Derivatives - Options 49 2.9.3. BULL CALL SPREAD: Meaning Buying one ITM Call and selling one OTM Call. Making profit only when the stock price /index goes up. If the stock falls to the lower strike, the investor makes Purpose maximum loss and if stock goes upwards to higher strike, the investor makes maximum profit. It limits the investor's upside & downside risk. | Investor View_| Moderately Bullish. Risk Limited to any initial premium paid in establishing the position, a Limited to the difference between the two strikes minus net premium cost Breakeven _| Strike Price of Purchased call + Net Premium Paid. Example 9: Current value of Stock of XYZ Ltd is Rs. 4100. Strike price is of call bought is Rs. 4000 — Premium is Rs. 170. Strike price of call sold is Rs. 4200 - Premium is Rs. 35. Show a pay-off schedule, when spot price is in the range’ 3700, 3800. 4500. Solution: Spot price Long Call (X = 4000) Short Call (X= 4200) Net Pay-off Intrinsic Vatue | Pr Pay-oft [intrinsic Value | Premium | Pay-off 3700 0 =170 | =170 0 Fy 3s | 15 3800 0 -170. | ~170 o 35 a | -195 3200 0 -170 | -170 0 35 35 | -135 4000 0 -170 | -170 ° 35 3 | 135 4100 100 170 | -70 0 35 35 35 4135 195 -170 | 35 0 Ed 35 0 4200 - 200 170 30 0 35 9% 65 4300 300 170 | 190 -100 5 5 65 4400 400 -170 | 290 200 3 165 | 65 4500 500 -170- |_ 380 200 95 285 65 Break-even point (BEP) = Strike price of purchased call + Net Premium Paid. i BEP = Strike price of long call + Premium of long call - premium of short call. BEP = 4000 + 170 - 35 = Rs. 4,135/- Bull Call Payoff - Graphical representation50, 2.9.4. BULL PUT SPREAD: 4 Vipul's™ International Finance (Bap 1 ot eee oo - 27 NetPay-of | iS NG | SSS | ry» | Meaning Buying one OTM Put and Selling one ITM Put option. Earns net income for investor as well as limits the ee downside risk of a Put sold. Investor View | Moderately Bullish. eae Limited. Maximum loss occurs where the underlying falls to the level of the lower strike or below. Reward Limited to the net premium received. Breakeven _| Strike Price of short Put - Net Premium received Example 10: Current value of Stock of XYZ Ltd is Rs. 4100, Mr. X sells one put at strike price of Rs. 4200 - Premium is Rs. 40, Strike price of put bought is Rs. 4100 - Premium is Rs. 35. Both options expiring on same date. Show a pay-off schedule, when| spot price is in the range 3700, 3800..... 4500. | | Solution: ; Long Put (X= 4100) ‘Short Put (X = 4200) Spot price trinsie Value Payot | ntinsi Value | Premium [Payot | No*P2Y 3700 200 365 ~500 «| -460] -9 3800 300 26s | 400 «| -360 | -95 3900 200 165 300 40 260 -95 4000 100 65 -200 4 | -160 | -95 4100 0 -35 -10 40 -60 | -95 4195 o “8 -5 40 35 0° 4200 0 -35 0 40 40 5 4300 0 -35 0° 40 40 5 4400 0 -35 0 40 40 5 4500 0 -35 0 40 40 5 Break-even point (BEP) = Strike price of short put - Né Premium received.me 3% me 51 Derivatives ~ Options BEP = Strike price of short put - (Premium of short put — premium of long put) BEP = 4200 — (40 - 35) = Rs. 4,195/- Bull Put Payoff - Graphical representation 500 | x % 300 Sa zo 7. 10 | : ee > oN = 400 | $700__3800_ 3900 4000“ igo’ OY + 200 | ae - 300 | oe 2 40 | AeA ; 3 - 500 | = 600 (B) BEARISH STRATEGIES: Bearish options strategies are used when an investor expects the underlying asset price to move downwards. 2.9.5. LONG PUT: Meaning Buying a put option. ‘Purpose ri investor can profit from reducing stock price by uying Puts. Investor View | Bearish on index/stock. Risk Limited to the amount of premium paid. Reward Unlimited. Breakeven __| Strike price ~ Premium paid. Example and payoff has been discussed already in this Chapter. 2.9.6. SHORT CALL: : Meaning Writing a call option. Purpose For making short term profits /income. Investor View Bearish on index/stock. Risk Unlimited., | ba rem Vipul’s™ International Finance (np 7 ) [Reward Limited to the amount of premium received. |Breakeven Strike price + Premium paid. Example and payoff has been discussed already in this Chapter, 2.9.7. BEAR CALL SPREAD: Meaning Selling one ITM Call and buying one OTM Call. Eams a net income for the investor as well as limits the downside risk of a Call sold. Investor View | Mildly Bearish. Limited to the difference between the two strikes minus Purpose = the net premium. Limited to the net premium received for the position’ Reward (premium received for short call minus premium paid| | for long call). Breakeven Strike Price of sold call + Net Premium Paid. Example 11: Current value of Stock of XYZ Ltd is Rs. 4100. | Strike price of call sold is Rs. 4000 - Premium is Rs. 170. Strike | price of call bought is Rs. 4200 - Premium is Rs. 35. Show a pay- off schedule, when spot price is in the range 3700, 3800..... 4500. Solution: | Long Call (X = 4200) Short Call (X = 4000) | Spot pre Frinste Value | Premium | Payoff | Inrinsie Value | Premium [Pay-ott| N&tPav-ot} 3700 0 35 | -3 0 170 170 | 135 |} 3800 0 -35 -5 0 170 170 135 | 3900 0 -35 — 0 170 170 135 4000 0 =35 -5 0 170 170 135 | 4100 ° -35 | -35 | -100 170 70 3 | 4195 0 -35 | -35 -15 | 170 5 0 4200 0 -35 =o - 200 170 -30 ~65 4300 100 ~ 35 65 - 300 170 - 130 -65 4400 200 35 | 165 ~ 400 7 =| -230 | -65 | | 4500 300 -35 265 -500 170 ~330 -65 Break-even point (BEP) = Strike price of short call + Net Premium received. BEP = Strike price of short call + (Premium of short call - premium of long call). BEP = 4000 + (170 - 35) = Rs. 4,135/-Derivatives ~ Options 53 Bear Call Payoff - Graphical representation ny es 300 A? —-e ee Le ve 200 i > 100 oF - 100 | 3700 3800 3900 4000 4100 ano. 440 4A 45) aa * Fey “| ee - 400 | 2.9.8. BEAR PUT SPREAD: Meaning Buying one ITM Put and selling one OTM Put. Purpose The effect of the strategy is to bring down the cost and raise the breakeven on buying a Put. Investor View | Moderately Bearish. Limited to the net amount paid for the spread. i.e., the Risk premium paid for long position less premium received for short position. Limited to the difference between the two strike prices Reward minus the net premium paid for the position. Limits the investor's upside & downside risk. Breakeven Strike Price of Long Put — Net Premium paid. Example 12: Current value of Stock of XYZ Ltd is Rs. 4100. Mr. X buys one put at strike price of Rs. 4200 — Premium is Rs. 40. Strike price of put sold is Rs. 4100 - Premium is Rs. 35. Both options expiring on same date. Show a pay-off schedule, when spot price is in the range 3700, 3800..... 4500. Solution: : Long Put (X = 4200) Short Put (X = 4100) Spot oe nas ale as Pay-of_| Intrinsic Value Premium [Pay-oft | NotPav-oft 3700 500 -40 460 400 35 365 95 300 400 40 | 360 ~300 a5 | -265 | 95 3900 300 -40 260 -200 3 - 165 95 4000 200 =40 160 -100 35 65 5 4100 100 -40 60 0 35 35 95, 4195 5 -40 -35 0 35 35 0 4200 0 40 | -40 ° 6 35 4300 0 -40" | -40 ° 8 35 4y > sa | ta Vipul's™ International Finance (Bary 4400 0 ~4 | -40 | 0 4500 ° 35 | 35 | 5 ~40 ~40 0 35 35. 5 Break-even point (BEP) = Strike price of long put ~ Nef Premium paid. | BEP = Strike price of long put - (Premium of long put _ premium of short put) BEP = 4200 - (40 + 35) = Rs. 4,195/- Bear Put Payoff - Graphical representation ~ 500 (C) NEUTRAL STRATEGIES: Neutral Strategies are also known as Non-Direction Strategies. Neutral strategies are used when an investor does not know whether the underlying stock price will rise or fall. : 2.9.9. LONG CALL BUTTERELY: Meaning Selling two ATM calls, buying one ITM call and buying] one OTM call, Purpose Investor is wants to gain from low volatility at a low cost. There is a good risk/reward ratio, Investor View | Neutral. A Risk Limited. Reward Limited.