Aim: Generating Fixed Income from this IT company.
Capital Requirement: Strike Price x Lot Size. In this case, 1200 x 400 = Rs. 4,80,000
Strategy used: Cash secured PUT and Covered CALL
Mechanism: An IT company has fallen around 28% from its 52 week high. The weaker business outlook had already been factored into the stock price. Now, sell a put option of a strike price where you are comfortable buying the stock. For discussion, let us assume the strike to be 1200. So we would sell the May expiry 1200 strike price PUT option at CMP 25. This will give us a premium of Rs. 20 x 400 = 8,000 and would require a margin of 80,000. If the stock price remains above 1200 until the expiry, the entire premium is profit (ROI of ~10%). However, if the price falls below 1200, take physical delivery of the shares and then execute a covered call strategy to exit/lower the cost of acquisition. Historically this strategy has given good returns over the benchmark. Do share your views on this?
Note: This strategy will only work as long as the company remains in F&O (which is quite obvious in case of Infosys) and you don’t mind having the stock in your portfolio
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Park the required capital in any liquid fund so that you don’t incur any economic loss.
A characteristic feature of option selling strategies is high accuracy. High enough to lure people in to a false sense of security. One black swan day is enough to take away all that was made in the preceding profitable trades spanning over many months. With that in mind I will present my different take on this strategy.
If we are keeping capital for trading it ain’t prudent to go invested in stocks every time we are in a lose making situation. There is no guarantee that we will be able to exit the stock in profit any time soon. The stock may keep sliding down. This means we lock our capital required for trading leaving less for trading.
What if we sell the 1200 May put and Infy decides to take a dive south overnight (not intraday) ? Without any hedge we could end up with a significant lose and increased margin requirements when market opens.
Agree. There is as such no guarantee that a black swan event will not happen. As option seller gets the benefit of time value, he must we well prepared with fire-fighting. But with companies with good fundamentals, these effects are just temporary. I remember the popular whistle blower case of Infosys, that was a hard hit on the stock. But in no time it made it again to the sky.
I recall the Satyam saga as well. Came out of the blue. There are other stocks that were cynosure of the eyes at a time which eroded investor wealth later - RCOM, UNITECH, DHFL, YES BANK, ABG SHIPYARD, AMTEK AUTO etc. No one knows with any certainty which one is going to bite the dust next.
That’s correct. There had been cases when companies got grounded from the skies. That kind of risk exists when we trade in any particular stock. Personally, CSP and CC I have being doing on INFY and BAJFINANCE had proven good for me. Luckily they were in F&O even during covid collapse so I was able to sail out lowering by COA by around 20%
I think this strategy is only for those investors who have already made decision to to buy Infosys of worth 5L at some specific price.
So, either they get the stock at their desired price or they get premium from selling OTM option. IMO, this is the correct way of thinking instead of considering as fixed income strategy, which isn’t true.
PS: Covered call for any long term portfolio stock is another strategy, which also is not guaranteed to generate good ROI compared to simple buy and hold strategy when compared via backtesting. Most importantly, it requires different mindset to do it.
Park the required capital in any liquid fund so that you don’t incur any economic loss.