Mid-Term Report

Stock Market Analysis

Meet
210010041

Mentor – Arya Somani

Module 1: Introduction to Stock Markets

Stock market is an electronic marketplace where you can conduct transactions

in equities, derivatives and other commodities.
The stock market attracts individuals and corporations from diverse
backgrounds. Anyone who transacts in the stock market is called a market
participant. The market participant can be classified into various categories –
• Domestic Retail Participants – These are people like you and me
transacting in markets
• NRI’s and OCI – These are people of Indian origin but based outside India
• Domestic Institutions – These are corporate entities in India
• Domestic Asset Management Companies (AMC) – Mutual fund
companies like SBI Mutual Fund, HDFC AMC, Edelweiss, ICICI Pru, etc.
• Foreign Institutional Investors – Non-Indian corporate entities. These
could be foreign asset management companies, hedge funds, and other
investors.
In India, the stock market regulator is called The Securities and Exchange Board
of India, often referred to as SEBI. SEBI aims to promote the development of
stock exchanges, protect the interest of retail investors, and regulate market
participants’ and financial intermediaries’ activities. In general, SEBI ensures:
• The stock exchange conducts its business fairly
• Stockbrokers conduct their business fairly
• Participants do not get involved in unfair practices
• Corporates do not use the markets to benefit themselves (Satyam
Computers) unduly
• Small investors’ interests are protected
• Large investors with mega cash piles should not manipulate the markets
• Overall development of markets
A stockbroker is a corporate entity registered as a trading member with the
stock exchange and holds a stockbroking license. SEBI grants the license
through due diligence, and the broker is expected to comply with the rules
prescribed by SEBI.
A Depository is a financial intermediary that offers the Demat account service.
One has three accounts one being the bank account to supply funds and
receive profits/dividends, the second being the trading account to interact
with the market and place trading orders third is the DEMAT account which
holds all the share certificates in a digital format.
IPO Markets
• The people who invest in your business in the pre-revenue stage are
called Angel Investors.
• Angel investors take the maximum risk. They take in as much risk as the
promoter.
• The money that angels give to start the business is called the seed fund.
• Angel’s invests a relatively small amount of capital
• The valuation of a company signifies how much the company is valued
by considering the company’s assets, liabilities, and future growth
prospects.
• Face value is simply a denominator to indicate how much one share is
originally worth. Face value is also called the notional value of a share.
• The money the company spends on business expansion is called capital
expenditure or CAPEX
• Series A, B, and C are funding the company seeks as it evolves. Usually,
the newer the series, the higher the company’s valuation.
• Beyond a certain size, VCs do not invest, and hence the company seeking
investments will have to approach Private Equity firms.
• PE firms invest large sums of money, usually at a slightly more mature
stage of the business.
• In terms of risk, PEs have a lower risk appetite as compared to VCs or
angels.
• Typical PE investors post their people on the investee company’s board
to ensure business moves in the right direction.
• The company’s valuation increases as and when the business, revenues,
and profitability increase.
 • An IPO is a process using which a company can raise funds from the
general public. The funds raised can be for any valid reason – for CAPEX,
restructuring debt, rewarding shareholders, etc
• Merchant banker acts as a key partner with the company during the IPO
process.
• SEBI regulates the IPO market and has the final word on whether a
company can go public or not
• As an investor in the IPO, you should read the DRHP to know everything
about the company.
• Most of the IPOs in India follow a book-building process.
IPO Jargons
• Under subscription – Let us say the company wants to offer 100,000
shares to the public. During the book-building process, it was discovered
that only 90,000 bids were received, then the issue is said to be under-
subscribed. This is not a great situation, as it indicates negative public
sentiment.
• Oversubscription – If there are 200,000 bids for 100,000 shares on offer,
then the issue is said to be oversubscribed two times (2x)
• Green Shoe Option – Part of the issue document that allows the issuer to
authorize additional shares (typically 15 percent) to be distributed in the
event of oversubscription. This is also called the overallotment option.
• Fixed Price IPO –Sometimes, the companies fix the price of the IPO and
do not opt for a price band. Such issues are called fixed-price IPO
• Price Band and Cut off price –A price band is a price range between
which the stock gets listed. For example, if the price band is between
Rs.100 and Rs.130, then the issue can list within the range. Let us say it
gets listed at 125; 125 is the cut-off price.
Corporate Actions
• Corporate actions have an impact on stock prices.
• Dividends are a means of rewarding shareholders. The dividend is
announced as a percentage of the face value.
• You must own the stock before the ex-dividend date to get the dividend.
• A bonus issue is a form of stock dividend. This is the company’s way of
rewarding the shareholders with additional shares.
 • A stock split is done based on the face value. The face value and the
stock price change in proportion to the change in face value
• A rights issue is how the company raises fresh capital from the existing
shareholders. Subscribe to it only if you think it makes sense
• Buyback signals a positive outlook for the promoters. This also conveys
to the shareholders that the promoters are optimistic about the
company’s prospects.
Key events and their impact on the market
• Markets and individual stocks react to events. Market participants
should equip themselves to understand and decipher these events.
• Monetary policy is one of the most important economic events. During
the monetary policy, review actions on a repo, reverse repo, CRR etc. are
initiated.
• Interest rates and inflation are related. Increasing interest rates curbs
inflation and vice versa
• Inflation data is released every month by MOSPI. As a consumer, CPI
inflation data is what you need to track.
• IIP measures industrial production activity. An increase in IIP cheers the
markets, and a lower IIP disappoints the market.
• PMI is a survey-based business sentiment indicator. The PMI number
oscillates around 50 marks. Above 50 is good news to markets, and PMI
below 50 is not.
• The Budget is an important market event where policy announcements
and reform initiatives are taken. Markets and stocks react strongly to
budget announcements.
• Corporate earnings are reported every quarter. Stocks react mainly due
to the variance in actual number versus the street’s expectation.
• Keep an eye on non-financial events and how they can impact the
markets.

Module 2: Technical Analysis

• Technical Analysis is a popular method to develop a point of view on
markets. Besides, TA also helps in identifying entry and exit points.
• Technical Analysis visualizes the actions of market participants in the
form of stock charts.
 • Patterns are formed within the charts, and these patterns help a trader
identify trading opportunities.
• TA works best when we keep a few core assumptions in perspective.
• TA is used best to identify short terms trades.
• TA is based on a few core assumptions.
1. Markets discount everything
2. The how is more important than the why
3. Price moves in trends
4. History tends to repeat itself.
Candlestick Patterns
• There are three important assumptions specific to candlestick patterns.
1. Buy strength and sell weakness.
2. Be flexible – quantify and verify.
3. Look for a prior trend.
Single Candlestick Pattern
• The textbook defines Marubozu as a candlestick with no upper and
lower shadow. It indicates strong bullish or bearish tendency based on
its colour.
• An aggressive trader can place the trade on the same day as the pattern
forms.
• Risk-averse traders can place the trade on the next day after ensuring
that it obeys rule number 1, i.e., Buy strength, and Sell weakness.
• Spinning tops have a small real body and equal head and tail. It indicates
indecision in the market. Body colour is insignificant.
• Paper Umbrella is a trend reversal pattern with no head and tail being
more than twice the body. One needs to look at the prior trend to
establish a point of view. It is classified based on the previous trend into
hammer and hanging man.
Multiple Candlestick Pattern
• Multiple candlestick patterns evolve over two or more trading days.
• The bullish engulfing pattern evolves over two trading days. It appears at
the bottom end of a downtrend. Day one is called P1, and day 2 is called
P2.
• In a bullish engulfing pattern, P1 is a red candle, and P2 is a blue candle.
P2’s blue candle completely engulfs P1’s red candle.
• A risk-taker initiates a long trade at the close of P2 after ensuring P1 and
P2 together form a bullish engulfing pattern. A risk-averse trader will
initiate the trade the day after P2, near the close of the day.
• The stoploss for the bullish engulfing pattern is the lowest low between
P1 and P2.
• The bearish engulfing pattern appears at the top end of an uptrend. P2’s
red candle completely engulfs P1’s blue candle.
• A risk-taker initiates a short trade at the close of P2 after ensuring P1
and P2 together form a bearish engulfing pattern. The risk-averse trader
will initiate the trade the day after P2, after confirming the day forms a
red candle.
• The highest high of P1 and P2 forms the stoploss for a bearish engulfing
pattern
• The presence of a doji after an engulfing pattern tends to catalyze the
pattern’s evolution.
• The piercing pattern works very similarly to the bullish engulfing pattern,
except that P2’s blue candle engulfs at least 50% and below 100% of P1’s
red candle.
• The dark cloud cover works like the bearish engulfing pattern, except
that P2’s red candle engulfs at least 50% and below 100% of P1’s blue
candle.
• The harami pattern evolves over 2 trading sessions – P1 and P2.
• Day 1 (P1) of the pattern forms a long candle and day 2(P2) of the
pattern forms a small candle which appears as if it has been tucked
inside the P1’s long candle.
• A bullish harami candle pattern is formed at the lower end of a
downtrend. P1 is a long red candle, and P2 is a small blue candle. The
idea is to initiate a long trade near the close of P2 (risk taker). A risk-
averse trader will initiate the long trade near the close of the day after
P2 only after ensuring it forms a blue candle day.
• The stop loss on a bullish harami pattern is the lowest low price between
P1 and P2.
• The bearish harami pattern is formed at the top end of an uptrend. P1 is
a long blue candle, and P2 is a small red candle. The idea is to initiate a
 short trade near the close of P2 (risk taker). The risk-averse will initiate
the short near the day’s close only after ensuring it is a red candle day.
• The stop loss on a bearish harami pattern is the highest high price
between P1 and P2.
• Star formation occurs over three trading sessions. The candle of P2 is
usually a doji or a spinning top.
• If there is a doji on P2 in a star pattern, it is called a doji star (morning
doji star, evening doji star) else it is just called the star pattern (morning
star, evening star)
• Morning star is a bullish pattern which occurs at the bottom end of the
trend. The idea is to go long on P3 with the lowest low pattern being the
stop loss for the trade.
• The evening star is a bearish pattern, which occurs at the top end of an
uptrend. The idea is to go short on P3, with the highest pattern acting as
a stop loss.
• The star formation evolves over a 3-day period. Hence both the risk-
averse and risk taker are advised to initiate the trade on P3.
• Candlesticks portray the traders thought process. One should nurture
this thought process as he dwells deeper into the candlestick study
Support and Resistance
• S&R are price points on the chart
• Support is a price point below the current market price that indicate
buying interest.
• Resistance is a price point above the current market price that indicate
selling interest.
• To identify S&R, place a horizontal line in such a way that it connects at
least 3 price action zones, well-spaced in time. The greater number of
price action zones (well-spaced in time) the horizontal line connects, the
stronger is S&R
• S&R can be used to identify targets for the trade. For a long trade, look
for the immediate resistance level as the target. For a short trade, look
for the immediate support level as the target.
• Lastly, comply with the checklist for optimal trading results
Moving Averages
 • A standard average calculation is a quick approximation of a series of
numbers
• In an average calculation where the latest data is included, and the
oldest is excluded called a Moving Average
• The simple moving average (SMA) gives equal weightage to all data
points in the series
• An exponential moving average (EMA) scales the data according to its
newness. Recent data gets the maximum weightage, and the oldest gets
the least weightage
• For all practical purposes, use an EMA as opposed to SMA. This is
because the EMA gives more weightage to the most recent data points
• The outlook is bullish when the current market price is greater than the
EMA. The outlook turns bearish when the current market price turns
lesser than the EMA
• In a non-trending market, moving averages may result in whipsaws,
thereby causing frequent losses. To overcome this, an EMA crossover
system is adopted
• In a typical crossover system, the price chart is overlaid with two EMAs.
The shorter EMA is faster to react, while the longer EMA is slower to
react
• The outlook turns bullish when the faster EMA crosses and is above the
slower EMA. Hence one should look at buying the stock. The trade lasts
up to a point where the faster EMA starts going below, the slower EMA
• The longer the time frame one chooses for a crossover system, the
lesser the trading signals.
Indicators
• Indicators are independent trading systems developed and introduced
by successful traders.
• Indicators are leading or lagging. Leading indicators signal the possible
occurrence of an event. Lagging indicators, on the other hand, confirms
an ongoing trend.
• RSI is a momentum oscillator which oscillates between 0 and 100 level
• A value between 0 and 30 is considered oversold. Hence the trader
should look at buying opportunities.
• A value between 70 and 100 is considered overbought. Hence the trader
should look at selling opportunities.
 • If the RSI value is fixed in a region for a prolonged period, it indicates
excess momentum. Hence, instead of taking a reversed position, the
trader can consider initiating a trade in the same direction.

• A MACD is a trend following system

• MACD consists of a 12 Day, 26-day EMA
• MACD line is 12d EMA – 26d EMA
• The signal line is the 9-day SMA of the MACD line
• A crossover strategy can be applied between the MACD Line and the
signal line
• The Bollinger band captures the volatility. It has a 20-day average, a +2
SD, and a -2 SD
• One can short when the current price is at +2SD with an expectation that
the price reverts to the average
• One can go long when the current price is at -2SD with an expectation
that the price reverts to the average
• BB works well in a sideways market. In a trending market, the BB’s
envelope expands and generates many false signals
• Indicators are good to know, but it should not be treated as an only
source for decision making.

Module 3: Fundamental Analysis

• Fundamental Analysis is used to make long term investments.
• Investment in a company with good fundamentals creates wealth.
• Using Fundamental Analysis, one can separate an investment-grade
company from a junk company.
• All investment-grade companies exhibit a few common traits. Likewise,
all junk companies exhibit common traits.
• Fundamental analysis helps the analysts identify these traits
Annual Report
• The Annual Report (AR) of a company is an official communication from
the company to its investors and other stakeholders.
• The AR is the best source to get information about the company; hence
AR should be the default choice for the investor to source company-
related information.
 • The AR contains many sections, with each section highlighting a certain
aspect of the business.
• The AR is also the best source to get information related to the
qualitative aspects of the company.
• The management discussion and analysis are one of the most important
sections in the AR. It has the management’s perspective on the country’s
overall economy, their outlook on the industry they operate in for the
year gone by (what went right and what went wrong), and what they
foresee for the year ahead.
• The AR contains three financial statements – Profit & Loss Statement,
Balance Sheet, and Cash Flow statement.
• The standalone statement contains the financial numbers of only the
company into consideration. However, the consolidated numbers
contain the company and its subsidiaries financial numbers.
P&L
• The financial statement provides information and conveys the financial
position of the company.
• A complete set of financial statements include the Profit & Loss Account,
Balance Sheet, and Cash Flow Statement.
• A fundamental Analyst is a financial statement user, and he needs to
know what the maker of the financial statements states.
• The profit and loss statement gives the profitability of the company for
the year under consideration.
• The P&L statement is an estimate, as the company can revise the
numbers at a later point. Also, by default, companies publish data for
the current year and the previous year, side by side.
• The revenue side of the P&L is also called the top line of the company.
• Revenue from operations is the main source of revenue for the
company.
• Other operating income includes revenue incidental to the business.
• The other income includes revenue from non-operating sources.
• The sum of revenue from (operations less of duty) and other operating
income gives the “net revenue from operations”.
• The P&L statement’s expense statement contains information on all the
expenses incurred by the company during the financial year.
 • Each expense can be studied concerning a note which you can explore
for further information.
• Depreciation and amortization are a way of spreading the cost of an
asset over its useful life.
• The cost of interest and other charges paid when the company borrows
money for its capital expenditure.
• PBT = Total Revenue – Total Expense – Exceptional items (if any)
• Net PAT = PBT – applicable taxes
• EPS reflects the earning capacity of a company on a per-share basis.
Earnings are profit after tax and preferred dividends.
• EPS = PAT / Total number of outstanding ordinary shares
Balance Sheet
• A Balance sheet also called the Statement of Financial Position is
prepared on a flow basis that depicts the company’s financial position at
any given point in time. It is a statement which shows what the company
owns (assets) and what the company owes (liabilities)
• A business will need a balance sheet when it seeks investors, applies for
loans, submits taxes etc.
• Balance sheet equation is Assets = Liabilities + Shareholders’ Equity.
• Liabilities are obligations or debts of a business from past transactions,
and Share capital is the number of shares * face value.
• Reserves are the funds earmarked for a specific purpose, which the
company intends to use in future.
• The surplus is where the profits of the company reside. This is one of the
points where the balance sheet and the P&L interact. Dividends are paid
out of the surplus.
• Shareholders’ equity = Share capital + Reserves + Surplus. Equity is the
claim of the owners on the assets of the company. It represents the
assets that remain after deducting the liabilities if you rearrange the
Balance Sheet equation, Equity = Assets – Liabilities.
• Non-current liabilities or the long-term liabilities are expected to be
settled in not less than 365 days or 12 months of the balance sheet date.
• Deferred tax liabilities arise due to the discrepancy in the way the
depreciation is treated. Deferred tax liabilities are amounts of income
taxes payable in the future concerning taxable differences as per
accounting books and tax books.
 • Current liabilities are the company’s obligations to settle within 365 days
/12 months of the balance sheet date.
• In most cases, both long- and short-term provisions are liabilities dealing
with employee-related matters
• Total Liability = Shareholders’ Funds + Non-Current Liabilities + Current
Liabilities.. Thus, total liabilities represent the total amount of money
the company owes to others
• The Assets side of the Balance sheet displays all the assets the company
owns
• Assets are expected to give an economic benefit during its useful life.
• Assets are classified as Non-current and Current asset.
• The useful life of non-current assets is expected to last beyond 365 days
or 12 months.
• Current assets are expected to pay off within 365 days or 12 months.
• Assets inclusive of depreciation are called the ‘Gross Block.’
• Net Block = Gross Block – Accumulated Depreciation
• The sum of all assets should equal the sum of all liabilities. Only then the
Balance sheet is said to have balanced.
• The Balance sheet and P&L statement are inseparable. They are
connected in many ways.
Cash Flow Statement
• The Cash flow statement gives us a picture of the true cash position of
the company.
• A legitimate company has three main activities – operating activities,
investing activities and the financing activities.
• Each activity either generates or drains money for the company.
• The company’s net cash flow is the sum of operating activities, investing
activities, and financing activities.
• Investors should specifically look at the cash flow from operating
activities of the company.
• When the liabilities increase, cash level increases and vice versa
• When the assets increase, cash level decreases and vice versa.
• The net cash flow number for the year is also reflected in the balance
sheet.
• The Statement of Cash flow is a useful addition to a company’s financial
statements because it indicates the company’s performance.
Financial Ratios
• A Financial ratio is a useful financial metric of a company. On its own
merit, the ratio conveys little information
• It is best to study the ratio’s recent trend or compare it with the
company’s peers to develop an opinion
• Financial ratios can be categorized into ‘Profitability’, ‘Leverage’,
‘Valuation’, and ‘Operating’ ratios. Each of these categories gives the
analyst a certain view on the company’s business
• EBITDA is the amount of money the company makes after subtracting
the operational expenses of the company from its operating revenue
• EBITDA margin indicates the percentage profitability of the company at
the operating level
• PAT margin gives the overall profitability of the firm
• Return on Equity (ROE) is a precious ratio. It indicates how much return
the shareholders are making over their initial investment in the company
• A high ROE and high debt are not a great sign
• DuPont Model helps in decomposing the ROE into different parts, with
each part throwing light on various aspects of the business
• DuPont method is probably the best way to calculate the ROE of a firm
• Return on Assets is an indicator of how efficiently the company is
utilizing its assets
• Return on Capital employed indicates the overall return the company
generates considering both the equity and debt.
• For the ratios to be useful, it should be analysed compared to other
companies in the same industry.
• Also, ratios should be analysed both at a single point in time and as an
indicator of broader trends over time
• Leverage ratios include Interest Coverage, Debt to Equity, Debt to Assets
and the Financial Leverage ratios
• The Leverage ratios mainly study the company’s debt with respect to the
company’s ability to service the long-term debt
• Interest coverage ratio inspects the company’s earnings ability (at the
EBIT level) as a multiple of its finance costs
• Debt to equity ratio measures the amount of equity capital with respect
to the debt capital. Debt to equity of 1 implies equal amount of debt and
equity
• Debt to Asset ratio helps us understand the asset financing structure of
the company (especially with respect to the debt)
• The Financial Leverage ratio helps us understand the extent to which the
assets are financed by the owner’s equity
• The Operating Ratios also referred to as the Activity ratios include –
Fixed Assets Turnover, Working Capital turnover, Total Assets turnover,
Inventory turnover, Inventory number of days, Receivable turnover, and
Day Sales Outstanding ratios
• The Fixed asset turnover ratio measures the extent of the revenue
generated in comparison to its investment in fixed assets
• Working capital turnover ratio indicates how much revenue the
company generates for every unit of working capital
• Total assets turnover indicates the company’s ability to generate
revenues with the given amount of assets
• Inventory turnover ratio indicates how many times the company
replenishes its inventory during the year
• Inventory number of days represents the number of days the company
takes to convert its inventory to cash
o A high inventory turnover and therefore a low inventory number
of days is a great combination
o However, make sure this does not come at the cost of low
production capacity
• The Receivable turnover ratio indicates how many times in each period
the company receives money from its debtors and customers
• The Days sales outstanding (DSO) ratio indicates the Average cash
collection period i.e the time lag between the Billing and Collection
• Valuation, in general, is the estimate of the ‘worth’ of something.
• Valuation ratios involve inputs from both the P&L statement and the
Balance Sheet.
• The Price to Sales ratio compares the company’s stock price with the
company’s sales per share.
• Sales per share is simply the Sales divided by the Number of shares.
• Sales of a company with a higher profit margin are more valuable than
the sales of a company with lower profit margins.
• If a company is going bankrupt, the ‘Book Value’ of a firm is simply the
amount of money left on the table after the company pays off its
obligations.
 • Book value is usually expressed on a per-share basis.
• The Price/BV indicates how many times the stock price is trading over
and above the firm’s book value.
• EPS measures the profitability of a company on a per-share basis
• The P/E ratio indicates market participants’ willingness to pay for a
stock, keeping the company’s earnings in perspective.
• One has to be cautious about earning manipulation while evaluating the
P/E ratio.
• The Indices have a valuation which can be measured by the P/E, P/B or
Dividend Yield ratio.
• It is advisable to exercise caution when the Index is trading at a valuation
of 22x or above.
• A valuation gets attractive when the index is trading at 16x or below.
• NSE publishes the index valuations on their website daily

Module 4: Futures Trading

• The forwards and futures markets give you a financial benefit if you have
an accurate directional view of an asset’s price.
• The Futures contract is an improvisation over the Forwards contract.
• The Futures price mimics the underlying price in the spot market.
• Unlike a forwards contract, the futures contract is tradable.
• The futures contract is a standardized contract wherein all the variables
of the agreement is predetermined.
• Futures contracts are time-bound, and the contracts are available over
different timeframes.
• Most of the futures contracts are cash-settled
• SEBI in India regulates the futures market.
• The lot size is the minimum quantity specified in the futures contract.
• Contract value = Lot size times the Futures price.
• To enter into a futures agreement, one must deposit a margin amount, a
certain % of the contract value.
• Every futures contract has an expiry date beyond which the contract
would seize to exist. Upon expiry, old contracts cease, and new ones are
created.
Futures Trade
 • If you have a directional view on an assets price, you can financially
benefit from it by entering into a futures agreement.
• To transact in a futures contract, one needs to deposit a token advance
called the margin.
• When we transact in a futures contract, we digitally sign the agreement
with the counterparty; this obligates us to honour the contract.
• The futures price and the spot price of an asset are different; this is
attributable to the futures pricing formula (we will discuss this topic
later)
• One lot refers to the minimum number of shares that needs to be
transacted.
• Once we enter into a futures agreement, there is no obligation to stick
to the agreement until the contract expires.
• Every futures trade requires a margin amount; the margins are blocked
when you enter a futures trade.
• We can exit the agreement anytime, which means you can exit the
agreement within seconds of entering the agreement.
• When we square off an agreement, we are transferring the risk to
someone else.
• Once we square off the futures position, margins are unblocked.
• The money that you make or lose in a futures transaction is credited or
debited to your trading account the same day.
• In a futures contract, the buyer’s gain is the seller’s loss and vice versa.
Leverage and Payoff
• Leverage plays a key role in futures trading.
• Margins allow us to deposit a small amount of money and take exposure
to a large value transaction.
• Margins charged is usually a % of the contract value.
• Spot market transactions are not leveraged; we can transact to the
extent of our capital.
• Under leverage, a slight change in the underlying results in a massive
impact on the P&L
• The profits made by the buyer is equivalent to the loss made by the
seller and vice versa.
• The higher the leverage, the higher is the risk and, therefore, the higher
the chance of making money.
 • Futures Instrument simply allows one to transfer money from one
pocket to another. Hence it is called a “Zero Sum Game.”
• The payoff structure of a futures instrument is linear.
Margin and M2M
• A margin payment is required (which will be blocked by your broker) if
the futures trade is live.
• The margin blocked by the broker at the time of initiating the futures
trade is called the initial margin.
• Both the buyer and the seller of the futures agreement will have to
deposit the initial margin amount.
• The margin amount collected acts as leverage, as it allows you to deposit
a small amount of money and take exposure to a large value transaction.
• M2M is a simple accounting adjustment; the process involves crediting
or debiting the daily obligation money in your trading account based on
how the futures price behaves.
• The previous day closing price figure is taken to calculate the current
day’s M2M.
• SPAN Margin is the margin collected as per the exchange's instruction,
and the Exposure Margin is collected as per the broker’s requirement
• The SPAN and Exposure Margin are determined as per the norms of the
exchange.
• The SPAN Margin is popularly referred to as the Maintenance Margin.
• If the margin account goes below the SPAN, the investor must deposit
more cash into his account if he aspires to carry forward the future
position.
• The Margin Call is when the broker requests the trader to infuse the
required margin money when the cash balance goes below the required
level.
Futures Pricing
• The futures pricing formula states that the Futures Price = Spot price
*(1+Rf (x/365)) – d
• The difference between futures and spot is called the basis or simply the
spread
• The futures price as estimated by the pricing formula is called the
“Theoretical fair value”
 • The price at which the futures trade in the market is called the ‘market
value’
• The theoretical fair value of futures and market value should be around
the same value. However, there could be slight variance mainly due to
the associated costs
• If the futures are rich to spot, then the futures are said to be at premium
else it is said to be at a discount
• In commodity parlance Premium = Contango and Discount =
Backwardation
• Cash and carry are a spread where one can buy in the spot and sell in the
futures
• Calendar spread is an extension of a cash and carry where one buys a
contract and simultaneously sells another contract (with a different
expiry) but of the same underlying
Hedging with Futures
• Hedging allows you to insulate your market position against any adverse
movements in the market
• When you hedge your loss in the spot market it is offset by gains in the
futures market
• There are two types of risk – systematic and unsystematic risk
• Systematic risk is risk specific to macroeconomic events. Systematic risk
can be hedged. Systematic risk is common to all stocks
• Unsystematic risk is the risk associated with the company. This is unique
to each company. Unsystematic risk cannot be hedge, but can be
diversified
Open Interest
• Open Interest (OI) is a number that tells you how many contracts are
currently outstanding (open) in the market
• OI increases when new contracts are added. OI decreases when
contracts are squared off
• OI does not change when there is transfer of contracts from one party to
another
• Unlike volumes, OI is continuous data
 • On a stand along basis OI and Volume information does not convey
information, hence it makes sense to always pair it with the price to
understand the impact of their respective variation
• Abnormally high OI indicates high leverage, beware of such situations.

Module 5: Options Theory for Professional Trading

• Options are traded in the Indian markets for over 15 years, but the real
liquidity was available only since 2006
• An Option is a tool for protecting your position and reducing risk
• A buyer of the call option has the right and the seller has an obligation to
make delivery
• The option is only given to one party in the transaction (buyer of an
option)
• The option seller is also called the option writer
• At the time of agreement, the option buyer pays a certain amount to the
option seller, this is called the ‘Premium’ amount
• The agreement happens at a pre-specified price, often called the ‘Strike
Price’
• The option buyer benefits only if the price of the asset increases higher
than the strike price
• If the asset price stays at or below the strike, the buyer does not benefit,
for this reason it always makes sense to buy options when you expect
the price to increase
• Statistically the option seller has higher odds of winning in a typical
option contract
• The directional view must pan out before the expiry date, else the
option will expire worthless
Jargons
• The strike price is the anchor price at which both the option buyer and
option writer enter into an agreement
• The underlying price is simply the spot price of the asset
• Exercising of an option contract is the act of claiming your right to buy
the options contract at the end of the expiry
• Like futures contract, options contract also have an expiry. Option
contracts expire on the last Thursday of every month
 • Option contracts have different expiries – the current month, mid-
month, and far month contracts
• Premiums are not fixed; in fact, they vary based on several factors that
act upon it
Buying Call Option
• It makes sense to be a buyer of a call option when you expect the
underlying price to increase
• If the underlying price remains flat or goes down, then the buyer of the
call option loses money
• The money the buyer of the call option would lose is equivalent to the
premium (agreement fees) the buyer pays to the seller/writer of the call
option
• Intrinsic value (IV) of a call option is a non-negative number
• IV = Max [0, (spot price – strike price)]
• The maximum loss the buyer of a call option experiences is to the extent
of the premium paid. The loss is experienced if the spot price is below
the strike price
• The call option buyer has the potential to make unlimited profits
provided the spot price moves higher than the strike price
• Though the call option is supposed to make a profit when the spot price
moves above the strike price, the call option buyer first needs to recover
the premium he has paid
• The point at which the call option buyer completely recovers the
premium he has paid is called the breakeven point
• The call option buyer truly starts making a profit only beyond the
breakeven point (which naturally is above the strike price).
Selling Call Option
• You sell a call option when you are bearish on a stock
• The call option buyer and the seller have a symmetrically opposite P&L
behaviour
• When you sell a call option you receive a premium
• Selling a call option requires you to deposit a margin
• When you sell a call option your profit is limited to the extent of the
premium you receive, and your loss can potentially be unlimited
• P&L = Premium – Max [0, (Spot Price – Strike Price)]
 • Breakdown point = Strike Price + Premium Received
Buying Put Option
• Buy a Put Option when you are bearish about the prospects of the
underlying. In other words, a Put option buyer is profitable only when
the underlying declines in value
• The intrinsic value calculation of a Put option is slightly different when
compared to the intrinsic value calculation of a call option
• IV (Put Option) = Strike Price – Spot Price
• The P&L of a Put Option buyer can be calculated as P&L = [Max (0, Strike
Price – Spot Price)] – Premium Paid
• The breakeven point for the put option buyer is calculated as Strike –
Premium Paid
Selling Put Option
• You sell a Put option when you are bullish on a stock or when you
believe the stock price will no longer go down
• When you are bullish on the underlying you can either buy the call
option or sell a put option. The decision depends on how attractive the
premium is
• Option Premium pricing along with Option Greeks gives a sense of how
attractive the premiums are
• The put option buyer and the seller have a symmetrically opposite P&L
behaviour
• When you sell a put option you receive premium
• Selling a put option requires you to deposit margin
• When you sell a put option your profit is limited to the extent of the
premium you receive, and your loss can potentially be unlimited
• P&L = Premium received – Max [0, (Strike Price – Spot Price)]
• Breakdown point = Strike Price – Premium received
Moneyness of an Option Contract
• The intrinsic value of an option is equivalent to the value of money the
option buyer makes provided if he were to exercise the contract.
• Intrinsic Value of an option cannot be negative; it is a non-zero positive
value.
• The intrinsic value of call option = Spot Price – Strike Price
 • The intrinsic value of put option = Strike Price – Spot Price.
• Any option that has an intrinsic value is classified as ‘In the Money’ (ITM)
option.
• Any option that does not have an intrinsic value is classified as ‘Out of
the Money’ (OTM) option.
• If the strike price is almost equal to spot price, then the option is
considered as ‘At the money’ (ATM) option.
• All strikes lower than ATM are ITM options (for call options)
• All strikes higher than ATM are OTM options (for call options)
• All strikes higher than ATM are ITM options (for Put options)
• All strikes lower than ATM are OTM options (for Put options)
• When the intrinsic value is extremely high, it is called ‘Deep ITM’ option.
• Likewise, when the intrinsic value is the least, it is called ‘Deep OTM’
option.
• The premiums for ITM options are always higher than the premiums for
OTM option.
• The Option chain is a quick visualization to understand which option
strike is ITM, OTM, ATM (for both calls and puts) along with other
information relevant to options.
The Option Greeks
Option Greeks are forces that influence the premium of an option
Delta
• Delta is an Option Greek that captures the effect of the direction of the
market
• Call option delta varies between 0 and 1, some traders prefer to use 0 to
100.
• Put option delta varies between -1 and 0 (-100 to 0)
• The negative delta value for a Put Option indicates that the option
premium and underlying value moves in the opposite direction
• ATM options have a delta of 0.5
• ITM option have a delta of close to 1
• OTM options have a delta of close to 0.
• The delta is additive in nature
• The delta of a futures contract is always 1
• Two ATM option is equivalent to owning 1 futures contract
 • The options contract is not really a surrogate for the futures contract
• The delta of an option is also the probability for the option to expire ITM
Gamma
• Gamma measures the rate of change of delta.
• Gamma is always a positive number for both Calls and Puts.
• Large Gamma can translate to large gamma risk (directional risk)
• When you buy options (Calls or Puts) you are long Gamma.
• When you short options (Calls or Puts) you are short Gamma
• Avoid shorting options which have a large gamma.
• Delta changes rapidly for ATM option.
• Delta changes slowly for OTM and ITM options.
Theta
• Option sellers are always compensated for the time risk
• Premium = Intrinsic Value + Time Value
• All else equal, options lose money daily owing to Theta
• Time moves in a single direction hence Theta is a positive number
• Theta is a friendly Greek to option sellers
• When you short naked options at the start of the series you can pocket a
long time value but the fall in premium owing to time is low
• When you short option close to expiry the premium is low (thanks to
time value) but the fall in premium is rapid
Vega
• Vega measures the rate of change of premium concerning the change in
volatility.
• Volatility is not just the up-down movement of markets.
• Volatility is a measure of risk.
• Volatility is estimated by the standard deviation.
• Standard Deviation is the square root of the variance.
• We can estimate the range of the stock price, given its volatility.
• Larger the range of stock, higher is its volatility aka risk.
 Stock Market Analysis
Summer of Science – 2023

Meet – 210010041

Reference Material: Zerodha Varsity Modules

▪ Contents:
▪ Module 1: Introduction to Stock Markets
▪ Module 2: Technical Analysis
▪ Module 3: Fundamental Analysis
▪ Module 4: Futures Trading
▪ Module 5: Options Theory for Professional Trading
▪ Module 6: Option Strategies
▪ Module 7: Markets and Taxation
▪ Module 8: Currency, Commodity and Government Securities
▪ Module 9: Risk Management and Trading Psychology
▪ Module 10: Trading Systems

Plan of Action:

▪ Week 1: Module 1 & 2

▪ Week 2: Module 2 & 3
▪ Week 3: Module 4 & 5
▪ Week 4: Module 5 & 6
▪ Week 5: Module 7 & 8
▪ Week 6: Module 9
▪ Week 7: Module 10
▪ Practice on virtual stock market for practical learning

This is my initial PoA and I am on track, so I intend to move forward with the
same PoA