Option Strategies I

Hedging :-

Poeple generally buy options to hedge thier investments.
Suppose you have bought a stock which u thought will rise in 6 months time. But there is uncertainty that the price might drop. So what you can so is buy an insurance for your investment at a premium. To do this you but a put call option for the same stock.

Lets take an example :-

You Bought 1000 GMR infra stocks at 690 Rs and you assume that it would go upto 1000 Rs in 6 months. Now to prtotect your investment you buy a Put call at strike price 600 ( You buy a put call when u think the price will drop ) for 1000 shares at an premium of 5000Rs.

Now after 6 months two things can happen

1) GMR stock shoots up and reaches 1000Rs. Now you have made a profit of 310*1000 so you will not exercise your put option and you will lose your money. ie only 5000Rs

2) GMR stock price drops to 500 Rs SO you would lose 190*1000 Rs. But as you have a put option you can sell those shares at 600 and your loss will be only 90*1000 + 5000 ( premium paid for put option ) .

So from the above example you can see by investing 5000 Rs in a put option you can limit your losses...