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What is Bear put spread, Long and Short Straddle?

           Bear Put spread: In this strategy investors assume rise in the price of an underlying assets. In this strategy buying a put option at higher strike price and selling another put option with lower strike price. The premium paid is more than premium received.

Maximum Profit = Strike price of long put – Strike price of short put – net premium paid – commission paid
Maximum Loss = Net premium paid + commission paid
Break-Even Point = Strike price of long put – Net premium paid

Example: How bear put option work where strike price of long put is Rs. 8700 for Rs.200 and the short put is Rs. 7900 for Rs. 160 and if market price of a stock is Rs.8200?

Solution:
If price of a stock is decreases to Rs.7700 then both options will exercise and the long put option having an intrinsic value of Rs. 1000 and short put having an intrinsic value of Rs. 200.The net profit is Rs. 760 (8700 – 7900 – 40).
If price increases to Rs.8900 then both options will expire worthless and the net loss is Rs.40.   

Straddle: It is a strategy in which two option contract are used one is call option and another is put option with same strike price and same expiration date. In straddle the options are at the money.

Long Straddle: It is a neutral strategy which is used when investor doesn’t know the direction of stock price in future. So, with the help of it investor earns profit either the stock price increases or decreases in future. It has two legs one is at the money call option it means strike price is equal to the spot price and another is at the money put option it means strike price is equal to the spot price.

Maximum Profit = Unlimited
Maximum Loss = Net premium paid + commission paid
Break-Even Point = Strike price of Long call + Net premium received    (Upper break-even point)
Strike price of long put – Net premium received                                       (Lower break-even point)

Example: Company ABC stock traded at Rs.5000 and the company decide to expand its business and due to this decision the stock prices of a company may be decline or rise in future. How to use long straddle where strike price of long call and long put is Rs.5000 for Rs.130 and Rs.210 as premium for call and put option respectively?

Solution:
If the price rises at Rs.5400 then put option will expire worthless and the call option is exercise and the intrinsic value will be Rs.400 and subtract Rs. 340 which is paid as premium to buy call and put option to ascertain the net profit or loss. The net profit will be Rs.60.
If the price of a stock remains same then the put option and call option remain worthless and the total loss will be Rs. 340.
If price decreases to Rs.4800 then the call option will not exercise because it become out of the money option and the put option become in the money. So, the intrinsic value of put option will be Rs.200 but the value is not enough to cover the premium paid to buy the call and put option. So, the net loss will be Rs.140 (200-(130+210).

Short Straddle:  This strategy is just opposite of long straddle in which both call and put option are sold at same strike price and same expiration date.

Maximum Profit = Net premium paid + commission paid
Maximum Loss = Unlimited
Break-Even Point = Strike price of short call + Net premium received    (Upper break-even point)
Strike price of short put – Net premium received                                      (Lower break-even point)

Example: Find out how investor earn profit by using short option and if the company X stock traded at Rs.8000 in market and the expert assume  that the stock price fluctuate in future. How to use Short Straddle where to earn profit in this situation?

Solution:

It is not mentioned that the stock price is increasing or decreasing in future. So, the investor writes a call and put option at Rs. 8000 and the premium received of Rs.500 (Rs.200 on put and Rs.300 call option). If the price remains same on expiration date then the option will not exercise and the maximum profit will be Rs.200.
If the stock price increases to Rs.8300 then only short call option will exercise and the intrinsic value is Rs. 300 and to find out the net profit or loss we have to subtract total net credit that is Rs.500 and the net loss is Rs.200. If Company X stock price decreases to Rs.7500 then only put option is exercise and the intrinsic value is Rs.500 and the net profit is Rs.100 (500-400).



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