets
doesn’t move at all.
Conclusion:
A Long Put is a good strategy to use when you expect the security to fall significantly and
quickly. It also limits the downside risk to the premium paid, whereas the potential return is
unlimited if Nifty moves lower significantly. It is perfectly suitable for traders who don’t
have a huge capital to invest but could potentially make much bigger returns than investing
the same amount directly in the underlying security.
Short Call Strategy Explained

Short Call Strategy:
What is Short Call strategy?
A Short Call means selling of a call option where you are obliged to buy the underlying asset
at a fixed price in the future. This strategy has limited profit potential if the stock trades
below the strike price sold and it is exposed to higher risk if the stock goes up above the
strike price sold.
When to initiate a Short Call?
A Short Call is best used when you expect the underlying asset to fall moderately. It would
still benefit if the underlying asset remains at the same level, because the time decay factor
will always be in your favour as the time value of Call option will reduce over a period of
time as you reach near to expiry. This is a good strategy to use because it gives you upfront
credit, which will help you to somewhat offset the margin. But by initiating this position you
are exposed to potentially unlimited losses if underlying assets goes dramatically high in
price.
How to construct a Short Call?
A Short Call can be created by selling 1 ITM/ATM/OTM call of the same underlying asset
with the same expiry. Strike price can be customized as per the convenience of the trader.
Strategy Short Call Option
Market Outlook Neutral to Bearish
Motive Earn income from selling premium
Breakeven at expiry Strike price + Premium received
Risk Unlimited
Margin required Yes
Probability 66.67%

NIFTY Current market Price 9600
Sell ATM Call (Strike Price) 9600
Premium Received 110
BEP (Rs.) 9710
Lot Size 75
Suppose Nifty is trading at Rs.9600. A Call option contract with a strike price of 9600 is
trading at Rs.110. If you expect that the price of Nifty will fall marginally in the coming
weeks, then you can sell 9600 strike and receive upfront premium of Rs.8,250 (110*75). This
transaction will result in net credit because you will receive money in your broking account
for writing the Call option. This will be the maximum amount that you will gain if the option
expires worthless.
So, as per expectation, if Nifty falls or remains at 9600 by expiration, therefore the option
will expire worthless. You will not have any further liability and amount of Rs.8,250
(110*75) will be your profit. The probability of making money is 66.67% as you can profit in
two scenarios: 1) when price of underlying asset falls. 2) When price stays at same level.
Loss will only occur in one scenario i.e. when the underlying asset moves above the strike
price sold.
Following is the payoff schedule assuming different scenarios of expiry. For the ease of
understanding, we did not take into account commission charges and Margin.
On Expiry Nifty closes at Net Payoff from Sell Buy (Rs.)
9300 110
9400 110
9500 110
9600 110
9700 10
9710 0
9800 -90
9900 -190
10000 -290
10100 -390
10200 -490
Payoff Diagram:
Delta: Short Call will have a negative Delta, which indicates any rise in price will have a
negative impact on profitability.
Vega: Short Call has a negative Vega. Therefore, one should initiate Short Call when the
volatility is high and expects it to decline.
Theta: Short Call will benefit from Theta if it moves steadily and expires at or below strike
sold.
upside movement, will lead to unlimited loss.
How to manage Risk?
A Short Call is exposed to unlimited risk; it is advisable not to carry overnight positions.
Also, one should always strictly adhere to Stop Loss in order to restrict losses.
Analysis:
A Short Call strategy can help in generating regular income in a falling or sideways market
but it does carry significant risk and it is not suitable for beginner traders. It’s also not a good
strategy to use if you expect underlying assets to fall quickly in a short period of time; instead
one should try Long Put strategy.
Put Ratio Spread Explained

What is Put Ratio Spread?
The Put Ratio Spread is a premium neutral strategy that involves buying options at higher
strike and selling more options at lower strike of the same underlying stock.
When to initiate the Put Ratio Spread
The Put Ratio Spread is used when an option trader thinks that the underlying asset will fall
moderately in the near term only up to the sold strike. This strategy is basically used to
reduce the upfront costs of premium and in some cases upfront credit can also be received.
How to construct the Put Ratio Spread?
 Buy 1 ITM/ATM Put

 Sell 2 OTM Put
The Put Ratio Spread is implemented by buying one In-the-Money (ITM) or At-the-Money
(ATM) put option and simultaneously selling two Out-the-Money (OTM) put options of the
Strategy Put Ratio Spread
Market Outlook Moderately bearish with less volatility
Upper
Long put strike (-/+) Net premium paid or received
Breakeven
Lower Short put strike - Difference between Long and Short strikes (-/+) premium
Risk Unlimited
Reward Limited (when underlying price = strike price of short put)
Margin required Yes

Buy ATM Put (Strike Price) Rs 9300
Premium Paid (per share) Rs 140
Sell OTM Put (Strike Price) Rs 9200
Premium Received Rs 70
Net Premium Paid/Received Rs 0
Upper BEP 9300
Lower BEP 9100
Lot Size 75
Suppose Nifty is trading at Rs.9300. If Mr. A believes that price will fall to 9200 on expiry,
then he can initiate Put Ratio Spread by buying one lot of 9300 put strike price at Rs.140 and
simultaneously selling two lot of 9200 put strike price at Rs 70. The net premium
paid/received to initiate this trade is zero. Maximum profit from the above example would be
Rs.7500 (100*75). It would only occur when the underlying asset expires at 9200. In this
case, short put options strike will expire worthless and 9300 strike will have some intrinsic
value in it. However, maximum loss would be unlimited if it breaches breakeven point on
downside.

On Expiry NIFTY Net Payoff from 9300 Put Net Payoff from 9200 Put Sold Net Payoff
closes at Bought (Rs) (Rs) (2Lots) (Rs)
8700 460 860 -400
8800 360 660 -300
8900 260 460 -200
9000 160 -260 -100
9100 60 -60 0
9150 10 40 50
9200 -40 140 100
9250 -90 140 50
9300 -140 140 0
9350 -140 140 0

9400 -140 140 0
9450 -140 140 0
9500 -140 140 0
The Payoff Graph:
Delta: If the net premium is received from the Put Ratio Spread, then the Delta would be
positive, which means any upside movement will result into marginal profit and any major
downside movement will result into huge loss.
If the net premium is paid, then the Delta would be negative, which means any upside
movement will result into premium loss, whereas a big downside movement is required to
incur huge loss.
Vega: The Put Ratio Spread has a negative Vega. An increase in implied volatility will have
a negative impact.
Theta: With the passage of time, Theta will have a positive impact on the strategy because
Gamma: The Put Ratio Spread has short Gamma position, which means any major downside
movement will affect the profitability of the strategy.
How to manage Risk?
The Put Ratio Spread is exposed to unlimited risk if underlying asset breaks lower breakeven
hence one should follow strict stop loss to limit losses.
Analysis of Put Ratio Spread:
The Put Ratio Spread is best to use when investor is moderately bearish because investor will
make maximum profit only when stock price expires at lower (sold) strike. Although your
profits will be none to limited if price rises higher.
Bear Call Option Trading Strategy

What is a Bear Call Spread Option strategy?
A Bear Call Spread is a bearish option strategy. It is also called as a Credit Call Spread
because it creates net upfront credit at the time of initiation. It involves two call options with
different strike prices but same expiration date. A bear call spread is initiated with
anticipation of decline in the underlying assets, similar to bear put spread.
When to initiate a Bear Call Spread Option strategy?
A Bear Call Spread Option strategy is used when the option trader expects that the underlying
assets will fall moderately or hold steady in the near term. It consists of two call options –
short and buy call. Short call’s main purpose is to generate income, whereas higher buy call is
bought to limit the upside risk.
How to construct the Bear Call Spread?
Bear Call Spread can be implemented by selling ATM call option and simultaneously buying
OTM call option of the same underlying assets with same expiry. Strike price can be
customized as per the convenience of the trader.
Probability of making money
A Bear Call Spread has a higher probability of making money. The probability of making
money is 67% because Bear Call Spread will be profitable even if the underlying assets holds
steady or falls. While, Bear Put Spread has probability of only 33% because it will be
profitable only when the underlying assets fall.
Strategy Sell 1 ATM call and Buy 1 OTM call
Market Outlook Neutral to Bearish
Motive Earn income with limited risk
Breakeven at expiry Strike Price of short Call + Net Premium received

Risk Difference between two strikes - premium received
Margin required Yes

Buy 1 OTM call of strike price (Rs) 9400
Break Even point (BEP) 9350
Lot Size 75
Suppose Nifty is trading at Rs.9300. If Mr. A believes that price will fall below 9300 or holds
steady on or before the expiry, so he enters Bear Call Spread by selling 9300 call strike price
at Rs.105 and simultaneously buying 9400 call strike price at Rs.55. The net premium
received to initiate this trade is Rs.50. Maximum profit from the above example would be
Rs.3750 (50*75). It would only occur when the underlying assets expires at or below 9300. In
this case both long and short call options expire worthless and you can keep the net upfront
credit received. Maximum loss would also be limited if it breaches breakeven point on
upside. However, loss would also be limited up to Rs.3750(50*75).

On Expiry Nifty Net Payoff from Call Sold Net Payoff from Call Bought Net Payoff
closes at 9300 (Rs) 9400 (Rs) (Rs)
8900 105 -55 50
9000 105 -55 50
9100 105 -55 50
9200 105 -55 50
9300 105 -55 50
9350 55 -55 0
9400 5 -55 -50
9500 -95 45 -50
9600 -195 145 -50
9700 -295 245 -50
9800 -395 345 -50
Bear Call Spread’s Payoff Chart:
Delta: The net Delta of Bear Call Spread would be negative, which indicates any upside
movement would result in to loss. The ATM strike sold has higher Delta as compared to
OTM strike bought.
Vega: Bear Call Spread has a negative Vega. Therefore, one should initiate this strategy
when the volatility is high and is expected to fall.
Theta: The net Theta of Bear Call Spread will be positive. Time decay will benefit this
strategy.
Gamma: This strategy will have a short Gamma position, so any upside movement in the
underline asset will have a negative impact on the strategy.
How to manage Risk?
A Bear Call is exposed to limited risk; hence carrying overnight position is advisable.
Analysis of Bear Call Options strategy:
A Bear Call Spread strategy is limited-risk, limited-reward strategy. This strategy is best to
use when an investor has neutral to bearish view on the underlying assets. The key benefit of
this strategy is the probability of making money is higher.
What Is A Bear Put Spread Options Trading Strategy?

A Bear Put Spread strategy involves two put options with different strike prices but the same
expiration date. Bear Put Spread is also considered as a cheaper alternative to long put
because it involves selling of the put option to offset some of the cost of buying puts.
When To Initiate A Bear Put Spread Options Trading?
A Bear Put Spread strategy is used when the option trader thinks that the underlying assets
will fall moderately in the near term. This strategy is basically used to reduce the upfront
costs of premium, so that less investment of premium is required and it can also reduce the
affect of time decay. Even beginners can apply this strategy when they expect security to fall
moderately in near the term.
How To Construct The Bear Put Spread?
 Buy 1 ITM/ATM Put

 Sell 1 OTM Put
Bear Put Spread is implemented by buying In-the-Money or At-the-Money put option and
simultaneously selling Out-The-Money put option of the same underlying security with the
same expiry.
Strategy Buy 1 ITM/ATM put and Sell 1 OTM put
Market Outlook Moderately Bearish
Breakeven at expiry Strike price of buy put - Net Premium Paid
Risk Limited to Net premium paid
Reward Limited
Margin required Yes
Let’s try to understand Bear Put Spread Options Trading with an example:
Nifty current market price Rs.8100
Buy ATM Put (Strike Price) Rs.8100

Premium Paid (per share) Rs.60
Sell OTM Put (Strike Price) Rs.7900
Premium Received Rs.20
Net Premium Paid Rs.40
Break Even Point (BEP) Rs.8060
Lot Size (in units) 75
Suppose Nifty is trading at Rs.8100. If you believe that price will fall to Rs.7900 on or before
the expiry, then you can buy At-the-Money put option contract with a strike price of Rs.8100,
which is trading at Rs.60 and simultaneously sell Out-the-Money put option contract with a
strike price of Rs.7900, which is trading at Rs.20. In this case, the contract covers 75 shares.
So, you paid Rs.60 per share to purchase single put and simultaneously received Rs.20 by
selling Rs.7900 put option. So, the overall net premium paid by you would be Rs 40.
So, as expected, if Nifty falls to Rs.7900 on or before option expiration date, then you can
square off your position in the open market for Rs 160 by exiting from both legs of the trade.
As each option contract covers 75 shares, the total amount you will receive is Rs 15,000
(200*75). Since, you had paid Rs.3,000 (40*75) to purchase the put option, your net profit for
the entire trade is, therefore Rs.12,000 (15000-3000). For the ease of understanding, we did
not take in to account commission charges.
Following is the payoff schedule assuming different scenarios of expiry.

On Expiry NIFTY closes Net Payoff from Put Buy Net Payoff from Put Sold Net Payoff
at (Rs) (Rs) (Rs)
7500 540 -380 160
7600 440 -280 160
7700 340 -180 160
7800 240 -80 160
7900 140 20 160
8000 40 20 60
8100 -60 20 -40
8200 -60 20 -40
8300 -60 20 -40

8400 -60 20 -40
8500 -60 20 -40
8600 -60 20 -40
8700 -60 20 -40
Bear Put Spread’s Payoff Chart:
The overall Delta of the bear put position will be negative, which indicates premiums will go
up if the markets go down. The Gamma of the overall position would be positive. It is a long
Vega strategy, which means if implied volatility increases; it will have a positive impact on
the return, because of the high Vega of At-the-Money options. Theta of the position would be
negative.
Analysis of Bear Put Spread strategy:
A Bear Put Spread strategy is best to use when an investor is moderately bearish because he
or she will make the maximum profit only when the stock price falls to the lower (sold)
strike. Also, your losses are limited if price increases unexpectedly higher.
Put Backspread Explained - Back Spread Options

Strategy
What is Put Backspread?
The Put Backspread is reverse of Put Ratio Spread. It is a bearish strategy that involves
selling options at higher strikes and buying higher number of options at lower strikes of the
same underlying asset. It is unlimited profit and limited risk strategy.
When to initiate the Put Backspread
The Put Backspread is used when an option trader believes that the underlying asset will fall
significantly in the near term.
How to construct the Put Backspread?
 Sell 1 ITM/ATM Put

 Buy 2 OTM Put
The Put Backspread is implemented by selling one In-the-Money (ITM) or At-the-Money

(ATM) put option and buying two Out-the-Money (OTM) put options simultaneously of the
Strategy Put Backspread
Market Outlook Significant downside movement
Upper
Strike price of short put -/+ premium paid/ premium received
Breakeven
Lower Long put strike - Difference between Long and Short strikes (-/+) premium
Risk Limited
Reward Unlimited (when Underlying price < strike price of buy put)
Margin required Yes

Sell ATM Put (Strike Price) Rs 9300
Buy OTM Put (Strike Price) Rs 9200
Premium paid (per lot) Rs 70
Net Premium Paid/Received Rs 0
Upper BEP 9300
Lower BEP 9100
Lot Size 75
Suppose Nifty is trading at Rs.9300. If Mr. A believes that price will fall significantly below
9200 on or before expiry, then he can initiate Put Backspread by selling one lot of 9300 put
strike price at Rs.140 and simultaneously buying two lot of 9200 put strike price at Rs.70.
The net premium paid/received to initiate this trade is zero. Maximum profit from the above
example would be unlimited if underlying asset breaks lower breakeven point. However,
maximum loss would be limited to Rs.7,500 (100*75) and it will only occur when Nifty
expires at 9200.

On Expiry NIFTY Net Payoff from 9300 Put Net Payoff from 9200 Put Bought Net Payoff
closes at Sold (Rs) (Rs) (2Lots) (Rs)
8700 -460 860 400
8800 -360 660 300
8900 -260 460 200
9000 -160 260 100
9100 -60 60 0
9150 -10 -40 -50
9200 40 -140 -100
9250 90 -140 -50
9300 140 -140 0
9350 140 -140 0

9400 140 -140 0
9450 140 -140 0
9500 140 -140 0
The Payoff Graph:
Delta: If the net premium is paid, then the Delta would be negative, which means any upside
movement will result into premium loss, whereas a big downside movement would result in
to unlimited profit. On the other hand, If the net premium is received from the Put
Backspread, then the Delta would be positive, which means any upside movement above
higher breakeven will result into profit up to premium received.
Vega: The Put Backspread has a positive Vega, which means an increase in implied volatility
will have a positive impact.
Theta: With the passage of time, Theta will have a negative impact on the strategy because
Gamma: The Put Backspread has a long Gamma position, which means any major downside
movement will benefit this strategy.
How to manage Risk?
The Put Backspread is exposed to limited risk; hence one can carry overnight position.
Analysis of Put Backspread:
The Put Backspread is best to use when investor is extremely bearish because investor will
make maximum profit only when stock price expires at below lower (bought) strike.
Long Put Ladder Strategy Explained

A Long Put Ladder is the extension of Bear Put spread; the only difference is of an additional
lower strike sold. The purpose of selling the additional strike is to reduce the cost of
premium. It is limited profit and unlimited risk strategy. It is implemented when the investor
is expecting downside movement in the underlying assets till the lower strike sold. The
motive behind initiating this strategy is to rightly predict the stock price till expiration and
gain from time value.
When to initiate a Long Put Ladder
A Long Put Ladder should be initiated when you are moderately bearish on the underlying
asset and if it expires in the range of strike price sold then you can earn from time value and
delta factor. Also, another instance is when the implied volatility of the underlying asset
increases unexpectedly and you expect volatility to come down then you can apply Long Put
Ladder strategy.
How to construct Long Put Ladder
A Long Put Ladder can be created by buying 1 ITM Put, selling 1 ATM Put and selling 1
OTM Put of the same underlying security with the same expiry. Strike price can be
customized as per the convenience of the trader. A trader can also initiate the Short Put
Ladder strategy in the following way - buy 1 ATM Put, Sell 1O TM Put and Sell 1 Far OTM
Put.
Strategy Buy 1 ITM Put, Sell 1 ATM Put and Sell 1 OTM Put
Market Outlook Moderately bearish
Upper Breakeven Strike price of long Put - Net Premium Paid
Lower Breakeven Addition of two sold Put strikes - Strike price of long Put + Net premium paid
Limited to premium paid if stock goes above higher breakeven.

Risk
Unlimited if stock falls below lower breakeven.
Reward Limited (expiry between upper and lower breakeven)
Margin required Yes

Buy 1 ITM Put of strike price (Rs) 9500

Sell 1 OTM Put of strike price (Rs) 9300
Lot Size 75
Suppose Nifty is trading at 9400. An investor Mr. A feels that Nifty will expire in the range
of 9400 and 9300 strikes, so he enters a Long Put Ladder by buying 9500 Put strike price at
Rs.180, selling 9400 strike price at Rs.105 and selling 9300 Put for Rs.45. The net premium
paid to initiate this trade is Rs.30. Maximum profit from the above example would be
Rs.5250 (70*75). It would only occur when the underlying assets expires in the range of
strikes sold. Maximum loss would be unlimited if it breaks lower breakeven point. However,
loss would be limited up to Rs.2250 (30*75) if Nifty surges above the higher breakeven
point.
The Payoff chart:

On Expiry Payoff from 1 ITM Put Payoff from 1 ATM Payoff from 1 OTM Net Payoff
NIFTY closes at Bought (9500) (Rs) Puts Sold (9400) (Rs) Put Sold (9300) (Rs) (Rs)
8800 520 -495 -455 -430
8900 420 -395 -355 -330
9000 320 -295 -255 -230
9100 220 -195 -155 -130
9200 120 -95 -55 -30
9230 90 -65 -25 0
9300 20 5 45 70
9400 -80 105 45 70
9470 -150 105 45 0
9500 -180 105 45 -30
9600 -180 105 45 -30
9700 -180 105 45 -30

9800 -180 105 45 -30
Delta: At the time of initiating this strategy, we will have a short Delta position, which
indicates any significant downside movement, will lead to unlimited loss.
Vega: Long Put Ladder has a negative Vega. Therefore, one should buy Long Put Ladder
spread when the volatility is high and expects it to decline.
Theta: A Long Put Ladder will benefit from Theta if it moves steadily and expires in the
range of strikes sold.
downside movement, will lead to unlimited loss.
How to manage Risk?
A Long Put Ladder is exposed to unlimited risk; hence it is advisable not to carry overnight
Analysis of Long Put Ladder Strategy:
A Long Put Ladder spread is best to use when you are confident that an underlying security
will move marginally lower and will stay in a range of strike price sold. Another scenario
wherein this strategy can give profit is when there is a decrease in implied volatility.
5paisa.com
Neutral Option Strategies | 5paisa

56-71 minutes
Neutral Option Strategies
Neutral Option Strategy is made use of when the trader expects the volatility in the market to
decline after a sharp spike. The trader expects the stock to trade in a narrow range and
expects the option premium of call and put options to decline. Following are the most popular
strategies that can be used when the market is expected to trade range bound with a decline in
volatility.
 Short Strangle Strategy

 Short Straddle Strategy
 Long Call Butterfly Strategy
 Short Iron Butterfly Strategy
 Long Call Condor Strategy
 Long Call Calendar Spread Strategy
How to make Profit in a Sideways Market: Short Strangle

strategy
How to make Profit in a Sideways Market: Short Strangle strategy
A Short Strangle strategy consists of one short call with higher strike price and one short put
with lower strike price. It is established for a net credit and generates profit only when the
underlying stock expires between two strikes sold. Every day that passes without large
movement in the underlying assets will benefit this strategy due to time erosion. Volatility is
a vital factor and it can adversely affect a trader’s profits in case it goes up.
When to initiate a Short Strangle strategy?
A Short Strangle strategy should only be used when you are very confident that the security
won’t move in either direction because the potential loss can be substantial if that happens.
This strategy can also be used by advanced traders when the implied volatility goes
abnormally high and the call and put premiums may be overvalued. After initiating Short
Strangle, the idea is to wait for implied volatility to drop and close the position at a profit.
Inversely, this strategy can lead to losses in case the implied volatility rises even if the stock
price remains at same level.
How to construct a Short Strangle strategy?
A Short Strangle strategy is implemented by selling Out-the-Money Call option and

simultaneously selling Out-the-Money Put option of the same underlying security with the
same expiry. Strike price can be customized as per convenience of the trader but the call and
put strikes must be equidistant from the spot price.
Strategy Sell OTM Call and Sell OTM Put
Market
Neutral or very little volatility
Outlook
Motive Earn income from selling option premium
Upper
Strike price of short call + Net Premium received
Breakeven
Lower
Strike price of short put - Net Premium received
Breakeven
Risk Unlimited
Limited to Net Premium received (when underlying assets expires in the range of
Reward
call and put strikes sold)
Margin
Yes
required

Nifty Current spot price Rs 8800
Sell OTM Call Strike Price Rs 9000
Sell OTM Put Strike price Rs 8600
Lot Size 75
Suppose Nifty is trading at 8800. An investor, Mr A is expecting very little movement in the
market, so he enters a Short Strangle by selling 9000 call strike at Rs.40 and 8800 put for
Rs.30. The net upfront premium received to initiate this trade is Rs.70, which is also the
maximum possible reward. Since this strategy is initiated with a view of no movement in the
underlying security, the loss can be substantial when there is significant movement in the
underlying security. The maximum profit will be limited to the upfront premium received,
which is around Rs.5250 (70*75) in the example cited above. Another way by which this
strategy can be profitable is when the implied volatility falls.
For the ease of understanding, we did not take into account commission charges. Following is
the payoff chart and payoff schedule assuming different scenarios of expiry.
The Payoff Chart:

On Expiry NIFTY closes Net Payoff from Call Buy Net Payoff from Put Buy Net Payoff
at (Rs) (Rs) (Rs)
8300 40 -270 -230
8400 40 -170 -130
8500 40 -70 -30
8530 40 -40 0
8600 40 30 70
8700 40 30 70
8800 40 30 70
8900 40 30 70
9000 40 30 70
9070 -30 30 0
9100 -60 30 -30
9200 -160 30 -130
9300 -260 30 -230
Impact of option Greeks:
Delta: A Short Strangle has near-zero delta. Delta estimates how much an option price will
change as the stock price changes. When the stock price trades between the upper and lower
wings of Short Strangle, call Delta will drop towards zero and put Delta will rise towards
zero as the expiration date draws nearer.
Vega: A Short Strangle has a negative Vega. This means all other things remain the same,
increase in implied volatility will have a negative impact.
Theta: With the passage of time, all other things remain same, Theta will have a positive
impact on the strategy, because option premium will erode as the expiration dates draws
nearer.
Gamma: Gamma estimates how much the Delta of a position changes as the stock prices
changes. Gamma of the Short Strangle position will be negative as we are short on options
and any major movement on either side will affect the profitability of the strategy.
How to manage risk?
Since this strategy is exposed to unlimited risk, it is advisable not to carry overnight
Analysis of Short Strangle strategy:
A Short Strangle strategy is the combination of short call and short put and it mainly profits
from Theta i.e. time decay factor if the price of the security remains relatively stable. This
strategy is not recommended for amateur/beginner traders, because the potential losses can be
substantial and it requires advanced knowledge of trading.
How to make Profit in a Neutral Market: Short Straddle

Option Strategy
A Short Straddle strategy is a race between time decay and volatility. Every day that passes
without movement in the underlying assets will benefit this strategy from time erosion.
Volatility is a vital factor and it can adversely affect a trader’s profits in case it goes up.
When to initiate a Short Straddle Options Trading Strategy?
A short options trading straddle strategy can be used when you are very confident that the
security won’t move in either direction because the potential loss can be substantial if that
happens. This strategy can also be used by advanced traders when the implied volatility goes
abnormally high for no obvious reason and the call and put premiums may be overvalued.
After selling straddle, the idea is to wait for implied volatility to drop and close the position at
a profit. Inversely, this strategy can lead to losses in case the implied volatility rises even if
the stock price remains at same level.
How to Construct a Short Straddle Options Trading Strategy?
A short straddle is implemented by selling at-the-money call and put option of the same
underlying security with the same expiry.
Strategy Sell ATM Call and Sell ATM Put
Market Outlook Neutral or very little volatility
Motivation Earn income from selling option premium
Upper
Breakeven
Lower
Breakeven
Risk Unlimited
Limited to Net Premium received (when underlying assets expires exactly at the
Reward
strikes price sold)
Margin
Yes
required

Nifty Current spot price Rs.8800
Sell ATM Call & Put(Strike Price) Rs.8800
Premium received (per share) Call Rs.80
Put Rs.90
Upper breakeven Rs.8970
Lower breakeven Rs.8630
Lot Size(in units) 75
Suppose, Nifty is trading at 8800. An investor, Mr. A is expecting no significant movement

in the market, so he enters a Short Straddle by selling a FEB 8800 call strike at Rs.80 and
FEB 8800 put for Rs.90. The net upfront premium received to initiate this trade is Rs.170,
which is also the maximum possible reward. Since this strategy is initiated with a view of no
movement in the underlying security, the loss can be substantial when there is significant
movement in the underlying security. The maximum profit will be limited to the upfront
premium received, which is around Rs.12750 (170*75) in the example cited above. Another
way by which this strategy can be profitable is when the implied volatility falls.
The Payoff Chart:

On Expiry NIFTY closes Net Payoff from Call Sell Net Payoff from Put Sell Net Payoff
at (Rs) (Rs) (Rs)
8300 80 -410 -330
8400 80 -310 -230
8500 80 -210 -130
8600 80 -110 -30
8630 80 -80 -0
8700 80 10 70
8800 80 90 170
8900 -20 90 70
8970 -90 90 0
9000 -120 90 -30
9100 -220 90 -130
9200 -320 90 -230
9300 -420 90 -330
Delta: Since we are initiating ATM options position, the Delta of call and put would be
around 0.50.
 8800 CE Delta @ 0.5, since we are short, the delta would be -0.5.
 8800 PE Delta @-0.5, since we are short, the delta would be +0.5.
 Combined delta would be -0.5+0.5=0.
Delta neutral in case of Short Straddle suggests profit is capped. If the underlying assets
move significantly, the losses would be substantial.
Gamma: Gamma of the overall position would be Negative.
Vega: Short Straddle Strategy has a negative Vega. Therefore, one should initiate Short
Straddle only when the volatility is high and expects to fall.
Theta: Time decay is the sole beneficiary for the Short Straddle trader given that other things
remain constant. It is most effective when the underlying price expires around ATM strike
price.
How to manage risk?
Since this strategy is exposed to unlimited risk, it is advisable not to carry overnight
Analysis of Short Straddle Option Trading Strategy:
A Short Straddle Option Trading Strategy is the combination of short call and short put and it
mainly profits from Theta i.e. time decay factor if the price of the security remains relatively
stable. This strategy is not recommended for amateur/beginner traders, because the potential
losses can be substantial and it requires advanced knowledge of trading.
Long Call Butterfly Options Strategy

A Long Call Butterfly is implemented when the investor is expecting very little or no
movement in the underlying assets. The motive behind initiating this strategy is to rightly
predict the stock price till expiration and gain from time value with limited risk.
When to initiate a Long Call Butterfly?
A Long Call Butterfly spread should be initiated when you expect the underlying assets to
trade in a narrow range as this strategy benefits from time decay factor. However, unlike
Short Strangle or Short Straddle, the potential risk in a Long Call Butterfly is limited. Also,
when the implied volatility of the underlying assets increases unexpectedly and you expect
volatility to come down, then you can apply Long Call Butterfly strategy.
How to construct a Long Call Butterfly?
A Long Call Butterfly can be created by buying 1 ITM call, buying 1 OTM call and selling 2
ATM calls of the same underlying security with the same expiry. Strike price can be
customized as per the convenience of the trader; however, the upper and lower strike must be
equidistant from the middle strike.
Strategy Buy 1 ITM Call, Sell 2 ATM Call and Buy 1 OTM Call
Market Outlook Neutral on market direction & Bearish on volatility
Upper Breakeven Higher Strike price of buy call - Net Premium Paid
Lower Breakeven Lower Strike price of buy call + Net Premium Paid
Risk Limited to Net Premium Paid
Reward Limited (Maximum profit is achieved when market expires at middle strike)
Margin required Yes

Premium received (Rs) 300 (150*2)
Lot Size 75

Suppose Nifty is trading at 8800. An investor Mr A thinks that Nifty will not rise or fall much
by expiration, so he enters a Long Call Butterfly by buying a March 8700 call strike price at
Rs.210 and March 8900 call for Rs 105 and simultaneously sold 2 ATM call strike price of
8800 @150 each. The net premium paid to initiate this trade is Rs.15, which is also the
maximum possible loss. This strategy is initiated with a neutral view on Nifty hence it will
give the maximum profit only when there is no movement in the underlying security.
Maximum profit from the above example would be Rs.6375 (85*75). The maximum profit
would only occur when underlying assets expires at middle strike. Maximum loss will also be
limited if it breaks the upper and lower break-even points i.e. Rs.1125 (15*75). Another way
by which this strategy can give profit is when there is a decrease in implied volatility.
The Payoff chart:

On Expiry Net Payoff from 1 ITM Net Payoff from 2 Net Payoff from 1 OTM Net Payoff
NIFTY closes at Call Bought (Rs) ATM Calls Sold (Rs) Call Bought (Rs) (Rs)
8200 -210 300 -105 -15
8300 -210 300 -105 -15
8400 -210 300 -105 -15
8500 -210 300 -105 -15
8600 -210 300 -105 -15
8700 -210 300 -105 -15
8715 -195 300 -105 0
8800 -110 300 -105 85
8885 -25 130 -105 0
8900 -10 100 -105 -15
9000 90 -100 -5 -15
9100 190 -300 95 -15
9200 290 -500 195 -15
9300 390 -700 295 -15
9400 490 -900 395 -15
Impact of Options Greeks before expiry:
Delta: The net delta of a Long Call Butterfly spread remains close to zero.
Vega: Long Call Butterfly has a negative Vega. Therefore, one should buy Long Call
Butterfly spread when the volatility is high and expect to decline.
Theta: It measures how much time erosion will affect the net premium of the position. A
Long Call Butterfly will benefit from theta if it expires at middle strike.
Gamma: This strategy will have a long gamma position.
How to manage Risk?
A Long Call Butterfly is exposed to limited risk, so carrying overnight position is advisable
but one can keep stop loss to further limit losses.
Analysis of Long Call Butterfly strategy:
A Long Call Butterfly spread is best to use when you are confident that an underlying
security will not move significantly and will stay in a range. Downside risk is limited to net
debit paid, and upside reward is also limited but higher than the risk involved.
Short Iron Butterfly Options Strategy

A Short Iron Butterfly strategy is implemented when an investor is expecting very little or no
movement in the underlying assets. The motive behind initiating this strategy is to rightly
predict the stock price till expiration and gain from time value. It is a limited risk and a
limited reward strategy, similar to Long Call Butterfly strategy. A Short Iron Butterfly could
also be considered as a combination of Bear Call Spread and Bull Put Spread.
When to initiate a Short Iron Butterfly?
A Short Iron Butterfly spread is best to use when you expect the underlying assets to trade in
a narrow range as this strategy benefits from time decay factor. Also, when the implied
volatility of the underlying assets increases unexpectedly and you expect volatility to come
down, then you can apply Short Iron Butterfly strategy.
How to construct a Short Iron Butterfly?
A Short Iron Butterfly can be created by selling 1 ATM call, buying 1 OTM call, selling 1
ATM put and buying 1 OTM put of the same underlying security with the same expiry. Strike
price can be customized as per the convenience of the trader; however, the upper and lower
strike must be equidistant from the middle strike.
Strategy Sell 1 ATM Call, Buy 1 OTM Call, Sell 1 ATM Put and Buy 1 OTM Put
Market Outlook Neutral on market direction & Bearish on volatility
Motive Earn from time value with limited risk
Upper Breakeven Short Option (Middle) Strike price + Net Premium Received
Lower Breakeven Short Option (Middle) Strike price - Net Premium Received
Risk Limited
Margin required Yes

Sell 1 ATM Call of strike price (Rs) 9200

Buy 1 OTM Call of strike price (Rs) 9300
Lot Size 75
Suppose Nifty is trading at 9200. An investor, Mr. A thinks that Nifty will not rise or fall
much by expiration, so he enters a Short Iron Butterfly by selling a 9200 call strike price at
Rs.70, buying 9300 call for Rs.30 and simultaneously selling 9200 put for Rs.105, buying
9100 put for Rs.65. The net premium received to initiate this trade is Rs.80, which is also the
maximum possible gain. This strategy is initiated with a neutral view on Nifty hence it will
give the maximum profit only when the underlying assets expire at middle strike. The
maximum profit from the above example would be Rs.6,000 (80*75). The maximum loss will
also be limited to Rs.1,500 (20*75), if it breaks the upper and lower break-even points.
Another way by which this strategy can give profit is when there is a decrease in implied
volatility.
The Payoff chart:

On Expiry Net Payoff from 1 Net Payoff from Net Payoff from 1 Net Payoff from Net
NIFTY ITM Call Bought 1 OTM Call Sold ATM Put bought 1 OTM Put sold Payoff
closes at (Rs) 9200 (Rs) 9300 (Rs) 9200 (Rs.) 9100 (Rs)
8800 70 -30 -295 235 -20
8900 70 -30 -195 135 -20
9000 70 -30 -95 35 -20
9100 70 -30 5 -65 -20

9120 70 -30 25 -65 0
9200 70 -30 105 -65 80
9280 -10 -30 105 -65 0
9300 -30 -30 105 -65 -20
9400 -130 70 105 -65 -20
9500 -230 170 105 -65 -20
9600 -330 270 105 -65 -20
Delta: The net delta of a Short Iron Butterfly spread remains close to zero if underlying
assets remains at middle strike. Delta will move towards -1 if the underlying assets expire
above the higher strike price and Delta will move towards 1 if the underlying assets expire
below the lower strike price.
Vega: Short Iron Butterfly has a negative Vega. Therefore, one should initiate Short Iron
Butterfly spread when the volatility is high and is expected to fall.
Theta: With the passage of time, if other factors remain the same, Theta will have a positive
impact on the strategy.
Gamma: This strategy will have a short Gamma position, so the change in underline asset
will have a negative impact on the strategy.
How to manage Risk?
A Short Iron Butterfly is exposed to limited risk compared to reward, so carrying overnight
position is advisable.
Analysis of Short Iron Butterfly strategy:
A Short Iron Butterfly spread is best to use when you are confident that an underlying
security will not move significantly and will stay in a range. Downside risk is limited to the
net premium received, and upside reward is also limited but higher than the risk involved. It
provides a good reward to risk ratio.
Long Call Condor Options Trading Strategy

Long Call Condor options trading strategy
A Long Call Condor is similar to a Long Butterfly strategy, wherein the only exception is that
the difference of two middle strikes sold has separate strikes. The maximum profit from
condor strategy may be low as compared to other trading strategies; however, a condor
strategy has high probability of making money because of wider profit range.
When to initiate a Long Call Condor
A Long Call Condor spread should be initiated when you expect the underlying assets to
trade in a narrow range as this strategy benefits from time decay factor.
How to construct a Long Call Condor?
A Long Call Condor can be created by buying 1 lower ITM call, selling 1 lower middle ITM
call, selling 1 higher middle OTM call and buying 1 higher OTM calls of the same
underlying security with the same expiry. The ITM and OTM call strikes should be
equidistant.
Strategy Buy 1 ITM Call, Sell 1 ITM Call, Sell 1 OTM Call and Buy 1 OTM Call
Market Outlook Neutral on market direction and Bearish on volatility
Motive Anticipating minimal price movement in the underlying assets
Upper
Higher Strike price - Net Premium Paid
Breakeven
Lower
Lower Strike price + Net Premium Paid
Breakeven
Ris> Limited to Net premium paid
Limited (Maximum profit is achieved when underlying expires between sold

Reward
strikes)
Margin required Yes

Nifty Current spot price 9100
Buy 1 deep ITM call of strike price (Rs) 8900
Sell 1 ITM call of strike price (Rs) 9000
Buy 1 deep OTM call of strike price (Rs) 9300

Lot size 75
Net premium paid 60
Suppose Nifty is trading at 9100. An investor Mr. A estimates that Nifty will not rise or fall
much by expiration, so he enters a Long Call Condor and buys 8900 call strike price at
Rs.240, sells 9000 strike price of Rs.150, sells 9200 strike price for Rs 40 and buys 9300 call
for Rs.10. The net premium paid to initiate this trade is Rs.60, which is also the maximum
possible loss. This strategy is initiated with a neutral view on Nifty hence it will give the
maximum profit only when there is little or no movement in the underlying security.
Maximum profit from the above example would be Rs.3000 (40*75). The maximum profit
would only occur when underlying assets expires in the range of strikes sold.
In the mentioned scenario, maximum loss would be limited up to Rs.4500 (60*75) and it will
occur if the underlying assets goes below 8960 or above 9240 strikes at expiration. If the
underlying assets expires at the lowest strike then all the options will expire worthless, and
the debit paid to initiate the position would be lost. If the underlying assets expire at highest
strike, all the options below the highest strike would be In-the-Money. Furthermore, the
resulting profit and loss would offset and net premium paid would be lost.
For the ease of understanding of the payoff schedule, we did not take in to account
commission charges. Following is the payoff schedule assuming different scenarios of expiry.

On Expiry Net Payoff from 1 Net Payoff from Net Payoff from Net Payoff from 1 Net
NIFTY Deep ITM Call 1 ITM Call sold 1 OTM Call sold deep OTM call Payoff
closes at bought (Rs) 8900 (Rs) 9000 (Rs) 9200 bought (Rs) 9300 (Rs)
8600 -240 150 40 -10 -60
8700 -240 150 40 -10 -60
8800 -240 150 40 -10 -60
8900 -240 150 40 -10 -60
8960 -180 150 40 -10 0
9000 -140 150 40 -10 40
9100 -40 50 40 -10 40
9200 60 -50 40 -10 40
9240 100 -90 0 -10 0
9300 160 -150 -60 -10 -60

9400 260 -250 -160 90 -60
9500 360 -350 -260 190 -60
9600 460 -450 -360 290 -60
The Payoff Graph:
Delta: If the underlying asset remains between the lowest and highest strike price the net
Delta of a Long Call Condor spread remains close to zero.
Vega: Long Call Condor has a negative Vega. Therefore, one should initiate Long Call
Condor spread when the volatility is high and expect to decline.
Theta: A Long Call Condor has a net positive Theta, which means strategy will benefit from
the erosion of time value.
Gamma: The Gamma of a Long Call Condor strategy goes to lowest values if it stays
between sold strikes, and goes higher if it moves away from middle strikes.
Analysis of Long Call Condor spread strategy
A Long Call Condor spread is best to use when you are confident that an underlying security
will not move significantly and stays in a range of strikes sold. Long Call Condor has a wider
sweet spot than the Long Call Butterfly. But there is a tradeoff; this is a limited reward to risk
ratio strategy for advance traders.
Long Call Calendar Spread

A Long Call Calendar Spread is initiated by selling one call option and simultaneously
buying a second call option of the same strike price of underlying assets with a different
expiry. It is also known as Time Spread or Horizontal Spread. The purpose of this strategy is
to gain from Theta with limited risk, as the Time Decay of the near period expiry will be
faster as compared to the far period expiry. As the near period option expires, far month call
option would still have some premium in it, so the option trader can either own the far period
call or square off both the positions at same time on near period expiry.
When to initiate a Long Call Calendar Spread?
A Long Call Calendar Spread can be initiated when you are very confident that the security
will remain neutral or bearish in near period and bullish in longer period expiry. This strategy
can also be used by advanced traders to make quick returns when the near period implied
volatility goes abnormally high as compared to the far period expiry and is expected to cool
down. After buying a Long Calendar Spread, the idea is to wait for the implied volatility of
near period expiry to drop. Inversely, this strategy can lead to losses in case the implied
volatility of near period expiry contract rises even if the stock price remains at same level.
How to construct a Long Call Calendar Spread?
A Long Call Calendar Spread is implemented by selling near month at-the-money/out-the-

money call option and simultaneously buying far month at-the-money/out-the-money call
option of the same underlying assets.
Strategy Buy far month ATM/OTM call and sell near month ATM/OTM call.
Market
Neutral to positive movement.
Outlook
Motive Hopes to reduce the cost of buying far month call option.
Risk Limited to the difference between the premiums.
Limited if both the positions squared off at near period expiry. Unlimited if far period
Reward
call option hold till next expiry.
Margin
Yes
required
Sell near month ATM call strike price Rs. 9000
Premium received (per share) Rs. 180
Buy far month ATM call strike price Rs. 9000
Premium paid (per share) Rs. 250
Suppose Nifty is trading at 8800. An investor, Mr. A is expecting no significant movement in

near month contract, so he enters a Long Call Calendar Spread by selling near month strike
price of 9000 call at Rs.180 and bought 9000 call for Rs.250. The net upfront premium paid
to initiate this trade is Rs.70, which is also the maximum possible loss. The idea is to wait for
near month call option to expire worthless by squaring off both the positions in near month
expiry contract or reduce the cost of far month buy call by setting off the profit made from
the near month call option. Another way by which this strategy can be profitable is when the
implied volatility of the near month falls.
the payoff chart of the expiry.
The Payoff Schedule on near period expiry date:
Near period expiry if Net Payoff from near Theoretical Payoff from far Net Payoff at near
NIFTY closes at period Call sold (Rs.) period call Buy (Rs.) period expiry (Rs.)
8700 180 -190 -10
8800 180 -160 20
8900 180 -120 60
9000 180 -70 110
9100 80 -10 70
9200 -20 +60 40

9300 -120 140 20
9400 -220 230 10
9500 -320 330 10
Following is the payoff schedule till far expiry, where maximum loss would be limited up to
320 Rs (250+70), Rs.70 is from near expiry and Rs.250 is the premium of far month call
bought. Maximum profit would be unlimited since far month call bought will have unlimited
upside potential.
Net Combined Payoff Schedule on next period expiry date:

NIFTY closing price on
Theoretical Payoff from far Net Payoff at near Net Payoff at Far
Near and Far period
period call Buy (Rs.) period expiry (Rs.) period expiry (Rs.)
expiry
8700 -250 -10 -260
8800 -250 20 -230
8900 -250 60 -190
9000 -250 110 -140
9100 -150 70 -80
9200 -50 40 -10
9300 50 20 70
9400 150 10 160
9500 250 10 260

The Payoff Graph
Impact of option Greeks:
Delta: The net Delta of a Long Call Calendar will be close to zero or marginally positive.
The negative Delta of the near month short call option will be offset by positive Delta of the
far month long call option.
Vega: A Long Call Calendar has a positive Vega. Therefore, one should buy spreads when
the volatility of far period expiry contract is expected to rise.
Theta: With the passage of time, if other factors remain same, Theta will have a positive
impact on the Long Call Calendar Spread in near period contract, because option premium
will erode as the near period expiration dates draws nearer.
Gamma: Gamma estimates how much the Delta of a position changes as the stock prices
changes. The near month option has a higher Gamma. Gamma of the Long Call Calendar
Spread position will be negative till near period expiry, as we are short on near period options
and any major upside movement till near period expiry will affect the profitability of the
spreads.
How to manage risk?
A Long Call Calendar spread is exposed to limited risk up to the difference between the
premiums, so carrying overnight position is advisable but one can keep stop loss on the
underlying assets to further limit losses.
Analysis of Long Call Calendar Spread strategy
A Long Call Calendar Spread is the combination of short call and long call option with
different expiry. It mainly profits from Theta i.e. Time Decay factor of near period expiry, if
the price of the security remains relatively stable in near period. Once the near period option
has expired, the strategy becomes simply long call, whose profit potential is unlimited.
5paisa.com
Volatility Option Strategies | 5paisa

70-88 minutes
Volatility Option Strategies
Volatility Option Strategies are made use by traders when they expect huge swing in the price
of the underlying asset in either direction. The trader tends to bet on the surge in volatility
rather than the trend. Following are the most popular strategies that can be used when the
volatility is expected to spike in the underlying asset.
 Long Strangle Strategy

 Long straddle Strategy
 Short Put Ladder Strategy
 Short Call Ladder Strategy
 Long Iron Butterfly Strategy
 Short Call Condor Strategy
 Short Call Butterfly Strategy
How to make Profit in a Volatile Market at low cost -

Long Strangle Option Strategy
A Long Strangle strategy is one of the simplest trading strategies, which can be used to make
profit in an extremely volatile market. A Long Strangle is a slight modification of the Long
Straddle strategy and also cheaper to execute as both the calls and puts are Out-the-Money. It
can generate good returns when the price of an underlying security moves significantly in
either direction. It means that you don’t have to forecast the trend of the market, but you have
to bet on the volatility.
When to initiate a Long Strangle?
If you believe that an underlying security is going to make a move because of any events,
such as budget, monetary policy, earning announcements etc, then you can buy OTM call and
OTM put option. This strategy is known as Long Strangle.
How to construct a Long Strangle Option strategy?
Long Strangle is implemented by buying Out-the-Money call option and simultaneously

buying Out-the-Money put option of the same underlying security with the same expiry.
Strike price can be customized as per convenience of the trader but the call and put strikes
must be equidistant from the spot price.
Strategy Buy OTM Call and Buy OTM Put
Market Outlook Significant volatility in underlying movement
Motive Capture a quick increase in implied volatility/ big move in underlying assets
Upper Breakeven Strike price of Long call + Net Premium Paid
Lower Breakeven Strike price of Long put - Net Premium Paid
Reward Unlimited
Margin required Limited to the premium paid
Let's try to understand with an example:

Nifty Current spot price Rs 8800
Buy OTM Call Strike Price Rs 9000
BUY OTM Put Strike price Rs 8600
Lot Size 75
Suppose, Nifty is trading at 8800. An investor Mr A is expecting a significant movement in
the market, so he enters a Long Strangle by buying 9000 call strike at Rs 40 and 8600 put for
Rs 30. The net premium paid to initiate this trade is Rs 70, which is also the maximum
possible loss. Since this strategy is initiated with a view of significant movement in the
underlying security, it will give the maximum loss only when there is very little or no
movement in the underlying security, which comes around Rs 70 in the above example.
Maximum profit will be unlimited if it breaks the upper and lower break-even points.
Another way by which this strategy can give profit is when there is an increase in implied
volatility. Higher implied volatility can increase both call and put’s premium.

at (Rs) (Rs) (Rs)
8300 -40 270 230
8400 -40 170 130
8500 -40 70 30
8530 -40 40 0
8600 -40 -30 -70
8700 -40 -30 -70
8800 -40 -30 -70
8900 -40 -30 -70
9000 -40 -30 -70
9070 30 -30 0
9100 60 -30 30
9200 160 -30 130
9300 260 -30 230

Impact of Option Greeks:
Delta: The net delta of a Long Strangle remains close to zero. The positive delta of the call
and negative delta of the put are nearly offset by each other.
Vega: A Long Strangle has a positive Vega. Therefore, one should buy Long Strangle spreads
when the volatility is low and expect it to rise.
Theta: With the passage of time, if other factors remain same, Theta will have a negative
nearer.
Gamma: Gamma estimates how much Delta of a position changes as the stock prices
changes. Gamma of the Long Strangle position will be positive since we have created long
positions in options and any major movement on either side will benefit this strategy.
How to manage risk?
A Long Strangle is exposed to limited risk up to premium paid, so carrying overnight position
is advisable but one can keep stop loss to further limit losses.
Analysis of Long Strangle spread strategy
A Long Strangle spread strategy is best to use when you are confident that an underlying
security will move significantly in a very short period of time, but you are unable to predict
the direction of the movement. Maximum loss is limited to debit paid and it will occur if the
underlying stocks remain between the two buying strike prices, whereas upside reward is
unlimited.
How Long Straddle Option Trading Strategy can be used

for making profits in a volatile market?
A Long Straddle Options Trading is one of the simplest options trading strategy which
involves a combination of buying a call and buying a put, both with the same strike price and
expiration. Long Straddle option strategy can be used to make profit in a volatile market. It
can generate good returns when the price of an underlying security moves significantly in
either direction. It means that you don’t have to forecast the trend of the market, but you have
to bet on the volatility.
When should you initiate a Long Straddle Option Trading?
If you believe that an underlying security is going to make a move because of events such as
budget, monetary policy, earning announcements, etc., and also implied volatility should be
at normal or at below average level, then you can buy call & put option. This strategy is
known as long straddle trading.
How should you construct a Long Straddle Option Strategy?
Long straddle options strategy is implemented by buying at-the-money call option and
simultaneously buying at-the-money put option of the same underlying security with the
same expiry.
Strategy Buy ATM Call and Buy ATM Put
Market Outlook Significant volatility in underlying movement
Upper Breakeven Strike price of buy call + Net Premium Paid
Lower Breakeven Strike price of long put - Net Premium Paid
Reward Unlimited
Margin required No
Let’s try to understand this with an example:
Nifty Current spot price Buy ITM/ATM Call+ Sell OTM Call
Buy ATM Call & Put (Strike Price) Rs. 8800
Premium Paid (per share) Call Rs. 80
Premium Paid (per share) Put Rs. 90
Upper breakeven Rs. 8970
Lower breakeven Rs. 8630
Lot Size (in units) 75
Suppose, Nifty is trading at 8800. An investor, Mr. A is expecting a significant movement in

the market, so he enters a long straddle by buying a FEB 8800 call strike at Rs. 80 and FEB
8800 put for Rs. 90. The net premium paid to initiate this trade is Rs. 170, which is also the
maximum possible loss. Since this strategy is initiated with a view of significant movement
in the underlying security, it will give the maximum loss only when there is no movement in
the underlying security, which comes around Rs. 170 in the above example. The maximum
profit will be unlimited if it breaks the upper and lower break-even points. Another way by
which this options trading strategy can give profit is when there is an increase in implied
volatility. Higher implied volatility can increase both call and put’s premium.
the payoff schedule assuming different scenarios of expiry.
at (Rs) (Rs) (Rs)
8300 -40 270 230
8400 -40 170 130
8500 -40 70 30
8530 -40 40 0
8600 -40 -30 -70
8700 -40 -30 -70
8800 -40 -30 -70
8900 -40 -30 -70
9000 -40 -30 -70
9070 30 -30 0
9100 60 -30 30
9200 160 -30 130
9300 260 -30 230
Analysis of Long Straddle Options Trading Spread Strategy
A Long Straddle Spread Strategy is best to use when you are confident that an underlying
security will move significantly in a very short period of time, but you are unable to predict
the direction of the movement. Downside loss is also limited to net debit paid, whereas
upside reward is unlimited.
Short Put Ladder Strategy Explained

Short Put Ladder Strategy
A Short Put Ladder is the extension of Bull Put spread; the only difference is of an additional
lower strike bought. The purpose of buying the additional strike is to get unlimited reward if
the underlying asset goes down.
When to initiate a Short Put Ladder
A Short Put Ladder should be initiated when you are expecting big movement in the
underlying asset, favoring downside movement. Profit potential will be unlimited when the
stock breaks lower strike price. Also, another opportunity is when the implied volatility of the
underlying asset falls unexpectedly and you expect volatility to go up then you can apply
Short Put Ladder strategy.
How to construct Short Put Ladder?
A Short Put Ladder can be created by selling 1 ITM Put, buying 1 ATM Put and buying 1
OTM Put of the same underlying asset with the same expiry. Strike price can be customized
as per the convenience of the trader. A trader can also initiate the Short Put Ladder strategy in
the following way - Sell 1 ATM Put, Buy 1 OTM Put and Buy 1 Far OTM Put.
Strategy Sell 1 ITM Put, Buy 1 ATM Put and Buy 1 OTM Put
Market
Significant movement (lower side)
Outlook
Upper
Strike price of Short Put - Net Premium Received
Breakeven
Lower
Addition of two Long Put strikes - Strike Price of Short Put + Net Premium Received
Breakeven
Risk Limited (expiry between upper and lower breakeven).
Limited to premium received if stock surges above higher breakeven Unlimited if

Reward
stock falls below lower breakeven.
Margin
Yes
required

Sell 1 ITM Put of strike price (Rs) 9500
Buy 1 ATM Put of strike price (Rs) 9400

Lot Size 75
Suppose Nifty is trading at 9400. An investor Mr. A is expecting a significant movement in

the Nifty with a slightly more bearish view, so he enters a Short Put Ladder by selling 9500
Put strike price at Rs 180, buying 9400 strike price at Rs 105 and buying 9300 Put for Rs 45.
The net premium received to initiate this trade is Rs 30. Maximum loss from the above
example would be Rs 5250 (70*75). It would only occur when the underlying asset expires in
the range of strikes bought. Maximum profit would be unlimited if it breaks lower breakeven
point. However, profit would be limited up to Rs 2250(30*75) if it moves above the higher
breakeven point.
The Payoff chart:

Net
On Expiry Payoff from 1 ITM Payoff from 1 ATM Puts Payoff from 1 OTM Put
Payoff
NIFTY closes at Put sold (9500) (Rs) Bought (9400) (Rs) Bought (9300) (Rs)
(Rs)
8700 -620 595 555 530
8800 -520 495 455 430

8900 -420 395 355 330
9000 -320 295 255 230
9100 -220 195 155 130
9200 -120 95 55 30
9230 -90 65 25 0
9300 -20 -5 -45 -70
9400 80 -105 -45 -70
9470 150 -105 -45 0
9500 180 -105 -45 30
9600 180 -105 -45 30
9700 180 -105 -45 30
9800 180 -105 -45 30
Delta: At the initiation of trade, Delta of the Short Put Ladder will be negative, indicating of a
decent profit potential if the underlying asset moves lower.
Vega: Short Put Ladder has a positive Vega. Therefore, one should initiate Short Put Ladder
spread when the volatility is low and expects it to rise.
Theta: A Short Put Ladder has negative Theta position and therefore it will lose value due to
time decay as the expiration approaches.
Gamma: This strategy will have a long Gamma position, which indicates any significant
downside movement, will lead to unlimited profit.
How to manage Risk?
A Short Put Ladder is exposed to limited loss; hence it is advisable to carry overnight
positions.
Analysis of Short Put Ladder Strategy:
A Short Put Ladder is best to use when you are confident that an underlying security will
move significantly lower. Another scenario wherein this strategy can give profit is when there
is a surge in implied volatility. It is a limited risk and an unlimited reward strategy only if
movement comes on the lower side or else reward would also be limited.
Short Call Ladder Options Strategy

A Short Call Ladder is the extension of Bear Call spread; the only difference is of an
additional higher strike bought. The purpose of buying the additional strike is to get unlimited
reward if the underlying asset moves up.
When to initiate a Short Call Ladder?
A Short Call Ladder spread should be initiated when you are expecting big movement in the
underlying assets, favoring upside movement. Profit potential will be unlimited when the
stock breaks highest strike price. Also, another opportunity is when the implied volatility of
the underlying assets falls unexpectedly and you expect volatility to go up then you can apply
Short Call Ladder strategy.
How to construct a Short Call Ladder
A Short Call Ladder can be created by selling 1 ITM call, buying 1 ATM call and buying 1
OTM call of the same underlying asset with the same expiry. Strike price can be customized
as per the convenience of the trader. A trader can also initiate the Short Call Ladder strategy
in the following way - Sell 1 ATM Call, Buy 1 OTM Call and Buy 1 Far OTM Call.
Strategy Sell 1 ITM Call, Buy 1 ATM Call and Buy 1 OTM Call
Market
Significant moment (higher side)
Outlook
Upper Higher Long call strike price + Strike difference between short call and lower long
Breakeven call - Net premium received
Lower
Strike price of Short call + Net Premium Received
Breakeven
Risk Limited (expiry between upper and lower breakeven).
Limited to premium received if stock falls below lower breakeven. Unlimited if

Reward
stock surges above higher breakeven.
Margin
Yes
required

Buy 1 ATM call of strike price (Rs) 9100

Lot Size 75
Suppose Nifty is trading at 9100. An investor Mr. A is expecting a significant movement in

the Nifty with slightly more bullish view, so he enters a Short Call Ladder by selling 9000
call strike price at Rs 180, buying 9100 strike price at Rs 105 and buying 9200 call for Rs 45.
The net premium received to initiate this trade is Rs 30. Maximum loss from the above
example would be Rs 5250 (70*75). It would only occur when the underlying assets expires
in the range of strikes bought. Maximum profit would be unlimited if it breaks higher
breakeven point. However, profit would be limited up to Rs 2250(30*75) if it drops below
the lower breakeven point.
The Payoff chart:

Net
On Expiry Payoff from 1 ITM Payoff from 1 ATM Calls Payoff from 1 OTM Call
Payoff
NIFTY closes at Call sold (9000) (Rs) Bought (9100) (Rs) Bought (9200) (Rs)
(Rs)
8600 180 -105 -45 30
8700 180 -105 -45 30
8800 180 -105 -45 30
8900 180 -105 -45 30

9000 180 -105 -45 30
9030 180 -105 -45 0
9100 80 -105 -45 70
9200 -20 -5 -45 -70
9270 -90 65 25 0
9300 -120 95 55 30
9400 -220 195 155 130
9500 -320 295 255 230
9600 -420 395 355 330
9700 -520 495 455 430
9800 -620 595 555 530
Delta: At the initiation of the trade, Delta of short call condor will be negative and it will turn
positive when the underlying asset moves higher.
Vega: Short Call Ladder has a positive Vega. Therefore, one should initiate Short Call Ladder
spread when the volatility is low and expects it to rise.
Theta: A Short Call Ladder has negative Theta position and therefore it will lose value due to
time decay as the expiration approaches.
Gamma: This strategy will have a long Gamma position, which indicates any significant
upside movement, will lead to unlimited profit.
How to manage Risk?
A Short Call Ladder is exposed to limited loss; hence it is advisable to carry overnight
positions. However, one can keep stop Loss in order to restrict losses.
Analysis of Short Call Ladder Options strategy:
A Short Call Ladder spread is best to use when you are confident that an underlying security
will move significantly. Another scenario wherein this strategy can give profit is when there
is a surge in implied volatility. It is a limited risk and an unlimited reward strategy if
movement comes on the higher side.
Long Iron Butterfly Options Strategy

A Long Iron Butterfly is implemented when an investor is expecting volatility in the
underlying assets. This strategy is initiated to capture the movement outside the wings of
options at expiration. It is a limited risk and a limited reward strategy. A Long Iron Butterfly
could also be considered as a combination of bull call spread and bear put spread.
When to initiate a Long Iron Butterfly
A Long Iron Butterfly spread is best to use when you expect the underlying assets to move
sharply higher or lower but you are uncertain about direction. Also, when the implied
volatility of the underlying assets falls unexpectedly and you expect volatility to shoot up,
then you can apply Long Iron Butterfly strategy.
How to construct a Long Iron Butterfly?
A Long Iron Butterfly can be created by buying 1 ATM call, Selling 1 OTM call, buying 1
ATM put and selling 1 OTM put of the same underlying security with the same expiry. Strike
price can be customized as per the convenience of the trader; however, the upper and lower
strike must be equidistant from the middle strike.
Strategy Buy 1 ATM Call, Sell 1 OTM Call, Buy 1 ATM Put and Sell 1 OTM Put
Market Outlook Movement above the highest or lowest strike
Motive Profit from movement in either direction
Upper Breakeven Long Option (Middle) Strike price + Net Premium Paid
Lower Breakeven Long Option (Middle) Strike price - Net Premium Paid
Risk Limited to Net Premium Paid
Reward Higher strike-middle strike-net premium paid
Margin required Yes

Buy 1 ATM put of strike price (Rs) 9200
Sell 1 OTM put of strike price (Rs) 9100

Lot Size 75
Suppose Nifty is trading at 9200. An investor Mr A thinks that Nifty will move drastically in
either direction, below lower strike or above higher strike by expiration. So he enters a Long
Iron Butterfly by buying a 9200 call strike price at Rs 70 , selling 9300 call for Rs 30 and
simultaneously buying 9200 put for Rs 105, selling 9100 put for Rs 65. The net premium paid
to initiate this trade is Rs 80, which is also the maximum possible loss.
This strategy is initiated with a view of movement in the underlying security outside the
wings of higher and lower strike price in Nifty. Maximum profit from the above example
would be Rs 1500 (20*75). Maximum loss will also be limited up to Rs 6000 (80*75).
For the ease of understanding of the payoff, we did not take in to account commission
charges. Following is the payoff chart and payoff schedule assuming different scenarios of
expiry.
The Payoff chart:

On Expiry Net Payoff from 1 Net Payoff from Net Payoff from 1 Net Payoff from Net
NIFTY ITM Call Bought 1 OTM Call Sold ATM Put bought 1 OTM Put sold Payoff
closes at (Rs) 9200 (Rs) 9300 (Rs) 9200 (Rs.) 9100 (Rs)
8800 -70 30 295 -235 20
8900 -70 30 195 -135 20
9000 -70 30 95 -35 20
9100 -70 30 -5 65 20
9120 -70 30 -25 65 0

9200 -70 30 -105 65 -80
9280 10 30 -105 65 0
9300 30 30 -105 65 20
9400 130 -70 -105 65 20
9500 230 -170 -105 65 20
9600 330 -270 -105 65 20
Delta: The net Delta of a Long Iron Butterfly spread remains close to zero if underlying
assets remain at middle strike. Delta will move towards 1 if underlying expires above higher
strike price and Delta will move towards -1 if underlying expires below the lower strike price.
Vega: Long Iron Butterfly has a positive Vega. Therefore, one should buy Long Iron
Butterfly spread when the volatility is low and expect to rise.
Theta: With the passage of time, if other factors remain same, Theta will have a negative
impact on the strategy.
Gamma: This strategy will have a long Gamma position, so the change in underline assets
will have a positive impact on the strategy.
How to manage Risk?
A Long Iron Butterfly is exposed to limited risk but risk involved is higher than the net
reward from the strategy, one can keep stop loss to further limit the losses.
Analysis of Long Iron Butterfly strategy:
A Long Iron Butterfly spread is best to use when you are confident that an underlying
security will move significantly. Another way by which this strategy can give profit is when
there is an increase in implied volatility. However, this strategy should be used by advanced
traders as the risk to reward ratio is high.
Short Call Condor Options Trading Strategy

A Short Call Condor is similar to Short Butterfly strategy. The only exception is that the
difference of two middle strikes bought has different strikes.
When to initiate a Short call condor?
A Short Call Condor is implemented when the investor is expecting movement outside the
range of the highest and lowest strike price of the underlying assets. Advance traders can also
implement this strategy when the implied volatility of the underlying assets is low and you
expect volatility to go up.
How to construct a Short Call Condor?
A Short Call Condor can be created by selling 1 lower ITM call, buying 1 lower middle ITM
call, buying 1 higher middle OTM call and selling 1 higher OTM calls of the same
underlying security with the same expiry. The ITM and OTM call strikes should be
equidistant.
Strategy Sell 1 ITM Call, Buy 1 ITM Call, Buy 1 OTM Call and Sell 1 OTM Call
Market Outlook Significant volatility above higher and lower strikes
Motive Anticipating price movement in the underlying assets
Upper Breakeven Highest strike price - Net credit
Lower Breakeven Lowest strike price + Net credit
Risk Limited (if expires above lower breakeven point and vice versa)
Reward Limited to Net premium received
Margin required Yes

Lot Size 75
Net premium received 60
Suppose Nifty is trading at 9100. An investor Mr. A estimates that Nifty will move
significantly by expiration, so he enters a Short Call Condor and sells 8900 call strike price at
Rs 240, buys 9000 strike price of Rs 150, buys 9200 strike price for Rs 40 and sells 9300 call
for Rs 10. The net premium received to initiate this trade is Rs 60, which is also the
maximum possible reward. This strategy is initiated with a view of significant volatility on
Nifty hence it will give the maximum profit only when there is movement in the underlying
security below 8900 or above 9200. Maximum profit from the above example would be Rs
4500 (60*75). The maximum profit would only occur when underlying assets expires outside
the range of upper and lower breakevens. Maximum loss would also be limited to Rs 3000
(40*75), if it stays in the range of higher and lower breakeven.
For the ease of understanding of the payoff schedule, we did not take in to account
commission charges. Following is the payoff schedule assuming different scenarios of expiry.

On Expiry Net Payoff from 1 Net Payoff from 1 Net Payoff from 1 Net Payoff from 1 Net
NIFTY Deep ITM Call ITM Calls Bought OTM Call bought deep OTM Call Payoff
closes at Sold (Rs) 8900 (Rs) 9000 (Rs) 9200 sold (Rs.) 9300 (Rs)
8600 240 -150 -40 10 60
8700 240 -150 -40 10 60
8800 240 -150 -40 10 60
8900 240 -150 -40 10 60
8960 180 -150 -40 10 0
9000 140 -150 -40 10 -40
9100 40 -50 -40 10 -40
9200 -60 -50 -40 10 -40
9240 -100 90 0 10 0
9300 -160 150 60 10 60
9400 -260 250 160 -90 60
9500 -360 350 260 -190 60
9600 -460 450 360 -290 60

The Payoff Graph:
Delta: If the underlying asset remains between the lowest and highest strike price the net
Delta of a Short Call Condor spread remains close to zero.
Vega: Short Call Condor has a positive Vega. Therefore, one should buy Short Call Condor
spread when the volatility is low and expect to rise.
Theta: Theta will have a negative impact on the strategy, because option premium will erode
as the expiration dates draws nearer.
Gamma: The Gamma of a Short Call Condor strategy goes to lowest if it moves above the
highest or below the lowest strike.
Analysis of Short Call Condor spread strategy
A Short Call Condor spread is best to use when you are confident that an underlying security
will move outside the range of lowest and highest strikes. Unlike straddle and strangles
strategies risk involved in short call condor is limited.
Short Call Butterfly Option Trading Strategy

A Short Call Butterfly is implemented when an investor is expecting volatility in the
underlying assets. This strategy is initiated to capture the movement outside the wings of the
options at expiration. It is a limited risk and a limited reward strategy.
When to initiate a Short Call Butterfly?
Short Call Butterfly can generate returns when the price of an underlying security moves
moderately in either direction. It means that you don’t have to forecast the trend of the
market, but you have to bet on volatility. When the implied volatility of the underlying assets
is low and you expect volatility to shoot up, then you can apply Short Butterfly Strategy.
How to construct a Short Call Butterfly?
A Short Call Butterfly can be created by selling 1 ITM call, buying 2 ATM call and selling 1
OTM call of the same underlying security with the same expiry, giving the trader a net credit
to enter the position. Strike price can be customized as per convenience of the trader but the
upper and lower strikes must be equidistant from the middle strike.
Strategy Sell 1 ITM Call, Buy 2 ATM Call and Sell 1 OTM Call
Market Outlook Movement on or above the sold strike price & Bullish on volatility
Attempt to correctly predict the movement in underlying assets in either

Motive
direction
Upper
Higher Strike price of short call Net Premium Received
Breakeven
Lower
Lower Strike price of short call + Net Premium Received
Breakeven
Risk Limited (Maximum loss only if expires at middle strike)
Reward Limited to Net premium received
Margin required Yes


Premium paid (Rs) 300(150*2)
Lot Size 75
Net premium received (Rs) 15
Suppose Nifty is trading at 8800. An investor Mr A enters a Short Call Butterfly by selling
8700 call strike price at Rs 210 and 8900 call for Rs 105 and simultaneously bought 2 ATM
call strike price of 8800 150 each. The net premium received to initiate this trade is Rs 15,
which is also the maximum possible reward. This strategy is initiated with a view of
moderate movement in Nifty hence it will give the maximum profit only when there is
movement in the underlying security either below lower sold strike or above upper sold
strike. Maximum loss from the above example would be Rs 6375 (85*75) if it expires at
middle strike. The maximum profit would only occur when underlying assets expires below
8700 or above 8900 i.e. Rs 1125 (15*75). Another way by which this strategy can give profit
is when there is an increase in an implied volatility. For the ease of understanding, we did not
take in to account commission charges. Following is the payoff chart and payoff schedule
assuming different scenarios of expiry.
The Payoff Chart:

On Expiry Net Payoff from 1 ITM Net Payoff from 2 Net Payoff from 1 OTM Net Payoff
NIFTY closes at Call Bought (Rs.) ATM Calls Sold (Rs.) Call Bought (Rs.) (Rs.)
8200 210 -300 105 15
8300 210 -300 105 15
8400 210 -300 105 15
8500 210 -300 105 15
8600 210 -300 105 15
8700 210 -300 105 15
8715 195 -300 105 0
8800 110 -300 105 -85
8885 25 -130 105 0
8900 10 -100 105 15
9000 -90 100 5 15
9100 -190 300 -95 15

9200 -290 500 -195 15
9300 -390 700 -295 15
9400 -490 900 -395 15
Delta: The net delta of a Short Call Butterfly spread remains close to zero.
Vega: The Short Call Butterfly has a positive Vega. Therefore, one should buy Short Call
Butterfly spread when the volatility is low and expect to rise.
Theta: With the passage of time, if other factors remain same, “Theta” will have a negative
nearer.
Gamma: The Short Call Butterfly will have a short gamma when it is initiated.
How to manage risk?
A Short Call Butterfly requires experience in trading, because as expiration approaches small
movement in underlying stock price can have a higher impact on the price of a Short Call
Butterfly spread. Therefore, one should always follow strict stop loss in order to restrict
losses.
Analysis of Short Call Butterfly spread strategy
A Short Call Butterfly spread is best to use when you are confident that an underlying
security will move in either direction. This is a limited reward to risk ratio strategy for
advance traders.
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Futures Pricing Formula | 5paisa

10-12 minutes
How is the price of a stock determined in the futures market?
A futures contract is nothing more than a standardized forwards contract. The price of a
futures contract is determined by the spot price of the underlying asset, adjusted for time and
dividend accrued till the expiry of the contract.
When the futures contract is initially agreed to, the net present value must be equal for both
the buyer and the seller else there would be no consensus between the two.
This difference in price between the futures price and the spot price is called the “basis or
spread”.
The futures pricing formula is used to determine the price of the futures contract and it is the
main reason for the difference in price between the spot and the futures market. The spread
between the two is the maximum at the start of the series and tends to converge as the
settlement date approaches. The price of the futures contract and its underlying asset must
necessarily converge on the expiry date.
The spot future parity i.e. difference between the spot and futures price arises due to variables
such as interest rates, dividends, time to expiry, etc. It is a mathematical expression to equate
the underlying price and its corresponding futures price.
According to the futures pricing formula:
Futures price = (Spot Price*(1+rf))- Div)
Where,
Spot Price is the price of the stock in the cash market.
rf = Risk free rate (T Bill/ Government securities)
d – Dividend paid by the company
A key point to take note of is ‘r’ is the risk free interest that we can earn for the entire year
but since the future contracts expires in 1, 2 or 3 months, we require to adjust the formula
proportionately.
Futures price = Spot price * [1+ rf*(x/365) – d]
x = number of days to expiry
One can take the RBI’s 91 or 182 days Treasury bill as a proxy for the short term risk free
rate. The ongoing rate can be referred from RBI’s website. The prevailing rate in the market
for 91 and 182 day t bill is ~6.68% and ~6.92% respectively.
Fair Value vs. Futures Price
Sometimes we observe that there is a difference in price between the value calculated through
the futures pricing formula (fair value) and value trade in the market (futures price). The
futures price may be different from the fair value due to the short term influences of supply
and demand for the futures contract. A large deviation between the two could result in an
arbitrage opportunity assuming that the futures price will eventually revert back to the fair
value.
Let us consider a practical example to understand the concept better.
We will calculate the futures price of ITC through the pricing formula and compare it with
the current futures price in the market.
The spot price of ITC is 302.55 as of 9/8/2018
The stock has not declared any dividend in the current August series.
August series expiry is on 30th i.e last Thursday of the month.
There are 22 days for expiry 30-9 (taking both the days into consideration)
What should ITC’s current month futures contract be priced at?
Futures price = 302.55* [1+6.68 %( 22/365)] – 0
Futures price =303.7
Solving the above equation, we obtain the futures price of 303.7, which is called its fair
value. However, the actual price in the market, of ITC Aug Futures is 303.5, which is called
its market price.
The price difference between the fair value and prevailing market price occurs due to supply
/demand, liquidity as well as factors such as transaction charges, taxes and margins. But on
most occasions, the theoretical future price would match the market price.
Similarly, we could determine the future price for the mid month and far month contracts.
Mid month calculation (September series)
Spot Price =302.65
Div =0
Days to expiry =22+28 (22 days of Aug series +28 days of Sep series)
Futures Price = 302.65 * [1+ 6.68%( 50/365)] – 0
= 305.4
Far month calculation (October series)
Spot Price =302.65
Div =0
Days to expiry =22+28 +28 (22 days of Aug series +28 days of Sep series+28 days of
October Series)
Futures price = 302.65 * [1+ 6.68%( 78/365)] – 0>
= 307.04
There is a difference of Rs. 2.66 between the fair value and the market price. This is due to
the low liquidity that is present. There are hardly any contracts of ITC October Futures which
are traded in the market, hence the premium.
Premium /Discount
If the price of the security is trading higher in the futures market vs. spot price (which is
usually the case) then the futures price is said to be at a premium. While it is said to be
trading at a discount if the futures price is less vs. the spot price. We will now see how a
trader can benefit if there is a major difference in the price of security in the cash and futures
market.
Arbitrage
An arbitrage is known as simultaneous buying and selling of securities, currency, or

commodities in different markets or in derivative forms in order to take advantage of
differing prices for the same asset.
Here we will see how arbitrage strategies can be made use of when there is a difference in
price between the spot market and the futures market.
It is considered a riskless strategy as the gains are locked right at the start and thereafter, it
does not matter in which direction the asset moves.
Consider a scenario where Infosys -
Spot = 1380
Rf – 6.68%
Days to expiry (x) = 22
div = 0
Having this information we calculate the future price using the mathematical formula as
earlier
Futures price = 1380*(1+6.68 %( 22/365)) – 0
= 1385.55
This is nearly the rate at which it is trading in the futures market at present
But what if Infosys Aug Futures is trading at 1410 drastically deviating from its theoretical
price.
According to the formula there should ideally be only a Rs5 difference between the spot and
future price. But if a huge gap is witnessed due to supply demand imbalances, an arbitrage
opportunity arises.
How can a trader benefit in such a scenario?
Clearly Infosys is trading above its fair value, and according the arbitrage strategy, we sell
the expensive asset and purchase the cheaper one. In this case, we will sell Infosys futures
and purchase the same quantity of shares in the cash market, knowing that by the end of the
series the price of the futures and spot will converge.
Sell Infosys Futures at 1410
Since the lot size of Infosys is 600 we purchase 600 shares of Infosys in the cash market at
1380.
Once we have executed the trade at the expected price you have locked in the spread. So
irrespective of where the market goes by expiry, profit is guaranteed. The strategy requires us
to square off our positions before expiry i.e. we would have to buy Infosys in the futures
market and sell the 600 shares in the cash market.
This arbitrage strategy between the spot and futures market is known as cash and carry
arbitrage.
Pay-off of cash and carry arbitrage
Expiry Value Spot Trade P&L (Long) Futures Trade P&L (Short) Net P&L
1390 1390 – 1380 = +10 1410 – 1390 = +20 +10 + 20 = +30
Similarly, if the stock is trading at discount in the futures market compared to its spot price,
we can implement the reverse cash and carry arbitrage strategy. In this strategy it is
required that the trader already has shares in his DP equal to or more than the lot size or its
multiple.
Here the trader purchases the future contract and sells the stock in the cash market. At the
time of expiry, a reverse trade has to be executed, as we had seen in the cash and carry
arbitrage.
Example: Price of Infosys in cash market 1380
Price of Infosys August Futures 1352.
Clearly, the stock is trading at a discount to its fair value, which has been calculated through
the mathematical formula and which had come up to 1385.
Hence, in order to take benefit of the situation, the trader sells 600 shares of Infosys (or
multiples of 600 lot size) in the cash market and purchase the proportionate quantity of
Infosys in futures market. In this strategy too, the spread is locked right at the start, and
hence, it does not matter at what price the stock ends on expiry.
Pay-off of reverse cash and carry arbitrage
Expiry Value Spot Trade P&L (Short) Futures Trade P&L (Long) Net P&L
1390 1380 – 1390 = -10 1390 – 1352 = +38 -10 + 38 = +28
Through these two examples we see how a trader can benefit if there is a price difference in
the spot and futures market.
5paisa.com
STT Trap : Present Scenario

7-9 minutes
STT Trap
STT Trap: Present Scenario
Trading in Futures & Options (F&O) without having a complete knowledge of the settlement
mechanism can be extremely risky.
Most newcomers, who trade options with a desire to make huge profits by buying cheap
options on the day of expiry make a common mistake and get caught in the STT trap. Thus,
these traders end up with huge losses, usually higher than the premium amount they paid at
the onset.
What is STT?
STT stands for security transaction tax.
This tax is levied on every purchase or sale of securities listed on the Indian stock exchanges.
This includes shares, derivatives, or equity-oriented mutual fund units.
P Chidambaram, then finance minister, had introduced this tax in the Union Budget for 2004-
05.
STT was introduced to curb tax evasion on capital gains. Prior to this, many traders refrained
from declaring their profits from the sale of securities and avoided paying capital gains tax.
STT in F&O Segment
New rate from

Sr. No. Taxable securities transaction Payable by
01.06.2016
(a) Sale of an option in securities 0.05% Seller
(b) Sale of an option in securities, where option is exercised 0.125% Purchaser
(c) Sale of a futures in securities 0.01% Seller
(Source: NSE)
Understanding the STT trap
Lots purchased 200 lots, Nifty 10800CE
Cost of purchasing 200CE options 1.2(Premium)*75*200 = Rs18,000
CMP of Nifty at 3PM 10,780
Price of Nifty at 3:30 PM on expiry 10,803
Profit Expected 3(Intrinsic value)*75(Nifty lot size)*200 = Rs45,000
Consider this situation: A trader purchases 200 lots of Nifty 10800CE option on the last day
of the expiry, when markets are trading at 10,780, expecting the market to give a close above
10,800.
Nifty, to the trader’s delight, does manage to give a close above 10,800 at 10,803. However,
the trader does not exercise his option and has it automatically exercised by the exchange in
order to save on brokerage charges. He is expecting to make a profit of Rs45,000, but, to his
horror, when he receives his contract note it shows a loss of Rs1,57,556.
The reason behind this loss was the exceptionally high STT charged by the exchange on in-
the-money (ITM) options that were not exercised by the trader before 3:30 pm on the expiry
day.
Why is it extremely important to square off your ITM options position rather than
letting it get automatically squared off?
On normal option trades that are squared off before 3:30 pm on the expiry day, STT is
charged at 0.05% on the selling side of the premium value. The trader does not pay STT on
option at the time of the purchase. A writer of an option pays STT at the time of writing the
option, while an option buyer pays STT at the time of squaring off his position.
In our trader’s case, if he had squared off his position, the STT he would pay would have
been:
STT= Selling premium*Lot Size*No of contracts *STT Rate
i.e., STT = 3*75*200*0.0005= Rs22.5, which is an insignificant amount.
The case stands true even when we trade in put options.
The problem arises when the trader lets his ITM option get automatically exercised. STT in
such a scenario is computed differently.
STT= Contract Value*0.125%
Where Contract Value = (Strike Price + Premium)*Lot Size
STT = (10800+3)*75*200*0.00125 = Rs2,02,556
Thus, instead of receiving a fair profit of Rs45,000, as he was expecting, the trader faces a
huge loss of Rs1,57,556 (2,02,556-45,000).
Options are automatically exercised if you continue to hold buy positions even after the
market closes on expiry day if they have some intrinsic value. In such cases, an additional
STT of 0.125% is charged instead of the normal levy of 0.05%.
In case the option is out-of-the-money or at-the-money, no STT is charged as the option
expires worthless. Hence, if a trader does not square of such positions, he does not have to
pay additional STT.
This problem is faced only by the options buyer, as the options writer (seller of the option)
has paid the STT right at the onset.
Why the additional STT?
If the trader does not exercise the ITM option contract on the expiry day, it is assumed he will
take delivery or provide delivery of the underlying security. The trader has the right to take
delivery of the underlying security in case he has purchased a call option or is ready to
provide delivery in case he has purchased a put option.
In the Indian markets, all equity derivative contracts are cash-settled, hence, there is no actual
physical delivery of the underlying. But according to the theoretical contract, since the trader
has asked for delivery, or agreed to provide delivery of the underlying security, STT is
charged as per delivery-based equity transaction, which was originally set at 0.125% (later
revised to 0.1% w.e.f 2013)
Hence, ITM options that are exercised are charged 0.125% STT.
Major changes brought about by the exchanges to fix this issue
Recently, stock exchanges came up with the facility of ‘Do not Exercise’ in equity options.
As per this facility, a file containing CTM (close to the money) contract details is made
available for download on the expiry day. The file contains all the CTM long positions in
both call and put options. The default exercise flag is set to ‘Y’ (Yes), and a file-upload
facility is provided to the members. Members have the option to change the default exercise
flag from ‘Y’ to ‘N’, indicating that they do not wish to exercise the position which was
being automatically exercised previously. A response file is then generated for each file
uploaded.
The CTM strikes range is arrived as under:
1. For Call Options: Three ITM options strikes immediately below the final settlement price
shall be considered as ‘CTM’
2. For Put Options: Three ITM options strikes immediately above the final settlement price
shall be considered as ‘CTM’
For e.g., If the market closes at 10,803 at the time of expiry, the following three strikes will
be considered ITM:
Call Option Put Option
10,800 10,850
10,750 10,900
10,700 10,950
All the remaining ITM option contracts that are not in the ‘CTM’ option series are exercised
automatically as per existing practice. Hence, if a trader purchases a 10600CE option and the
market closes at 10803 on expiry, the trader will be liable to pay the higher STT of 0.125% if
he lets his option get automatically exercised.
A member can upload the file specifying exercise instructions multiple times till the cut off
time. If the member does not provide any preference within the cut-off time, or if the
information provided by the member is incomplete or invalid, then as per existing procedure,
the option will be automatically exercised. Positions where exercise flag is indicated as ‘N’
by the cut-off time shall not be exercised.
File format and timelines is as follows:
Annexure Tentative
Sr. No. Particulars
Reference Timelines
File providing the details of CTM

(1) Annexure 1 4 pm
contracts
File providing the details of CTM

(2) Annexure 2 4:30 pm
Positions
File to be uploaded by member

(3) Annexure 3 4:30 pm-5 pm
for ‘Do not Exercise’ instruction
(4) Return file for ‘Do not Exercise’ instruction uploaded by member Annexure 4 4:30 pm-5 pm
(Source: NSE)
Trading members are required to provide ‘Do not Exercise’ instructions for their clients as
well as for proprietary positions. Trading-cum-clearing members are required to provide
exercise instructions for their Custodian Participant positions in addition to their clients and
proprietary positions. Professional Clearing Members are required to confirm for their
Custodian Participant positions only.
This functionality has been introduced for all weekly as well as monthly expiries with effect
from August 31, 2017.

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Introduction To Derivatives | 5paisa

Reasons to trade in derivatives market

 Transfer risk to the person who is willing to accept it

Participants in the derivative market

Risks Faced by Participants in Derivative market

Different Types Of Derivatives | 5paisa

 Speculate by taking a view on the market and buying or selling accordingly

 Participate in the market without trading or holding a large quantity of stock

Future and Option Products Available in Indian Markets

Future Contracts - Significance & Future

Scope of Futures in the Indian Market

Equity Derivatives Watch

Equity Derivatives Watch

Equity Derivatives Watch

Equity Derivatives Watch

Contract Size and Contract Value

Equity Derivatives Watch

Naked and Calendar Spread Positions

Convergence of Spot and Future Price

Benefits of trading in Index Futures compared to any

 The contracts are highly liquid

Pay-off for Buyer of Futures contract: Long Futures

Short Futures Pay Off

Drawbacks of Trading in Futures

Margins, Mark To Market & Settlements |

Symbol NIFTY 31-Aug-17

Mark to Market - Long Position

Beginning Funds Nifty Settlement Future Price Gain Ending

Net Profit/ Loss From the trade = (63250-59500) = Rs. 3750

Mark to Market - Short Position

Beginning Funds Nifty Settlement Future Price Gain Ending

Net Profit/Loss From the trade = (55,750- 59,500) = Rs. -3,750

Options In Derivatives | Types Of Options |

Lot size is the number of units of underlying asset in a contract.

Underlying Expiry Date Option Type Strike Price Option Premium

NIFTY 31 Aug 2017 Call 9900 50.10

NIFTY 31 Aug 2017 Put 9900 33.15

Important points for Delta:

Important points for Gamma:

 Gamma of Option is always positive.

Strike Price LTP of Calls

At the Money (ATM) Option

Out of the Money (OTM) Option

Difference between ITM, ATM and OTM

Scenario Analysis at various expiry levels:

Spot Closing at Expiry

Long Put Payoff

Scenario Analysis at various expiry levels:

Spot Closing at Expiry

Put Buy 9900 34 1 266 166 66 -34 -34 -34 -34

 Opening purchase – This is done with the purchasing intention of creating or

A Closing transaction is one that reduces or eliminates an existing position by an appropriate

 Closing purchase – This is done with the purchasing intention of reducing or

Long Premium paid Unlimited

Short Unlimited Premium received

Option Trading Strategies

Risk & Reward

Flexibility & Versatility

 Bullish Option Strategies

Bullish Option Strategies | 5paisa

 Long Call Strategy

Why to use the Long call

Strategy Buy/Long Call Option