Options Trading Strategies: Playing with Options strategically: Part 2

In the previous article, we learned about the various Options strategies that can be employed for a bullish or a bearish view on the market or on a particular stock. In this article, we will learn the various Options strategies that can be employed when one has a neutral or a volatile view about the movement of the market or a particular stock.

Neutral Market Strategy: A neutral market strategy is employed when the outlook for the market or a stock is stable. That is, the market or the stock is not expected to move too much in any one direction and remain more or less at the same level.

Volatile Market Strategy: A volatile market strategy is employed when the outlook for the market or a stock is unstable. That is, the market or the stock is expected to move up or down significantly from its present level.

STRADDLE
A Straddle involves simultaneous buying (long straddle) or selling (short straddle) of a Call Option as well as a Put Option of the same stock or index with the same strike price and with the same expiry date.

Buying A Straddle (Long Straddle): A long straddle is a strategy when you have a volatile view on the market or a particular stock and you feel that a particular stock or an index will move significantly on either side. It involves buying a Call as well as a Put.

For example, if a stock ABC is trading at a price of Rs 100 in the spot market, you buy a 100 strike price Call at a premium of say, Rs 20 and a 100 strike price Put at a premium of say, Rs 18, with the same expiry, then
The total premium paid for this strategy will be Rs 20 + Rs 18 = Rs 38.
This is the total loss that you can incur on this transaction. Hence, if the lot size of ABC is 200, your net total loss is limited to Rs 38 x 200 = Rs 7,600. While your loss is limited, your profits can, however, be unlimited to the extent of the movement of the stock ABC above or below the breakeven point which is
Breakeven for the Call = Strike price of the Call + total premium paid for the straddle,

That is, Rs 100 + Rs 38 = Rs 138

Breakeven for the Put = Strike price of the Put total premium paid for the straddle, that is Rs 100- Rs 38 = Rs 62
The breakeven point for the above example is Rs 62 on the lower side and Rs 138 on the upper side. Any move below Rs 62 or above Rs 138 results in a profitable position for the buyer of the straddle.

Basically, you believe that ABC will have a volatile move. The only glitch is that you are unsure as to whether it will move up or down. This is normally the case when some news is expected pertaining to the markets or a stock which can impact the stock price, either favourably or adversely.

This news can be of a varied nature, there may be election results, the budget, expectations of a good quarterly result, anticipation of a huge order, a huge deal going through, etc. Whatever the reason, the stock is expected to react violently.

Selling A Straddle (Short Straddle): You would sell a straddle when you have a neutral view on the market. Basically, if you feel that a particular stock or an index will not move significantly, you will sell a Call as well as sell a Put.

For example: If a stock ABC is around 100 and you feel that there will not be any great movement in the stock price in the near term, you sell a 100 Call Option at a premium of say Rs 20, and simultaneously sell a 100 Put Option at a premium of say, Rs 18. In this case you receive a total premium of Rs 20 + Rs 18 = Rs 38 upfront upon selling this straddle.

With a lot size of say 200, the total premium amount received by you on the sale of this Straddle would be Rs 38 x 200 = Rs 7,600. This is the maximum profit that you can have as the seller of this straddle. Whereas, the loss can be unlimited if ABC moves significantly on either side - above or below the breakeven point.

Breakeven for the Call = Strike price of the Call + total premium paid for the straddle, that is, Rs 100 + Rs 38 = Rs 138

Breakeven for the Put = Strike price of the Put- total premium paid for the straddle, that is, Rs 100- Rs 38 = Rs 62

The seller of a straddle has to keep aside margin amounts for selling the Call and the Put. Also, as the time of expiry nears, the premium drops in value and this is favourable for the seller.