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By Malvika Raghuvanshi,

People are afraid in investing their money in today’s market, thinking that the market may again come down. But wherever the market goes, you can always make profit. Whether the particular script is moving up,  coming down or not moving at all. In any case, you are in profit only. Some people do not believe it but it is the fact. Believe me.

There are some strategies by which hedging the positions the profit can be made. These can be explained through some examples.

Before explaining the hedging strategies let me clear one thing that investing in future & option is beneficial than investing in cash market. The investment amount is reduced to margin money only. Example1. The short position can be taken and carried it forward Example2 and Hedging can be position Example3.

There are various hedging strategies. But the strategies that are useful in such type of volatile market are selling options (call and put) rather then buying them along with long or short particular stock or nifty.

Assuming, the Maximum downside & upside of stock is 10% in the below example and the contracts have been taken in the beginning of the month.

The most straightforward example of this is the short call or Naked call, a common strategy in the stock market as shown in the diagram 1. As such, thinking the Market can move up, if we buy a stock, we could sell a call with a strike price of Rs. 25, collecting Rs 5 in premium. If the price of the stock goes up to 10%, we get to sell at a profit – the call is exercised on expiration date, we sell at Rs 27.5, and the premium will reduced. So the total profit is Rs 2.5 + Rs 2 = 4.5. If the price comes down to 10%, the price of stock become Rs. 23.5 and but there is premium will remain Rs 5(As the time value become zero). So, the total profit is Rs 5 –Rs 2.5 = 2.5. If the price does not move then also there is a profit of Rs 5, the premium amount.

Like the same, there is short put, in the stock market as shown in the diagram 2. As such, thinking the market can come down, if we sell a stock, we could sell a put with a strike price of Rs. 25, collecting Rs 5 in premium. . If the price comes down to 10%, the price of stock become Rs. 23.5 and there is premium will remain Rs 2. So, the total profit is Rs 2.5 + Rs 2 =4.5. If the price of the stock goes up to 10%, we sell at Rs 27.5, and we also get to keep the Rs 5 in premium we received (As the time value become zero). So the total profit is Rs 5- Rs 2.5 = 2.5. If the price does not move then also there is a profit of Rs 5. Maximum profit for the short put is achieved when the underlying stock price on expiration date is trading at the strike price of the options sold. At this price, both written put contracts expire worthless and the options trader gets to keep the entire net premium received taken as profit.

Some other keywords used in the article

What is put option? A put option (sometimes simply called a “put”) is a financial contract between two parties, the seller (writer) and the buyer of the option. The put allows the buyer the right but not the obligation to sell a commodity or financial instrument (the underlying instrument) to the writer (seller) of the option at a certain time for a certain price (the strike price). The writer (seller) has the obligation to purchase the underlying asset at that strike price, if the buyer exercises the option.
What is call option? A call option is a financial contract between two parties, the buyer and the seller of this type of option. Often it is simply labeled a “call”. The buyer of the option has the right, but not the obligation to buy an agreed quantity of a particular commodity or financial instrument (the underlying instrument ) from the seller of the option at a certain time (the expiration date) for a certain price (the ). The seller (or “writer”) is obligated to sell the commodity or financial instrument should the buyer so decide. The buyer pays a fee (called a premium) for this right.

What is intrinsic value? Intrinsic value is the amount by which a call option or a put option is in the money, calculated by taking the difference between the strike price and the market price of the underlying security.

• Call Option Intrinsic Value = Underlying Stock’s Current Price – Call Strike Price
• Put Option Intrinsic Value = Put Strike Price – Underlying Stock’s Current Price

Time Value

Time value = Option Price – Intrinsic Value

The more time an option has until it expires, the greater the chance it will end up in the money. Looking again at the example from above, if stock is trading at Rs 34.80 and the one-month to expiration stock 30 call option is trading at Rs 5, the time value of the option is Rs 0.20 (Rs 5.00 – Rs 4.80 = Rs 0.20).

Example1: To buy DLF Qty 400 in cash market, Rs 2,00,000 is require, in future it is reduced to 20-30%, i.e, Rs 40,000 approx. In option it is reduced to premium value i.e, 20*400= Rs 8000.

Example2: Selling shock and buying back either on next day, if is it STBT (sell today, but tomorrow) or carry forword upto the expiration day of the month.

Example3: Hedging between options and futures.

Diagram 1

Strike price Call Premium Put Premium

20 10 0

21 9 .05

22 8 1

23 7 2

24 6 3

25 5 5

26 3 6

27 2 7

28 1 8

29 .05 9

30 0 10

Diagram 2