Exploring the Different Types of Option Trading Strategies

Options strategies are a combination of buying and selling two or more options to have defined risk and return.

There are a host of options trading strategies traders employ, but you need not know all the strategies to begin trading. Here are the commonly used ones to understand the basics.

Used when trader expects limited increase in stock price. Trader buys one call option and sells one call option of same expiry but higher strike price. It caps the gains and limits the losses.

Suppose Nifty Spot Price is: 8000

1. Leg 1 you buy 1 ATM call option at 7950 Premium 90
2. Leg 2 you sell 1 OTM call option at 8050 Premium 30

If the market expires below ATM price, suppose 7850, you lose the premium on 7950 CE.

For 8050 CE you retain the premium Rs 30.

You net loss = 90-30 = 60

Hence, your loss is limited to Rs 60 here.

Assume market expiry @ 7950, the loss is again limited to Rs 60.

If market expiry is at 8050,

The Buy Option fetches = 8050-7950 = 100 – Premium = 10

The Sell Option you earn premium Rs 30

Net Gain = 10+30 = 40

Trader shortsells a put option and buys another put option of the same stock with same expiry but a lower strike price. Suitable for a moderately bearish view and earns an upfront credit.

E.g. Assume Nifty Spot: 8000

Sell PE 8100 at premium Rs 170

If market expires at 7800, you make 7900-7800 = 100 – 85 = 15

For PE 8100 option: You make Premium – (8100-7800) = 170-300 = (130)

Overall Payoff : Rs 85-130 = Rs (45)

If market expires at 8200

Net Payoff = Rs (170-85) = Rs 85

Employed when the view is bullish, trader buys calls and sells calls with the same expiry at different strike prices in ratio of 1:2, 1:3.or  2:3. Gains are unlimited if the market goes up and limited if not.

Suppose Nifty Spot is at 7500

1. Sell one lot of 7400 CE  Premium 150
2. Buy two lots of 7700 CE Premium Rs 60 per lot = 120

Assume market expiry: 7300

Net outflow = Rs 150 – Rs 120 = Rs 30

If market expires at 8200

Net Payoff: Rs 150 – 800 + (2*500) – 120 = Rs 230

Used when outlook is bearish and for a net credit. Combines long and short puts in ratios of 2:1, 3:2 oe 3:1. Trader profits from volatility in underlying stock.

Assume Nifty spot = 7430. Trader expects 7000 level at expiry.

Sell one lot of 7400 PE Premium Rs 150

Buy two lots of 7100 PE  Premium Rs 50 for one lot, total Rs 100

Net Outflow = Rs 150 – Rs 100 = Rs 50

Assume expiry @ 7500

Net Payoff = Rs 150 – 100 = Rs 50

If market expires @ 6800

Payoff for 7400 PE = 150 – 600 = -450

Payoff for 7100 PE = 300*2 – 100 = 500

Net Payoff = + 50

Used for a moderately bearish view. Trader buys call options at a strike price and also sells the same number of  call options of the same stock and expiry but at a lower strike price.

Assume Nifty spot : 7400

Sell 7300 CE premium Rs 140

Outflow Rs 100.

Assume market expiry @ 7700

Value of 7600 CE = 100-40 = 60

Value of 7100 CE = -400+140 = – 260

Net Payoff = -260+60 = -200

If market expires @ 7200

Net Payoff = Rs 140-40 = 100

Used for a moderately bearish outlook. Trader buys put options and while also selling the same no of puts for same stock and same expiry at a lower strike price.

Long Strangle

Trader buys an OTM call and OTM put option simultaneously. Profit potential of call option unlimited on the upside and put option profits on the downside. Risk limited to premium paid.

Assume Nifty spot 7800

If market expires @ 7500

Value of Put Option = 200 – 30 = 170

Net Payoff: 170 – 25 = 145

Short Strangle

Used when a stock trades in a narrow range between the break even points. The trader sells an OTM put and OTM call at the same time which are at equal distance from the strike.

Trader buys ATM call option and ATM put option of the same expiry. Used to profit from a strong swing due to unexpected event.

Assume Market is trading at 7400

If Market expiry is 7100

Value of 7500 PE = 400-66 = 334

Net Payoff = 334-56 = 278

An advance level strategy, employed when underlying stock lacks volatility. Short strangle is executed in just the opposite way of the Long Straddle. Trader sells ATM call option and ATM put option of the same expiry and at equal distance from the strike.

Iron Condor

Used when stock has less volatility. Involves two puts, one long and one short and two calls, one long and one short, four strike prices and same expiry.

Iron Butterfly

Used to profit from price movement in a narrow range. Trade creates four options – two call and two put options all with the same expiry. Designed to benefit from reduction in implied volatility.

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