S3: Bullish index, buy Nifty calls or sell Nifty puts

sunandaC

New member
Do you sometimes think that the market index is going to rise? That you could make a profit by adopting a position on the index? How does one implement a trading strategy to benefit from an upward movement in the index? Today, using options you have two choices:

1. Buy call options on the index; or,

2. Sell put options on the index

We have already seen the payoff of a call option. The downside to the buyer of the call option is limited to the option premium he pays for buying the option. His upside however is potentially unlimited.

Having decided to buy a call, which one should you buy? Table 7.1 gives the premia for one-month calls and puts with different strikes.

Given that there are a number of one–month calls trading, each with a different strike price, the obvious question is: which strike should you choose? Let us take a look at call options with different strike prices.

Assume that the current index level is 1250, risk-free rate is 12% per year and index volatility is 30%. The following options are available:

1. A one month call on the Nifty with a strike of 1200.

2. A one month call on the Nifty with a strike of 1225.

3. A one month call on the Nifty with a strike of 1250.

4. A one month call on the Nifty with a strike of 1275.

5. A one month call on the Nifty with a strike of 1300.

Which of these options you choose largely depends on how strongly you feel about the likelihood of the upward movement in the market index, and how much you are willing to lose should this upward movement not come about.

There are five one–month calls and five one–month puts trading in the market. As a person who wants to speculate on the hunch that the market index may rise, you can also do so by selling or writing puts. As the writer of puts, you face a limited upside and an unlimited downside.
Having decided to write a put, which one should you write?

Given that there are a number of one-month puts trading, each with a different strike price, the obvious question is: which strike should you choose ? This largely depends on how strongly you feel about the likelihood of the upward movement in the market index.

In the example in Figure 7.2, at a Nifty level of 1250, one option is in–the–money and one is out–of–the–money.

As expected, the in–the–money option fetches the highest premium of Rs.64.80 whereas the out–of–the–money option has the lowest premium of Rs.18.15.
 
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