Financial Risk Management

Course Code: BAEF3139

Dr. Muneer Shaik
School of Management
Mahindra University
STRATEGY 1: LONG CALL
• Mr. XYZ is bullish on Nifty on 24th June, when the Nifty is at 4191.10. He buys a call option with a strike
price of Rs. 4600 at a premium of Rs. 36.35, expiring on 31st July. If the Nifty goes above 4636.35, Mr. XYZ
will make a net profit (after deducting the premium) on exercising the option. In case the Nifty stays at or
falls below 4600, he can forego the option (it will expire worthless) with a maximum loss of the premium.

• When to use: Investor is very bullish on the stock/index

• Risk: Limited to the premium (maximum loss if market expires at or below the option strike price.
• Reward: Unlimited
• Breakeven: Strike Price + Premium
STRATEGY 2: SHORT CALL
• Mr. XYZ is bearish about Nifty and expects it to fall. He sells a Call option with a strike price of Rs. 2600 at
a premium of Rs. 154, when the current Nifty is at 2694. If the Nifty stays at 2600 or below, the Call
option will not be exercised by the buyer of the Call and Mr. XYZ can retain the entire premium of Rs. 154.

• When to use: Investor is very aggressive and he is very bearish about the stock/index.
• Risk: Unlimited
• Reward: Limited to the amount of premium
• Breakeven: Strike Price + Premium
• Since the investor does not own the underlying stock that he is shorting this strategy is also called Short
Naked Call.
STRATEGY 3: LONG PUT
• Mr. XYZ is bearish on Nifty on 24th June, when the Nifty is at 2694. He buys a Put option with a
strike price Rs. 2600 at a premium of Rs. 52, expiring on 31st July. If the Nifty goes below 2548,
Mr. XYZ will make a profit on exercising the option. In case the Nifty rises above 2600, he can
forego the option (it will expire worthless) with a maximum loss of the premium.

• When to use: Investor is bearish about the stock index.

• Risk: Limited to the amount of premium paid. (Maximum loss if stock/index expires at or above the option
strike price.
• Reward: Unlimited
• Breakeven: Stock price – Premium
STRATEGY 4: SHORT PUT
• Mr. XYZ is bullish on Nifty when it is at 4191.10. He sells a Put option with a strike price of Rs. 4100 at a
premium of Rs. 170.50 expiring on 31st July. If the Nifty index stays above 4100, he will gain the amount
of premium as the Put buyer won’t exercise his option. In case the Nifty falls below 4100, Put buyer will
exercise the option and the Mr. XYZ will start losing money. If the Nifty falls below 3929.50, which is the
breakeven point, Mr. XYZ will lose the premium and more depending on the extent of the fall in Nifty.

• When to use: Investor is very bullish on the stock/index. The main idea is to make a short term income.
• Risk: Put Strike price – Put Premium
• Reward: Limited to the amount of Premium received.
• Breakeven: Put Strike price – Premium
STRATEGY 5: SYNTHETIC LONG CALL /: BUY STOCK, BUY PUT
PROTECTIVE PUT
• Mr. XYZ is bullish about ABC Ltd stock. He buys ABC Ltd. at current market price of Rs. 4000 on 4th July. To
protect against fall in the price of ABC Ltd. (his risk), he buys an ABC Ltd. Put option with a strike price Rs.
3900 (OTM) at a premium of Rs. 143.80 expiring on 31st July.

• When to use: When ownership is desired of stock yet investor

is concerned about the near-term downside risk. The outlook is
Conservatively bullish.
• Risk: Losses limited to stock price + Put premium – Put strike price
• Reward: Profit potential is unlimited
• Breakeven: Put Strike price + Put premium + Stock price – Put Strike price
STRATEGY 6: SYNTHETIC LONG PUT / : SELL STOCK, BUY CALL
PROTECTIVE CALL
• Suppose ABC Ltd. is trading at Rs. 4457 in June. An investor Mr. A buys a Rs 4500 call for Rs. 100 while
shorting the stock at Rs. 4457. The net credit to the investor is Rs. 4357 (Rs. 4457 – Rs. 100).

• When to use: Investor is bearish, but wants to protect against any unexpected rise in the price of the stock.
• Risk: Limited.
Maximum risk is Call strike price – Stock price + Premium
• Reward: Maximum is stock price – call premium
• Breakeven: Stock price – call premium
STRATEGY 7: COVERED CALL : BUY STOCK, SELL CALL
• Mr. A bought XYZ Ltd. for Rs. 3850 and simultaneously sells a call option at a strike price of Rs. 4000.
Which means Mr. A does not think that the price of XYZ ltd. Will rise above Rs. 4000. However, in case it
raises above Rs. 4000, Mr. A does not mind getting exercised at that price and exiting the stock at Rs.
4000. (Target sell price = 3.90% return on the stock purchase price). Mr. A receives a premium of Rs. 80 for
selling the call. Thus net outflow to Mr. A is (Rs 3850-80 ) Rs 3770. He reduces the cost of buying the stock
by this strategy.
• If the stock price stays at or below Rs. 4000, the call option will not get exercised and Mr. A can retain Rs.
80 premium, which is an extra income.
• If the stock price goes above Rs 4000, the call option will get exercised by the call buyer. The entire
position will work like this.
STRATEGY 7: COVERED CALL: BUY STOCK, SELL CALL
• When to use: This is often employed when an investor has a short-term neutral to moderately bullish view
on the stock he holds. He takes a short position on the call option to generate income from the option
premium.
• Since the stock is purchased simultaneously with writing(selling) the call, the strategy is commonly referred
to as “buy-write”.
• Risk: If the stock price falls to zero, the investor losses the entire value of the stock but retains the premium,
since the call will not be exercised against him. So maximum risk = stock price paid – Call premium.
• Upside capped at the strike price plus the premium received. So if the stock rises beyond the strike price
the investor (call seller) gives up all the gains on the stock.
• Reward: Limited to (Call Strike price – Stock price paid)+premium received.
• Breakeven: Stock price paid – Premium received.
STRATEGY 8: COVERED PUT: SELL STOCK, SELL PUT
• Suppose ABC Ltd. is trading at Rs 4500 in June. An investor, Mr. A, shorts Rs 4300 Put by selling a July Put
for Rs. 24 while shorting an ABC Ltd. stock. The net credit received by Mr. A is Rs. 4500 + Rs. 24 = Rs. 4524.

• When to use: Investor views that markets are moderately bearish,

• Risk: Unlimited, if the price of the stock raises substantially.
• Reward: Maximum is (Sale price of stock - Strike price) + Put premium
• Breakeven: Sale Price of Stock + Put premium
Thank You!