Options Trading Strategies: Bearish - Protective Call strategy

This strategy is simply the reversal of Synthetic Call Strategy. It is implemented when a trader is bearish on the market and expects to go down. Trader will short underlying stock in the cash market and buy either an ATM Call Option or OTM Call Option. The Call Option is bought to protect / hedge the upside risk on the short position. The net payoff will be similar to that of Long Put.

Risk: Limited

Reward: Unlimited

Construction

Sell 250 RIL Shares
Buy 1 ATM Call Option

Example

RIL is trading at Rs. 745 levels; Mr. X is bearish and expects the stock to fall in the near future. He shorts 250 shares of RIL @ Rs. 745 in the futures market. Remember when you short in cash market you have to cover it by end of the day, so here you will short in the futures market so that you can hold your short positions till expiry. In order to hedge himself in short positions, he will buy one 740 ATM Call Option at a premium of Rs. 22. The lot size of RIL Option is 250.

Case 1: At expiry if RIL falls up to Rs. 720, then Mr. X will make a profit of Rs. 750. [(745-720)-22)*250]

Case 2: At expiry if RIL stays at Rs. 742, then Mr. X will make a loss of Rs. 4250. [(745-742) + (2-22)*250]

Case 3: At expiry if RIL goes up to Rs. 760, then Mr. X will make a loss of Rs. 4250 [{(745-760) + (20-22)}*250]. Here Mr. X will make loss both on his short position and long call position.

Payoff Chart