Investment in Derivatives
A few basis strategies which investor can take into consideration while investing into the market-
A view on the market
A. Assumption: Bullish on the market over the short term
Possible Action by investors: Buy Nifty calls
Example:
Current Nifty is 1880. You buy one contract of Nifty near month calls for Rs.20 each. The strike price is 1900, i.e. 1.06% out of the money. The premium paid by you will be (Rs.20 * 200) Rs.4000.Given these, your break-even level Nifty is 1920 (1900+20). If at expiration Nifty advances by 5%, i.e. 1974, then
Nifty expiration level 1974.00
Less Strike Price 1900.00
Option value 74.00 (1974-1900)
Less Purchase price 20.00
Profit per Nifty 54.00
Profit on the contract Rs.10800 (Rs. 54* 200)
1) If Nifty is at or below 1900 at expiration, the call holder would not find it profitable to exercise the option and would loose the entire premium, i.e. Rs.4000 in this example. If at expiration, Nifty is between 1900 (the strike price) and 1920 (breakeven), the holder could exercise the calls and receive the amount by which the index level exceeds the strike price. This would offset some of the cost.
2) The holder, depending on the market condition and his perception, may sell the call even before expiry.
B. Assumption: Bearish on the market over the short term
Possible Action by Investors: Buy Nifty puts
Example:
Nifty in the cash market is 1880. You buy one contract of Nifty near month puts for Rs.17 each. The strike price is 1840, i.e. 2.12% out of the money. The premium paid by you will be Rs.3400 (17*200).
Given these, your break-even level Nifty is 1823 (i.e. strike price less the premium). If at expiration Nifty declines by 5%, i.e.1786, then
Put Strike Price 1840
Nifty expiration level 1786
Option value 54 (1840-1786)
Less Purchase price 17
Profit per Nifty 37
Profit on the contract Rs.7400 (Rs.37* 200)
1) If Nifty is at or above the strike price 1840 at expiration, the put holder would not find it profitable to exercise the option and would loose the entire premium, i.e. Rs.3400 in this example. If at expiration, Nifty is between 1840 (the strike price) and 1823 (breakeven), the holder could exercise the puts and receive the amount by which the strike price exceeds the index level.
2) The holder, depending on the market condition and his perception, may sell the put even before expiry.
Put as a portfolio Hedge
Assumption: Investors are concerned about a downturn in the short term in the market and its effect on your portfolio.
The portfolio has performed well and you expect it to continue to appreciate over the long term but would like to protect existing profits or prevent further losses.
Possible Action by Investor: Buy Nifty puts.
Example:
You held a portfolio with say, a single stock, HLL valued at Rs.10 Lakhs (@ Rs.200 each share). Beta of HLL is 1.13. Current Nifty is at 1880.
Nifty near month puts of strike price 1870 is trading at Rs.15. To hedge, you bought 3 puts 600{Nifties, equivalent to Rs.10 lakhs*1.13 (Beta of HLL) or Rs.1130000}. The premium paid by you is Rs.9000, (i.e.600 * 15). If at expiration Nifty declines to 1800, and Hindustan Lever falls to Rs.195, then
Put Strike Price 1870
Nifty expiration level 1800
Option value 70 (1870-1800)
Less Purchase price 15
Profit per Nifty 55
Profit on the contract Rs.33000 (Rs.55* 600)
Loss on Hindustan Lever Rs.25000
Net profit Rs. 8000
A few basis strategies which investor can take into consideration while investing into the market-
A view on the market
A. Assumption: Bullish on the market over the short term
Possible Action by investors: Buy Nifty calls
Example:
Current Nifty is 1880. You buy one contract of Nifty near month calls for Rs.20 each. The strike price is 1900, i.e. 1.06% out of the money. The premium paid by you will be (Rs.20 * 200) Rs.4000.Given these, your break-even level Nifty is 1920 (1900+20). If at expiration Nifty advances by 5%, i.e. 1974, then
Nifty expiration level 1974.00
Less Strike Price 1900.00
Option value 74.00 (1974-1900)
Less Purchase price 20.00
Profit per Nifty 54.00
Profit on the contract Rs.10800 (Rs. 54* 200)
1) If Nifty is at or below 1900 at expiration, the call holder would not find it profitable to exercise the option and would loose the entire premium, i.e. Rs.4000 in this example. If at expiration, Nifty is between 1900 (the strike price) and 1920 (breakeven), the holder could exercise the calls and receive the amount by which the index level exceeds the strike price. This would offset some of the cost.
2) The holder, depending on the market condition and his perception, may sell the call even before expiry.
B. Assumption: Bearish on the market over the short term
Possible Action by Investors: Buy Nifty puts
Example:
Nifty in the cash market is 1880. You buy one contract of Nifty near month puts for Rs.17 each. The strike price is 1840, i.e. 2.12% out of the money. The premium paid by you will be Rs.3400 (17*200).
Given these, your break-even level Nifty is 1823 (i.e. strike price less the premium). If at expiration Nifty declines by 5%, i.e.1786, then
Put Strike Price 1840
Nifty expiration level 1786
Option value 54 (1840-1786)
Less Purchase price 17
Profit per Nifty 37
Profit on the contract Rs.7400 (Rs.37* 200)
1) If Nifty is at or above the strike price 1840 at expiration, the put holder would not find it profitable to exercise the option and would loose the entire premium, i.e. Rs.3400 in this example. If at expiration, Nifty is between 1840 (the strike price) and 1823 (breakeven), the holder could exercise the puts and receive the amount by which the strike price exceeds the index level.
2) The holder, depending on the market condition and his perception, may sell the put even before expiry.
Put as a portfolio Hedge
Assumption: Investors are concerned about a downturn in the short term in the market and its effect on your portfolio.
The portfolio has performed well and you expect it to continue to appreciate over the long term but would like to protect existing profits or prevent further losses.
Possible Action by Investor: Buy Nifty puts.
Example:
You held a portfolio with say, a single stock, HLL valued at Rs.10 Lakhs (@ Rs.200 each share). Beta of HLL is 1.13. Current Nifty is at 1880.
Nifty near month puts of strike price 1870 is trading at Rs.15. To hedge, you bought 3 puts 600{Nifties, equivalent to Rs.10 lakhs*1.13 (Beta of HLL) or Rs.1130000}. The premium paid by you is Rs.9000, (i.e.600 * 15). If at expiration Nifty declines to 1800, and Hindustan Lever falls to Rs.195, then
Put Strike Price 1870
Nifty expiration level 1800
Option value 70 (1870-1800)
Less Purchase price 15
Profit per Nifty 55
Profit on the contract Rs.33000 (Rs.55* 600)
Loss on Hindustan Lever Rs.25000
Net profit Rs. 8000