Options StrategiesBull Call SpreadWhen prices are expected to increase in the market, a spread strategy will help investor to lock the share price between two prices for a specific time. A bull spread is also termed as the bull call spread. Option contracts are available with the same expiry date for different strike prices at different premiums.

A call option for BHEL at Rs 190, for a premium of Rs 13.25, with an expiry date of February 27,2003A call option for BHEL at Rs 220, for a premium of Rs 1.50, with an expiry date of February 27,2003

Step 1: An investor can take two positions with these two contracts. A call option can be bought at Rs 190 for a payment of Rs 13.25 as premium.

Step 2: The investor can sell a call option contract at Rs 220 for receipt of a premium of Rs 1.50.Step 3: The net cost for the investor from these two contracts of a payment of Rs 13.25 and a receipt of Rs 1.50 is a net expenditure of Rs 11.75.

A Buy a call option with the strike price of Rs. 280 at a premium of Rs 18.10, with an expiry date of February 27,2003A Write call option with the strike price of Rs. 340, for a premium of Rs 0.40, with an expiry date of February 27,2003

Bear Put SpreadWhen prices are expected to decline in the market, a spread strategy will help investor to lock the share price between two prices for a specific time. The bear spread is formed by buying a put option at a higher price and selling a put option at a lower price simultaneously for a share with the same expiry date.

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Put option with a strike price of Rs 480, at a premium of Rs 2.00, with the expiry date 27/02/2003.

Put option with a strike price of Rs 660, at a premium of Rs 44.00, with the expiry date 27/02/2003.

Step 1: The investor buys a put option with a strike price of Rs 660 and pays a premium of Rs 44.

Step 2: The investor sells a put option with a strike price of Rs 480 and receives a premium of Rs 2.00.

Step 3: The net cost out of these trading is Rs 42.00 (Rs 44.00-Rs 2.00). The options will not be exercised when the market price at expiry date is greater than Rs 660. In that situation the net loss for the investor is the loss of entering into the option contracts i.e., Rs 42.

Bull Put Spread

Writing a put option with a high exercise price and buying a put option with a low exercise price creates a bull put spread. A bull put spread is entered into when there is a bullish expectation in the market price of the share.

Infosys put option strike price Rs. 4,000, at a premium of Rs. 19.05, with the expiry date February 27, 2003

Infosys put option strike price Rs 4,800, at a premium of Rs 505.00, with the expiry date February 27, 2003.

Step 1: Sell a put option at the strike price of Rs 4,800 and receive a premium of Rs 505.

Step 2: Buy a put option at the strike price of Rs 4,000 and pay a premium of Rs 29.05.Step 3: Since the market price of Infosys shares are

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expected to rise, the investor can benefit to the extent of the premium differential. For example, if the market price goes up beyond Rs 4,800, both the options will not be exercised and the investor will gain Rs 475.95 (Rs 505-Rs 29.05) per share.

Bear Call Spread

When the expectations are bearish, an investor can also enter into a bear call spread trading strategy. A bear call spread involves selling a call option with a low exercise price and buying a call option with a high exercise price.

The Wipro call options with a strike price of Rs. l, 350 has a premium of Rs 90.00.

The Wipro call option with a strike price of Rs 1,400 has a premium of Rs 50.50. Both call options have a 27/02/2003 expiry date.

The investor can enter into a bear call spread when he expects a decline in the price of Wipro's shares.

Step 1: Sell a call option at Rs 1,350 and receive a premium of Rs 90.00

Step 2: Buy a call option at Rs 1400 and pay a premium of Rs 50.50.

Step 3: The net profit out of the two simultaneous trades will be Rs 39.50 (Rs 90.00-Rs 50.50). When the market price, at expiry date, goes down below Rs 1350, both contracts are not exercised and the profit to the investor is Rs 39.50. When the market price goes above Rs 1,400, both options are exercised and the net

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loss to the investor will be (Rs 1350-Rs 1400 + Rs 39.50) Rs 10.50.

Butterfly Spread

A butterfly spread takes three call prices all having the same expiry date into consideration. A butterfly call spread is created by buying a call option with a low strike price, another call option with a high strike price, and selling two call options with a strike price in between the high and low strike prices.

When the share price in the market moves between the low and high prices, the investor makes a profit from the butterfly spread position.

When the share price moves nearer to the low and high prices and goes beyond these points the investor incurs a loss, ie, cost of entering into the butterfly strategy. The following example uses a butterfly spread.

Strike Price Premium Expiry Date

55 6.70 28/11/2002

60 3.85 28/11/200265 1.95 28/11/2002

The investor buys one call option with a strike price of Rs 55 and Rs 65 and pays a premium of Rs 8.65 (Rs 6.70 + Rs 1.95). The investor also sells two call options at the strike price ofRs 60, receiving Rs 7.70 (Rs 3.85 * 2). The net cost of the strategy is Rs 0.95 (Rs 8.65-Rs 7.70).

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Straddles

Combining a long call and a long put creates a long straddle. The simultaneous purchase of a call and a put on the same security, with the same exercise price, and for the same expiry month results in a long straddle. A short straddle, on the other hand, is the simultaneous sale of a call and put option with the same exercise price and with the same expiry time.

Suppose that shares in Mahindra and Mahindra are at Rs 99 and that on December 12, January Rs 100 call options carry a premium of Rs 4, while January Rs 100 put options carry a premium of Rs 3. A long straddle could be constructed by simultaneously buying a January Rs 100 call and a January Rs 100 put

The holder of the long straddle would make net profits if the share price moved outside the range Rs 93-Rs 107 (break-even points). The maximum loss would be Rs 7, the sum of the premiums paid. This loss would be incurred if the share price moved to and stayed at Rs 100.

Strangles

Strangles are similar to straddles but they differ since the two options will have different exercise prices, though the date of expiry is the same.

If shares in M&M are Rs 99, a long strangle on December 10 can be made by buying a January Rs 95 put option for a premium of Rs 1.40 and a January Rs 110 call option for a

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premium ofRs 3.80.

The holder of strangle would make a profit if the stock price moved outside the range ofRs 89.80-Rs 115.20. The maximum loss of Rs 5.20, the sum of the premiums paid, would be incurred in the event of the stock price remaining in the range Rs 95-Rs 110

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