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Protective Call

A Protective Call is a hedging strategy where you buy a call option to protect a short position in the underlying asset. It works best when there’s a risk of the price rising unexpectedly.

  • Ideal for bearish conditions, where the price might unexpectedly rise.
  • Buying a slightly OTM call provides cost-effective protection.
  • Limits potential losses on the short position while retaining profits if the price falls.
  • Risk is limited to the premium paid for the call option.

Example:

  • NIFTY trading at 18,000.
  • You short 1 lot of NIFTY Futures (lot size = 50) at 18,000.
  • Buy 18,200 Call (OTM) at ₹50 with a near-month expiry.
  • Outcome:
    1. If NIFTY stays below 18,000 at expiry:
      • No impact from the call; you profit from the short futures.
    2. If NIFTY rises to 18,300 at expiry:
      • Loss on futures = ₹15,000.
      • Gain from the call = ₹5,000.
      • Net loss = ₹10,000 (partially offset by the call).
    3. If NIFTY rises to 18,100 at expiry:
      • Loss on futures = ₹5,000.
      • No gain from the call (not exercised).
      • Net loss = ₹5,000 + ₹2,500 (cost of the call).
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