Option Contracts

[tintin]

There are more than 100 option strategies, e.g covered calls, iron condor, straddle etc.

However these strategies are executed on expiry day and find differences in spot price and strike price to book profit.

Does that mean this strategies are not useful for short term trading where option contracts are squared off?

 

[Alchemist]

Does that mean this strategies are not useful for short term trading where option contracts are squared off?

Why not?

You can make money from these strategies even by squaring-off before expiry.

Covered call example:

Suppose you buy futures lot of a stock at Rs 100 and sell a 100 call for the same stock for Rs 5.

The stock goes to 130 in a few days.

The 100 call will then be "deep in the money" and will have nearly 0 time value.

You will have an MTM profit of Rs 30 in the futures and Rs 25 MTM loss in the call option.

You can square-off your positions and book a profit of Rs 5. You need not wait till expiry.

 

[tintin]

Thanks, that's a very nice example.

Is not I have to square off two times? First I need to square off future and then I need to square off option, right ?

It seems to me in your example there is no loss, there is a limited guaranteed profit (in your example its Rs 5 ) right ? So it seems to me one can use this approach as a monthly income, what say?

But anyway. I'll prefer index options rather than stock option because NSE stock options are not liquid.

 

[Alchemist]

It seems to me in your example there is no loss, there is a limited guaranteed profit (in your example its Rs 5 ) right ? So it seems to me one can use this approach as a monthly income, what say?

No, there is a possibility of a loss if the futures price goes down.

Futures + Short Call = Short Put.

A covered call with futures is equivalent to writing a put. There is limited upside, but unlimited downside.

Covered calls are usually used by those holding the underlying stock for the long term.

It makes no sense to have such a position with futures. It is better to write a put option instead.

I just gave the example to illustrate how profits can be booked with option strategies.