Trading in F&O

Group Members
Sagar Mehta – 09FN-095
Soumyadeep Sinharay – 09FN-106
Sriram Chandrashekhar – 09FN-109
 Agenda
• Futures
• Options
• Trading Basis
• Eligibility Criteria

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 Derivatives
• A financial instrument whose value depends on the
value of the underlying variables
• Very often, the underlying variables are the prices
of the traded assets
• They are broadly categorized as:
– Relationship between the underlying asset and the
derivative(futures, options, swaps)
– Type of underlying asset(equity, interest rates, currency)
– The market (exchange, OTC)

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 Types of traders
• Hedgers
– Use derivatives to reduce the risk that they face from
potential future movements in a market variable
• Speculators
– Use derivatives to bet on the future direction of a
market variable
• Arbitrageurs
– Lock in a riskless profit by simultaneously entering
into transactions in two or more markets

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 Advantages & Disadvantages of Derivatives

• Advantages
– Flexibility
– Leverage
– Limited risk
– Hedging
• Disadvantages
– Costs
– Liquidity
– Complexity
– Time decay
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 Futures
• Futures
– Agreement between 2 parties to buy or sell an
asset at a certain time for a certain price
– Traded on the exchange
– Wide range of commodities and financial assets
form the underlying assets

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 Futures Contract Specification

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 Contract Cycle (Futures)

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 Hedging
• Short hedges
– Involves a short position in futures contracts
– Appropriate when the hedger already owns an
asset and expects to sell it at some time in future
• Long hedges
– Involves a long position in a futures contract
– Appropriate when a hedger knows it will have to
purchase a certain asset in future

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 Basis Risk
• Basis = spot price of the asset to be hedged –
futures price of the contract used
• Basis risk is the uncertainty associated with
the basis at the time of closing of the contract
• Strengthening of basis improves hedger’s
position in a short hedge and vice versa

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 Currency Futures
• USD/INR future contracts are allowed to be traded on
NSE
• The underlying asset is the exchange rate in Indian
rupees for US dollars
• The final settlement day is the last working day of the
expiry month
• The base price is the theoretical price on the first day
of the contract
• The contract follows “T+1” cycle for daily settlement
and “T+2” cycle for final settlement
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 Options
• Option holders have right but are not obligated to
exercise their right, in future.
• Right to Buy : Call Option.
• Right to Sell : Put Option.
• American Options : Exchange Traded & Early
exercisable.
• European Options: Exercised only on expiry date.
• Underlying Assets : Stock, Index, FX, Futures etc.
• Specification :
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 Option Contract Specification

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 Call Options
Long Call
• When to Use: Investor is very
bullish on the stock / index.
Short Call
• When to use: Investor is very
aggressive and he is very
bearish about the stock / index.

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 Put Options
Long Put Short Put
• When to use: Investor is • When to Use: Investor is very
bearish about the stock Bullish on the stock / index. The
/index. main idea is to make a short
term income.

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 Covered Call
• You own shares in a company which you feel may rise but not much in
the near term.
• You would still like to earn an income from the shares. The covered call
is a strategy in which an investor Sells a Call option on a stock he owns
(netting him a premium).
• The Call Option which is sold in usually an OTM Call.
• Adopted by a stock owner who is Neutral to moderately Bullish about
the stock

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Protective Call / Synthetic Long Put
• This is a strategy wherein an investor has gone short
on a stock and buys a call to hedge.
• This is an opposite of Synthetic Call.
• An investor shorts a stock and buys an ATM or slightly
OTM Call.

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 Covered Put
• This strategy is opposite to a Covered Call.
• A Covered Call is a neutral to bullish strategy, whereas a
Covered Put is a neutral to Bearish strategy.
• You do this strategy when you feel the price of a stock /
index is going to remain range bound or move down.

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 Long Combo
• A Long Combo is a Bullish strategy.
• If an investor is expecting the price of a stock to move up he
can do a Long Combo strategy.
• It involves selling an OTM (lower strike) Put and buying an
OTM (higher strike) Call. This strategy simulates the action of
buying a stock (or a futures) but at a fraction of the stock price.

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 Collar
• It is a Covered Call with a limited risk.
• So a Collar is buying a stock, insuring against the downside by
buying a Put and then financing (partly) the Put by selling a Call.
• The put generally is ATM and the call is OTM having the same
expiration month and must be equal in number of shares.
• Adopted when the investor is conservatively bullish

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 Long Straddle
• A Straddle is a volatility strategy and is used when the stock
price / index is expected to show large movements.
• This strategy involves buying a call as well as put on the same
stock / index for the same maturity and strike price.
• ATM strikes are purchased.

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 Short Straddle
• The investor feels the market will not show much movement.
• He sells a Call and a Put on the same stock / index for the
same maturity and strike price.

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 Long Strangle
• This strategy involves the simultaneous buying of a slightly out-
of-the-money (OTM) put and a slightly out-of-the-money (OTM)
call of the same underlying stock / index and expiration date.
• Cheaper to execute than Straddle which uses ATM strikes.
• Greater Movement required to make profit.

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 Short Strangle
• It tries to improve the profitability of the trade for the
Seller of the options by widening the breakeven points.
• It involves selling of a slightly out-of-the-money (OTM)
put and a slightly out-of-the-money (OTM) call of the
same underlying stock and expiration date.

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 Long Call Butterfly
• The investor is looking to gain from low volatility at a low cost. The
strategy offers a good risk / reward ratio, together with low cost.
• A long butterfly is similar to a Short Straddle except your losses are
limited.
• The strategy can be done by selling 2 ATM Calls, buying 1 ITM Call, and
buying 1 OTM Call options (there should be equidistance between the
strike prices).
• When to use: When the investor is neutral on market direction and
bearish on volatility.

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 Short Call Butterfly
• It is the opposite of Long Call Butterfly, which is a range bound strategy.
• BUY 2 ATM CALL OPTIONS, SELL 1 ITM CALL OPTION AND SELL 1 OTM
CALL OPTION.
• When to use: You are neutral on market direction and bullish on
volatility. Neutral means that you expect the market to move in either
direction - i.e. bullish and bearish.

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 Long Call Condor
• A Long Call Condor is very similar to a long butterfly strategy. The
difference is that the two middle sold options have different strikes.
• The profitable area of the pay off profile is wider than that of the Long
Butterfly.
• BUY 1 ITM CALL OPTION (LOWER STRIKE), SELL 1 ITM CALL OPTION
(LOWER MIDDLE), SELL 1 OTM CALL OPTION (HIGHER MIDDLE), BUY 1
OTM CALL OPTION (HIGHER STRIKE)
• When to Use: When an investor believes that the underlying market will
trade in a range with low volatility until the options expire.

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 Short Call Condor
• A Short Call Condor is very similar to a short butterfly strategy. The
difference is that the two middle bought options have different strikes.
• SHORT CALL CONDOR : SHORT 1 ITM CALL OPTION (LOWER STRIKE),
LONG 1 ITM CALL OPTION (LOWER MIDDLE), LONG 1 OTM CALL
OPTION (HIGHER MIDDLE), SHORT 1 OTM CALL OPTION (HIGHER
STRIKE).
• When to Use: When an investor believes that the underlying market
will break out of a trading range but is not sure in which direction.

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 Bull Call Spread
• It is constructed by buying an in-the-money (ITM) call option,
and selling another out-of-the-money (OTM) call option.
• The net effect of the strategy is to bring down the cost and
breakeven on a Buy Call (Long Call) Strategy.
• But the gains are also limited.
• Ideal for Moderately Bullish markets.

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 Bear Call Spread
• The concept is to protect the downside of a Call Sold by
buying a Call of a higher strike price to insure the Call sold.
i.e. Buy OTM call, sell ITM call options.
• The strategy earns a net income for the investor as well as
limits the downside risk of a Call sold.

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 Bull Put Spread
• The concept is to protect the downside of a Put sold by
buying a lower strike Put, which acts as an insurance for the
Put sold.
• The strategy earns a net income for the investor as well as
limits the downside risk of a Put sold.

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 Bear Put Spread
• Buy an in-the-money (higher) put option and sell an out-of-the-money
(lower) put option on the same stock with the same expiration date.
• Bring down the cost and raise the breakeven on buying a Put (Long
Put).
• When to use: When you are moderately bearish on market direction

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 Entities In Trading System (NSE)
• Trading Member
– Trading members are members of NSE.
– They can trade either on their own account or on behalf of their
clients including participants.
• Clearing Member
– Clearing members are members of NSCCL.
– They carry out risk management activities and confirmation/inquiry of
trades through the trading system
• Professional Clearing Member
– A professional clearing members is a clearing member who is not a
trading member. E.g. Banks.
• Participants

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 Basis of Trading (NSE)
• The NEAT F&O system supports an order driven market,
wherein orders match automatically.
• Order matching is essentially on the basis of security, its
price, time and quantity.
• All quantity fields are in units and price in rupees.
• The exchange notifies the regular lot size and tick size for
each of the contracts traded on this segment from time to
time.
• Types of Orders
– Active Order
– Passive Order -> Outstanding Order Book.

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 Order Conditions
• Time Conditions
– Day Order
– Immediate or Cancel (IOC)
• Price Conditions
– Stop-Loss
• Other Conditions
– Market Price
– Trigger Price
– Limit Price
– Pro
– Cli

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 Business Growth in Derivatives Segment
(NSE)

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 Client Broker Relationship
A trading member must ensure compliance particularly with relation to
the following while dealing with clients:
• Filling of 'Know Your Client' form
• Execution of Client Broker agreement
• Bring risk factors to the knowledge of client by getting
acknowledgement of client on risk disclosure document
• Timely execution of orders as per the instruction of clients in respective
client codes.
• Collection of adequate margins from the client
• Maintaining separate client bank account for the segregation of client
money.
• Timely issue of contract notes as per the prescribed format to the client

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 Client Broker Relationship
• Ensuring timely pay-in and pay-out of funds to and
from the clients
• Resolving complaint of clients if any at the earliest.
• Avoiding receipt and payment of cash and deal only
through account payee cheques
• Sending the periodical statement of accounts to
clients
• Not charging excess brokerage
• Maintaining unique client code as per the regulations.

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 Eligibility Criteria For Stocks
• The stock is chosen from amongst the top 500 stocks in terms of
average daily market capitalization and average daily traded value
in the previous six months on a rolling basis.
• The stock's median quarter-sigma order size over the last six
months should be not less than Rs. 5 lakhs. For this purpose, a
stock's quarter-sigma order size should mean the order size (in
value terms) required to cause a change in the stock price equal to
one-quarter of a standard deviation.
• The market wide position limit in the stock should not be less than
Rs.100 crores. The market wide position limit (number of shares) is
valued taking the closing prices of stocks in the underlying cash
market on the date of expiry of contract in the month.

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 Eligibility Criteria For Stocks
• For an existing F&O stock, the continued eligibility criteria is that market
wide position limit in the stock shall not be less than Rs. 60 crores and
stock’s median quarter-sigma order size over the last six months shall be not
less than Rs. 2 lakh.
• If an existing security fails to meet the eligibility criteria for three months
consecutively, then no fresh month contract will be issued on that security.
• However, the existing unexpired contracts can be permitted to trade till
expiry and new strikes can also be introduced in the existing contract
months.
• Further, once the stock is excluded from the F&O list, it shall not be
considered for re-inclusion for a period of one year.
• Futures & Options contracts may be introduced on (new) securities which
meet the above mentioned eligibility criteria, subject to approval by SEBI.

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 Eligibility Criteria For Indices
• The exchange may consider introducing derivative contracts
on an index if the stocks contributing to 80% weightage of
the index are individually eligible for derivative trading.
• However, no single ineligible stocks in the index should have
a weightage of more than 5% in the index.
• The above criteria is applied every month, if the index fails to
meet the eligibility criteria for three months consecutively,
then no fresh month contract would be issued on that index.
• However, the existing unexpired contacts will be permitted
to trade till expiry and new strikes can also be introduced in
the existing contracts.

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 Thank You !

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