Rich or Wealthy- Know the Financial planning way

Financial Planning

Financial Planning

We often use the term rich and wealthy interchangeably. But do they actually mean the same. If one gets hundred rupees now as gift we say he is richer by hundred rupees, however we do not use the term that he is wealthier by hundred rupees. The term Wealthy is defined as abundance of material wealth. However when we talk about this under the financial planning aegis, we could imply as someone who is financially free. Now when we say that someone is financially free the question is when can we really call ourselves as financially free? Is there a benchmark figure or number which can term us, as one who has achieved financial freedom. The answer lies in us going through the following points which can help us decide if we indeed have reached financial independence.

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Long Butterfly

long-butterflyThe strategy could be called as a ‘Non Directional Strategy’, and is generally deployed in a Low volatility environment. The position is created by using both calls as well as puts. Here we would be discussing The Long Butterfly ‘using Calls and the same logic can be extended in creating Long butterfly using Puts. The position basically requires buying an ITM call, selling two ATM Calls and then again buying an OTM Call (all options with the same expiration date) at a net debit. Also the Strike prices of the options used in the strategy should be equally apart. And the Number of long options should be equal to the number of short options. This position makes maximum money if the stock ends up being near the strike price of the sold call options.

Maximum Risk: Limited to the combined initial Debit Paid. Maximum Profit: Difference between Strike price of Short Calls and Strike price of Lower Long Call – Combined initial Debit Paid Breakeven Price: The strategy would have two breakeven points an upper and a lower breakeven point Upper Breakeven point: Strike Price of Higher strike Long Call -Net Debit Paid. Lower Breakeven point: Strike Price of Lower strike Long Call +Net Debit Paid Let us consider this illustration: We see Nifty trading at around 4500 range and we expect the volatility to be low. We then Buy 4300 CE at Rs.271, Sell Two 4500 CE at 145 and Buy 4700 CE at Rs.62 The Maximum Risk involved in this position would be limited to the initial combined debit paid i.e. Rs (2*145-62-271) = Rs.43. The maximum profit would be the Difference between Strike Price of Short Calls (4500 CE) and Strike Price of Lower Long Call (4300 CE) – Combined initial Debit paid = (4500- 4300 – 43) = 157 And the Strategy would stop making profit once Nifty starts trading beyond the band of the upper and lower breakeven points. Upper Breakeven point would be Rs. 4657 (4700 – 43) Lower Breakeven point would be Rs. 4343 (4300 + 43)

Long Strangle

l strangleThis strategy too could be called as a ‘Non Directional Strategy’, because just like the Long Straddle it is generally
deployed when the stock or index under consideration is expected to show a sharp move and the direction of such a move
is not certain.

The position is created by buying an OTM (out of the money) call and an OTM put with the same expiration date at a net
debit.

This position makes money if the stock makes a move up or down beyond the breakeven points. We would like to choose
a greater time till expiration as we want to give the stock sufficient time to make a move large enough in either direction and
to reduce the effect of time decay on both options.

 

In terms of payoff, a Long strangle is less costly to construct (as compared to the Long straddle) as the Debit paid is lesser
(in buying an OTM call and an OTM put). But here a greater price move in the stock is required in either direction (as
compared to the Long straddle) in order to make the strategy profitable. This is because the breakeven points get shifted
further, due to the difference between the Long strikes.

 

As with the Long Straddle, the Long Strangle strategy too is known to be of best use when an event specific move in the
stock is expected with uncertainity in the direction of the move.

Maximum Risk: Limited to the combined initial debit paid.
Maximum Profit: Unlimited on the upside, and is significant on the downside but limited to Lower Strike price (long
put) – Combined initial debit paid. (Since the underlying can only fall to zero).

Breakeven Price: The strategy would have two breakeven points an upper and a lower Breakeven point
Upper Breakeven point: Upper Strike Price (Long call) + Total initial debit paid.
Lower Breakeven point: Lower Strike Price (Long Put) – Total initial debit paid.

 

Let us consider this illustration: we believe that Nifty is getting consolidated in and around the 4300 range and we expect
the prices to give a break out in either direction. We now Buy 4500 CE at Rs.80 and Buy 4100 PE at Rs.105.
The Maximum Risk involved in this position would be limited to the initial combined debit paid i.e. Rs (105+ 80) = Rs.185.
The maximum profit would be Unlimited on the upside, and on the downside it is substantial but limited to Rs (4100 – 185)
= Rs 3915

And the Strategy would start making profit once Nifty starts trading beyond the band of the upper and lower breakeven points.

Upper Breakeven point would be Rs. 4685(4500 + 185)
Lower Breakeven point would be Rs. 3915(4100 – 185)

Long Straddle

long-straddleThe strategy could be called as a ‘Non Directional Strategy’, because it is generally deployed when the stock or index
under consideration is expected to show a sharp move and the direction of such a move is not known.

The position is created by buying a call and a put at the same strike price (At the money options) and with the same
expiration date at a net debit.

This position makes money if the stock makes a move up or down beyond the breakeven points. We would like to choose
a greater time till expiration as we want to give the stock sufficient time to make a move large enough in either direction and
to reduce the effect of time decay on both options.
The strategy is known to be of best use when an event specific move in the stock is expected (e.g. litigation, earnings
report etc).

 

Maximum Risk: Limited to the combined initial Debit Paid.
Maximum Profit: Unlimited on the upside, and is significant on the downside but limited to: Strike price – Combined
initial Debit Paid (since the underlying can only fall to zero).
Breakeven Price: The strategy would have two breakeven points an upper and a lower breakeven point
Upper Breakeven point: Strike Price + Debit Paid.
Lower Breakeven point: Strike Price – Debit Paid.

 

Let us consider this illustration: we believe that Nifty is getting consolidated in and around the 4300 range and we expect
the prices to give a break out in either direction. We then Buy 4300 CE at Rs.180 and Buy 4300 PE at Rs.180
The Maximum Risk involved in this position is limited to the initial combined debit paid i.e. Rs (180+ 180) = Rs.360.
The maximum profit would be Unlimited on the upside, and on the downside it is substantial but limited to Rs (4300 – 360)
= Rs 3940.

And the Strategy would start making profit once Nifty starts trading beyond the band of the upper and lower breakeven
points.

Upper Breakeven point would be Rs. 4660(4300 + 360)
Lower Breakeven point would be Rs. 3940(4300 – 360)

Short Iron Butterfly strategy

Short-Iron-ButterflyThe Short Iron Butterfly is a variant of the ‘Butterfly Strategy’.

The strategy could be called as a ‘Non Directional Strategy’, and is generally deployed in a situation where the stock is expected to show a sharp move, and the direction of such a move is uncertain.

The position basically requires selling an ITM Put, Buying an ATM Call and an ATM Put (same strike) and then again selling an OTM Call (all options with the same expiration date) at a net debit. Also the Strike prices of the options used in the

strategy should be equally apart.

This position makes maximum money if the stock makes a move beyond the break-even point.

Maximum Risk: Limited to the combined Debit paid.

Maximum Profit: Difference between Strike price of Short Call and Strike price of Lower long Call/Put – Combined Debit Paid.

Breakeven Price: The strategy would have two breakeven points an upper and a lower breakeven point

Upper Breakeven point: Strike Price of Long Call + Net Debit Paid.

Lower Breakeven point: Strike Price of Long Put – Net Debit Paid

Let us consider this illustration: In the same situation as above where Nifty is trading at around 4500 range and we expect a sharp move in either direction.

We then Sell 4300 PE at Rs.50

Buy 4500 PE at Rs.118

Buy 4500 CE at Rs.104

And Sell 4700 CE at Rs.34

The maximum risk would be Limited to the Net initial Debit Paid = (-104-118+50+34) = Rs.138

 

The Maximum Profit involved in this Position is the difference between strike price of Short call (4700 CE) and Strike Price of Long call (4500 CE) – Net initial Debit Paid = (4700 – 4500 -138 ) = Rs 62

And the Strategy would start making profit once Nifty starts trading beyond the band of the upper and lower breakeven points.

Upper Breakeven point would be Rs.4638 (4500 + 138)

Lower Breakeven point would be Rs.4362 (4500 -138)

Short Butterfly

short-butterflyThe strategy could be called as a ‘Non Directional Strategy’, and it is generally deployed in a situation where we are expecting high volatility in the stock.

The position is created by using both calls as well as puts. Here we would be discussing The Short Butterfly ‘using Calls and the same logic can be extended in creating Short butterfly using Puts.

The position basically requires selling an ITM call, buying two ATM Calls and then again selling an OTM Call (all options with the same expiration date) at a net credit. Also the Strike prices of the options used in the strategy should be equally

apart. And the Number of long options should be equal to the number of short options.

This position makes maximum money when the stock moves beyond the breakeven points.

Maximum Risk: Difference between Strike price of Short Call and Strike price of Lower Long Calls – Combined Credit received.

Maximum Profit: Limited to the combined Credit received.

Breakeven Price: The strategy would have two breakeven points an upper and a lower breakeven point

Upper Breakeven point: Strike Price of Higher strike Short Call -Net Credit Received.

Lower Breakeven point: Strike Price of Lower strike Long Call + Net Credit Received.

Let us consider this illustration: Nifty is trading at around 4500 and we expect it to give a sharp move in either direction.

We then Sell 4300 CE at Rs.231, Buy Two 4500 CE at Rs.104

And Sell 4700 CE at Rs.34

The Maximum Profit involved in this position would be limited to the initial credit received i.e. Rs (231+34-2*104) = Rs.57

The Maximum Risk would be the Difference between Strike Price of Short Call (4700 CE) and Strike Price of Lower LongCalls (4500 CE) – Combined credit received

Maximum risk = (4700- 4500 – 57) = 143

 

And the Strategy would start making profit once Nifty starts trading beyond the band of the upper and lower breakeven points.

Upper Breakeven point would be Rs. 4643 (4700 – 57)

Lower Breakeven point would be Rs. 4357 (4300 + 57)

Short Strangle strategy

short-strangleThe strategy is a neutral strategy and is generally deployed when the stock or index under consideration is expected to move sideways until expiration.

The position is created by selling an OTM (out of the money) call and an OTM put with the same expiration date at a net credit.

Ideally we would want the underlying to move sideways until expiry in between the Strike prices for the options sold, so that we would either have the options expire worthless or shrink in value. Generally as much short time till expiration is

used to take advantage of time decay on both short options, and not give the stock time to make a significant move beyond the strike prices of the options sold.

In terms of payoff, a Short strangle offers a wider profit zone than a Short straddle due to the difference between the short strikes, but the credit received is smaller in comparison to the Short straddle. The Short Strangle is also one of the risky

strategies due to the presence of two naked options. Also Margin is required as a result of selling options.

Maximum Risk: Unlimited on the upside, and is significant on the downside but limited to Lower Strike price(short put) – Combined initial credit received (since the underlying can only fall to zero)

Maximum Profit: Limited to the combined initial credit received

Breakeven Price: The strategy would have two breakeven points an upper and a lower breakeven point

Upper Breakeven point: Upper Strike Price (Short call) + Total Credit received

Lower Breakeven point: Lower Strike Price (Short Put) – Total Credit received

Let us consider this illustration: We estimate that Nifty will be moving in a rangebound manner at 4320 and that it will continue to do so for a while. We then Sell 4500 CE at Rs.110 and Sell 4100 PE at Rs.100.

The Maximum Risk involved in this position is Unlimited on the upside, and on the downside it is substantial but limited to Rs (4100 – 210) = Rs 3890.

The maximum profit would be limited to the initial combined credit received i.e. Rs (100+ 110) = Rs.210.

And the Strategy would stop making profit and start making a loss once Nifty starts trading beyond the band of the upper and lower breakeven points.

Upper Breakeven point would be Rs. 4710(4500 + 210)

Lower Breakeven point would be Rs. 3890(4100 – 210)

Short Straddle

The strategy is a neutral strategy and is generally deployed when the stock or index under consideration is expected to move sideways until expiration.

The position is created by selling a call and a put at the same strike price (At the money options) and with the same expiration date at a net credit.

Ideally we would want the underlying to move sideways until expiry around the Strike price for the options sold, so that we would either have the options expire worthless or shrink in value. Generally as much short time till expiration is used to

take advantage of time decay on both short options, and not give the stock time to make a significant move away from the short strike.

This is one of the more risky strategies due to the presence of two naked options. Also Margin is required as a result of selling options.

Maximum Risk: Unlimited on the upside, and is significant on the downside but limited to. Strike price – Combined initial credit received (since the underlying can only fall to zero)

Maximum Profit: Limited to the combined initial credit received

Breakeven Price: The strategy would have two breakeven points an upper and a lower breakeven point

Upper Breakeven point: Strike Price + Total Credit received

Lower Breakeven point: Strike Price – Total Credit received

Let us consider this illustration: we believe that Nifty is moving in a range bound manner and that it will continue to do so for a while. We then Sell 4100 CE at Rs.139 and Sell 4100 PE at Rs.143.

The Maximum Risk involved in this position is Unlimited on the upside, and on the downside it is substantial but limited to Rs (4100 – 282) = Rs 3818.

The maximum profit would be limited to the initial combined credit received i.e. Rs (143+ 139) = Rs.282.

And the Strategy would stop making profit once Nifty starts trading beyond the band of the upper and lower breakeven points.

Upper Breakeven point would be Rs. 4382(4100 + 282)

Lower Breakeven point would be Rs. 3818(4100 – 282)

Bear Call spread strategy

This strategy is chosen when we are Bearish and we expect the stock to move lower or remain sideways so that the calls expire worthless and we get to keep the entire credit collected.

The position is created by selling a call (at the money or slightly out of the money) and buying another call at a higher strike price with the same expiration date for a net credit.

Here too we would be using short time till expiration to take advantage of time decay and give the stock less time to move against us.

Maximum Risk: Limited to the difference between Strikes minus Net credit received.

Maximum Profit: Limited to the Net credit received.

Breakeven Price: Short Call Strike + Net credit received.

 

Let us consider this illustration; we are currently Bearish on the Nifty which trades at 4000 and we expect it to correct up to or remain sideways below 4000 levels.

 

We Sell a July 4000 Call at Rs.135 and Buy a July 4200 Call at Rs 70.

The Maximum Risk here is Limited to the difference between Strikes minus Net credit received ((4200-4000)-(135-70)) =(200-65) = i.e. Rs.135

The Maximum Profit involved is Limited to the Net credit received (provided the price remains below 4000) i.e.Rs.65 (135-

70)

This Loss would start once the price moves the Breakeven Point which is Rs .4065 (4000+65).

Ratio Bear spread

The Bear Ratio Spread could be called as a variation of the Bear Put Spread. Here we expect the stock to move sideways to slightly lower.

 

The Position is created by purchasing a Put (preferably At-the-money or slightly Out-of-the-money) and selling more than one Put at a lower strike price in a ratio of 1:2 or 1:3 (preferably near to the target price) with the same expiration (same month). The strategy is preferred when the downside seems to be limited.

 

A short time till expiration is generally preferred for the strategy to take advantage of the time decay in the short options and not give the stock enough time to move very low in price and produce a loss.

Maximum Risk: Substantial on the downside but limited to Short strike – Difference between strikes +/ Net premium paid or Received and it would be Limited on the upside to the initial debit paid or none if the position is opened for a credit.

Maximum Profit: (Long Put strike – Short Put Strike) -/+ Net Premium paid or received.

Breakeven Price: Here there would be two breakeven points

(a) Upper breakeven point: Strike price of Long Put -/+ Net premium paid or Received.

(b) Lower Breakeven Point: Strike price of Short Puts – Difference in strike prices +/- Net premium paid or received.

Let us consider an illustration; we are moderately bearish on the Nifty which trades at 4000 and are anticipating not more than a 150 points downside move.

We Buy a July 4000 Put at Rs.130 and Sell two July 3800 Puts at Rs.75 each.

 

The Maximum Risk here is Substantial on the downside but limited to Short strike – Difference between strikes +/-Net premium paid or Received = 3800 -200 -20=3580.

 

None in this case since the position was established at a net credit.

The Maximum Profit involved is Difference in strikes -/+ Net Premium paid or received =220 i.e. (4000-3800+20)

 

Here there would be two Breakeven Points:

(a) Upper breakeven Point (when the strategy starts making a loss) Long Put strike -/+ Net premium paid or received =Rs 4020 (4000+20).

(b) Lower Breakeven Point (when the strategy stops making a profit) Short Put Strike – Difference in Strikes +/- Net premium paid or received= Rs.3580 (3800-200-20).