InvestorQ : Can I use naked options to trade in bullish market conditions?
Aditi Sharma made post

Can I use naked options to trade in bullish market conditions?

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Aashna Tripathi answered.
2 years ago

This is the simplest use of options in a bullish market. A call option is a right to buy a stock or an index without the obligation to buy. That means you will pay the premium to get the right without the obligation. That premium is your option price and represents the maximum loss that you will incur in the transaction. Let us understand that better with a live example.

Investor View

Investor Action

Investor pay-off

Has a bullish view on Reliance Industries and expects the stock to go up from Rs.960 to Rs.1050 during the month

Investor buys Reliance 980 Call option in February 2018 contract by paying a premium of Rs.22

CMP (940) - Loses Premium

CMP (970) – Loses Premium

CMP (1000) – Net Loss of Rs.2

CMP (1050) – Net Profit of Rs.48

In the above scenario it is clear that the break-even point for the naked long call option is Rs.1002 (strike price of Rs.980 + premium of Rs.22). It is only after the price level of Rs.1002 that the trader starts to make net profit. Below Rs.980, the trader is indifferent as he loses his entire premium irrespective of the price. Above Rs.980 he starts to recover his premium cost and keeps recovering it till the breakeven point of Rs.1002. It is only post this point that he starts making profits.