This non-directional strategy must be used when the investor is not sure on the market direction but all he is looking out for is the stock/index to break out exponentially in either direction (upside or downside).
This strategy involves Buying a Call as well as Put on the same underlying for the same maturity and different out of the money Strike Price. This strategy gives the investor an advantage of a movement in either direction — i.e. Upside or Downside.
The best part is, The profits can be made in either direction if the underlying shows volatility to cover the cost of the trade. The loss is limited to the premium paid in buying the options.
Let’s discuss it in detail (with an example):
Trader’s view: Exponentially in either direction.
Trader’s Risk: Limited to the premium paid.
Trader’s Reward: Unlimited.
Lower Breakeven: Strike Price — net premium paid.
Higher Breakeven: Strike Price + net premium paid
• Upper Breakeven Point = Strike Price of Long Call + Net Premium Paid
• Lower Breakeven Point = Strike Price of Long Put — Net Premium Paid
Let’s understand with the help of a very simple example:
Example- On 11th December 2018 assembly election results of four states were supposed to be announced and we were pretty sure that whatever will be the result, the market will fluctuate accordingly. So we saw Nifty Bank Index in the morning (around 9.45 AM) and bought one OTM call option of Strike price 25800 and one OTM put option of strike price 25400. Call Option’s premium was at 225.00Rs and Put option was at 213.15Rs. (I have indicated the premiums with the help of black arrow and boxes).
Please note the prices in the option chain of the nifty bank given below.
The amount we spent on taking these calls are 225 + 213.15 = 438.15 Rs
We will be in profit as soon as the total of both the option premium reaches above 438.15 Rs. and if in case the market does not fluctuate a lot and remains neutral, then there will be the loss in both option premiums due to Time Decay and we will be in Loss.
Now let us check the premium at 3.25 PM on the same day.
At 3.25 PM
CALL Option premium at the strike of 25800 is 449.95 Rs
PUT Option premium at the strike of 25400 is 29.45 Rs
Total of Premium = 449.95 + 29.45 = 479.4 Rs
Total Profit from the trade is = 479.4 –438.15 = 41.25 Rs
Thus we made a good amount of profit due to high volatility in the market. so, remember that the price of premium always increases with an increase in volatility.
Let’s see the Payoff chart and understand what would have happened if we would have held the contracts till expiry.
Payoff from Call Purchased = Stock Price-Strike Price –Premium Price
Payoff from Put Purchased = Strike price — Stock Price — Premium
So, this strategy will work every time you expect a sudden upswing or downswing in the market. (which is usual in most of the cases.)
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