OVERVIEW

Option Strategies
Option Properties
Option Volatility
Bull Spread
Bear Spread

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 OPTION STRATEGIES

 Options give tremendous flexibility to traders to

capture market movements.
 Options can be used as a single instrument or in
combination with other options or futures to generate
a desired risk-return pay-off.
 Options can be used under any market scenarios. It is
possible to create strategies if one has:
A Mildly or strongly bullish or bearish view on the
markets.
A Volatile view on the markets.
A Range bound view on the markets. 2
 In-the-money Options

In-the-money options

In-the-money options comprises of both intrinsic

value and time value.
Deep in-the-money options will have more of intrinsic
value and less of time value.
In-the-money options are more expensive than both
at-the-money and out-of-the-money.
In-the-money options have comparatively less liquidity
than both at-the-money and out-of-the-money.

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 In-the-money Options

In-the-money options

 In-the-money options have greater Delta's compared to

both at-the-money and out-of-the-money.
 In-the-money options are more sensitive to the
underlying movement compared to both at-the-money
and out-of-the-money.
 Deep in-the-money options have Delta's close to 100
and behave almost like futures.

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 At-the-money Options

At-the-money options
 At-the-money options have no intrinsic value and is
made up entirely of time value.
 At-the-money options have the maximum time value
component compared to both in-the-money options and
out-of-the money.
 At-the-money options have Delta's close to 50 which
means that they are roughly 50% sensitive to the
movement in underlying.

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 At-the-money Options

At-the-money options
 At-the-money options are less expensive than in-the-
money options but are more expensive than out-of-the
money options.
 At-the-money options have the maximum time value
component compared to both in-the-money and out-of-
the money.
 At-the-money options are most liquid compared to both
in-the-money options and out-of-the money options.

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 Out-of-the-money Options

Out-of-the-money options
 Out-of-the-money options are the least expensive
options compared to both in-the-money options and at-
the money options.
 Out-of-the-money options have no intrinsic value. They
are entirely made up of time value.
 Out-of-the money options are fairly more liquid
compared to in-the-money options.

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 Out-of-the-money Options

Out-of-the-money options
 Out-of-the-money options have lesser Delta's compared
to both at-the-money and in-the-money options.
 Out-of-the-money options are least sensitive to the
underlying movement compared to both at-the-money
and in-the-money options.
 Deep out-of-the-money options have Delta's close to zero
and have negligible sensitivity to the change in underlying
prices.

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 OPTION PROPERTIES

 Deep in-the-money call options have Delta's close to 100 and

behave like long futures.
 Deep in-the-money put options have Delta's close to -100 and
behave like short futures.
 At-the-money call options will have Delta's close to 50 and
behaves like half long futures.
 At-the-money put options will have Delta's close to - 50 and
behaves like half short futures.
 Far out-of-the money call and put options will have Delta's
close to zero and are relatively insensitive to the changes in
underlying prices. 9
 TRADER PERSPECTIVES

 When a trader has a mildly bullish view on the markets,

he may prefer buying an in-the-money call option.
 When a trader has a moderately bullish view on the
markets, he may prefer buying an at-the-money call
option.
 When a trader has a strongly bullish view on the markets,
he may prefer buying an out-of-the-money call option.

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 OPTION PROPERTIES

 Since an in-the-money call option is very sensitive, the call option

will quickly move into profits if the markets firm up and the price
moves in his favor.
 An at-the-money call option is relatively less sensitive, the call
option will take some time to move into profits should the price
moves in his favor.
 An out-of-the-money call option is least sensitive and hence it will
require a quick and a large upside move from the markets to make
his position profitable. However, the gains in terms of return on
investment is the biggest in OTM options.
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 Long Call Option

HPCL Long 300CE @ Rs. 20

200

150
Profit/Loss (Rs.)

100

50

0
220 240 260 280 300 320 340 360 380 400 420 440 460 480 500

-50
Price (Rs)

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 OPTION PROPERTIES

 Since an in-the-money put option is very sensitive, the put

option will quickly move into profits if the market corrects and
the price moves in his favor.
 An at-the-money put option is relatively less sensitive, the put
option will take some time to move into profits should the
price moves in his favor.
 An out-of-the-money put option is least sensitive and hence it
will require a quick and a large downside move from the
markets to make his position profitable. However, the gains in
terms of return on investment is the biggest in OTM options.
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 Long Put Option

HPCL Long 300PE @ Rs 20.00

200

150
Profit/Loss (Rs)

100

50

0
100 120 140 160 180 200 220 240 260 280 300 320 340 360 380

-50
Price (Rs)

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 Short Call Option

 When an investor has a mild to moderately bearish view on the

markets, he may consider selling an ATM or OTM call options.
 His maximum profit will be the premium amount should the
markets remain below the sold strike.
 His sold call option trade could be in danger if the markets
start firming up.
 He potentially carries an unlimited risk in case of a sharp
upside move.

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 Short Call Option

HPCL Short 300CE @ 20

50

0
220 240 260 280 300 320 340 360 380 400 420 440 460 480 500
Profit/Loss (Rs)

-50

-100

-150

-200
Price (Rs)

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 Short Put Option

 When an investor has a mild to moderately bullish view on

the markets, he may consider selling an ATM or OTM put
options.
 His maximum profit will be the premium amount should the
markets remain above the sold strike.
 His sold put option trade could be in danger if the markets
starts correcting.
 He potentially carries an unlimited risk in case of a sharp
downside move.

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 Short Put Option

HPCL Short 300PE @ 20

50

0
100 120 140 160 180 200 220 240 260 280 300 320 340 360 380
Profit/Loss (Rs)

-50

-100

-150

-200
Price

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 Synthetics

 A trader can buy a synthetic call by using a combination of

long futures and a long put.
 The risk reward ratio and the pay-off diagram will be
identical to that of the original long call.
 A trader can buy a synthetic put by using a combination of
short futures and a long call.
 The risk reward ratio and the pay-off diagram will be
identical to that of the original long put.
 Similarly, a short call and a short put can be synthetically
created to replicate the risk-reward profile and the pay-off
diagram. 19
 Volatility Considerations

 Option Pricing models like the Black-Scholes model use

volatility assumptions to calculate the fair value or the
mathematical value of options.
 The mathematical value may often differ from the actual
traded price of the options.
 This happens because of different volatility assumptions
by the market participants.
 The volatility implied by the market participants and
reflected in the option pricing is called the implied
volatility of the options.
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 Volatility Considerations

 The Implied Volatility is not a static concept and can

keep on changing under different market conditions.
 The Implied Volatility is mean reverting in nature. It rises
and falls and has a tendency to come back towards its
mean.
 An option trader cannot hope to succeed in the long run
without having a deep understanding about volatility.
 Many a time the success (or failure) of the option
strategies is due to the correct (or incorrect) choice of
strategies under varying volatility conditions.
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 Volatility Considerations

Low Implied Volatility

When the Implied Volatility is low, it makes a lot of sense to buy
options.
A trader will prefer to be net long options. i.e. more bought
options than sold options in a spread.
When a trader is net long options, such trades are called as Long
Gamma trades.
A Long Gamma trader will prefer the markets to move very swiftly.
A Long Gamma trader carries time value risk (theta) in his
position.
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 Volatility Considerations

High Implied Volatility

 When the Implied Volatility is high, it is more practical to
sell options.
 A trader will prefer to be net short options. i.e. more sold
options than bought options in a spread.
 When a trader is net short options, such trades are called as
Short Gamma trades.
 A Short Gamma trader will prefer the markets to move very
slowly.
 A Short Gamma trader gets the benefit of time value in his
position.
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 CALL BULL SPREAD

 A Call Bull Spread is an option strategy wherein a lower

strike call option is bought and a higher strike call option
is sold, simultaneously.
 It is a net debit strategy. i.e. there is a premium outflow.
 The strategy has a limited profit and limited loss type of a
profile.
 It is generally done when the outlook on the market is
mild to moderately bullish and also with the intention of
bringing down the cost of acquisition of the bought call.

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 CALL BULL SPREAD

HPCL Long 300CE @ 20 and Short 340CE @ 5

30
25
20
15
Profit/Loss (Rs)

10
5
0
220 240 260 280 300 320 340 360 380 400 420 440 460 480 500
-5
-10
-15
-20
Price (Rs)

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 PUT BEAR SPREAD

 A Put Bear Spread is a option strategy wherein a higher

strike put option is bought and a lower strike put option is
sold, simultaneously.
 It is a net debit strategy i.e. there is a premium outflow.
 The strategy has a limited profit and limited loss type of a
profile.
 It is generally done when the outlook on the market is
mild to moderately bearish and also with the intention of
bringing down the cost of acquisition of the bought put.

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 PUT BEAR SPREAD

30 HPCL Long 300PE @ 20 and Short 260PE@ 5

25
20
15
Profit/Loss (Rs.)

10
5
0
100 120 140 160 180 200 220 240 260 280 300 320 340 360 380
-5
-10
-15
-20
Price (Rs)

27
THANK YOU

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