Page 88 - DMGT513_DERIVATIVES_AND_RISK_MANAGEMENT

Unit 7: Option Strategies and Pay-offs

7.2 Bearish Strategies Notes

Five kinds of bullish option strategies are discussed below. They are:
1. Short Call

2. Long Put
3. Call Bear Spread
4. Put Bear Spread
5. Strips
1. Short Call: A short call is simply the sale of one call option. A selling option is also known
as "writing" an option. A short is also known as a naked call. Naked calls are considered
very risky positions because our risk is unlimited.
When you firmly believe that the underlying is not going to rise, sell a call option. When
you firmly believe that index (Nifty/Sensex) is not going to rise, sell a call option on
index. When you firmly believe that a particular stock is not going to rise, sell call option
on that stock. Sell out-of-the-money (higher strike price) options if you are only somewhat
convinced; sell at-the-money options if you are very confident that the underlying would
remain at the current level or fall.

Upside potential: Your profit is limited to the premium received. At expiration the break-
even is strike price plus premium. Maximum profit is realised if the underlying price is
below the strike price.

Downside risk: The price of the option increases as the underlying price rises. You can cut
your losses by buying the same option if you think that your view is going wrong. Losses
keep on increasing as the underlying rises and are virtually unlimited. Such a position
must be monitored closely.

Maximum Loss: Unlimited as the market rises.
Maximum Gain: Limited to the premium received for selling the option.
When to use: When we are bearish on market direction and also bearish on market volatility.

Figure 7.8: Profit/Loss at Expiration for Short Call

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