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Options Trading Strategies
Long Put
Buy Put
Let’s face
it, at one point or another, you probably thought a stock was weak and it could
drop further. Well, you could do that with options because sometimes, it’s
riskier than just short shares of the stock outright. That said, let’s see how
you could implement some bearish options strategies.
This is the simplest bearish strategy. You would buy a put option if you’re bearish on a stock. Puts are great as an alternative to short selling a stock. In this strategy, the options trader who buys a put option, believes that the price of the underlying security will fall significantly beyond the strike price before the Options contract expires.
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This
strategy is for aggressive traders who are extremely bearish on the stock /
index and want to exploit the perceived downside trend with limited risk of
loss
When you short a stock, you’re exposed to unlimited risk, theoretically, because you simply don’t know where the stock could go. On the other hand, when you buy a put option, the maximum potential loss is just the premium paid.
This strategy is implemented by buying 1 Put Option i.e. a single position, when the person is bearish on the market and expects the market to move downwards in the near future.
The maximum profit potential here is if the stock goes to zero. Your profit would be equal to the strike price less the premium paid. However, you should keep in mind that it’s rare for stocks to go to zero. So don’t think that once the stock drops 10 to 20% that it could go to 0.
Benefits of using the strategy Unlimited profits as the stock or index can fall to any level before the expiry
Risk:
The maximum
loss will be the premium amount paid.
Reward:
The profits will be limited by the maximum fall in the underlying asset price i.e. potentially null value (i.e. zero ‘0’).
Break-Even Point:
The break-even point for
the Put Option Holder will be ‘Strike Price – Premium
Example of Long Put
Just to refresh your
memory, here’s a look at the profit and loss (PnL) diagram of a Put option
contract.
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Mr. X is bearish on NIFTY
and expects the market to move downwards in the near future. NIFTY is currently
trading around Rs. 11175 level. Lot size of NIFTY is 75. Mr. X buys 1 11200 Put
Option of NIFTY for a premium of Rs. 164.45. His initial investment will be Rs.
12,333.75. (164.45*75)
Break-Even Point: The break-even point for
the Put Option Holder will be 11,035.55. (11200-164.45)
Case 1: If the market moves as per
Mr. X’s expectations and dips down to Rs. 10700 level, then the net profit will
be Rs. 25,166.25 [(500-164.45)*75]
Case 2: If the market moves upwards against his expectations then the maximum loss/risk will be the premium amount paid i.e. Rs. 12,333.75. (164.45*75)
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