Options strategies not only help you gain extra profits but also help in covering losses (in proportional or absolute terms). All you need to do is, be careful about when you ‘call' and when you ‘put'. You might be wondering, that I am mentioning only two things ‘call' and ‘put'. Then, what are the other strategies? Well, all the options strategies move around these two jargons. (Click here to read more about options. Let us look into them, in detail.)
An option strategy answers questions like
When to ‘call'?
When to ‘put'?
What do you get if you hold your options for long?
What do you get by using options in the short run?
What are the ways of covering risk, using options?
What are the ways of earning a profit, using options?
In options, there are as many as 475 strategies. Each of these strategies has different risks and benefits associated with them. Here, we will explain 22 unique strategies, commonly used by investors, applicable for Indian stock markets. (Click here to read more about call and put options.)
Here is a list of options strategies that apply to different market situations:
If you are bullish about the stock performance, you can go for the long call. In simple terms, when you are positive about the growth of stock price you have invested in, you can buy your right to buy (Call Option), to maximize your profit.
As discussed earlier, ‘call' is your right to buy. Here, you buy a ‘call' option after predicting that the market price of the underlying aster will rise above your strike price before the option expires. That is one of the most basic options strategies. (Click here to read more about call options.)
Consider, you have bought ‘call' options for an index, say Nifty. The index was bullish at 11,000 points, in July 2018. Say, you bought a ‘call' option with a strike price of 11,500, at a premium of Rs.90, and an expiration date of October 2018. If the Nifty would have gone above your strike price of 11,500, let’s say to 12,000, then you would have earned the profit of Rs.410 (12,000 –11,500 - Rs.90) on exercising the option. However, the markets moved downward. Nifty was 10,460 points in October 2018. Therefore, the only loss suffered here was the loss of the premium Rs 90.
This strategy works best when markets are bullish (moving aggressively forward). You will gain the most from the long call if exercise your option when markets cross your strike rate.
It is the most basic options strategy. It can be avoided when markets are bearish.
Risk: Limited to the premium amount.
You can use this options strategy during bear market conditions. In a call option, you buy a call in case of a bull market, and during bear market, you sell the call. This strategy involves unlimited risk. Therefore, a short call must be bought with utmost caution. This strategy is easy to execute. However, your reward is only limited to the premium. Here, you do not own the stock. Therefore, it is also called ‘short naked call'. (Click here to read about how call options work.)
Consider, you are short call options for Nifty at the strike price of 11,500 when the index is 11,500. You have received the premium of Rs.80 If Nifty stays at 11,500 points, or declines further, the call option will not be exercised, and you will only be able to retain the premium amount of Rs.80.
During bearish markets, you can exercise your option, to cut your losses.
You should avoid using this strategy during bull market conditions. If the price of the stock/index rises, you may experience unlimited losses.
Risk: Unlimited risk
This is a conservative bull-market strategy. You may start out with a gut feeling that the markets are going to rise, but what if the prices fall? During this time, you will have to insure against your losses. You can do this by buying a put option. As discussed earlier, the put option gives you the right to sell the underlying stock at a pre-agreed strike price. In synthetic long call options, your strike price can be the price at which you bought the stock or a rate slightly below that. Since you are buying the put option, that acts as a hedge. (Click here to read about other derivatives, like Futures and Forwards.)
Consider, you are bullish about a stock XYZ, at the current market price of Rs.1000, on 1 June 2018. However, you are feeling uncertain about the market now, and buy the put option of the stock, with the strike price of 900 at OTM. OTM or Out of The Money is a condition when the strike price of the underlying asset is higher than its market price. Now consider, that you have paid the premium of Rs.80 for the put option, expiring on 1 July 2018. Therefore, if the market goes up, you will benefit from the price rise. However, if it falls, you have your put option placed at 900 to cap your losses.
If the price of the underlying asset rises, you will benefit from the price rise. However, if the price falls, you can cap the risk by using the put option. This stops your losses from rising further. Therefore, if the stock prices rise, you get unlimited profit, but in the case of market plunges, it has only limited losses.
You should avoid using it if the markets are more or less stable. However, the risk is minimal.
Risk: This is a low-risk strategy. Losses are limited to the price of the underlying stock + Put Premium
As discussed earlier, the put option is the opposite of the call option. This is a bear market strategy and is used to limit risk from the falling market conditions. When you buy put, you benefit from the bear market and limit your risk to the premium paid for buying the option. In a long put, your profit potential is unlimited. (Click here to read more about call options vs put options.)
Suppose, you are bearish on SENSEX for on 20 May 2018. Consider that SENSEX is at 37,000 points during this period. You buy a put option at the strike rate of 36,400, at a premium of Rs.370. Now, if the SENSEX falls below 36,130 points, you will benefit by exercising your put option. However, if the SENSEX rises above 37,000 points, you can benefit from the rise in the value of your underlying asset. Here, you forego your put option. Your loss here will only be limited to your premium.
If you are bearish about your underlying asset, you can put a cap on your losses by buying a put option. Here, your loss will be limited to your premium.
It is a fundamental options strategy and has a limited amount of risk.
Risk: The risk/loss is limited to only the premium amount paid to buy the put option.
Here, you sell a put option instead of buying it. You can sell the put when markets are bearish and can buy it during bull market conditions. Selling a put during market upswings, helps you gain from the rising markets. By selling your put option, you have sold your right to sell the stock at your pre-agreed strike price. If the price of the underlying asset rises above its strike price (during in the market condition), thus short put position will give you profit from the premium. That is because the buyer of the put option will not be able to exercise it. However, when the price of your underlying asset falls below your premium, you will face losses. The potential loss during the short put is unlimited. (Read here about how put options work.)
SENSEX is bullish at 37,000 points. You plan to sell puts for the strike rate of 36,400, at a premium of Rs.300. The expiration date of this option is on 30 June 2018.
If the SENSEX stays above 36,400, you will gain through the premium amount. This is because the buyer of the put option won't be able to exercise it. However, if the SENSEX falls below this point, the buyer will use the option, and you will start losing money. If the SENSEX falls below 36,100 points, you will lose the premium, and your loss potential will be unlimited.
Selling a put option during bull markets helps you gain from the market upswing. It is an income generation strategy, as it generates regular income in a range-bound asset price.
This strategy should be avoided during bearish markets since the potential loss is unlimited.
Risk: The potential for loss is unlimited. You will face losses as the stock price falls below the strike rate by more than the premium amount until it falls to zero.
This strategy is for neutral to moderately bullish market conditions. If you own an asset, whose price you expect to rise in the long term, but stay bearish in the short run, you can go for a covered call. Here, you sell your right to buy, for the stock you own. You can only exercise this option during the OTM conditions (the strike price of the underlying asset is greater than its market price). Until then you can retain your premium. Since you sell (write) the call option after buying, it is also called the ‘buy-write strategy'. (Read more about dealing with market flip flops here.)
Say you own 100 shares of XYZ company, at the market price of Rs.50 each. If you don't expect the stock prices to move up. You can write (sell) the call option at the strike price of 55 for 100 shares priced at Rs2. Here, you will receive a premium of Rs.2/share on selling the option. Therefore, for your entire lot, you will receive a premium of Rs.200.
It is a popular options strategy that can generate income, in the form of premiums, for an investor's account. To execute this, an investor holding a long position in an asset then writes (sells) call options on that same asset to generate an income stream.
This options strategy should be avoided during bear market conditions.
Risk: If the price of the underlying asset falls to zero, you will lose all the invested money, except the premium.
Here, you sell a put and buy a call. This is a bull market strategy, i.e. you are expecting the markets to march north. In the long combo strategy, you sell the right to sell (put) at the OTM and buy the right to buy (call) at a higher strike rate OTM. This strategy starts making profits as the price of the underlying asset rises.
Consider, you are interested in a stock, when bullish. The market price of the stock is Rs.400, but you don't wish to buy it at that price. You can opt for a Long Combo strategy. You can sell the put option, with a strike price of 350, at Rs.1 premium, and then buy the call option at the strike rate of 450, at Rs.2 premium. Therefore, the net cost of your long combo strategy is Rs.1.
For such minor investment, the return can be huge in a Long Combo, when the stock price rises. However, in case, the price falls, your losses can be unlimited.
This strategy is comparatively more complex than the long call or long put strategy.
This strategy should be avoided during bear market conditions, as the losses can be unlimited.
Risk: The long combo strategy comes with unlimited risk during the bear market.
This strategy is also called the synthetic long put options strategy. When you buy a call just to hedge, it is called the protective call strategy. When you chose the opposite position in a strategy, just to avoid/reduce losses from one of the moves is called hedging. The best example of hedging is insurance. You hedge for the market upside while retaining your downside profit potential. (Click here to read more about strike rates in options.)
Say, you are short a stock XYZ which is trading at Rs.400, in July 2018. You buy a call for Rs.420 strike rate, at Rs.10 premium. So you are hedged on the long side.
You can make pay-offs like the long put, but instead of paying its premium, you gain from the decline in the share price. However, during bull market conditions, you bear only limited losses. In such cases, you get a higher premium from the long call.
A protective call works best, when you are bearish about the market, but want to protect against an unexpected rise in the stock price.
Since it is a protective strategy, you can use it under any bearish condition, by limiting your risk.
Risk: In a protective call, your loss is limited to the call strike price – stock price + premium
Earlier in the piece, we had discussed how covered call can protect your portfolio from downside risk. The covered put is just the opposite of the covered call strategy. You can use this strategy during neutral to bullish market conditions. Here, you can sell your put option during OTM conditions (when your strike price for the asset is higher than the market price of the asset). Selling the put means selling your right to sell. (Click here to read more about how options strategies work.)
Consider, you have short stocks of a company at Rs.400, in July 2018. You hedge it by selling the 380 July put for Rs.10.
If you are bearish about the underlying asset, but you want to buy it back once it has fallen to your target price. This target price can be your put strike price. By selling the put, you can buy the stock at the strike price. You can withhold the premium by selling the put. Therefore, you are covered. However, if the asset price does not change, you get your premium. This can be a form of regular income during neutral markets.
Since it is a covered options strategy; it can help you get a regular income from bearish markets. However, you can lose considerably, if the price of your underlying asset rises substantially. Therefore, it should be avoided when markets seem bullish.
Risk: Losses can be unlimited if the underlying asset price rises substantially.
A straddle is a volatility strategy. Usually, it is used when you expect markets to show rapid movements. Here, you buy a call as well as a put, for the same strike price and maturity date. By this, you can make the most when markets move in either direction. If the price of the stock/index increase, you can exercise your call option, while letting your put option expires. However, if the price falls, the put option can be exercised, while the call option expires. In either case, you gain profit.
Say, SENSEX is at 38,000 points on April 2019. You can enter the long straddle by buying a 38,800 May put at Rs.30, and a 38,800 May call for Rs.50. Therefore, you pay the net amount Rs.80 to enter the trade.
Here, you can be direction neutral in terms of markets. Therefore, it covers you against market volatility. It brings out the true characteristics of an option, where you have the choice to either exercise your option, or let it expire.
This strategy can be used when the markets are expected to move rapidly in either direction, in the near future. If there's no considerable movement, both of your options may expire worthlessly. However, your losses are limited to just your initial premium amount. During such situations, the short straddle strategy should be adopted. This strategy is explained further in the piece.
Risk: Your losses are limited to just your premium amount.
This strategy is the opposite of the long straddle. If you feel that there is no substantial movement going to be experienced in the short run, you can go for the short straddle. You can sell the call and the put for the same asset, at the same strike price, for the same expiration date. However, if the markets move significantly in either direction, your losses can be enormous. To gain from the short straddle, your underlying asset value should be close to your strike price, before the expiration date.
Suppose, Nifty is at 11,000 points, on 2 May 2019. If you enter into a short straddle by selling a 11,050 strike 30th May put at Rs.100, and 11,050 30th May call at Rs.150. Therefore, if the market doesn't show any rapid movements, you get the credit of Rs.250. This is also your maximum profit on the short straddle strategy.
The short straddle is good to create a regular income through your underlying asset.
You should avoid using short straddle during highly volatile market conditions. (To know what should be done during volatile markets, click here.) Risk: Losses can be high if the invested stock/index moves significantly in either direction. This strategy involves high risk.
Long strangle is the cheaper version of the long straddle options strategy. Here, you buy a slightly OTM put and a slightly OTM call of the same underlying asset, with the same expiration date. This too is a direction neutral options strategy. However, in a long strangle, you require a higher movement on both sides to gain from the strategy. Therefore, a high level of volatility is required to exercise it.
Suppose Nifty is at 11,000 in July 2018. You can execute a long strangle by buying an Rs.11,200 call at Rs.100, and 10,800 put for Rs.60 premium. The net cost of entering this strategy is Rs.160. This is also your maximum possible loss on the strategy.
Like the long straddle, even in this strategy, you benefit during high volatility. Since both, call and put options are purchased when the market price of the underlying asset is lower than the strike rate (OTM Condition), it is cheaper than the long straddle. Since the cost is lower than the long straddle, the benefits are higher in long strangle. It has a limited downside and an unlimited upside potential.
There is a higher amount of volatility required for the execution of the option. Therefore, one must tread with caution. You can avoid this strategy if you are not expecting high volatility before the expiration date.
Risk: Your risk is limited to the initial premium paid.
The short strangle strategy is similar to the short straddle strategy. It increases your benefits as the buyer of your option gets the least chance to exercise the option. Here, you sell a slightly OTM call and a slightly OTM put for the same option, at the same strike rate and expiration date. The underlying asset price has to move significantly for the buyer of the option to exercise it. If the asset does not exhibit much movement, you get to keep the premium.
Suppose Nifty is at 11,400 in April 2019. You can execute the short strangle by selling a 11,200 May 2019 put for a premium of Rs.100, and a 11,600 May 2019 call for Rs.150. The net credit for your strategy is Rs.250. This is also your maximum possible gain. Meaning, if the index doesn't move by 250 points on either side, before the expiration date, the buyer of the option doesn't get to exercise the option. Thus, you gain from the premium.
There are minimum chances for the option buyer to exercise the call or the put option.
This strategy should be avoided if the markets are witnessing a high level of volatility.
Risk: You can face unlimited risk if the markets experience rapid movements.
This strategy is quite similar to the covered call. However, there's a slight twist. Here, you further limit the covered call risk, by buying put to cover the downside, and then finance the put by selling a call. Generally, put and calls are an OTM (Out of the Money). Both of these strategies should have the same expiration date, along with an equal number of shares. When the put limits your risk, the call also limits your gains. Therefore, it is a low risk, low reward options strategy.
Consider that an XYZ company stock is trading at Rs.1000 when you are holding it. You can establish a collar by writing (selling) a call of 1200 strike, for Rs.20. Now, you can simultaneously purchase a 960 strike put for Rs.15. You have paid Rs.1000 for the stock, plus Rs.15, but you receive Rs.20 as premium. Your total investment is Rs.995.
You can use this strategy when you are conservatively bullish about your investments.
Since both, risk and reward are limited. You can avoid this strategy if you are looking for higher investment gains.
Risk: This is a low-risk strategy. The put option limits the downside risk.
Here, you can buy ‘in the money' call option and sell in the ‘out of the money' option. However, both options must have the same expiration date. (Click here to read more about stock market risk.)
Suppose, you buy a Nifty call with a strike price of 11,000, at Rs.210 premium, and sell the Nifty call option 11,500 strike price, at Rs.180 premium. Your net loss here would be Rs.30. This will be your maximum loss if the asset price falls below your strike rate.
You can exercise this strategy under moderately bullish to bullish conditions. This is because you can make a profit only when the underlying asset price rises.
You should avoid using it during bearish markets.
Risk: You can experience limited risk. It is limited to the net total of the premiums paid for the strategy.
Here, you can protect the downside of the put by buying another put (at a lower strike rate). This acts as an insurance for the put sold. If the value of the underlying asset rises, both puts expire, and you are only left with the premium. Therefore, you only gain from the bull market condition. Did you know: Kotak Securities offers stock research insights for traders. (Click here to know more)
Suppose, you sell a Nifty put option with the strike price of 11,500, at a premium of Rs.100. Now you buy further OTM Nifty put at a strike rate of 11,000, at a premium of Rs.20. Here, your strategy is ‘sell a put' + ‘buy a put'.
You can benefit from this strategy when the value of the underlying asset is either range bound or rising. When the markets move upward, you gain a regular income, while being protected against market downfalls.
This is a moderate market strategy. Therefore, it can be avoided during bear market conditions.
Risk: This options strategy has limited risk and return.
This is the opposite of the bull call spread strategy. It is used when markets are either range bound, or marching south. Here, you sell the ITM call and buy the OTM call. You protect the downside of the call option sold by buying another call option of a higher strike price to insure the downfall. (Click here to more about how call strategies work.)
Consider that you are bearish on Nifty. You Buy the call option at the strike price of Rs.11,000, at a premium of Rs.200, and Sell a call option with the strike price of Rs.10,600, at a Rs.400 premium. If Nifty falls below 10,600 points, you will receive a premium of Rs.200.
This is a bear market strategy. If the price of the underlying asset falls below the level, you will make a profit. It not only earns a regular income for the investor but also limits downside risk.
If the asset price rises, you will suffer a loss. Since this is a low risk, low return options strategy, it should be avoided if you are expecting higher rewards.
Risk: The maximum loss is the difference between the two strike rates, minus the net credit received.
A bear put spread strategy requires you to buy put and sell put. You buy a higher ITM put, and sell a lower OTM put option. Thus, your net debit is created. However, you can gain only when the stock/index falls. The puts are bought to cap the asset downside. The sold puts will reduce your investment cost. )Click here to know more about how put options strategy works.)
Consider, SENSEX is presently at 38,000 points. You expect the benchmark index to fall. Therefore, you buy the SENSEX ITM put option at 39,000, at a premium of Rs. 1000, and sell the SENSEX OTM put with the strike rate of 37,500, at a premium of Rs.400.
Now, if the price of the index falls below 37,500 points, you get a reward of Rs.1100 (the difference between the two strike prices minus the lower position premium paid).
This is a bear market strategy, and you can make money when the stock/index falls. If the stock/index closes below the OTM (lower) put option, on the expiration date, you can make maximum profits.
Since it is a bear market strategy, if the stock/index rises above the ITM (higher) put option, you will make a maximum loss. Therefore, this strategy should be avoided when markets are bullish.
Risk: You face limited risk in this strategy. Your maximum loss is the premium paid for the higher position minus the premium paid for the lower position.
This options strategy can be exercised only when you are expecting the underlying asset to experience very minor price movements. The maximum reward in long call butterfly is restricted and gains occur only when the asset price is in the middle of the range at expiration. (Click here to know more about other derivatives.)
Suppose, Nifty is at 10,000, and very little movements are expected in the short run. Here, you sell the 2 ATM (At Time Money) Nifty call option, with a strike price of Rs.10,000, at Rs.300 premium. (During the ATM condition, the strike price of the asset is identical to its market price.) You also buy 1 ITM Nifty call option, with the strike price of 9,800, at a premium of Rs.350, and 1 Nifty OTM call option at the strike rate of 10,200, at a premium of Rs.320. Therefore, your net debit is Rs.70. This is your maximum risk.
You can gain if the price of the underlying asset remains highly range bound. You can use this strategy when you are neutral on market direction and bearish on market volatility.
You should avoid this strategy if the markets are witnessing high short-run volatility.
Risk: The maximum loss in this strategy is limited. Therefore, it is a low-risk options strategy.
Here you buy 2 ATM call options, sell one ITM call option and one OTM call option. Unlike the long call butterfly, it is for volatile markets. You will gain if there is a substantial rise in the index/stock. However, if there's a minor change in the underlying asset value during expiration, you will lose.
Consider that Nifty is at 10,000. You are expecting the market to be highly volatile. However, you are not certain about the market direction. You can buy 2 ATM call options at Rs.10,000 strike rate, at the premium of Rs.300 each. Now, you sell 1 ITM Nifty call option, with the strike price of 9800, at a premium of Rs.350, and 1 Nifty OTM call option at the strike rate of 10,200, at a premium of Rs.320. Therefore, your net debit is Rs.70. This is your maximum risk.
You can gain from the high upward volatility in stock/index.
It is a limited risk, limited reward options strategy You can avoid it if you are looking for higher returns. (Click here to know more about derivative expiration.)
Risk: Your risk is limited to the net difference between the adjacent strike rates (200 in this case) minus the premium for the position.
This strategy is very similar to the long butterfly strategy. The difference is that the two ATM options sold have different strike rates, and the profitable area is wider than that of the long butterfly.
Consider, Nifty is at 10,000 points, with little expected volatility. Therefore, the index is expected to remain range bound. You can buy 1 Nifty ITM put option with a strike price of 9,000, at a premium of Rs.90, sell one ITM option with a strike price of 9,500, at Rs.40. Now, you sell 2 OTM Nifty put option at with a strike price of 11,000 at a premium of Rs.10each and buy 1 Nifty put option of 11,200 strike price at Rs.5 premium. The net debit for this strategy is Rs.35. This is your maximum possible loss.
You can gain from this strategy, if you expect the market to work in the range bound low volatility, until the option expiration. (Click here to know about derivatives settlement.)
IT is a limited risk, limited return strategy. Therefore, it should be avoided if you are considering higher returns.
Risk: There is limited risk involved.
This strategy is very similar to the short butterfly strategy. The only difference is that the two middle bought options have different strike rates.
Consider, Nifty is at 10,000 points, with little expected volatility. Therefore, the index is expected to remain range bound. You can buy 1 Nifty ITM put option with a strike price of 9,000, at a premium of Rs.90, sell one ITM option with a strike price of 9,500, at Rs.40. Now, you sell 2 OTM Nifty put option at with a strike price of 11,000 at a premium of Rs.10 each and buy 1 Nifty put option of 11,200 strike price at Rs.5 premium. The net credit for this strategy is Rs.35.
You can benefit from this strategy if you know the value of your underlying asset will break out of the trading range, but you are unsure of the direction.
It is a limited risk, limited return strategy. It should be avoided if you are looking for higher returns.
Risk: There is limited risk involved in this strategy.
There are several options strategies available for different market conditions. However, the core of this instrument is the same. Since it is an option, you have a choice of exercising it, or not exercising it. This is unlike stocks, where you either buy or sell the asset. Through options strategies, you only buy or write (sell) the right to buy or sell. Options revolve around the world of ‘call' and ‘put'. Therefore, to gain maximum benefit, you must use them well. Options strategies can be your option for smart investing.