InvestorQ : How do you decide whether to buy or sell calls and puts? Is there is model to work that out?
Nishant Chandani made post

How do you decide whether to buy or sell calls and puts? Is there is model to work that out?

Answer
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Abhi Yadav answered.
1 year ago


You can adopt the quadrant model to decide on when to buy and what to buy in options? When it comes to futures the periphery is quite simple. If you expect the stock price to go up then you buy futures on the stock and if you expect the stock price to go down then you sell futures on the stock or the index. Options will have 4 possibilities. Let us understand each one of them with a futures and options trading example. Let us assume that Infosys is currently quoting at Rs.1000. Let us understand how different traders will use different kinds of options based on their outlook.

Investor A expects Infosys to go up to Rs.1150 over the next 2 months. The best strategy for him will be to buy a call option on Infosys of 1050 strike. He will get to participate in the upside by paying a much lower premium.

Investor B expects Infosys to go down to Rs.900 over the next 1 month. The best approach for him will be to buy put options on Infosys of 980 strikes. He can easily participate in the downside movement and make profits after his premium cost is covered.

Investor C is not sure of the downside in Infosys. However, he is certain that with the pressure on the stock from global markets, Infosys will not cross 1080. He can sell Infosys 1100 call option and take home the entire premium.

Investor D is not sure of the upside potential of Infosys. However, he is certain that considering its recent management changes, the stock should not dip below Rs.920. A good strategy for him will be too sell the 900 put option and take the entire premium.

Futures and options are conceptually different but intrinsically they are the same as they try to profit from a stock or an index without investing the full sum! Basically it is a leveraged way of trading on the price movements.