I am sorry for the delayed post. But I
promise this strategy will more than make up for the delay. Like the
milk which takes time to freeze and become the satisfying ice cream,
this post took its time to come but would be a sweet reward for the
patience you showed. OK OK !!! I am not an ice cream seller so will come
back to today’s strategy.
Protective Call (Short a Stock, Buy a Call)
Protective Call is a very good hedging
strategy using which the trader, who has an existing short position in
any particular stock, can buy an ATM of slightly OTM call option of that
stock to guard himself against the rise in the price of that stock. In
case the price of the stock falls, we can profit from the downward fall
in the price. But, in case there is an unexpected rise in the price of
the stock, our loss is limited.
This way, you can play both sides in this
strategy. If the price of the stock falls, you will earn profits. If
the price rises, you will always have the right to exercise your call.
When can we use this strategy??
When you are bearish in the stock but want to protect yourself from the unexpected rise in the price of the stock.
Risk involved while using this strategy
Limited. Maximum Risk is Call Strike Price – Stock Price + Premium
Benefits of using the strategy
Maximum profit is Stock Price – Call Premium
When do we achieve the breakeven?
The break-even point for us will be: Stock Price – Call Premium
Let’s assume current stock price of XYZ Company is Rs. 4460
We buy Rs 4500 call for Rs. 100
To protect yourself from any rise in the stock price, we short the stock of XYZ Company at Rs. 4460.
The net credit that will come to us is Rs. 4360 (Rs.4460 – Rs. 100).
Analysis of the Strategy :
The protective call is also known as a
synthetic long put as its risk/reward profile is the same that of a long
put’s. There is no limit to the maximum profit attainable using this