[MUSIC] Learning outcomes, after watching this video you will be able to understand options from a buyer's perspective. [MUSIC] >> So, as I've told you, there is a strategy which can save you from a momentum crash. Now, this will require someone to sell you options. This course not our options, I'm not going to cover options in detail, those are few things, that options are very complicated. You may skip this part, we will not test you on this but then the strategies in testing those of you have some background in investments and markets can try this strategy. Now, we have a module, separate on investment management, there we talk about options in detail. But, those of you interested, let me do a quick recap of what options are. Or, you can go back to that module and have a look at it. But options, let's take the definitions of options and it says, it's a right but not an obligation. Sounds beautiful right? It's a right but not an obligation. So anything which is a right but you don't have an obligation. That's an option. But then as any good thing in life, it comes at a price, it's like insurance, right? What's the insurance, think about say a building fire insurance, let's. What is it all about? So pay a premium, and that event happens, you get insurance covered. Otherwise, the money is gone, it's sunk, right? That's insurance, options are like insurance progress. So there are two basic types of options, call option and put option. What is call option? Call option is a right to buy. Now let me explain there are some thumbs in wall. I think a graph will help us. So imagine, let me draw this whole thing. So, suppose you think that a stock is going to go up. That is your outlook but then you're not very sure about it and you also think that there is some non zero probability that there could be a crash. So you don't want to have the down side. And for this, you want to benefit from that site, but you want some production on the down side. And obviously you have to pay for it. So in such situations you buy a call option. So a call option is a right to buy on a future date at a price specified now. And that price is known as strike price. So let's take an example. And the money that you're to pay right now upfront is called premium. Now let's take an example. Suppose, so there is a store which is let's say, which is 100 right now and it's new thing that is going to work. But there is a chance that it may collapse as well, right? So what you do? You buy a call option with a strike price of 100. Every strike there are options at different strike prices. Now you can guess, lower the strike price. Lower the stock price, higher will be the premium, why? Because you are getting a chance to buy at the low price. Buy anything at low price is more valuable, right? So that's all the logic is. Now if you're not getting it, please see the investment management model. I won't be able to go into details of options here. So let's assume you pick up this 100 strike price option. And the premium let's say is four. So you start with the, so this is your payoff here in the vertical axis. And here in the horizontal axis you have stock price. Suppose you pay a premium of this much, whatever it is, P. And or we can give it a number say four and now what happens is this has a maturity say you buy a one month option that means after a month you have a right to buy other specified price, right? So, there are options where you can buy only after a month, there are options you can buy at any time. I know that is consider of American and European option. So, you can see the in [INAUDIBLE] management course for more details. Assume in this case you can buy after a month, right? So, at the end of one month suppose, the price, let's say the stock price, the stock price goes up, right, is 200. Now what happens? Think what happens. So you have a right to buy at how much? 100, right, now the stock price is 200. This is the current stock price and this is strike price. Now what you can do, just buy the stock, exercise this option, get the stock, pay a hundred and you can immediately sell it 200. So you make 100. Do you make hundred less or more? Pose for a while and think, so you've already paid this four right? So your net profit, your cost which is premium is four so you effectively make 96. Right? So if the stock price is above this you make profit, how much? The gap minus the four. Imagine the stock price is say 50. I'll make a calculation. You have to guess whether this right or wrong. 50 minus 4, minus 54, is this correct? Do you lose 54? What did I say? It's a right but not an obligation, so this is wrong. All that will happen at 54, is that you will not exercise this, so your loss will be how munch? Your loss will be? Sorry Four because it is the premium. So you need prices below 100 your loss is. Now as the stock starts growing above 100 this will be 104 you'll start making money and then you can make unlimited amount of money. Now this is call option for you. Right? Now what is put option? Put option is a right to sell. So call option is a right to buy. Put option is a right to sell. Now, when do you use this option? Suppose you think that a stock price is going to fall See you can go and directly short, right? But what's the risk of shorting? What if the stock rallies? What if it goes up? Then you'll be under trouble. So if you want to protect yourself from a possible up move in the stock, you're primary view is that the stock is going to go down. That's your view. But, at the same time, you want to be protected against surprise happening. Some surprises won't happen. At that time, you buy a put option. So, the definition of put option is it's a right to sell. Put option is a right to sell at a particular strike price for which you are to pay a premium. Now let's take the earlier example. Now suppose you buy a put option at 100, let's say the prices is three and a half, there's a reason why it has to be three and a half, those who are interested can read. It need not exactly be three and half, suppose the price is three and a half Now you buy a month production and the stock and the end of one month, let's say it's 50. So this is your strike price and your. Stock price is 50. Now think about it. What will you do now? You have a right to sell at 100, right? So you can sell at 100, you have a right to sell at 100. What you can do? You can go to the spot market Buyers top at 50 and exercise your right to sell at 100. So then you basically you evaluate the stock which you bought at 50 and get 100, and you pocket 50. Do you really pocket 50? No, because you have a premium, right. So my subtract premium which is three and a half, so you make 46 and a half. This is your profit if a stock from a 100 it fall to 50. Now, who pays you a 100, how does it work? Is beyond this scope of this module, we can do a separate on module option itself. But, All that you have to understand if you think a stock is going to go down but you want to be protected against a surprise up move this is how you can do. You can buy a put option. Now let's complete this with an alternative scenario. Suppose you buy at 100, the stock goes to 200. Now it should be simple. What will you do? You will not exercise the option. And then hence you will lose your pay off will be minus 3.5. That's the bill. Now let's try to sketch this like we did with. Please remember there's a difference between shorting and buying an option and there is also selling an option. I will not get into selling an option. So I'm only talking about buying because for our strategy all I really need is buying an option. So I'm not talking about selling an option, don't get confused. So you have buying a call option or buying a put option. Let's just say to draw. So as before. You pay a premium, this is three and a half. Now this is 100. What happens if the price is 700? What will you do? You loose. Three and a half. Any price above 100, you lose this your loss capped, right? As the stock starts going below 100, so this is your 96.5, your loss becomes 0, because you recall your premium. And any price below this You start making money. So there is a difference between call input. this is practically, I know this may not happen in most of cases. So in call, there is a possibility of unlimited gates. Input in all the minimum, my stock can fall to zero because you have limited of it. So that is why the stock cannot go below zero. So in this case the maximum you can make is 96 and a half, right. So this is a concept of a column of production. Now what I suggest is before trying to understand the strategy modeling moment and crash, what I suggest is do some reading writing options. So that you'll be well prepared. You can pause this video here, do some reading our option. Because the moment them scrash trading strategy it's very simple. But it requires descent understanding of production. Call is not required.