Option Trading Strategies

A currency option gives the holder the right, but not the obligation, to buy (call) or sell (put) a specified amount of foreign currency at a predetermined strike price on or before the expiry date. In the Indian context, options are listed on the NSE and BSE, and settlement is typically cash‑settled in INR.

The premium paid for the right is the price of the option. For a buyer, the premium is a cost; for a writer (seller), it is a receipt. Understanding the direction of the underlying (INR‑USD) movement relative to the strike determines which strategy is appropriate.

Exam questions often test the candidate’s ability to choose a strategy that matches a given market view, compute the maximum profit, maximum loss and breakeven level, and recognise the regulatory implications under SEBI’s margin framework.

• Right – no obligation to exercise.
• Premium – paid upfront by the buyer.
• Cash settlement – difference between spot and strike, multiplied by contract size.

Option strategies are grouped by the trader’s market outlook: bullish, bearish or neutral. Each strategy combines one or more options (and sometimes the underlying) to create a defined payoff profile. The NISM syllabus expects you to recognise the shape of the payoff diagram and the associated risk‑reward metrics.

For a bullish view, the trader expects INR to depreciate against USD (i.e., USD/INR rises). Strategies such as a long call or bull call spread profit when the spot exceeds the strike, while limiting downside to the premium paid.

Neutral strategies, like straddles or butterflies, are used when the trader anticipates high volatility but no clear direction. These have limited profit potential but can generate significant gains if the spot moves sharply away from the strike(s).

• Bullish – profit when spot > strike.
• Bearish – profit when spot < strike.
• Neutral – profit when spot moves far from strike(s) in either direction.

Long Call: Purchase a call option. Maximum loss equals the premium; profit rises linearly after breakeven (Strike + Premium). This is the simplest way to express a bullish view with limited risk.

Bull Call Spread: Buy a call at a lower strike and sell another call at a higher strike. The net premium is lower than a plain long call, capping both profit (difference between strikes minus net premium) and loss (net premium paid). It is useful when the trader expects a moderate rise in USD/INR.

Protective Call (Synthetic Long): Hold the underlying foreign currency (e.g., USD) and buy a call to protect against further INR appreciation. The combined position mimics a long forward with limited downside, which is often required for corporate hedgers under SEBI guidelines.

• Key metric – breakeven = Strike + Net Premium.
• Exam focus – identify the capped profit and limited loss.

Long Put: Purchase a put option. Maximum loss is limited to the premium, while profit increases as the spot falls below the strike (INR appreciates). This is the direct bearish counterpart to a long call.

Bear Put Spread: Buy a put at a higher strike and sell a put at a lower strike. The net premium is reduced, and profit is capped at the difference between strikes minus the net premium. It suits traders who anticipate a modest INR appreciation.

Protective Put (Synthetic Short): Hold a short position in the foreign currency (e.g., borrow USD) and buy a put to limit losses if INR moves against the short. This structure is often used by importers to safeguard against INR strengthening.

• Key metric – breakeven = Strike – Net premium.
• Exam tip – remember that the writer of a put faces unlimited loss, while the buyer’s loss is capped.

Straddle: Simultaneously buy a call and a put with the same strike and expiry. The strategy profits when the spot moves sharply in either direction, covering the combined premium. Maximum loss equals total premium paid.

Strangle: Buy an out‑of‑the‑money call and an out‑of‑the‑money put with different strikes but same expiry. It is cheaper than a straddle but requires a larger move to become profitable. The loss is limited to the sum of premiums.

Butterfly: Combine a long call (or put) at a lower strike, a short two‑call (or two‑put) spread at a middle strike, and a long call (or put) at a higher strike. This creates a profit zone around the middle strike with limited risk and limited reward, ideal when the trader expects low volatility.

• Exam focus – calculate breakeven range and identify the limited‑risk nature.
• Common mistake – mixing up the number of contracts in a butterfly; remember the middle strike is sold twice.

SEBI mandates that option writers post margin based on the option’s premium, strike distance and underlying volatility. The margin is intended to cover potential losses up to a predefined confidence level (usually 99%). Buyers do not need margin beyond the premium paid.

For spread strategies, the net premium reduces the required margin. The exchange calculates the margin using a SPAN model, which considers the worst‑case scenario across all legs of the spread.

Exam questions may ask you to identify which strategy requires the highest margin or to compute the margin for a simple spread. Remember: higher leverage = higher margin, and cash‑settled options follow the same margin rules as equity options under SEBI’s framework.

• Key point – margin is on the writer’s side, not the buyer’s.
• Common error – adding premiums of both legs in a spread; only net premium influences margin.