Futures and Options

Futures
& Options
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Different Types of Asset Classes
1. Equity
2. Derivatives / Futures and Options
3. Commodities
4. Currency
5. Cryptocurrency
Futures Meaning
Futures are derivative financial contracts that obligate the

parties to transact an asset at a predetermined future date and
price.
The buyer must purchase or the seller must sell the underlying
asset at the set price, regardless of the current market price at
the expiration date.
Futures Contract in Stock Markets
1. Standardised Contracts - Size and expiry of contracts are

fixed
2. Cash Settlement – No exchange of underlying asset
3. Trading is possible – The parties need not honour the

contract till the expiry
Few Terms To Know
1. Lot Size – It specifies the minimum quantity that you have to
transact
2. Spot Price – Current equity market price of the underlying

asset
3. Future Price – Price of the future contract (mimics the spot

price)
4. Expiry – The date at which the contract expires. It’s the last
Thursday of every month
5. Contract Value – Lot Size x Future Price
6. Future Premium – Future Price – Spot Price

Calculation of Future Price
Futures Price = Spot Price * [1+rf*(x/365)] - d
Spot price = Current equity market price

rf = Risk free rate
x = No. of days till expiry
d = Dividend
Practical Formula = Spot Price * [1+(rf+s)*(x/365)] – d

s = sentiment
Relationship Between Spot & Future
Prices
Futures price comes closer and closer to the spot price as the
expiry date comes closer.
Payoff Table and Structure
It’s a graphical representation of the potential outcomes at the

expiry date.
The biggest problem in the above structure?
Risk of default!!
Solution…
1. Initial Margin – SPAN + Exposure Margin
2. M2M – Mark to Market
Advantages as compared to Equity
1. High Leverage
2. Shorting
3. Possible to get customized exposure
4. Hedging
Disadvantages as compared to Equity
1. High Leverage
2. Expiry
3. Lot size
4. Mark to Market
Trading Futures
• Make sure to have atleast 10L in your portfolio before

entering the futures market.
• Use the same strategies which we use in equities.
• Do the analysis on the future graph.
• Open interest, is it a reliable way to trade?
Few Terms to Understand
1. Strike Price
2. Underlying Asset
3. Exercising an option
4. Expiry
5. Premium
Options Meaning
Four Sides of Options:
1. Buy Call – Buyer of the call option has the right to buy the
underlying asset at a given date and a given price.
2. Sell Call – Seller has the obligation to sell the underlying

asset at a given date and a given price.
3. Buy Put – Buyer of the put option has the right to sell the
underlying asset at a given date and a given price.
4. Sell Put – Seller has the obligation to buy the underlying

asset at a given date and a given price.
Option Also Known As Market Premium Type
Expectation
Buy Call Long Call Bullish Pay Unlimited

profit &
limited loss
Sell Call Short Call Flat or bearish Receive Limited profit

& unlimited
loss
Buy Put Long Put Bearish Pay Unlimited

profit &
limited loss
Sell Put Short Put Flat or bullish Receive Limited profit

& unlimited
loss
Things to keep in mind
1. Options are traded in lots just like futures.
2. They have expiry just like futures.
3. If you want to buy an option, you just have to pay the premium.
4. If you want to sell an option then you have to pay the same margin
what you would pay to sell a future.
5. Before buying/selling an option you have to choose the following:

- Underlying asset
- CE or PE
- Expiry date
- Strike Price
2 Constituents in Premium
Premium = Intrinsic Value + Time Value
Intrinsic Value (CE) = Spot price – strike price
Intrinsic Value (PE) = Strike price – spot price
Intrinsic Value is calculatable but Time Value is not. So we back

calculate to find Time Value
Time Value = Premium – Intrinsic value
Classification of Options
Classifications Call Put
Deep in the money Strike price far below the Strike price far more
spot price than spot price
In the money (ITM) Strike price below the Strike price more than
spot price spot price
At the money (ATM) Strike price equal to spot Strike price equal to spot
price price
Out of the money (OTM) Strike price more than Strike price below the
spot price spot price
Deep out of the money Strike price far more Strike price far below the
than spot price spot price
Option Greeks
• Delta – Measures the rate of change of options
premium based on the directional movement of the
underlying
• Gamma – Rate of change of delta itself
• Theta – Measures the impact on premium based on

time left for expiry
• Vega – Rate of change of premium based on change in

volatility
Option Type Approx value of Delta Approx value of Delta
(CE) (PE)
Deep in the money Between 0.8 and 1 Between - 0.8 and - 1
In the money (ITM) Between 0.6 and 0.8 Between - 0.6 and – 0.8
At the money (ATM) Between 0.45 and 0.55 Between - 0.45 and – 0.55
Out of the money (OTM) Between 0.45 and 0.3 Between - 0.45 and – 0.3
Deep out of the money Between 0.3 and 0 Between - 0.3 and - 0
Gamma
It can be understood as the change in Delta as the price of the
underlying asset changes.
It’s a second order derivative.
Theta
Theta is rate of change of premium as time passes.
Theta can also be called time decay factor.
Vega
Vega measures the change of premium as the volatility changes.
The premium of every option increases as the volatility

increases. This makes sense as there is a higher chance for the
price to become in the money.
General Rules To Follow
1. Prefer shorting calls instead of puts – This is because the
market tends to come down quickly and goes up slowly.
2. Sell options when you expect the volatility to decrease –

This is because as volatility decreases the premiums of all
options are directly affected
3. When should you buy call or sell put?

- Buy call if you’re aggressively bullish and sell put if you’re
moderately bullish
- Buy call if volatility is low and sell put if volatility is high
- Above all it depends on the strategy
Option Strategies
Bullish Strategies Bearish Strategies Neutral Strategies
Bull Call Spread Bear Call Spread Long Straddle
Bull Put Spread Bear Put Spread Short Straddle
Call Ratio Back Spread Put Ratio Back Spread Covered calls
Bull Call Spread
Opinion: Moderately Bullish
What to do:
1. Buy ATM Call
2. Sell OTM Call
Keep in mind:
1. Underlying asset should be the same
2. The options should have the same expiry
3. Same no. of options bought/sold
4. The positions have to be made simultaneously
Bull Call Spread
1. The strike price of the OTM call depends on how bullish you
are on the trade.
2. The higher the difference between the strike prices. The

higher risk and reward in that trade.
Bull Put Spread
What to do:
1. Sell ITM Put
2. Buy OTM Put
Keep in mind:
When to choose Bull Put Spread over
Bull Call Spread?
1. The markets have already declined significantly – In this
situation the put premiums considerably increase
2. The volatility is high – India VIX is above MA 60
Call Ratio Back Spread
Opinion: Aggressively Bullish
What to do:
1. Sell 1 ITM Call
2. Buy 2 OTM Calls
Keep in mind:
3. Stick with slightly ITM + slightly OTM
Bear Put Spread
Opinion: Moderately Bearish
What to do:
1. Buy ITM Put
2. Sell OTM Put
Keep in mind:
Bear Call Spread
What to do:
1. Sell ITM Call
2. Buy OTM Call
Keep in mind:
When to choose Bear Put Spread over
Bear Call Spread?
1. The markets have already gone up significantly – In this
situation the call premiums considerably increase
2. The volatility is high – India VIX is above MA 60
Put Ratio Back Spread
Opinion: Aggressively Bullish
What to do:
1. Sell 1 ITM Put
2. Buy 2 OTM Puts
Keep in mind:
3. Stick with slightly ITM + slightly OTM
Long Straddle
Opinion: High Volatility in future
What to do:
1. Buy Call
2. Buy Put
Keep in mind:
Short Straddle
Opinion: Low Volatility in future
What to do:
1. Sell Call
2. Sell Put
Keep in mind:
Covered Call
Objective: Creating cashflow from existing investments
What to do:
1. Hold position on existing investments
2. Sell OTM Call
Keep in mind:
1. The number of shares held and shorted with call option
should be the same
2. Short Calls every month
Covered Call - Steps
1. Decide the income you require. (Recommended income
should be the current FD rate).
2. Identify the number of days since the next expiry (n).
3. Use this formula to find out the premium of the call option
you need to sell:
Premium = Spot price*(FD rate)*(n)/365
4. Short the strike price of the call which is trading at the

above calculated premium

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Futures

2. Derivatives / Futures and Options

Futures are derivative financial contracts that obligate the

1. Standardised Contracts - Size and expiry of contracts are

2. Cash Settlement – No exchange of underlying asset

3. Trading is possible – The parties need not honour the

2. Spot Price – Current equity market price of the underlying

3. Future Price – Price of the future contract (mimics the spot

5. Contract Value – Lot Size x Future Price

6. Future Premium – Future Price – Spot Price

Futures Price = Spot Price * [1+rf*(x/365)] - d

Spot price = Current equity market price

Practical Formula = Spot Price * [1+(rf+s)*(x/365)] – d

It’s a graphical representation of the potential outcomes at the

1. Initial Margin – SPAN + Exposure Margin

2. M2M – Mark to Market

3. Possible to get customized exposure

• Make sure to have atleast 10L in your portfolio before

• Use the same strategies which we use in equities.

• Do the analysis on the future graph.

• Open interest, is it a reliable way to trade?

2. Sell Call – Seller has the obligation to sell the underlying

4. Sell Put – Seller has the obligation to buy the underlying

Buy Call Long Call Bullish Pay Unlimited

Sell Call Short Call Flat or bearish Receive Limited profit

Buy Put Long Put Bearish Pay Unlimited

Sell Put Short Put Flat or bullish Receive Limited profit

2. They have expiry just like futures.

5. Before buying/selling an option you have to choose the following:

Intrinsic Value (CE) = Spot price – strike price

Intrinsic Value (PE) = Strike price – spot price

Intrinsic Value is calculatable but Time Value is not. So we back

Time Value = Premium – Intrinsic value

• Gamma – Rate of change of delta itself

• Theta – Measures the impact on premium based on

• Vega – Rate of change of premium based on change in

It’s a second order derivative.

The premium of every option increases as the volatility

2. Sell options when you expect the volatility to decrease –

3. When should you buy call or sell put?

Bull Call Spread Bear Call Spread Long Straddle

Bull Put Spread Bear Put Spread Short Straddle

2. The higher the difference between the strike prices. The

2. The volatility is high – India VIX is above MA 60

2. The volatility is high – India VIX is above MA 60

2. Identify the number of days since the next expiry (n).

Premium = Spot price*(FD rate)*(n)/365

4. Short the strike price of the call which is trading at the

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Premium = Spot price(FD rate)(n)/365