Put Backspread Explained - Back Spread Options Strategy

Put Backspread Explained - Back Spread Options Strategy
by Nilesh Jain 06/01/2017

What is Put Backspread?

The Put Backspread is reverse of Put Ratio Spread. It is a bearish strategy that involves selling options at higher strikes and buying higher number of options at lower strikes of the same underlying asset. It is unlimited profit and limited risk strategy.

When to initiate the Put Backspread

The Put Backspread is used when an option trader believes that the underlying asset will fall significantly in the near term.

How to construct the Put Backspread?

  • Sell 1 ITM/ATM Put

  • Buy 2 OTM Put

The Put Backspread is implemented by selling one In-the-Money (ITM) or At-the-Money (ATM) put option and buying two Out-the-Money (OTM) put options simultaneously of the same underlying asset with the same expiry. Strike price can be customized as per the convenience of the trader.

Strategy

Put Backspread

Market Outlook

Significant downside movement

Upper Breakeven

Strike price of short put -/+ premium paid/ premium received

Lower Breakeven

Long put strike - Difference between Long and Short strikes (-/+) premium received or paid

Risk

Limited

Reward

Unlimited (when Underlying price < strike price of buy put)

Margin required

Yes

Let’s try to understand with an Example:

 

NIFTY Current market Price Rs

9300

Sell ATM Put (Strike Price) Rs

9300

Premium received (Rs)

140

Buy OTM Put (Strike Price) Rs

9200

Premium paid (per lot) Rs

70

Net Premium Paid/Received Rs

0

Upper BEP

9300

Lower BEP

9100

Lot Size

75

 

Suppose Nifty is trading at Rs 9300. If Mr. A believes that price will fall significantly below 9200 on or before expiry, then he can initiate Put Backspread by selling one lot of 9300 put strike price at Rs 140 and simultaneously buying two lot of 9200 put strike price at Rs 70. The net premium paid/received to initiate this trade is zero. Maximum profit from the above example would be unlimited if underlying asset breaks lower breakeven point. However, maximum loss would be limited to Rs 7,500 (100*75) and it will only occur when Nifty expires at 9200.

For the ease of understanding, we did not take in to account commission charges. Following is the payoff schedule assuming different scenarios of expiry.

The Payoff Schedule:

 

On Expiry NIFTY closes at

Net Payoff from 9300 Put Sold (Rs)

Net Payoff from 9200 Put Bought (Rs) (2Lots)

Net Payoff (Rs)

8700

-460

860

400

8800

-360

660

300

8900

-260

460

200

9000

-160

260

100

9100

-60

60

0

9150

-10

-40

-50

9200

40

-140

-100

9250

90

-140

-50

9300

140

-140

0

9350

140

-140

0

9400

140

-140

0

9450

140

-140

0

9500

140

-140

0

 

The Payoff Graph:

Impact of Options Greeks:

Delta: If the net premium is paid, then the Delta would be negative, which means any upside movement will result into premium loss, whereas a big downside movement would result in to unlimited profit. On the other hand, If the net premium is received from the Put Backspread, then the Delta would be positive, which means any upside movement above higher breakeven will result into profit up to premium received.

Vega: The Put Backspread has a positive Vega, which means an increase in implied volatility will have a positive impact.

Theta: With the passage of time, Theta will have a negative impact on the strategy because option premium will erode as the expiration dates draws nearer.

Gamma: The Put Backspread has a long Gamma position, which means any major downside movement will benefit this strategy.

How to manage Risk?

 

The Put Backspread is exposed to limited risk; hence one can carry overnight position.

Analysis of Put Backspread:

The Put Backspread is best to use when investor is extremely bearish because investor will make maximum profit only when stock price expires at below lower (bought) strike.

Next Article

Costs and Taxes Associated With Investing In Mutual Funds

Costs and Taxes Associated With Investing In Mutual Funds
by Priyanka Sharma 06/01/2017
New Page 1

The best things in life are free. However, realistically speaking, it may have some charges associated with it. Your child’s laughter is free. However, if your child is not a kid anymore, the laughter would be possible only if you bought them what they want. Your child could want a gaming console or a foreign trip. The laughter, in this case, involves some monetary charges. This is also true when it comes to Mutual Funds. You will get returns on your investment; however, there are certain charges and taxes that would be levied.

Let’s glance at the charges and taxes that you will have to shell out when investing in mutual funds.

Charges

1. Entry Load:  The charges levied by an asset management company (AMC) when you purchase a mutual fund is called Entry Load. This is a one-time charge. While this charge could increase your buying cost, this has been abolished for Indians by Securities and Exchange Board of India (SEBI).

2. Exit Load: This is the charge levied by the AMC when you sell off your units before a stipulated time. This is also a one-time charge. From a broader perspective, these charges favor you as an investor. Mutual funds use these charges as a deterrent so that you do not exit the investment avenue without earning substantial profits. These charges are also imposed to safeguard other investors who are with the fund for a longer time as any investor’s exit could increase the cost for other investors. The exit load is charged according to a pre-defined holding period cut-offs. The AMC may not levy any charges if the fund’s objective is to be a short-term fund. The exit load is usually between 1-3% depending on the exit timeline specified by the AMC.

3. Transaction Charges: Since 2011, SEBI has allowed AMCs to collect a nominal charge if the investment is above Rs. 10,000. This is the final one-time direct charge for now. If the investment amount is less than Rs. 10,000, then no investment charge would be levied. The investment charges are Rs.150 for a new investor and Rs. 100 for an existing investor. In case of systematic investment plan (SIP), if your total investment is more than Rs.10,000, a transaction charge of Rs.100 would be payable in 4 equal installments.

4. Expense Ratio: The expenses incurred by the AMC are not borne by them; they are borne by the investors. This is charged daily and the daily NAV is adjusted accordingly. The charges that AMC can incur are fund management fees, marketing/selling expenses, Audit charges, Registrar fees, Trustee fees and Custodian fees. Of these charges, fund management fees and marketing/selling expenses could be charged by the AMC at their own discretion. The other charges are the actual expenses that the AMC will actually incur while managing the funds.

5. Other Indirect Charges: When an AMC proposes a new fund offer, it incurs certain charges as well. These charges can be 6% of the total net assets and can be adjusted in over a period of 5 years. There are other minor one-time charges when you invest in mutual funds. If you invest in ETFs, you need to open an account. You will need to pay maintenance charges and broker charges as well. Mutual funds are also required to pay a security transaction tax while buying and selling stocks. This is also ultimately borne by the investors.

Taxes

1. Tax Deducted at Source: Tax deducted at source or TDS is the tax that the government collects on the returns on your investment. This is usually 10% of the returns. There would not be any tax on the dividend distribution or re-purchase proceeds to Indian resident investors.

2. Securities Transaction Tax: This tax is applicable only on funds dealing with equities, derivatives and mutual funds. STT can be collected for selling and purchasing through stock exchanges. STT is not applicable for debt, debt-oriented or commodities mutual funds.

3. Dividend Distribution Tax: The dividend distributed by debt-oriented mutual fund schemes is also taxed as dividend distribution tax (DDT). This additional tax is not applicable for any equity-oriented funds.

4. Capital Gains Tax: The government levies capital gains tax on investments that are supposed to be long term but are cashed in the short term. For equity-oriented schemes, capital gains tax is not applicable if the fund is held for more than a year. For debt-oriented scheme, there is no capital gains tax if the investment is held for more than 3 years.

Bottom Line

As Albert Einstein famously said—The hardest thing in the world to understand is the Income Tax. Thus, most charges and taxes can be difficult to understand. Now that you know what are the taxes and charges associated when buying mutual funds, you can make an informed decision.

Next Article

Long Put Ladder Strategy Explained - Online Options Trading Guide

Long Put Ladder Strategy Explained - Online Options Trading Guide
by Nilesh Jain 06/01/2017

A Long Put Ladder is the extension of Bear Put spread; the only difference is of an additional lower strike sold. The purpose of selling the additional strike is to reduce the cost of premium. It is limited profit and unlimited risk strategy. It is implemented when the investor is expecting downside movement in the underlying assets till the lower strike sold. The motive behind initiating this strategy is to rightly predict the stock price till expiration and gain from time value.

When to initiate a Long Put Ladder

A Long Put Ladder should be initiated when you are moderately bearish on the underlying asset and if it expires in the range of strike price sold then you can earn from time value and delta factor. Also, another instance is when the implied volatility of the underlying asset increases unexpectedly and you expect volatility to come down then you can apply Long Put Ladder strategy.

How to construct Long Put Ladder

A Long Put Ladder can be created by buying 1 ITM Put, selling 1 ATM Put and selling 1 OTM Put of the same underlying security with the same expiry. Strike price can be customized as per the convenience of the trader. A trader can also initiate the Short Put Ladder strategy in the following way - buy 1 ATM Put, Sell 1O TM Put and Sell 1 Far OTM Put.

Strategy

Buy 1 ITM Put, Sell 1 ATM Put and Sell 1 OTM Put

Market Outlook

Moderately bearish

Upper Breakeven

Strike price of long Put - Net Premium Paid

Lower Breakeven

Addition of two sold Put strikes - Strike price of long Put + Net premium paid

Risk

Limited to premium paid if stock goes above higher breakeven.

Unlimited if stock falls below lower breakeven.

Reward

Limited (expiry between upper and lower breakeven)

Margin required

Yes

Let’s try to understand with an example:

Nifty Current spot price (Rs)

9400

Buy 1 ITM Put of strike price (Rs)

9500

Premium paid (Rs)

180

Sell 1 ATM Put of strike price (Rs)

9400

Premium received (Rs)

105

Sell 1 OTM Put of strike price (Rs)

9300

Premium received (Rs)

45

Upper breakeven

9470

Lower breakeven

9230

Lot Size

75

Net Premium Paid (Rs)

30

Suppose Nifty is trading at 9400. An investor Mr. A feels that Nifty will expire in the range of 9400 and 9300 strikes, so he enters a Long Put Ladder by buying 9500 Put strike price at Rs 180, selling 9400 strike price at Rs 105 and selling 9300 Put for Rs 45. The net premium paid to initiate this trade is Rs 30. Maximum profit from the above example would be Rs 5250 (70*75). It would only occur when the underlying assets expires in the range of strikes sold. Maximum loss would be unlimited if it breaks lower breakeven point. However, loss would be limited up to Rs 2250 (30*75) if Nifty surges above the higher breakeven point.

For the ease of understanding, we did not take in to account commission charges. Following is the payoff chart and payoff schedule assuming different scenarios of expiry.

The Payoff chart:

The Payoff Schedule:

On Expiry NIFTY closes at

Payoff from 1 ITM Put Bought (9500) (Rs)

Payoff from 1 ATM Puts Sold (9400) (Rs)

Payoff from 1 OTM Put Sold (9300) (Rs)

Net Payoff (Rs)

8800

520

-495

-455

-430

8900

420

-395

-355

-330

9000

320

-295

-255

-230

9100

220

-195

-155

-130

9200

120

-95

-55

-30

9230

90

-65

-25

0

9300

20

5

45

70

9400

-80

105

45

70

9470

-150

105

45

0

9500

-180

105

45

-30

9600

-180

105

45

-30

9700

-180

105

45

-30

9800

-180

105

45

-30

Impact of Options Greeks:

Delta: At the time of initiating this strategy, we will have a short Delta position, which indicates any significant downside movement, will lead to unlimited loss.

Vega: Long Put Ladder has a negative Vega. Therefore, one should buy Long Put Ladder spread when the volatility is high and expects it to decline.

Theta: A Long Put Ladder will benefit from Theta if it moves steadily and expires in the range of strikes sold.

Gamma: This strategy will have a short Gamma position, which indicates any significant downside movement, will lead to unlimited loss.

How to manage Risk?

A Long Put Ladder is exposed to unlimited risk; hence it is advisable not to carry overnight positions. Also, one should always strictly adhere to Stop Loss in order to restrict losses.

Analysis of Long Put Ladder Strategy:

A Long Put Ladder spread is best to use when you are confident that an underlying security will move marginally lower and will stay in a range of strike price sold. Another scenario wherein this strategy can give profit is when there is a decrease in implied volatility.

Next Article

Why Gold Jewelry is Not a Sound Investment?

Why Gold Jewelry is Not a Sound Investment?
by Nutan Gupta 06/01/2017

Gold is one of the most precious metals in the world. It plays a major role in almost all the cultural celebrations. Having a lot of aesthetic and historical value, it has been passed on from generations as a symbol of security and trust. Neha had purchased a gold necklace, earrings, and a golden bracelet as a security investment during her marriage. But, a few years later, when she and her husband faced financial crises, the gold could not be mortgaged at the price they hoped to get. The return on her investment was still less and she had to mortgage her home for a better price.

Gold jewelry is good from a visual point, but using gold jewelry may not be the right choice in today’s time. There are other financial instruments that you could invest and get better returns than from gold.

Some of the reasons why gold is not the best investment options are:

A costly investment

Making gold jewelry involves a lot of costs. If you are to buy ornaments of gold, it includes the making and wastage charges along with the price. This is then reduced when you try to resell it in the market. So, it can lead to about 30% loss of your invested money. This can reduce your profits significantly.

Capital appreciation is scarce

Investment in gold gives comparatively less profit. The capital appreciation from gold is less than real estate and equities. Even though the prices tend to usually rise every year, gold prices barely manage to outperform inflation marginally. You might lose more money while holding gold jewelry than while investing in equities.

An inefficient investment vehicle

Even though it is regarded as a precious metal, gold is not as popular as an investment vehicle. Modern investors see gold as an inefficient vehicle for investment. Getting your gold, storing it in security safe at home or depositing into a safe box at the bank also have an additional cost. Not to mention the various risks associated with it. So, even though you own your gold, you might have to store it with someone else who would be charging you for that service.

No tax benefits

One of the goals that people look for while investing is to save tax. Having gold jewelry is not beneficial from a tax standpoint. Capital gains from equities also become tax-free in the long term but there is no such benefit for gold assets. Hence, investing in them might not provide you any tax deductions or exemptions.

Does not match expectations of serious investors

Gold was an investment vehicle since before the boon of internet and mass communication. It no longer holds the same value in terms of returns on investment. Stocks earn the most returns followed by government bonds and other debt instruments. Gold provides the least growth among all. Hence, it is good as a safety instrument but if you into serious investing and expect returns, this might not be your best option.

To sum it up

Gold jewelry does not have much use in the financial market. You can invest your money into it for safety purposes but the purity of the gold would also matter. Only the 24 karat gold does give much value of the investment. Others have some amount of other metals mixed in it, reducing the value proportionately. You might get two different prices for your gold jewelry from two different shops. Hence, choose your investment option wisely keeping your goals and potential returns in mind.

Next Article

How women can become better investors?

How women can become better investors?
by Nutan Gupta 06/01/2017

Over the generations, men have tried in grasping their hold on a majority of sectors, leaving women to what’s known as 'feminine' duties. But as is with nature, scenarios of the 21st-century world have changed drastically. Women now find themselves competing in par with their opposite gender in every imaginable field.

In this men dominated society, we see modern women playing with numbers in finance. Apart from the usual competition, they face a different kind of pressure from their colleagues/competitors of the opposite gender. Even so, women hold certain traits that can provide them with an upper hand in the finance market. This has been repeated proved by research conducted by Ledbury Research, Barclays Capital, and other firms. So, if you as women are still thinking twice about your decision to invest, read this and make an informed choice.

Women exhibit a calm, disciplined approach

Women tend to portray a calm, thoughtful approach towards investment. They tend to avoid impulsive decisions like their male counterparts. Men might indulge in more situational decisions. For men, a huge gain could mean a huge party; a major loss would mean haphazard selling of stocks in the bear market. Women, on the other hand, happen to be on the calmer side. Their disciplined and cautious approach helps them refrain from making reckless decisions and help them take the next step wisely.

Having a research-oriented approach

A woman would do the necessary research before planning on investing her money in any stocks/funds. She would make sure that every stock/fund she invests into is worth her money and time. Women understand that financial news might be sensationalized around segments. Hence, depending on her own research is what they prefer.

Patience is the virtue of the wise

Women tend to play the safe game. They are conservative in their approach towards investment. Buying and holding are the key virtues of investing. Though it may not be applicable always, when it comes to it, women know exactly how it's done. This conservatism of buying and holding in right proportions help them achieve long-term targets.

Target-oriented approach

The divide between being goal-oriented and returns-oriented splits the factions of women and men. A woman would set a target and pursue it with all her heart and mind. They take relatively fewer risks than their male counterparts. This helps them be mindful of their competence, and navigate themselves even under risky market conditions.

Taking calculated risks

Psychological rift plays a bigger part in helping women do well in the finance market. The vociferous attitude that pertains to men makes them want to take bold decisions. A woman would keep it to herself, play it safe and gleam at every stock that pays out sufficient returns to her.

Things to keep in mind if you are a women investor

  • Do a fairly good amount of research before deciding to invest or not invest in something

  • Ensure that you don’t take every financial advice on your way. What works for others might not work for you

  • Plan your investment strategy keeping your goals in mind

  • Take risks when you are confident of the consequences and can handle it

  • Trust your instincts. If you believe in it, it is more likely to pay off, than when you don’t

Final Word:

As much as these are encouraging for women, one thing they have to realize is there is a lot to learn from male investors as well. Understanding, learning and acquiring the positive traits from both the sexes is the true way of excelling the finance market.

Next Article

What is Call Backspread?

What is Call Backspread?
by Nilesh Jain 06/01/2017
New Page 1

The Call Backspread is reverse of call ratio spread. It is bullish strategy that involves selling options at lower strikes and buying higher number of options at higher strikes of the same underlying stock. It is unlimited profit and limited risk strategy.

When to initiate the Call Backspread

The Call Backspread is used when an option trader thinks that the underlying asset will experience significant upside movement in the near term.

How to construct the Call Backspread?

  • Sell 1 ITM/ATM Call

  • Buy 2 OTM Call

The Call Backspread is implemented by selling one In-the-Money (ITM) or At-the-Money (ATM) call option and simultaneously buying two Out-the-Money (OTM) call options of the same underlying asset with the same expiry. Strike price can be customized as per the convenience of the trader.

Strategy

Call Backspread

Market Outlook

Significant upside movement

Upper Breakeven

Long call strikes + Difference between long and short strikes -/+ net premium received or paid

Lower Breakeven

Strike price of Short call +/- net premium paid or received

Risk

Limited

Reward

Unlimited (when Underlying price > strike price of buy call)

Margin required

Yes

Let’s try to understand with an Example:

NIFTY Current market Price Rs

9300

Sell ATM Call (Strike Price) Rs

9300

Premium Received (per share) Rs

140

Buy OTM Call (Strike Price) Rs

9400

Premium Paid (per lot) Rs

70

Net Premium Paid/Received

0

Upper BEP

9500

Lower BEP

9300

Lot Size

75

Suppose Nifty is trading at Rs 9300. If Mr. A believes that price will rise significantly above Rs 9400 on or before expiry, then he initiates Call Backspread by selling one lot of 9300 call strike price at Rs 140 and simultaneously buying two lot of 9400 call strike price at Rs 70. The net premium paid/received to initiate this trade is zero. Maximum profit from the above example would be unlimited if underlying assets break upper breakeven point. However, maximum loss would be limited to Rs 7,500 (100*75) and it will only occur when Nifty expires at 9400.

For the ease of understanding, we did not take in to account commission charges. Following is the payoff schedule assuming different scenarios of expiry.

The Payoff Schedule:

On Expiry NIFTY closes at

Net Payoff from 9300 Call Sold (Rs)

Net Payoff from 9400 Call Bought (Rs) (2Lots)

Net Payoff (Rs)

9000

140

-140

0

9100

140

-140

0

9200

140

-140

0

9300

140

-140

0

9350

90

-140

-50

9400

40

-140

-100

9450

-10

-40

-50

9500

-60

60

0

9600

-160

260

100

9700

-260

460

200

9800

-360

660

300

9900

-460

860

400

The Payoff Graph:

Impact of Options Greeks:

Delta: If the net premium is received from the Call Backspread, then the Delta would be negative, which means even if the underlying assets falls below lower BEP, profit will be the net premium received.

If the net premium is paid then the Delta would be positive which means any upside movement will result into profit.

Vega: The Call Backspread has a positive Vega, which means an increase in implied volatility will have a positive impact.

Theta: With the passage of time, Theta will have a negative impact on the strategy because option premium will erode as the expiration dates draws nearer.

Gamma: The Call Backspread has a long Gamma position, which means any major upside movement will benefit this strategy.

How to manage risk?

The Call Backspread is exposed to limited risk; hence one can carry overnight position.

Analysis of Call Backspread:

The Call Backspread is best to use when an investor is extremely bullish because investor will make maximum profit only when stock price expires above higher (bought) strike.