Option Trading Strategies

In the commodity derivatives market, an option gives the holder the right, but not the obligation, to buy (call) or sell (put) a specified quantity of a commodity at a predetermined strike price on or before expiry. SEBI classifies these as “standardised” (exchange‑traded) or “non‑standardised” (OTC) contracts, but the payoff mechanics are identical.

The premium paid for an option is the price of that right. For a call, the buyer expects the spot price to rise above the strike, whereas for a put the expectation is a fall below the strike. The seller (writer) receives the premium and hopes the option expires worthless.

Exam questions often test your ability to translate a market view into the appropriate option strategy and to compute the resulting profit or loss. Remember that the NISM syllabus emphasises the net premium (premium received minus premium paid) and the breakeven price as the primary calculation points.

• Option buyer – pays premium, limited loss to premium.
• Option writer – receives premium, unlimited loss for naked positions.

Both formulas assume the option is held to expiry; early exercise is rare for European‑style commodity options, which dominate Indian exchanges. The net payoff for the option holder is the payoff minus the premium paid. For the writer, the net payoff is the premium received minus the payoff.

In exam calculations, always write the payoff first, then subtract (or add) the premium. Forgetting the sign of the premium is a common trap that flips profit into loss.

These basic payoffs underpin every multi‑leg strategy that you will study next. By substituting the appropriate strike prices and premiums for each leg, you can derive the combined profit‑loss diagram required in many NISM questions.

Covered Call – The investor holds the underlying commodity (or a futures position) and sells a call option against it. The premium received provides downside cushion, while the upside is capped at the strike price plus premium. This strategy is bullish to neutral and is frequently asked to test the concept of “capped upside”.

Protective Put – The holder of the commodity purchases a put to guard against price falls. The cost is the premium paid, but the floor price is the strike minus premium. This is a classic risk‑management tool and appears in suitability questions.

Bull Call Spread – Buy a call at a lower strike (K1) and sell a call at a higher strike (K2) with the same expiry. The net premium is usually a debit. Maximum profit occurs if the spot price is at or above K2, and the loss is limited to the net premium paid. This spread illustrates a moderate bullish view with limited risk.

Bear Put Spread – Buy a put at a higher strike (K1) and sell a put at a lower strike (K2). It mirrors the bull call spread for a bearish outlook. The net premium is a debit, and the maximum loss is the premium paid.

Straddle – Simultaneously buy a call and a put with the same strike and expiry. The trader expects high volatility but is unsure of direction. The total premium paid is the sum of both premiums, and profit occurs only if the spot moves far enough beyond either strike.

Strangle – Similar to a straddle but the call and put have different strikes (out‑of‑the‑money). It is cheaper than a straddle but requires a larger price move to become profitable.

Butterfly Spread – Constructed with three strikes: buy one lower‑strike call, sell two at‑the‑money calls, and buy one higher‑strike call (or the analogous put version). The strategy profits from low volatility and the spot staying near the middle strike.

Condor – An extension of the butterfly with four strikes, creating a wider profit zone while still limiting risk. It is useful when the trader expects the price to stay within a broader range.

Calendar (Horizontal) Spread – Buy and sell options with the same strike but different expiries. Typically, the near‑term option is sold (credit) and the longer‑term option is bought (debit). The strategy profits from time decay of the short leg while the underlying price stays near the strike.

Diagonal Spread – Combines a calendar spread with a strike difference. It offers flexibility to target a specific price move over a longer horizon while still benefiting from time decay.

These spreads are examined to test understanding of theta (time decay) and the impact of differing expiries on net premium. Remember that the net premium can be either a debit or a credit depending on the relative option prices.