22 Straddle Strategy:
This strategy involves purchasing one call and one put of the same strike price and same expiration period. On the first day of the option series one call and one put both at the money are purchased at the same strike price nearest to the index closing price of the day. In some cases option price with exact stick or closing are not available. The payoff by using this strategy are calculated below
Index (opening) 4150.85
We can see that the closing the index is at 4295.8. Therefore the put option become out-of-the-money and therefore we will not exercise it. The call option will be exercised and the payoff will be
4295.8 – 4150 = 145.8
Deduction the premium from this we will get 145.8 – (115.05 + 101.3) = -70.55
Therefore the final payoff is negative , i.e. we incur loss.
This process is repeatedly applied on the data from Jan- 2007 to May-2011. The corresponding results and graphs are given below
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25 As seen from the above graphs when there was large movement in the index the final pay-off is positive, regardless of the direction of the index movement. When the index is close to the stick price at the time of expiry of contract we realize profit. This is equal to premium paid initially. When the index move above the stick price the call option is exercised and when it moves below the strike price the put option is exercised. In any case the loss is limited to the premium paid however the profit potential is unlimited.
26 Strangle strategy
This strategy involve writing one call and one put with different strike price but same expire date. On the first day of the option contract cycle one call and one put option are written. Both contract expait in one month. This strategy can be applied in two ways.
Purchase of call and put option with different strike price but same expiry date.
Writing of call and put option with different strike price but same expiry date.
The first one work best when large movement in the market is expected but the direction of the movement is uncertain. The second one also called “top vertical strangle” assumes no large movement in the market. Thus the profit is realize if the index movement is within the range of two strike price of the all and the put. Now we will use this strategy on the NSE data from Jan-2007 to May-2011. The payoffs using this strategy are as fallows (in this strategy we will take deepest out of money call option)
Expiry date 25-Jan-07
Suppose we have written these call and put options then the payoff is as follows
As we can see the index closing is 4147.7, now since the call option is in the money it will be exercised and we will have loss equal to
4147.7 – 4110 = 37.7
But we will also get the premium amount of 49.95 which mean we will have a profit of 9.25. and if we see the put option the put option is out of the money therefore it will not be exercised so we will get the premium amount of 11.1. so the actual profit from this strategy will be
9.25 + 11.1 = 20.32
This process is repeatedly applied on the data from Jan- 2007 to May-2011. The corresponding results and graphs are given below
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29 As we can see from the above graph this strategy is very risky with unlimited loss potential and limited profit potential (maximum profit is premium received). But the loss is incurred only when there is extraordinary movement in the index which rarely happens. As the deepest out of the money contract are taken the chances of index going out of the range are less. The strategy works well in the bearish market.
30 Strips and straps strategy
A strips consists of a long position in one call and two puts with the same strike price and expiration date. A straps consist of a long position in two call and one put with the same strike price and expiration date. In a strap the investor is betting that there will be a big stock price movement and consider a decrease in the stock price to be more likely than an increase. In strap the investor is also betting that there will be a big stock price movement. However in this case an increase in the stock price is considered to be most likely than decrease.
Now we will use this strategy on the NSE data from Jan-2007 to May-2011. The payoffs using this strategy are as fallows
The index closing is 4295.8 and we are the buyer of the call and put option so the call options will we in the money so our gain will be
4294.8 – 4150 – 115.05 = 29.75
But the put options are out of the money so we will have a loss of premium paid on two put option 101.3 * 2 = 202.6
So the net position will 29.75 – 202.6 = - 172.85. We have incurred a loss of -202.6. This process is repeatedly applied on the data from Jan- 2007 to May-2011. The corresponding results and graphs are given below
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The index closing is 4295.8 and we are the buyer of the call and put option so the call options will we in the money so our gain will be
[{2(4294.8 – 4150)} –{( 115.05*2)}] = 59.5
But the put options are out of the money so we will have a loss of premium paid on one put option 101.3
So the net position will 59.5 – 101.3 = - 39.8. We have incurred a loss of 39.8. This process is repeatedly applied on the data from Jan- 2007 to May-2011. The corresponding results and graphs are given below
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36 Butterfly strategy
A butterfly involves positions in options with three different strike price. It can be created by buying a call options with a relatively low strike price, k1, buying a call option with a relatively high strike price k3, and sell two call options with a strike price k2, halfway between k1 & k3. Generally k2 is close to the current stock price. A butterfly strategy leads to a profit if the stock prices stay close to k2, but rise to a small loss if there is a significant stock price movement either way. It is therefore appropriate strategy for all an investor who feels that large stock price moves are unlikely. The strategy requires a small investment initially. The payoffs of butterfly strategy are given below.
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Expiry Strike Price Premium index closing
Call option(K1 ) 25-Jan-07 4110 46.95 4007.4
2 Call option(K2)
25-Jan-07 4000 101.95 4007.4
Call option(K3) 25-Jan-07 3590 300.45 4007.4
Now we can see that index closing is 4007.4 and we have purchase two call options (k1 &k3 ) and we have sold two call option (k2), as we see both the call options i.e. k1 & k3 are out of the money so we will not exercise those call options. So the loss will be the premium amount paid
46.95 + 300.45 = 347.4
And the buyer of the call option will exercise the call option so the cash flow from the transaction will be 2* (4007.4 – 4000 + 101.95 )= 217.9
So the net amount from the transaction will be
217.9 – 347.4 = - 129.5
This process is repeatedly applied on the data from Jan- 2007 to May-2011. The corresponding results and graphs are given below
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40 Butterfly strategies have given negative return in all the period because these year there was a great volatility in the stock price movement.
Buy and hold strategy
Buy and hold strategy simply involves buying a index at a price at the opening of the month and selling at the end of the month. The corresponding results and graphs are given below for the buy and hold strategy.
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Dec 216.5 276.25 79.05 140.95
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43 Comparison of various derivatives trading strategies(on monthly basis from jan-2007 to may-2011)
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