InvestorQ : What is the naked / un-hedged strategy that I can employ in bearish markets?
Tisha Malhotra made post

What is the naked / un-hedged strategy that I can employ in bearish markets?

Answer
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Moii Chavate answered.
2 years ago


This is the simplest use of options in a bearish market. A put option is a right to sell a stock or an index without the obligation to well. 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 bearish view on Cummins Industries and expects the stock to go down from Rs.960 to Rs.900 during the month

Investor buys Cummins 940 put option in February 2018 contract by paying a premium of Rs.22

CMP (980) - Loses Premium

CMP (950) – Loses Premium

CMP (920) – Net Loss of Rs.2

CMP (900) – Net Profit of Rs.18

In the above scenario it is clear that the break-even point for the naked long put option is Rs.918 (strike price of Rs.940 - premium of Rs.22). It is only below the price level of Rs.918 that the trader starts to make net profit. Above Rs.940, the trader is indifferent as he loses his entire premium irrespective of the price. Below Rs.940 he starts to recover his premium cost and keeps recovering it till the breakeven point of Rs.918. It is only below this breakeven point that he starts making profits.