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:
- If NIFTY stays below 18,000 at expiry:
- No impact from the call; you profit from the short futures.
- 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).
- 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).
- If NIFTY stays below 18,000 at expiry: