Suggest two different option strategies if
a) the price of the underlying asset is expected to increase,
b) the price of the underlying asset is expected to decrease
Please explain.
Answer - underlying asset is the asset on which the options stategies are applied. In financial market underlying asset can be a stock whose price is expected to rise or fall in future.
a) when the price of underlying asset us expected to increase - in this case 2 strategies can be opted,
(1) buy call option - it is the right to buy the underlying asset at a predetermined price. Let's say the current price of stock is 100. Now if the price is expected to increase, one can buy call option to buy the stock at 100 in future. There after when the price increases let's say 150. The call option can be exercised and the stock can be purcaspur at 100 and can be sold at a price of 150 to make a profit of 50 less the price paid as premium to buy the call option.
(2) sell put option - it is an obligation to buy the security at a predetermined price. Let's say the current price of stock is 100. Now even if the price increases to 150 the obligation will be to buy the stock at 100 ( predetermined price). And hence if the option is exercised by the buyer of put option, there will be a profit of 50 plus the price received by selling the put option. And if the option is not exercised by the buy the premium received will be the profit for the seller of put option.
b) when the price of underlying asset is expected to decrease - in this case two strategies can be opted,
(1) buy put option - it is a right to sell the stock at a predetermined price. Let's say if the price of stock is 100 currently and it's expected to decrease in future. In this case if a person buys put option he will have the right to sell the stock at 100. Now if the price fell down to 50. The buyer of put option will have the right to sell the stock at 100 and thus he will make a profit of 100 - 50 = 50 less the premium paid to buy the option.
(2) sell call option - it is an obligation to sell the stock at a predetermined price. Suppose the currently the price of stock is 100 and a call option is sold with an strike price of 100. Now if the price of asset falls to 50 and the option is exercised by the buyer, the seller of option will have a profit of 100 - 50 = 50 plus the premium received by selling the call option. And if the option is not exercised, the premium received will be the profit for the seller of call option.
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