Option trading in indian stock market

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Beginners Guide to Options.
What is an option?
An option is a contract giving the buyer the right, but not the obligation, to buy or sell an underlying asset (a stock or index) at a specific price on or before a certain date.
An option is a derivative. That is, its value is derived from something else. In the case of a stock option, its value is based on the underlying stock (equity). In the case of an index option, its value is based on the underlying index (equity).
· Listed Options are securities, just like stocks.
· Options trade like stocks, with buyers making bids and sellers making offers.
· Options are actively traded in a listed market, just like stocks. They can be bought and sold just like any other security.
· Options are derivatives, unlike stocks (i. e, options derive their value from something else, the underlying security).
· Options have expiration dates, while stocks do not.
· There is not a fixed number of options, as there are with stock shares available.
· Stockowners have a share of the company, with voting and dividend rights. Options convey no such rights.
Some people remain puzzled by options. The truth is that most people have been using options for some time, because option-ality is built into everything from mortgages to auto insurance. In the listed options world, however, their existence is much more clear.
Types Of Expiration.
There are two different types of options with respect to expiration. There is a European style option and an American style option. The European style option cannot be exercised until the expiration date. Once an investor has purchased the option, it must be held until expiration. An American style option can be exercised at any time after it is purchased. Today, most stock options which are traded are American style options. And many index options are American style. However, there are many index options which are European style options. An investor should be aware of this when considering the purchase of an index option.
An option Premium is the price of the option. It is the price you pay to purchase the option. For example, an XYZ May 30 Call (thus it is an option to buy Company XYZ stock) may have an option premium of Rs.2.
The Strike (or Exercise) Price is the price at which the underlying security (in this case, XYZ) can be bought or sold as specified in the option contract.
The Expiration Date is the day on which the option is no longer valid and ceases to exist. The expiration date for all listed stock options in the U. S. is the third Friday of the month (except when it falls on a holiday, in which case it is on Thursday).
People who buy options have a Right, and that is the right to Exercise.
When an option holder chooses to exercise an option, a process begins to find a writer who is short the same kind of option (i. e., class, strike price and option type). Once found, that writer may be Assigned.
There are two types of options - call and put. A call gives the buyer the right, but not the obligation, to buy the underlying instrument. A put gives the buyer the right, but not the obligation, to sell the underlying instrument.
The predetermined price upon which the buyer and the seller of an option have agreed is the strike price, also called the exercise price or the striking price. Each option on a underlying instrument shall have multiple strike prices.
Call option - underlying instrument price is higher than the strike price.
Put option - underlying instrument price is lower than the strike price.
Call option - underlying instrument price is lower than the strike price.
Put option - underlying instrument price is higher than the strike price.
The underlying price is equivalent to the strike price.
Options have finite lives. The expiration day of the option is the last day that the option owner can exercise the option. American options can be exercised any time before the expiration date at the owner's discretion.
A class of options is all the puts and calls on a particular underlying instrument. The something that an option gives a person the right to buy or sell is the underlying instrument. In case of index options, the underlying shall be an index like the Sensitive index (Sensex) or S&P CNX NIFTY or individual stocks.
An option can be liquidated in three ways A closing buy or sell, abandonment and exercising. Buying and selling of options are the most common methods of liquidation. An option gives the right to buy or sell a underlying instrument at a set price.
Options prices are set by the negotiations between buyers and sellers. Prices of options are influenced mainly by the expectations of future prices of the buyers and sellers and the relationship of the option's price with the price of the instrument.
The time value of an option is the amount that the premium exceeds the intrinsic value. Time value = Option premium - intrinsic value.
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Options Trading In Indian Market.
Recent Posts.
Top 10 Beginner’s Question on Options?
How to learn trading options?
NIFTY Weekly price action analysis – 14-October-2011.
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Top 10 Beginner’s Question on Options?
An valid tradable instrument, the holder of which has the right, but no obligation to buy or sell the stock or underlying instrument. Generally the buyer will pay some price to get this right (called premium).
The seller of option will have OBLIGATION to buy or sell the underlying stock/instrument, if the owner of option decides to exercise their right.
2. What are the specifics of an option?
An option is made up of following.
- Underlying stock or other instrument.
- Option type as CALL or PUT.
The different combination of above 4 parameters gives us a unique tradable option chain. eg – NIFTY 5200 CALL 26-Apr-2012.
An option that gives you the RIGHT to BUY the underlying stock/instrument at agreed price (called strike price), before agreed date (called expiry date). The person who is selling you the CALL option carries the obligation to deliver you the stock/instrument, if you decide to exercise your right.
An option that gives you the RIGHT to SELL the underlying stock/instrument at agreed price (called strike price), before agreed date (called expiry date). The person who is selling you the PUT option carries the obligation to take the delivery from you of stock/instrument, if you decide to exercise your right.
5. What are the two considerations in determining the value of an Option?
The value of option is determined mainly by the volatility of the underlying instrument and the distance of option expiry date from today i. e.life of option. More volatile the instrument, or longer the life, costlier the options will be.
6. What are the 3 instruments for trading?
The underlying stock, CALL options on the underlying stock and PUT options on the underlying stock are the three types of instrument for trading.
7. What are the 6 actions that can be taken?
One each of the above 3 instruments, one can take BUY or SELL actions e. g. – Buy stock, Sell stocks, Buy Call option, Sell Call option etc. That gives us overall 6 types of actions.
An option chain is unique combination of 4 parameters given in question 2 above. Each combination is a tradable instrument on its own. eg Nifty 5200 CALL 26-Apr-2012 ang NIFTY 5300 PUT 26-Apr-2012.
9. I have small account size. Can I trade options and make big returns ?
Chances of this happening is very close to zero. Due to small account size, you might end up taking big risk as %age of the account with options. Options are traded in lot size (i. e. minimum quantity for buy or sell), hence the risk will always be in multiple of that lot size. If you trade stocks, this minimum quantity is 1 hence you have much better control on the risk. It is true that %age return can be large in option trade but this can also hit adversely as risk is also high %age term.
My suggestion will be to learn the basics of trading first. If account is small then, use stocks for this learning. Once you have consistent and profitable performance, then move into options trading. That too with appropriate account size.
10. How /where to learn option trading?
Please go through this post “How to learn options trading” where I have given my suggestions on how to get started in options trading. In case of any questions, feel free to leave comment or contact me.
How to learn trading options?
I get many requests from readers who want to start trading in Options, but lost about the path to take. In this post, I am suggesting a possible direction that should help any new option trader to get establish solid foundation for their trading.
1) To make money in any trading (be it a stock, futures, options or anything), very first thing to know is the direction of the market. Can you make money by buying something, when market is falling ? So very first thing you need to learn is to identify the current trend of the market (up, down or sideway). Better you are in deciding the trend, stronger is your foundation. E. g. – If you are in Nagpur and want to go to Delhi, then first thing u have to do is to be on platform where Northbound trains are arriving.
2) Once you know the direction of market /instrument that you want to trade, then choose appropriate option strategy for this. There are options strategies for each type of market conditions offering different return-risk profile that may suit you.
3) There 6 basic risk graphs in core option and stock strategy. All other strategy is just combination of these 6 basics. These core risk graphs are for – Buy Stock, Sell stock, Buy Call, Sell Call, Buy Put and Sell Put position. Spend as much time as required to understand them on parameters I am going to mention in next point.
4) For any strategy (including the 6 basic ones), know.
How they are constructed What is max risk, What is max reward, Where is BREAK-EVEN point, How the risk graph looks like at expiry, What are suitable market condition favourable for these strategies.
Once, you should are in a position to draw risk graph without any option analysis tool, then you pass out of this stage.
5) Understand the concept of option pricing, intrinsic value and time value and the factors that affect option premium. Focus not just on the theory, but also on how changes in those factors will affect the premium. Watch them in real life, experiment with them using option calculator, take notes and track them over next few days using real market data.
6) At advance stage, you can look at transition of risk graph from now to final stage at expiry, various option Greeks etc., various strategies that are combination of 6 core strategies. This is the stage, I will advise one to start using a tool. IMO, A professional doesn’t become handicap without a tool. He/she knows how to work without tools. But when they are given the tools, then their performance and efficiency zooms. They know what they are doing, or what they want to do because they have solid foundation. IMO, a great tool in the hand of a monkey is no different from a banana or a stone in its hand. But give a great tool a professional, and see the difference.
There are different approach to cover above points (read books, take mentorship from experienced and successful trader, play in market and learn the hard way, go-to school/collage etc). The decision is yours. But be careful about selecting the place or option that you are going for. If you read wrong book, go to wrong person for training or do wrong course, you might end up just wasting your resources (time, money, energy etc.).
This is just to give base in option trading, so that you can plan an option trader properly. Remember, that doesn’t make you a trader still. Trading involves Money management, developing right trading psychology, risk management, developing suitable trading system etc. All those areas are beyond the scope of this post but please don’t ignore them.
Last but not the least, there is no single defined path that you need to follow to get started in options trading e. g.first trade stocks, then futures, then options. If it is done appropriately, then you can start directly in options, without getting into stocks etc. If you know stock trading (better if you have profitable track record in stock trading), then few initial steps are not required.
But that is not limitation, even if you have never traded stocks. As long as you learn to read market trend, you can start with options trading.
LEARNING MATERIAL.
There are many good resources available on internet to learn about Options. Some of them are:-
1) Learning Center section on cboe.
3) NSE site // *Home > NCFM > NCFM Modules” section and check out the study material on following modules.
- Equity Derivatives: A Beginner’s Module.
- Derivatives Market (Dealers) Module.
- Options Trading Strategies Module.
NIFTY Weekly price action analysis – 14-October-2011.
Here is the Nifty weekly chart with trend lines, trend channel and swing points marked on it.
Nifty weekly price action based analysis.
Let’s take a look at NIFTY’s weekly chart and do the analysis based on facts shown by price action-
1) We have got a new pivot low confirmed at 4730.
2) Strong bullish bar with close at upper end.
3) Increase in volume with bullish price action.
1) Price is still below the crucial resistance level of 5180 / 5200.
2) Long term price trend channel is still pointing down.
Interpretation and possibilities for next week -
As a trader, we have to be prepared to face anything that market throws on us. So lets see what might come in next week.
1) Nearest supply zone of 5200 level to be watched closely in next week. Market has still not tested this level yet.
2) Possible support of 4720 level has worked in this week and gave us nice bounce. It resulted in Hammer candle. I would like to see higher volume and close in top 10% for a hammer. As expected, we got higher volume this week and strong bullish candle closing in top 10%. This indicates the strength of 4720 support level.
3) Volume has increased this week. My view of short term accumulation by smart-money is turning out to be correct as prices are moving up with strong candle. It is still not bullish move but in a sideway range with short term bullish bias.
4) Lower swing low at 5200 level is still not broken. As this level is below the long term bullish trend line from March-2009 low, it confirms that the trend line is broken. In other words the Bull market that started from March-2009 low is over. The long term direction of market is down and the deciding trend line for this is the down sloping line starting from 6300 high made in Oct-2010.
Important levels to watch for – For up-move – 5150, 5200, For down-move – 4880, 4720. For sideway – 4880, 5150..
Hope this analysis helps you in forming your own views on market. Feel free to drop your comments on the post. Let me know if you would like to see something more in the analysis.
Disclaimer – These are my views on the market and I could be wrong in reading it. Please use your own judgment and make sensible trading decision based on your own analysis.
NIFTY Weekly price action analysis – 07-October-2011.
Here is the Nifty weekly chart with trend lines, trend channel and swing points marked on it.
Nifty weekly price action analysis.
Let’s take a look at NIFTY’s weekly chart and do the analysis based on facts shown by price action-
1) There was large pullback from the low of 4720 and bar closed marginally in green.
2) Hammer candle is formed, though not very strong as the weekly close is roughly 20% of range below the high. For strength of hammer, I would like to see the close being in top 10% range.
1) This week has given lower high and lower low too. Hence down trend continues.
2) Volume this week has been lower then previous 4 weeks. The low volume gives me doubt on strength of hammer candle. Lets see what happens in next week.
Interpretation and possibilities for next week -
As a trader, we have to be prepared to face anything that market throws on us. So lets see what might come in next week.
1) Nearest supply zone of 4950/5170 level worked last week and it also hold as resistance during this week too. As anticipated last week that 5000 levels will act as new supply zone, it turned out to be true this week when price struggled to stay above 5000 and finally dropped and closed below this.
2) Possible support of 4720 level has worked in this week and gave us nice bounce. It resulted in Hammer candle. I would like to see higher volume and close in top 10% for a hammer. Hence would like to wait for next weeks action to tell me more about it.
3) Volume has been lowest of last 5 weeks. I would like to watch it closely during next week for break or support of 4720 level. Else my view of short term accumulation by smart-money will be supported. My tracking of FII flows also giving the sign of short term bottom formation.
4) This weeks lower high bar resulted in giving us lower swing low at 5200 level. As this level is below the long term bullish trend line from March-2009 low, it confirms that the trend line is broken. In other words the Bull market that started from March-2009 low is over. The long term direction of market is down and the deciding trend line for this is the down sloping line starting from 6300 high made in Oct-2010.
Important levels to watch for – For up-move – 4920, 5000, For down-move – 4720, 4675. For sideway – 4720, 4920.
Hope this analysis helps you in forming your own views on market. Feel free to drop your comments on the post. Let me know if you would like to see something more in the analysis.
Disclaimer – These are my views on the market and I could be wrong in reading it. Please use your own judgment and make sensible trading decision based on your own analysis.
NIFTY Weekly price action analysis – 30-September-2011.
Here is the Nifty weekly chart with trend lines, trend channel and swing points marked on it.
NIFTY weekly price action analysis.
Let’s take a look at NIFTY’s weekly chart and do the analysis based on facts shown by price action-
1) Weekly close is above previous weeks close. The week has also shown a green candle.
2) Wide range candle closing in middle.
3) Volume has been higher then previous week.
1) Market made lower high and lower low on weekly chart. It also resulted in new lower swing high below the important level of 5200.
Interpretation and possibilities for next week -
As a trader, we have to be prepared to face anything that market throws on us. So lets see what might come in next week.
1) Nearest supply zone of 5170/5200 level worked last week and it also hold as resistance during this week too. As anticipated last week that 5000 levels will act as new supply zone, it turned out to be true this week when price struggled to stay above 5000 and finally dropped and closed below this.
2) Possible support is at 4720 level. Any break of this, can easily take market to 4550 level on downside.
3) Volume has been fairly high during this week indicating active participation by smart money. I would like to watch it closely during next week for break or support of 4720 level. Else my view of short term accumulation by smart-money will be supported. My tracking of FII flows also giving the sign of short term bottom formation.
4) This weeks lower high bar resulted in giving us lower swing low at 5200 level. As this level is below the long term bullish trend line from March-2009 low, it confirms that the trend line is broken. In other words the Bull market that started from March-2009 low is over. The long term direction of market is down and the deciding trend line for this is the down sloping line starting from 6300 high made in Oct-2010.
Important levels to watch for – For up-move – 5000/5170, For down-move – 4750, 4720. For sideway – 4750 to 5030.
Hope this analysis helps you in forming your own views on market. Feel free to drop your comments on the post. Let me know if you would like to see something more in the analysis.
Disclaimer – These are my views on the market and I could be wrong in reading it. Please use your own judgment and make sensible trading decision based on your own analysis.
Interpreting top 10 open interest – 30-September-2011.
As options open interest shows us the footprint of smart money/big players, so lets try to decipher their footprint. Here is the list of option strikes (October expiry) that have got highest open interest as of Friday’s close.
1) 5000 and 5200 CALLs have seen highest OI in this new series indicating these levels as resistance.
2) 4700 and 4800 PUT have seen highest OI in this new series indicating these levels as good support.
1)4400 PUT had seen trading in the order of 22 lacs OI. This could provide support in event of fall below 4700 level.
2) 4500 PUT do not have higher OI then 4400 or 4600 level hence this psychological level might not be of much use.
Hope this analysis helps you in forming your own views on market. Feel free to drop your comments on the post. Let me know if you would like to see something more in the analysis.
Disclaimer – These are my views on the market and I could be wrong in reading it. Please use your own judgment and make sensible trading decision based on your own analysis.
NIFTY Weekly price action analysis – 23-September-2011.
Here is the Nifty weekly chart with trend lines, trend channel and swing points marked on it.
NIFTY weekly price action analysis.
Let’s take a look at NIFTY’s weekly chart and do the analysis based on facts shown by price action-
I am struggling to find bullish reasons on chart once again on this week. Except that the volume in this bearish week are lower then previous week, which show lack of bearish strength.
Once again we had bearish week.
1) Price broke above previous NR week, just to indicate that it was false breakout. It the resistance zone 5170 and dropped from there.
2) We have a bearish engulfing candle that has engulfed the bullish price action of last 2 weeks. It is also wide range candle, indicating strength in bearish move.
3) Volume has been low in this week. It is important to watch the price action and volume as it reaches the previous swing low point 4720.
4) I have marked Green think link on this weeks chart to project the possible downside target for this leg. Of course it will not be straight line move and we will see some intermediate bounces. Possible levels where market might support are green lines at 4700 /4550 levels.
Interpretation and possibilities for next week -
As a trader, we have to be prepared to face anything that market throws on us. So lets see what might come in next week.
1) Nearest supply zone of 5170/5200 level worked during this week and pushed the market down from here. Market found some support above 5000 which is also broken later. Now 5000 levels will act as new supply zone.
2) Possible support is at 4720 level. Any break of this, can easily take market to 4550 level on downside.
3) Volume has been low during this week indicating that new supply has not yet entered the market. I would like to watch it closely during next week. Else my view of short term accumulation by smart-money will be supported. My tracking of FII flows also giving the sign of short term bottom formation.
Important levels to watch for – For up-move – 5170/5300, For down-move – 4830, 4720. For sideway – 4830 to 5170.
Hope this analysis helps you in forming your own views on market. Feel free to drop your comments on the post. Let me know if you would like to see something more in the analysis.
Disclaimer – These are my views on the market and I could be wrong in reading it. Please use your own judgment and make sensible trading decision based on your own analysis.
Interpreting top 10 open interest – 23-September-2011.
As options open interest shows us the footprint of smart money/big players, so lets try to decipher their footprint. Here is the list of option strikes (September expiry) that have got highest open interest as of Friday’s close.
1) 4800 and 4900 CALLs have seen good addition in OI making them immediate resistance for current series.
2) 4600 PUT has also shown very good increase in OI making it stronger support level.
3) 4700 PUT has seen drop in OI indicating this level might not provide any support here.
1) We are in the last week of this series hence change in OI could be very fast. As per the highest OI at this stage, 4600/4700/4800 are potential support levels.
2) Resistance level is currently built up at 4900 and then at 5000 level.
4) This being last week of current series, the quick look at next month’s OI indicates good build up of CALLs at 5200/5100/5000 level and PUTs at 4800/4700/4500 levels. Hope this analysis helps you in forming your own views on market. Feel free to drop your comments on the post. Let me know if you would like to see something more in the analysis.
Disclaimer – These are my views on the market and I could be wrong in reading it. Please use your own judgment and make sensible trading decision based on your own analysis.
Interpreting top 10 open interest – 16-September-2011.
As options open interest shows us the footprint of smart money/big players, so lets try to decipher their footprint. Here is the list of option strikes (September expiry) that have got highest open interest as of Friday’s close.
1) 5300 CALL have shown good addition in OI making them strong resistance for current series. 5200 CALL OI has gone down, i. e. this level has weaken as resistance.
2) 4900 PUT has also shown very good increase in OI making it stronger support level.
3) 5500 CALLs have shown drop in OI indicating people are booking profit on these calls.
4) Higher volume of Open Interest in CALLs is at 5200 level and then at 5300 level. Highest level of PUTs is at 4700, 4800, 5000 level.
1) As market moved up during this week, support level has shifted up which is indicated by heavy increaes in PUT OI at 4900/5000 levels.
2) Resistance level is currently built up at 5200 and then at 5400 level.
3) As market moved up, if sentiments are turning bullish then we should have seen more CALLs OI. Unfortunately, that is not the case. This is indication of lack of strength in bullish move. We have seen increase in PUT OI which is going to provide support during current series, if market falls from here.
Hope this analysis helps you in forming your own views on market. Feel free to drop your comments on the post. Let me know if you would like to see something more in the analysis.
Disclaimer – These are my views on the market and I could be wrong in reading it. Please use your own judgment and make sensible trading decision based on your own analysis.
NIFTY Weekly price action analysis – 16-September-2011.
Here is the Nifty weekly chart with trend lines, trend channel and swing points marked on it.
Nifty Weekly price action analysis.
Let’s take a look at NIFTY’s weekly chart and do the analysis based on facts shown by price action-
1) We had weekly Green bar indicating continuation of bullish move in short term.
2) Weekly volume has been very good supporting the upmove. Friday’s daily volume has been one of the highest in last 20 days.
3) Weekly close is above the psychological level of 5000.
1) The week made Lower High and Lower Low compared to last week, indicating weakness.
2) Previous week with range of 226 points was NR7 week (narrowest range in last 7 weeks). This weeks range of 232 is also among the narrower range. It indicates that market is still in consolidation phase, but sooner or later, we are going to see range expansion and move.
3) Price has dropped from the previous support level of 5177, which acted as resistance on daily chart. The lower high resulted in giving us Swing High point at 5177 which will act as first resistance going forward.
3) Market closed at more or less same level as previous weeks close indicating lack of strength in trend.
Interpretation and possibilities for next week -
As a trader, we have to be prepared to face anything that market throws on us. So lets see what might come in next week.
1) Nearest supply zone was around 5177/5200 level. Market needs to cross this level to show any further sign of strength. Looking at global weakness, it is going to be a challenge.
2) Any break of 5177 level, can easily take market to 5328 level on upside.
3) Volume has been high on last 2 days of the week, indicating that accumulation might be in progress. My tracking of FII flows also giving the sign of short term bottom formation.
4) On first 3 days of this week, market made daily low between 4910 /4920 range. Hence this level will act as support or trend decider in days to come.
5) I will not call it as end of bearish trend. This could very well be a bearish rally. We are still in down trend, global markets are still going down. In such situation, it is better to wait for more confirmation before we call it return of bull market.
Important levels to watch for – For up-move – 5200/5300, For down-move – 4800, 4900. For sideway – 4910 to 5150.
Hope this analysis helps you in forming your own views on market. Feel free to drop your comments on the post. Let me know if you would like to see something more in the analysis.
Disclaimer – These are my views on the market and I could be wrong in reading it. Please use your own judgment and make sensible trading decision based on your own analysis.

FAQs: Futures and Options trading in India.
WITH the exit of badla from the coming month, the stockmarket will see the introduction of options and futures in a big way. For investors who have difficulty in understanding the terminologies associated with options and futures as well as its modes of working, here's some lucid explanation.
An option is a contract, which gives the buyer (holder) the right, but not the obligation, to buy or sell specified quantity of the underlying assets, at a specific (strike) price on or before a specified time (expiration date).
Underlying - The specific security / asset on which an options contract is based.
When the holder of an option exercises his right to buy/ sell, a randomly selected option seller is assigned the obligation to honor the underlying contract, and this process is termed as Assignment.
An American style option is the one which can be exercised by the buyer on or before the expiration date, i. e. anytime between the day of purchase of the option and the day of its expiry.
A call option gives the holder (buyer/ one who is long call), the right to buy specified quantity of the underlying asset at the strike price on or before expiration date.
A Put option gives the holder (buyer/ one who is long Put), the right to sell specified quantity of the underlying asset at the strike price on or before a expiry date.
A call option position that is covered by an opposite position in the underlying instrument (for example shares, commodities etc), is called a covered call.
The intrinsic value of an option is defined as the amount by which an option is in-the-money, or the immediate exercise value of the option when the underlying position is marked-to-market.
Time value is the amount option buyers are willing to pay for the possibility that the option may become profitable prior to expiration due to favorable change in the price of the underlying. An option loses its time value as its expiration date nears. At expiration an option is worth only its intrinsic value. Time value cannot be negative.
There are two types of factors that affect the value of the option premium:
The theoretical option pricing models are used by option traders for calculating the fair value of an option on the basis of the earlier mentioned influencing factors.
Options Premium is not fixed by the Exchange. The fair value/ theoretical price of an option can be known with the help of pricing models and then depending on market conditions the price is determined by competitive bids and offers in the trading environment.
The price of an Option depends on certain factors like price and volatility of the underlying, time to expiry etc. The option Greeks are the tools that measure the sensitivity of the option price to the above mentioned factors.
An option calculator is a tool to calculate the price of an Option on the basis of various influencing factors like the price of the underlying and its volatility, time to expiry, risk free interest rate etc.
Developmental institutions, Mutual Funds, FIs, FIIs, Brokers, Retail Participants are the likely players in the Options Market.
Besides offering flexibility to the buyer in form of right to buy or sell, the major advantage of options is their versatility. They can be as conservative or as speculative as one's investment strategy dictates.
High leverage as by investing small amount of capital (in form of premium), one can take exposure in the underlying asset of much greater value.
If you anticipate a certain directional movement in the price of a stock, the right to buy or sell that stock at a predetermined price, for a specific duration of time can offer an attractive investment opportunity.
Option is a contract which has a market value like any other tradable commodity. Once an option is bought there are following alternatives that an option holder has:
The risk/ loss of an option buyer is limited to the premium that he has paid.
The risk of an Options Writer is unlimited where his gains are limited to the Premiums earned. When a physical delivery uncovered call is exercised upon, the writer will have to purchase the underlying asset and his loss will be the excess of the purchase price over the exercise price of the call reduced by the premium received for writing the call.
Option writing is a specialized job which is suitable only for the knowledgeable investor who understands the risks, has the financial capacity and has sufficient liquid assets to meet applicable margin requirements. The risk of being an option writer may be reduced by the purchase of other options on the same underlying asset thereby assuming a spread position or by acquiring other types of hedging positions in the options/ futures and other correlated markets.
In the Indian Derivatives market, Sebi has not created any particular category of options writers. Any market participant can write options. However, margin requirements are stringent for options writers.
The Stock Index Options are options where the underlying asset is a Stock Index for e. g. Options on S&P 500 Index/ Options on BSE Sensex etc.
Index options enable investors to gain exposure to a broad market, with one trading decision and frequently with one transaction. To obtain the same level of diversification using individual stocks or individual equity options, numerous decisions and trades would be necessary.
Index Options are effective enough to appeal to a broad spectrum of users, from conservative investors to more aggressive stock market traders.
Options contracts where the underlying asset is an equity stock, are termed as Options on stocks. They are mostly American style options cash settled or settled by physical delivery.
Options can offer an investor the flexibility one needs for countless investment situations. An investor can create hedging position or an entirely speculative one, through various strategies that reflect his tolerance for risk.
The equity options traded on exchange are not issued by the companies underlying them. Companies do not have any say in selection of underlying equity for options.
Holder of the equity options contracts do not have any of the rights that owners of equity shares have - such as voting rights and the right to receive bonus, dividend etc. To obtain these rights a Call option holder must exercise his contract and take delivery of the underlying equity shares.
Long term equity anticipation securities (Leaps) are long-dated put and call options on common stocks or ADRs.
Derivatives with more complicated payoffs than the standard European or American calls and puts are referred to as Exotic Options. Some of the examples of exotic options are as under:
Over-The-Counter options are those dealt directly between counter-parties and are completely flexible and customized. There is some standardization for ease of trading in the busiest markets, but the precise details of each transaction are freely negotiable between buyer and seller.
Like stocks, options and futures contracts are also traded on any exchange. In Bombay Stock Exchange, stocks are traded on BSE On Line Trading (BOLT) system and options and futures are traded on Derivatives Trading and Settlement System (DTSS).
The underlying for the index options is the BSE 30 Sensex, which is the benchmark index of Indian Capital markets, comprising 30 scrips.
BSE's first index options is based on BSE 30 Sensex. The Sensex options would be European style of options i. e. the options would be exercised only on the day of expiry.
Specific Portfolio Analysis of Risk (SPAN) is a worldwide acknowledged risk management system developed by Chicago Mercantile Exchange (CME). It is a portfolio-based margin calculating system adopted by all major Derivatives Exchanges.
SPAN identifies overall risk in a complete portfolio of futures and options at the same time recognizing the unique exposures associated with both inter-month and inter-commodity risk relationships.
PC-SPAN is an easy to use program for PC's which calculates SPAN margin requirements at the members' end. How PC SPAN works:
Each business day the exchange generates risk parameter file (parameters set by the exchange ) which can be down loaded by the member.
A portfolio based margining model (SPAN), would be adopted which will take an integrated view of the risk involved in the portfolio of each individual client comprising of his positions in all the derivatives contract traded on the Derivatives Segment.
On Exercise of an Option by an Option Holder, the trading software will assign the exercised option to the option writer on random basis based on a specified algorithm.
An investor has to register himself with a broker who is a member of the BSE Derivatives Segment.
The exchange is conducting free of cost futures and options awareness programs for member brokers and their clients. This will be conducted across the country to reach investors at large.
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Option trading indian stock market. I am interested in trading in stock and nifty options. Can you please guide on how to be profitable in options trading. Options are a major trend in Indian stock markets now, with turnover in options category being significantly higher than that of stocks, index or derivatives category. Just to take an example.
Option trading indian stock market. Options vs. Stocks Similarities: � Listed Options are securities, just like stocks. � Options trade like stocks, with buyers making bids and sellers making offers. � Options are actively traded in a listed market, just like stocks. They can be bought and sold just like any other security. Differences: � Options are derivatives, unlike.
As with any of the previous modules in Varsity, we will again make the same old assumption that you are new to options and therefore know nothing about options. For this reason we will start from scratch and slowly ramp up as we proceed. Let us start with running through some basic background information. The options market makes up for a significant part of the derivative market, particularly in India.
Internationally, the option market has been around for a while now, here is a quick background on the same �. Clearly the international markets have evolved a great deal since the OTC days. However in India from the time of inception, the options market was facilitated by the exchanges. The badla system no longer exists, it has become obsolete. Here is a quick recap of the history of the Indian derivative markets �.
Though the options market has been around since , the real liquidity in the Indian index options was seen only in ! I remember trading options around that time, the spreads were high and getting fills was a big deal. However in , the Ambani brothers formally split up and their respective companies were listed as separate entities, thereby unlocking the value to the shareholders.
In my opinion this particular corporate event triggered vibrancy in the Indian markets, creating some serious liquidity. However if you were to compare the liquidity in Indian stock options with the international markets, we still have a long way to catch up. There are two types of options � The Call option and the Put option. You can be a buyer or seller of these options. In fact the best way to understand the call option is to first deal with a tangible real world example, once we understand this example we will extrapolate the same to stock markets.
Consider this situation; there are two good friends, Ajay and Venu. Ajay is actively evaluating an opportunity to buy 1 acre of land that Venu owns. The land is valued at Rs.
Ajay has been informed that in the next 6 months, a new highway project is likely to be sanctioned near the land that Venu owns. If the highway indeed comes up, the valuation of the land is bound to increase and therefore Ajay would benefit from the investment he would make today.
So what should Ajay do? Clearly this situation has put Ajay in a dilemma as he is uncertain whether to buy the land from Venu or not. While Ajay is muddled in this thought, Venu is quite clear about selling the land if Ajay is willing to buy.
Ajay wants to play it safe, he thinks through the whole situation and finally proposes a special structured arrangement to Venu, which Ajay believes is a win-win for both of them, the details of the arrangement is as follows �. So what do you think about this special agreement? Who do you think is smarter here � Is it Ajay for proposing such a tricky agreement or Venu for accepting such an agreement?
Well, the answer to these questions is not easy to answer, unless you analyze the details of the agreement thoroughly. I would suggest you read through the example carefully it also forms the basis to understand options � Ajay has plotted an extremely clever deal here! In fact this deal has many faces to it. Now, after initiating this agreement both Ajay and Venu have to wait for the next 6 months to figure out what would actually happen.
However irrespective of what happens to the highway, there are only three possible outcomes �. Remember as per the agreement, Ajay has the right to call off the deal at the end of 6 months. Now, with the increase in the land price, do you think Ajay will call off the deal?
This means Ajay now enjoys the right to buy a piece of land at Rs. Clearly Ajay is making a steal deal here.
Venu is obligated to sell him the land at a lesser value, simply because he had accepted Rs. Another way to look at this is � For an initial cash commitment of Rs. Venu even though very clearly knows that the value of the land is much higher in the open market, is forced to sell it at a much lower price to Ajay. The profit that Ajay makes Rs.
It turns out that the highway project was just a rumor, and nothing really is expected to come out of the whole thing. People are disappointed and hence there is a sudden rush to sell out the land. As a result, the price of the land goes down to Rs. So what do you think Ajay will do now?
Clearly it does not make sense to buy the land, hence he would walk away from the deal. Here is the math that explains why it does not make sense to buy the land �. Remember the sale price is fixed at Rs. Hence if Ajay has to buy the land he has to shell out Rs. Which means he is in effect paying Rs. Clearly this would not make sense to Ajay, since he has the right to call of the deal, he would simply walk away from it and would not buy the land. However do note, as per the agreement Ajay has to let go of Rs.
For whatever reasons after 6 months the price stays at Rs. What do you think Ajay will do? Well, he will obviously walk away from the deal and would not buy the land. Why you may ask, well here is the math �. Clearly it does not make sense to buy a piece of land at Rs. Do note, since Ajay has already committed 1lk, he could still buy the land, but ends up paying Rs 1lk extra in this process.
For this reason Ajay will call off the deal and in the process let go of the agreement fee of Rs. I hope you have understood this transaction clearly, and if you have then it is good news as through the example you already know how the call options work! But let us not hurry to extrapolate this to the stock markets; we will spend some more time with the Ajay-Venu transaction. I would suggest you be absolutely thorough with this example.
If not, please go through it again to understand the dynamics involved. Also, please remember this example, as we will revisit the same on a few occasions in the subsequent chapters.
Do note, I will deliberately skip the nitty-gritty of an option trade at this stage. The idea is to understand the bare bone structure of the call option contract. Assume a stock is trading at Rs. You are given a right today to buy the same one month later, at say Rs. Obviously you would, as this means to say that after 1 month even if the share is trading at 85, you can still get to buy it at Rs. In order to get this right you are required to pay a small amount today, say Rs. If the share price moves above Rs.
If the share price stays at or below Rs. All you lose is Rs. After you get into this agreement, there are only three possibilities that can occur. Case 1 � If the stock price goes up, then it would make sense in exercising your right and buy the stock at Rs.
Case 2 � If the stock price goes down to say Rs. Case 3 � Likewise if the stock stays flat at Rs. This is simple right?
If you have understood this, you have essentially understood the core logic of a call option. What remains unexplained is the finer points, all of which we will learn soon.
At this stage what you really need to understand is this � For reasons we have discussed so far whenever you expect the price of a stock or any asset for that matter to increase, it always makes sense to buy a call option! Now that we are through with the various concepts, let us understand options and their associated terms.
Hi Sir, Options is like greek and latin to me. Thanks for the analogies. No, all derivative contracts are routed via the exchanges. You cannot enter into an OTC arrangement, even if you do, it would not be regulated hence quite dangerous. What benefit would Ajay get by calling off the deal before the expiry of 6 months? He will instead wait for the whole 6 months for any chance of the highway project. My first question Karthik is this: The dropdown value on the NSE website does not contain all months expiries � after 18th May we have 25th June followed by 24th Sept and then 31st Dec What happened to the other months?
For to only June and Dec contracts are available. What happened to the remaining? Saurabh, glad you noticed it! For all stocks options the expiry is very similar to futures. Hence we have current month, mid month, and far month contracts. However for Nifty there are several different expiry options. Leaps are good if you have a super long term view on markets. However the problem with leaps in India is that they are not liquid, there are hardly any trading activity here.