Question

The US economy is currently the healthiest among the developed world - we are growing at a modest rate, inflation is under control and we are steadily reaching higher employment. You believe this is a scenario where you can take advantage of upside movement. You are also aware that you need to protect yourself from downside risk. Suggest two strategies in the options market that take care of your objective. Please name and explain these strategies.

Answer 1

Two strategies in the option market to take the benefit of upside movement and to protect ourselves from downside risk are as under-

1) Strap Strategy

A strap strategy is one where the option buyer buys 2 calls and 1 put at the given strike price. 2 calls are bought because we are of the opinion that the market will move upwards. one put is taken so as to ensure that our downside risk is reduced incase market goes down.

2) Long Call Strategy

This is the simplest strategy. Under Long call strategy, option buyer buys one call option when he is of the opinion that market will go up. In case market goes down then also his loss will be limited to the amount of option premium paid by him. Profit in this case can be unlimited.

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