With various option strategies such as long call/put, short call/put, straddle, strangle, butterfly, spread etc. possible, it is very easy to get confused as to which strategy one should adopt to fulfill ones objective of maximizing gains or hedging. If you have a view on market trend (bullish / bearish / neutral / volatile), you can make optimum use of the strategy guide given below. Click on the appropriate link to get details of the strategy that you should adopt in the given scenario.

BULLISH STRATEGY Very Bullish Buy Call Moderately Bullish + Certain that the market will not fall Sell Put Moderately Bullish + Fairly certain that the market will not fall Bull Spread Bearish in immediate near-term (weeks) + bullish in long term (months) Diagonal Spread BEARISH   Very Bearish Buy Put Certain that the market will not rise Sell Call Moderately bearish + Fairly certain that the market will not rise Bear Spread Flat/mod. bullish in near-term(weeks) + bearish in longer term (months) Diagonal Spread Hold stock and bearish Put Hedge NEUTRAL   Expect prices to fluctuate in very narrow range Sell Straddle Expect prices to fluctuate in a broader range Sell Strangle Moderately certain that prices will not fluctuate much Long Butterfly Expect short-term weakness but longer-term rally Calendar Spread Hold stock but expect no movement Covered Call VOLATILE   Expect prices to be very volatile Buy Straddle Expect prices to be volatile Buy Strangle Moderately expect prices to be volatile Short Butterfly

BULLISH

Very Bullish – BUY CALL

Strategy View You think that the market will rise significantly in the short-term. Strategy Implementation Buy Call option with a strike price ‘x’. The more bullish you are, the higher the strike price should be, i.e. the more out-of-the-money the option you buy. (However, the more out-of-the-money the option is, the less likely that it will make money) Upside Potential Profit potential is unlimited and rises as the market rises. Breakeven Point at Expiry Strike Price + Premium Downside Risk Limited to the premium paid for the option and is incurred if the market at expiry is at, or below, the strike ‘x’. Margin Not Required Comment Once you have bought the option, the strike price is fixed. Other things remaining constant, the value of the option decays as time passes. This is why some people say, a call is a “wasting asset”. If price goes up or volatility increases, the erosion slows. If price drops or volatility decreases, the erosion speeds up.

Moderately Bullish + Certain that the market will not fall – SELL PUT

Strategy View You are certain that the market will not go down, but unsure / unconcerned about whether it will rise. Strategy Implementation Sell Put option with a strike price ‘x’. If you are very bullish and aggressive, then sell in-the-money puts. If conservative, sell out-of-the-money puts. Upside Potential Profit potential is limited to the premium received. The more the option is in-the-money, the greater will be the premium you will receive. Breakeven Point at Expiry Strike Price - Premium Downside Risk Loss is almost unlimited (“almost” as the underlying price cannot fall below Zero!). [ If the strategy appeals, but not the downside risk, investors may prefer a ‘Bull Spread’] Margin Always Required Comment If the market does little, and time passes, this helps as the short position gains when the time value erodes.

Moderately Bullish + Fairly certain that the market will not fall – BULL SPREAD

Strategy View You are bullish but unsure. You think that the market will not fall, but want to cap the risk. Conservative strategy for one who thinks that the market is more likely to rise than fall. Strategy Implementation USING CALLS USING PUTS   Long a Call with strike price ‘x’ and Short another Call with a higher strike price ‘y’, producing a net initial debit. Long a Put at a strike price ‘x’ and Short another Put with a higher strike price ‘y’, producing a net initial credit. Upside Potential Limited to Difference between Strikes minus Initial Debit. Limited to Net Initial Credit Maximum Profit if market at expiry is above the higher strike price. Downside Risk Limited to Net Initial Debit Limited to Difference between Strikes minus Initial Credit. Maximum Loss if market at expiry is below the lower strike price. Margin Possibility for Margin Requirements to be off-set. Comment Time value erosion not too significant due to balanced position. The benefit of buying a spread is that it requires a smaller investment than buying a single call / put. The cost is that it makes less money (limited) than the call (unlimited) should the stock rise sharply.

Bearish in immediate near-term (weeks) + bullish in long term (months) – DIAGONAL SPREAD

Strategy View You think that the market will be weak in the short term, but then rally later. Strategy Implementation A near-dated call option is sold, and a longer dated, further out-of-the-money call option is bought. Upside Potential Unlimited, if the bought option is held after the short option expires (the position then becomes a straight-forward buy call). If the position is closed at expiry of the near option, maximum profit will accrue if the market is at the level of the sold strike. Downside Risk Limited to the difference in strikes plus / minus the initial debit / credit when establishing the spread. Margin Yes, but off-set may apply Comment There is a risk of the sold options being called (i.e. being exercised).

BEARISH

Very Bearish – BUY PUT

Strategy View You think that the market will fall significantly in the short-term. Strategy Implementation Buy Put option with a strike price ‘x’. The more bearish you are, the lower the strike price should be, i.e. the more out-of-the-money the option you buy. (However, the more out-of-the-money the option is, the less likely that it will make money) Upside Potential Profit potential is unlimited (well, not really unlimited of course, as the market cannot fall below Zero!) Breakeven Point at Expiry Strike Price – Premium paid Downside Risk Limited to the premium paid for the option and is incurred if the market at expiry is at, or above the strike ‘x’ Margin Not Required Comment If the market does little, and time passes, the value of the position will decrease as the option time value erodes.

Certain that the market will not rise – SELL CALL

Strategy View You are certain that the market will not rise, but unsure / unconcerned whether it will fall. Strategy Implementation Sell Call option with a strike price ‘x’. If conservative, sell out-of-the-money calls. If you are not so conservative and believe the stock is stagnant, sell at-the-money options. If you are aggressive and confident that the market is going down, sell in-the-money call options. Upside Potential Profit potential is limited to the premium received. The more the option is in-the-money, the greater will be the premium you will receive. Breakeven Point at Expiry Strike Price + Premium Downside Risk Downside risk is unlimited. Losses on the position will increase as the market rises. [ If the strategy appeals, but not the downside risk, investors may prefer a ‘Bear Spread’] Margin Always Required Comment If the market does little, and time passes, this helps as the short position gains when the time value erodes.

Moderately bearish + Fairly certain that the market will not rise – BEAR SPREAD

Strategy View You are bearish but unsure. You think that the market will not rise, but want to cap the risk. Conservative strategy for one who thinks that the market is more likely to fall than rise. Strategy Implementation USING CALLS USING PUTS   Sell a Call with strike price ‘x’ and Buy another Call with a higher strike price ‘y’, producing a net initial credit. Sell a Put at a strike price ‘x’ and Buy another Put with a higher strike price ‘y’, producing a net initial debit. Upside Potential Limited to Net Initial Credit Limited to Difference between Strikes minus Initial Debit. Maximum Profit if market at expiry is below the lower strike price. Downside Risk Limited to Difference between Strikes minus Initial Credit.t Limited to Net Initial Debit Maximum Loss if market at expiry is above the higher strike price. Margin Possibility for Margin Requirements to be off-set. Comment Time value erosion not too significant due to balanced position. The benefit of a bear spread is that it requires a smaller investment. The cost is that it makes less money than a pure long put position should the stock fall sharply.

Flat / moderately bullish in near-term(weeks) + bearish in longer term (months) – DIAGONAL SPREAD

Strategy View You think that the market will be flat or rise only slightly in the short term, but then fall later. Strategy Implementation A near-dated put option is sold, and a longer dated, further out-of-the-money put option is bought. Upside Potential Large, if the bought option is held after the short option expires (the position then becomes a straight-forward buy put). If the position is closed at expiry of the near option, maximum profit will accrue if the market is at the level of the sold strike. Downside Risk Limited to the difference in strikes plus / minus the initial debit / credit when establishing the spread. Margin Yes, but limited Comment There is a risk of the sold options being called (i.e. being exercised).

Hold stock and bearish – PUT HEDGE

Strategy View You hold stock and are worried about a market fall. You can buy Put Options to protect the value of the stock position, while allowing the position to benefit in the event of a market rise. Strategy Implementation Buy Put Options with a strike price ‘x’. The number of put options bought will depend on your bearishness and the size of your stock holding. Upside Potential Profit potential is unlimited, being the ordinary return on the stock minus the fixed premium paid for the put options. Downside Risk Potentially limited (depending on the hedge-ration initially applied). The gains on the put options as the market falls, will off-set the loss in the value of the stock. Margin Not Required Comment Strategy characteristics are similar to a Buy Call.

NEUTRAL

Expect prices to fluctuate in very narrow range – SELL STRADDLE

Strategy View You are certain that the market will not be very volatile, but will stagnate (neither go up or down very much). Strategy Implementation Short a Call and a Put option at the same strike price ‘x’ Upside Potential Limited to the 2 premiums received. This will be realized if market at expiry is exactly at the level of the strike price. Breakeven Point at Expiry The lower point ‘a’ will be the strike minus the value of the 2 premiums received. The upper point ‘b’ will be the strike plus the 2 premiums received. (If you would like to broaden this band, a Sell Strangle might appeal to you) Downside Risk Unlimited, should the market rise or fall greatly. Margin Always Required Comment If the market does little, and time passes, then the value of the position will benefit as the short positions gain when the time value erodes.

Expect prices to fluctuate in a broader range – SELL STRANGLE

Strategy View You expect the market to stagnate within a broadish band. Strategy Implementation Sell Put option with a strike price ‘ x’ and Sell Call option with a higher strike price ‘y’ Upside Potential Limited to the 2 premiums received. Breakeven Point at Expiry Lower point ‘a’ will be the lower strike ‘x’ minus the value of the 2 premiums received. The upper point ‘b’ will be the higher strike ‘y’ plus the 2 premiums received. Downside Risk Unlimited, should the market rise or fall greatly. (If you like this strategy, but not the downside risk, a Long Butterfly might be interesting) Margin Always Required Comment If the market does little, and time passes, then the value of the position will benefit as the short positions gain when the time value erodes.

Moderately certain that prices will not fluctuate much – LONG BUTTERFLY

Strategy View You expect that prices will not fluctuate much, but want to cap the downside risk. Strategy Implementation Buy Call option with low strike ‘a’, Sell 2 Call options with medium strike ‘x’(x > a) and Buy Call option with high strike ‘b’ (b > x > a) Upside Potential Limited to the difference between the lower and the middle strikes minus the net debit of establishing the spread. This is obtained if the stock ends up at the middle point (x) on the expiration day Downside Risk Limited to the initial debit of establishing the spread. This occurs if the stock is on the ‘wing’. Comment Can be difficult to execute such strategies quickly.

Expect short-term weakness but longer-term rally – CALENDAR SPREAD

Strategy View You think that the market will be weak in the short-term, but rally in the longer term. Strategy Implementation You Sell a near-dated Call option and Buy a longer-dated Call option, both options having the same strike price. (If you have the opposite view, then a comparable strategy can be constructed using puts) Upside Potential Large, if the bought option is held after the short option expires (the position then becomes a straightforward Buy Call). If the position is closed at expiry of the near option, maximum profit will accrue if the market is at the level of the sold strike. Breakeven Point at Expiry Strike Price + Premium Downside Risk Limited to the Initial Debit incurred for establishing the spread. Margin Off-set maybe available Comment There is a risk of the sold options being called (i.e. being exercised). Sometimes, this strategy is also called Horizontal or Time spread.

Hold stock but expect no movement – COVERED CALL

Strategy View You hold stock but do not think that the stock will rise in the short term, or that the stock will be neutral. Income can be earned by selling call options against the stock holding. Strategy Implementation Sell Call options. The number of call options that you sell will be determined by your market view and the size of the stock holding. Upside Potential Limited. By selling calls, you are writing off the potential profit of the stock position. Downside Risk Large. Similar to that incurred with ordinary stock ownership, only offset partially by the fixed option premium received. Main loss could be the opportunity lost if the market rises strongly. Margin Always Required

VOLATILE

Expect prices to be very volatile – BUY STRADDLE

Strategy View You think that the market will be very volatile in the short term. You expect a big move but are not sure in which direction. Especially good strategy if the market has been quiet then starts to zigzag sharply. Strategy Implementation Buy Call option and Put option with the same strike price ‘x’, usually at-the-money. Upside Potential Unlimited. The maximum gain is obtained when the stock is up or down significantly. Breakeven Point at Expiry Lower point is the Strike minus the 2 Premiums paid. The upper point is the Strike plus the 2 Premiums paid. Downside Risk Limited to the 2 Premiums paid. This occurs if the stock ends up at the strike price. (If you want to reduce the premium paid, then a Buy Strangle might be interesting) Margin Not Required Comment Position loses value with passage of time as time value decreases on options.

Expect prices to be volatile – BUY STRANGLE

Strategy View You think that the market will be very volatile in the short term. You expect a big move but are not sure in which direction. Strategy Implementation Buy Put option with a strike ‘x’ and Buy Call option with a higher strike ‘y’ Upside Potential Unlimited. The maximum gain is obtained when the stock is up or down significantly. Downside Risk Limited to the 2 Premiums paid. (If you want to reduce the premium paid even further, then a Short Butterfly might be interesting) Margin Not Required Comment Position loses value with passage of time as time value decreases on options. A strangle is cheaper because you buy a lower strike Put, but the stock has to move further to make a profit.

Moderately expect prices to be volatile – SHORT BUTTERFLY

Strategy View Short a Call at strike ‘a’, Buy 2 Calls at a higher strike ‘x’ and Short another Call at a still higher strike ‘b’. (b > x > a) Upside Potential Maximum gain is the proceeds received (net premium) which occurs if the stock rises above the highest strike (b) or falls below the lowest strike (a) Breakeven Point at Expiry Lower point is the lowest strike (a) plus the initial credit. The upper point is the highest strike (b) minus the initial credit. Downside Risk Limited. This occurs when the stock is at the middle strike (x) Comment A Short Butterfly position can also be created using puts, by selling 2 put at strikes ‘a’ and ‘b’, and buying 2 puts at a middle strike ‘x’ (b > x > a)

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