One strategy that could to benefit in this bearish trend would be the ’strip’ strategy. This strategy is considered the bear market adaptation of the ‘straddle‘ strategy. It’s developed on the concepts of ‘at-the-money’ and ‘in-the-money.’ Let us focus on the terms that require understanding before moving to the actual strategy.

Strike Price: The price at which the option holder can buy or sell the item underlying the option from the writer of that option.

Example
An ABC 50 call option gives the holder the right to purchase 100 shares of ABC stock at a price of Rs. 50 per share. On the other hand, an ABC 40 put option gives the holder the right to sell 100 shares of ABC at a price of Rs. 40 per share.

At-the-money: Options are defined ‘at the money’ when the common stock price is equal to the strike price.

In-the-money: A call option is defined ‘in the money’ when the strike price is less than the market price of the stock. A put option is in the money when the strike price is greater than the market price of the stock.

Ok, that’s clear, then? Let’s move ahead to our main plot.

Strip strategy involves buying a number of at-the-money calls and twice the number of puts of the same underlying stock, strike price, and expiration date.

Investors can take the most benefit from this strategy whenever the market has a bounce back. This could happen due to measures such as CRR rate cuts, Repo rate and Reverse Repo rate cuts, PLR and SLR rate cuts by the RBI to increase the liquidity for banks and investors, the government announcing stimulus packages for certain sectors, or steps taken by the US central bank to make the global financial market stabilize. This would be the right time to execute this strategy if, as an investor, you are convinced that it is a bear market relief rally and direction of the market in the near term is going to remain south.

Profit Potentiality: This strategy has the potential for large amounts of profit when the underlying stock price makes a strong move either upwards or downwards at expiration, with greater gains to be made with a downward move.

Risk: The risk is limited in this strategy. The maximum loss for the strip occurs when the underlying stock price on expiration date is trading at the strike price of the call and put options purchased. At, this price all the options expire worthless and the customer losses the net premium and commissions paid.

Computation of break-even points: There are 2 break-even points for the strip option strategy. The break even points can be computed as given below:

• Upper break-even point (BEP) = Strike price of calls/puts + net premium paid

• Lower break-even point = Strike price of calls/puts - (net premium paid/2)

Example: ABC stock is trading at Rs. 2000 in December. An options trader implements a strip strategy buying two January puts for Rs. 120 per share as premium for strike price of Rs. 2000 and a January call for Rs. 100 per share as premium for the same strike price. The net debit taken to enter the trade is Rs. 34,000. The market lot size as 100 shares.

If ABC stock is trading at Rs. 2500 on expiration in January, the January puts will expire worthless but the January call expires in the money and has an intrinsic value of Rs. 50,000 (500 rise in per stock price x 100 lot size). Subtracting the initial debit of Rs. 34,000 the strip’s profit will be Rs. 16,000.

If ABC stock price reduces to Rs.1500 on expiration in January, the January call will expire worthless but the two January puts expires ‘in the money’ and possess intrinsic value of Rs. 1 lakh (i.e. Rs. 50,000 x 2 put options). Reducing the initial debit of Rs. 34,000 the strip’s profit will be Rs. 66,000.

On expiration in January, if ABC stock is still trading at Rs. 2000, both the January puts and the January call will expire worthless and strip will suffer the loss of the Rs. 34,000 paid as premium to enter the trade.
The 2 break-even points in this case will be:

• Upper break-even point = Rs.2000 (strike price) + Rs. 340 (Rs. 120 x 2 put premium + Rs. 100 call premium) = Rs. 2340.

• Lower break-even point = Rs.2000 (strike price) - Rs. 170 (Rs. 340 i.e. net premium/2) = Rs. 1830.

In this example the stock has to break the price band of Rs.1830 to Rs.2340 to be profitable i.e. decline below Rs. 1830 or appreciate beyond Rs. 2340. If the stock price fails to break the price band upper and lower BEP investors will end up losing the entire premium paid for executing this strategy.

The strip strategy could be the right option-trading approach for investors who are bearish on the market and expect it to correct in near future.

The equity markets were up with a bang. The bulls had a party and celebrations post Diwali festival. It is considered as a remarkable recovery from the bottom. Well, it seems difficult to talk about whether this bull party will last for a long time. Global economic issues have still not been resolved and how much of that it’s going to affect other emerging markets, including India, is difficult to predict. The markets are facing many negative news and higher volatility in the day-to-day sessions. It’s getting difficult for investors to take a position in these market conditions. This is where the straddle strategy will play a vital role for the investors to hedge the position and profit from it.

This strategy is built on the concept of call and put options. Let’s understand what these mean before going in-depth to understand straddle.

Call Options - A call option gives its holder the right to buy a specified number of shares of the underlying stock at a predetermined price (strike price) between the date of purchase and the option’s expiration date.

Example: An investor who bought an ABC December 1000 call option would have the right, but not the obligation, to buy 100 shares of ABC common stock at a cost of Rs. 1000 per share at any time before the option expires in December.

The right to purchase common stock at a fixed price becomes more valuable as the price of the underlying common stock increases in the bullish trend.

Put Options - A put gives the holder the right to sell a specified number of shares of the underlying common stock at a predetermined price (strike price) on or before the expiration date of the contract.

Example: An investor who bought an ABC December 1000 put option would have the right, but not the obligation, to sell 100 shares of ABC common stock at a cost of Rs. 1000 per share at any time before the option expires in December.

The right to sell common stock at a fixed price becomes more valuable as the price of the underlying common stock decreases in the bearish trend.

Now let’s understand how the straddle strategy operates for investors. Fundamentally, a straddle is the simultaneous purchase of a call and a put on the same stock, with the identical strike price (the price at which the holder can sell or buy from the writer of the option) and expiration month. Typically, the buyer of a straddle anticipates a substantial movement in a stock but is uncertain what the direction will be. Because the investor is betting on an extraordinary stock movement in this the volatile markets. The probability of profiting is good.

A straddle buyer risks losing only the amount of premium (the price that the buyer of an option pays and the writer of the option receives). The maximum loss occurs only if the price of the stock on the expiration date of the options is exactly equal to the strike price. Although it is difficult to lose the entire premium paid for the straddle, it also can be difficult to make a profit. Either the put or the call side of a straddle is almost certain to expire worthless. As, a result, the stock has to move substantially for a profit to be made. Considering the trend of last few trading sessions there were many intense moves for investor. Therefore, it’s considered one of the best strategies to bet on these volatile markets, where the swing in stock prices to different levels in multiple/one trading session gives the opportunity for investors to fill their bag full of profits.

Example:

An investor purchases both a put and a call on a stock, paying Rs. 250 for the call and Rs. 200 for the put. Therefore, the total premium cost would be Rs. 450. Suppose the underlying stock’s price is Rs. 3000 and the strike price of the options is Rs. 3000. If the price of the stock rises above Rs. 3450 or drops below Rs. 2550, the investor will make a profit. Only if the stock expires at a strike price of Rs. 3000 will the investor lose the entire investment. The investor loses only part of the investment at any other price between Rs. 2550 and Rs. 3450.

The investor earns a profit if the stock sells at a price exceeding Rs. 3450 or drops to less than Rs. 2550. If the stock rises to Rs. 3750 per share and the investor exercises the call at Rs. 3000, the investors profit is Rs. 300 (Rs. 750 - Rs. 450 premium). Alternatively, if the stock drops to Rs. 2150 per share and the investor exercises his/her put at Rs. 3000, the profit is Rs. 400 (Rs. 850 - Rs. 450 premium). Thus, the investor is assured of a profit only if the stock moves by more than Rs. 450 in either direction.

The above strategy and example were discussed considering equity markets. This strategy is also useful to hedge a position on commodities in commodity market.

Today, the equity market has been discounted by almost 50% from its peak. Investors are bearish to enter in this market. In the current scenario Indian equity markets are reacting with global cues. So, any positive cue of stabilization in global markets will start showing uptrend in our markets too. To take the advantage of this uptrend with minimum risk exposure in these scenario investors should follow the 90/10 strategy which will keep them in the loop. Now, there might be few questions rising in the mind of investors such as, what is 90/10 strategy? How they will be benefiting with this strategy?
Basically, the 90/10 strategy involves purchasing calls on the same number of shares of stock that would have been purchased outright, then investing the difference in a fixed income security such as government bonds. The name of the strategy is derived from the most common proportion in which the investments are allocated: 90 percent in government bonds and 10 percent in index or stock call options. This strategy is particularly appropriate for an investor who is not interested to risk his/her capital by investing in the stock market but wishes to participate in the growth of the stock market with limited risk exposure. Interest on the government bonds covers part of the possible loss on the calls. This strategy permits the investor to benefit from favorable stock price movements while limiting the downside risk to the call premium less any interest earned. It is particularly effective approach in periods of high interest rates because of greater interest income.

Example:
The common stock of ABC sells at Rs. 2000 per share. The purchase of 100 shares will cost Rs. 200,000. Let’s also assume that this investor’s upper limit on investment is Rs. 200,000.
Now, let’s assume that the stock call option’s strike price is fixed at Rs. 2000 per share, with a premium of Rs 200 per share. Therefore, if the investor wants to buy the hundred shares it would cost him/her just Rs. 20000. This, in turn, would leave him/her Rs. 180,000 to be invested in something safer, such as government bonds.
Suppose the government bonds mature in six months and earn 6 percent interest. The Rs. 180,000 would earn interest of Rs. 5400 (Rs. 1,80,000 x 0.06 x 6/12). This interest reduces the investor’s cost of the call to Rs. 14600 (Rs. 20000 - Rs. 5400). The Rs. 14600 also represents the investors maximum risk exposure compared to the Rs. 200,000 cost if the 100 shares were purchased outright.
The beauty of this strategy is that although the risk is limited, the potential capital appreciation is not. Once the market price of ABC increases beyond the strike price, the call buyer could realize the same rupee appreciation at expiration as that of an investor who owns 100 shares of the common stock. Therefore, this strategy limits risk to the net cost of the call while still enabling investors to realize capital appreciation.