Options The rising Wave

Derivatives Segment Growth

Overall market volumes increased by about 150%

300 250 200

Index Option Volumes grown by more than 10 times in last five years

Trillions

150 100 50 0 2001-02 2002-03 2003-04 2004-05 2005-06 2006-07 2007-08 2008-09 2009-10 2010-11

Stock and index future Volumes were in a declining trend

In d e x F u t u re s

S t o c k F u t u re s

In d e x O p t io n s

S t o c k O p t io n s

Cas h

Reasons for growth of option segment

Lower cost. (Options: 13 Paisa, Futures: 1.25 Rupees) Inbuilt stop loss. Does not require large corpus. Higher leverage with limited risk.. Potential to make exponential profit. Protection against opening gap risk. Can take advantage of volatility (Events). Flexibility to control risk, using strategies. Risk reward will be in your favor. (Delta example)

What is an Option
Option is an instrument giving holder the right to buy or sell a specific quantity (lot) of a specific assets (Underlying) at a specific price (Premium) up to a specific date (Contract Expiry).

Options are further classified in two types :Call Option :

An agreement which gives buyer the right to buy but not the obligation to buy a stock.

Put Option :
It is opposite of call option I.e.., giving the owner the right to sell but not the obligation.

Terminologies of Options
Index options: These options have the index as the underlying.

Like index futures contracts, index options contracts are also cash settled.
Stock options: Stock options are options on individual stocks. Buyer of an option: The buyer of an option is the one who by

paying the option premium buys the right but not the obligation to exercise his option on the seller/writer.
Writer/Seller of an option: The writer of a call/put option is the

one who receives the option premium and is thereby obliged to sell/buy the asset if the buyer exercises on him.
Cont...

option buyer pays to the option seller.

Option price/premium: Option price is the price which the

known as the expiration date, the exercise date, the strike date or the maturity.
Strike price: The price specified in the options contract is known

Expiration date: The date specified in the options contract is

as the strike price.

exercised at any time up to the expiration date.

American options: American options are options that can be

European options: European options are options that can be

exercised only on the expiration date itself.

In The Money ---- At The Money ---- Out Of Money

P&L
4600 4650 4800 4850 4900

Premium = 50
Strike Price 4700 Underlying Price CMP4750

Option Buying Vs Option Writing

Corpus Option knowledge Risk Position Management Returns Volatility Time

Option Buying Minimal Basic Limited Passive Exponential Positive Negative

Option Selling Sizeable In-depth Unlimited Active Linear Negative Positive

Option Risk Classification:

Majority of volumes happens at this level as risk and capital required is minimal

Why not able to reap option benefits:

Lack of money management. Dont trade option but invest/ Longer holding period. Wrong Strike price selection.

Why money management?

Cash
Leverage Nifty Lots Capital Erosion Profitability Cost N.A N.A 100% Fall Medium Risk free rate

Futures
Up to 5-10 Times 4 lots 10% Move High Basis

Options
Up to 20-30 Times 20-30 Lots 3-4% Move Very High Time Value

Traders have a tendency to take positions to the maximum extent possible irrespective in which segment they are trading. As a thumb rule one should apply more stringent money management rule in accordance with level of leverage.

To win the game you have to be in the game .

Strike Rate 50% 60% 70% 80% 90% 100%

Exposure/ Call

20%

25%

30%

40%

50%

100%

Loss/ trade

5%

6%

7%

8%

10%

Max trades

17

13

11

The longer you stay more probability of you being a winner. Discipline is the key to trading option.

50% strike rate and 1:1 Risk reward

Can we still make money?

Why option investments loses money

Every 5 days will cost option buyer around 25 points (0.5%)

Which Option to buy?

Wrong strike price selection. Beginning of the Fresh contract : Out Of money option Middle of the month: Move towards ATM Option Towards the expiry: At the Money option. Momentum Delta, gamma, Vega. Lesser Theta ITM Option should never be used for trading as it require huge premium and Liquidity issue. If ITM option is left for expiry it will attract delivery STT that is 0.125% (67 nifty points) and will trade at a discount to that extent towards the expiry.

Strike Price Selection

5600

5500 Strike

5400

5300 21 20 19 18 17 16 15 14 13 12 11 10 9 8 7 6 5 4 3 2 1 5200 Days to expire

Nifty Spot= 5300

Cash/Future/Option Trading
Reliance has given upside breakout above 1000 levels now it may test 1050 levels. But if it fails to hold 1000 then may test 950 levels. ----------------------------------------------------------------------------Buy Cash : Buy 250 shares @ 1000/Investment : 2,50,000/If it moves to 1050 then profit = 12,500/- Return on Investment : 5% If it goes to 950 then risk = 12,500/Risk on Investment : -5% ----------------------------------------------------------------------------Buy Future : Buy 1 lot of 250 shares Investment : 20% of total value = 50,000 If it moves to 1050 then profit = 12,500 Return on Investment : 25% If it goes to 950 then risk = 12,500 Risk on Investment : -25% -----------------------------------------------------------------------------

Strategies

Non Directional

Directional

Range Contraction

Range Expansion

Up

Down

Long Butterfly Long Condor

Straddle Strangle

Long Call Long Strap Bull Call Spread Ratio Call Spread

Long put Long Strip Baer Put spread Ratio Put Spread.

Call Option
Buy option: Buy 1000 Call @ 25/Investment = 6,250/After 2 days : If it moves to 1050 then option value: 57/Profit = (57-25)*250= 8,000 ROI = 128% If it goes down to 950 then Option Value:7 Risk = (7-25)*250 = (4500)/ROI = -72%

Straddle
Straddle: Involves buying ATM Call and Put of the same strike price.

Buy 1000 Call @ 25/Buy 1000 Put @ 25/Investment = 12500/After 2 days : If it moves to 1050 then Call: 57 ; Put: 8 Profit = (65-50)*250=3,750 ROI = 30% If it goes down to 950 then Call: 7 ; Put: 57 Profit = (64-50)*250=3,500 ROI = 28%

Strangle
Strangle: Involves buying OTM of call and OTM Put.

Buy 1050 Call @ 8/Buy 950 Put @ 7/Reliance= 1000 Investment = 3,750/After 2 days : If it moves to 1050 then Call: 26 ; Put: 1 Profit = (27-15)*250=3,250 ROI = 87% If it goes down to 950 then Call: 1 ; Put: 23 Profit = (24-15)*250=2,750 ROI = 73%

Strip
Strip: Involves buying one ATM/OTM Call and Buying two ATM/OTM Put.

Buy 1000 Call @ 25/Buy 1000 Put @ 25/Buy 1000 Put @ 25/Investment = 18750/After 2 days : If it moves to 950 then Call: 7 ; Put: 57 Profit = (121-75)*250=11,500 ROI = 63% If it goes to 1050 then Call: 58 ; Put: 7 Profit = (72-75)*250=(750) ROI = -4%

Strap
Strap: Involves buying two ATM/OTM Call and Buying one ATM/OTM Put.

Buy 1000 Call @ 25/Buy 1000 Call @ 25/Buy 1000 Put @ 25/Investment = 18,750/2 days : If it moves to 1050 then Call: 57 ; Put: 7 Profit = (121-75)*250=11,500 ROI = 63% If it goes down to 950 then Call: 7 ; Put: 57 Profit = (71-75)*250=1,000 ROI = -5.5%
After

Summary
Cash Future Call Straddle Strangle Strip

Risk is substantial higher if market remains at the same level.

Strap

Investment

250000

50000

6250

12500

3750

18750

18750

Risk

5%

25%

72%

N.A (28%)

N.A (73%)

4%

6%

Return

5%

25%

128%

30%

87%

60%

63%

Return/Risk

1.77

N.A

N.A

15

11

Option Traders

Trader A

Trader B

Trader C

Trader D

Momentum Player

Strategy player (Volatility and delta)

Positional player

Destiny player

Buy options in large quantity for intraday (Typically out of money option) and book profit or loss within 4-5 Rs.

Buy both call and put options on the basis of the expected range of the nifty and square off the trade with 3-4 days for a profit or loss.

Accumulate deep out of money put or call option depending upon the view of the nifty for the month and book profit or loss in the middle of the month.

Buy option with a perspective to make a fortune out of the single trade or lose the option premium. Generally hold it till expiry.

Where to get option calls from:

Trading Systems. Pattern Finder. Derivative Calls. Derivative Portfolio. Fortune finder (Intraday).

Myths
Complex. Only writing makes money. Option will expire worthless. Option takes time to appreciate. 80% of the option buyers loses money. Option trading is only for professionals. Option trading will lose when volatility reduces.
Writing option is the key to growth of options

Thank You..