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A PRACTICAL HANDBOOK OF TRADING NIFTY OPTIONS Updated on 27th June for July series, 2010 1 Contents 1. Introduction to Nifty Options 3 2. Types of Nifty Call Options 5 3. Types of Nifty Put options 6 4. Bullish Nifty Trading Strategies 7 Nifty Option Long Call 7-8 Nifty Option Bull Call Spread 8-9 Nifty Option Bull Put Spread 10-11 Nifty Option Bull Call Ratio Back Spread 11-12 Nifty Option Bull Call Calendar Spread 13 5. Bearish Nifty Trading Strategies 14 Nifty Option Long Put 14-15 Nifty Option Bear Put Spread 15-16 Nifty Option Bear Call Spread 17-18 Nifty Option Bear Put Ratio Back Spread 18-19 Nifty Option Bear Put Calendar Spread 20 6. Highly Volatile Market Nifty Trading Strategies 21 Nifty Option Long Straddle 21-22 Nifty Option Long Strangle 22-23 7. Nifty Option Intra-Day Trading Strategies 24 8. The Universally Proven Dos of Successful Option Trading 25 2 Introduction to Nifty Options A Nifty Index option is a contract between two parties in which the Nifty option buyer (holder) purchases the right but not the obligation to buy/sell Nifty Index Securities at a predetermined price from/to the Nifty option seller or writer within a fixed period of time. However, our course is not for exercising them but to trade them just like a simple stock. The two classes of Nifty options are puts and calls. A Nifty Call Option confers the buyer the right to buy the underlying stock while Nifty Put Options give him the rights to sell them. You buy Nifty Calls when you bet on bullishness and you buy Nifty Puts in bearishness of the Nifty Index. OPTIDX NIFTY 29JUL2010 CE 5300: This is a Nifty Call Option for the month of July, 2010 with a strike price of Rs.5200/- when Nifty index level is at 5300 (for example). This particular Nifty Call Option will gain when Nifty Index goes up and will keep on rising above 5300 level. So, if the market is bullish, one should consider buying Nifty Call Options. OPTIDX NIFTY = Option of the underlying security which is Nifty Index 29JUL2010 = the expiry date of July month CE = Call Option 5300 = The Strike Price (when Nifty goes above 5200, the call option gains) OPTIDX NIFTY 29JUL2010 PE 5100:- This is a Nifty Put Option for the month of July, 2010 with a strike price of Rs.5300/- when Nifty index level is at 5300 (for example). This particular Nifty Call Option will gain when Nifty Index goes down below 5300 level. So, if the market is bearish, one should consider buying Nifty Put Options. OPTIDX NIFTY = Option of the underlying security which is Nifty Index 29JUL2010 = the expiry date of July month PE = Put Option 5300 = The Strike Price (when Nifty goes below 5200, the put option gains) Nifty options trading are one of the best when it comes to returns. At the same time, it’s one of the most risky trades. We at Nifty options profit comes at this point and make you learn how to trade it with less risk yet high rewards. It’s all in the way of choosing the right trades and timings of buy and sell. There are times when a particular Nifty Call or Put options has a buy price of Rs.200/ - and maximum change in the day upside limits to around Rs.20/- only. Again there are times when the same Call or Put options has a buy price of Rs.20/- and moves upside up to Rs.20/- in a day which is a 100% return. In the above two scenarios, the later one is the right one to trade because you risk only Rs.20/ - to get a profit of Rs.20/- even if you don’t keep stop losses*, while the former scenario carries a bigger risk of loosing Rs.100/- if you don’t put stop loss. Keeping stop loss is a very tricky thing while trading Nifty 3 options because huge volatility and big gap openings often skips the stop losses we keep and make us loose the whole amount we put. Options are a great way of making money out of very little money in a very short span of time. Let us assume that the Nifty market today is at 4800. And you have bought the Nifty Call Option of strike price 4900 of May month end at a cost of Rs 25 per unit. If you buy 1 lot which is 50 units, then the total cost for this would be Rs 1250. So you have invested just Rs 1250. Now suppose if the market goes up in the coming days to 4800-4900 levels. At this time the value of your call options will be like Rs 50 to Rs 60 per unit. And you can square off your position anytime before the option closing date (which is 27th May). So suppose you square off your position at Rs 50 to Rs 60 per unit, then the money you will get will be 50 multiplied by Rs.55 (average) equals Rs.2750. And the profit that you would generate would be Rs 2750 minus Rs 1250, that is Rs.1500, a whooping 120 % returns in a day or two. You should also assume the worst case scenario. What if the market went down from 4800 to 4700 and the value of your options went to near zero. So in the worst case you will only lose your initial investment amount Rs 1250. So for making money in Options trading you need to have a perception of whether the market will go up or down. And yes, you need to look daily about current value of the options that you have bought so that you can square off your position at any day before the final closing day of the option. In my course I would be explaining about type of options and how to buy two options at a time to minimize risk. This way the returns would be less but, you would have fair chance of making money irrespective of Nifty going up or down. Remember, volatility is the most important factor which will determine how much money you will make while trading in options. Before I discuss with all the Nifty Options Trading strategies, I need to clear off your mind and decide yourself a few things. Most of the time, new option trader gets lost in the maze of so many option strategies and find it difficult to select right strategy for correct market condition. Let me give you a framework for strategy selection:- Decide your holding period of the trade – intraday, few days, weeks, till expiry etc Decide on your view about the market for above time-frame – up, down or sideway. Asses the current volatility scenario of market – high, low, normal. Option trading has all kind of strategies to play above 3 market conditions and 3 volatility situations. From that lot, select 1 or 2 strategy for each type of market condition. Master the selected strategies. Know their risk graph, break-even points, maximum risk, maximum return, behavior for change in various option Greeks etc. Develop your personalized trading system for each strategy. Address the decision variables like which strike, which expiry month, how much of premium to collect, when to trade and when not to trade this strategy, where to put stops, your action plan when position goes in your favor, against you, or goes nowhere. Back test, paper trade, etc and get a feel of trading them in paper. Make sure that your personalized trading system has positive expectancy. Put your risk management plan, trade planning etc in place Start trading your trading system [Tiger (share khan), TT5 (India info line), ICICI Direct trade] 4 Type of Calls according to Strike prices:- ITM (In-the-Money) Nifty Calls: In-the-Money calls are those calls which strike prices are lower than the Nifty index level. These types of calls are best for conservative traders who are strict in keeping stop losses with a fixed profit target in their mind when the market rallies. In-the-Money Nifty Calls = Strike price less than Nifty index level For example: - when Nifty index is trading at 5300, ITM calls for the month of July series are:- OPTIDX NIFTY 29JUL2010 CE 5200 OPTIDX NIFTY 29JUL2010 CE 5100 OPTIDX NIFTY 29JUL2010 CE 5000 OPTIDX NIFTY 29JUL2010 CE 4900 ATM (At-the-Money) Nifty Calls: An at-the-money call is a call which strike price is the same as Nifty index level. This particular call is good for intra-day trading with a specific plan of buying and selling in the same day as soon as it achieves a target. At-the-Money Nifty Calls = Strike price equals to Nifty index level For example: - when Nifty index is trading at 5300, ATM calls for the month of July series is:- OPTIDX NIFTY 29JUL2010 CE 5300 OTM (Out-the-Money) Nifty Calls: Out-the-Money calls are those calls which strike prices are higher than the Nifty index level. These types of calls are best for aggressive traders who can take risk and likes to earn big by investing a little amount of capital. Also, these calls are great for short selling and spread trading strategies which takes advantage of time decay. Out-the-Money Nifty Calls = Strike price higher than Nifty index level For example: - when Nifty index is trading at 5300, OTM calls for the month of July series are:- OPTIDX NIFTY 29JUL2010 CE 5400 OPTIDX NIFTY 29JUL2010 CE 5500 OPTIDX NIFTY 29JUL2010 CE 5600 OPTIDX NIFTY 29JUL2010 CE 5700 5 Type of Puts according to Strike prices:- ITM (In-the-Money) Nifty Puts: In-the-Money Puts are those puts which strike prices are higher than the Nifty index level. These types of Puts are best for conservative traders who are strict in keeping stop losses with a fixed profit target in their mind when the market goes down. In-the-Money Nifty Puts = Strike price higher than Nifty index level For example: - when Nifty index is trading at 5300, ITM puts for the month of July series are:- OPTIDX NIFTY 29JUL2010 PE 5400 OPTIDX NIFTY 29JUL2010 PE 5500 OPTIDX NIFTY 29JUL2010 PE 5600 OPTIDX NIFTY 29JUL2010 PE 5700 ATM (At-the-Money) Nifty Puts: An at-the-money put is the one which strike price is the same as Nifty index level. This particular call is good for intra-day trading with a specific plan of buying and selling in the same day as soon as it achieves a target when the market goes down. At-the-Money Nifty Puts = Strike price equals to Nifty index level For example: - when Nifty index is trading at 5300, ATM Put for the month of July series is:- OPTIDX NIFTY 29JUL2010 PE 5300 OTM (Out-the-Money) Nifty Puts: Out-the-Money Puts are the ones which strike prices are lower than the Nifty index level. These types of Puts are best for aggressive traders who can take risk and likes to earn big by investing a little amount of capital when the market falls down. Also, these calls are great for short selling and spread trading strategies which takes advantage of time decay at the time of Bullish market. Out-the-Money Nifty Puts = Strike price lower than Nifty index level For example: - when Nifty index is trading at 5300, ITM puts for the month of July series are:- OPTIDX NIFTY 29JUL2010 PE 5200 OPTIDX NIFTY 29JUL2010 PE 5100 OPTIDX NIFTY 29JUL2010 PE 5000 OPTIDX NIFTY 29JUL2010 PE 4900 6 Bullish Nifty Trading Strategies:- Nifty Option Long Call Nifty Option Bull Call Spread Nifty Option Bull Put Spread Nifty Option Bull Call Ratio Back Spread Nifty Option Bull Call Calendar Spread 1) Nifty Option Long Call The Nifty Option long call option strategy is the most basic option trading strategy whereby the options trader buys Nifty call options with the belief that Nifty Index level will rise significantly beyond the strike price before the option expiration date. Long Call Trading Position in the month of July at Nifty level 5300 for July, 2010 series: Buy 1 ITM or ATM or OTM Call (OPTIDX NIFTY 29JUL2010 CE 5200/5300/5400) N.B: Remember Nifty Option Call options have a limited lifespan. If the Nifty index level does not move above the strike price before the option expiration date, the call option will expire worthless. Unlimited Profit Potential Since they can be no limit as to how high the Nifty Index level can be at expiration date, there is no limit to the maximum profit possible when implementing the long call Nifty option strategy. The formula for calculating profit is given below: Maximum Profit = Unlimited Profit Achieved When Nifty Index level >= Strike Price of Long Call + Premium Paid Profit = Price of Underlying - Strike Price of Long Call - Premium Paid Limited Risk Risk for the long call Nifty options strategy is limited to the price paid for the call option no matter how low the Nifty index level is trading on expiration date. The formula for calculating maximum loss is given below: Max Loss = Premium Paid + Commissions Paid Max Loss Occurs When Nifty index level <= Strike Price of Long Call 7 Breakeven Point(s) The Nifty Index level at which break-even is achieved for the Nifty Option Long Call position can be calculated using the following formula. Breakeven Point = Strike Price of Long Nifty Option Call + Premium Paid Nifty Option Long Call Example: Suppose the Nifty Index trading at 5000 level and a Nifty Call Option contract as OPTIDX NIFTY 29JUL2010 CE 5000 is priced at Rs.200.00. You believe that Nifty index level will rise sharply in the coming weeks and so you paid Rs.10000.00 to purchase 1 lot of OPTIDX NIFTY 29JUL2010 CE 5000 covering 50 units. Say you were proven right and the Nifty Index rallies to 6000 level on option expiration date of July, the 29th, 2010. With underlying Nifty index at 6000, you can sell them immediately in the open market for Rs.1000.00 a unit. This gives you a profit of Rs.800.00 per unit. As 1 lot of Nifty call option contract covers 50 units, the total amount you will receive from selling the OPTIDX NIFTY 29JUL2010 CE 5000 is Rs.50000.00. Since you had paid Rs.10000.00 in total to purchase the Nifty call option, your net profit for the entire trade is therefore Rs.40000.00. However, if you were wrong in your assessment and the Nifty Index level had instead dived to 4000, your call option will expire worthless and your total loss will be the Rs.200.00 or Rs.10000.00 in total that you paid to purchase the Nifty Call Option. 2) Nifty Option Bull Call Spread: The Nifty option bull call spread strategy is employed when the options trader thinks that the Nifty index level will go up moderately in the near term. Bull call spreads can be implemented by buying ITM Nifty Call option while simultaneously selling a higher striking OTM Nifty call option of the same expiration month. Bull Call Spread Trading Position in the month of July at Nifty level 5300 for July, 2010 series: Buy 1 ITM Nifty Call (OPTIDX NIFTY 29JUL2010 CE 5200) Sell 1 OTM Nifty Call (OPTIDX NIFTY 29JUL2010 CE 5400) By short selling the OTM Nifty call, the options trader reduces the cost of establishing the bullish position but forgoes the chance of making a large profit in the event that Nifty Index level skyrockets. The bull call spread option strategy is also known as the bull call debit spread as a debit is taken upon entering the trade. 8 Limited Upside Profit Potential Maximum gain is reached for the Nifty bull call spread options strategy when the Nifty index level move above the higher strike price of the two calls and it is equal to the difference between the strike prices of the two call options minus the initial debit taken to enter the position. The formula for calculating maximum profit is given below: Max Profit = Strike Price of Sold Call - Strike Price of Long Call - Net Premium Paid - Commission Paid to broker Max Profit Achieved When Nifty Index>= Strike Price of Short Call Limited Downside risk The Nifty Option bull call spread strategy will result in a loss if the stock price declines at expiration. Maximum loss cannot be more than the initial debit taken to enter the spread position. The formula for calculating maximum loss is given below: Max Loss = Net Premium Paid + Commissions Paid Max Loss Occurs When Nifty<= Strike Price of Long Call Breakeven Point(s) The Nifty Index level at which break-even is achieved for the Nifty Option Bull Call spread position can be calculated using the following formula. Breakeven Point = Strike Price of Long Nifty Call + Net Premium Paid Nifty Option Bull Call Spread Example: An options trader believes that Nifty Index trading at 5200 is going to rally soon and enters a bull call spread by buying 1 OPTIDX NIFTY 29JUL2010 CE 5000 for Rs.300.00 and selling 1 OPTIDX NIFTY 29JUL2010 CE 5500 for Rs.100.00. The net investment required to put on the spread is a debit of Rs.200.00 per unit. The Nifty Index level begins to rise and closes at 5600 on expiration date. Both options expire in- the-money with the OPTIDX NIFTY 29JUL2010 CE 5000 having an intrinsic value of Rs.600.00 and the OPTIDX NIFTY 29JUL2010 CE 5500 having an intrinsic value of Rs.100.00. This means that the spread is now worth Rs.500.00 at expiration. Since the trader had a debit of Rs.200.00 when he bought the spread, his net profit is Rs.300.00 per unit. If the Nifty Index level had declined to 4800 instead, both options expire worthless. The trader will lose his entire investment of Rs.200.00, which is also his maximum possible loss. 9 3) Nifty Option Bull Put Spread The Nifty Option Bull Put spread trading strategy is employed when the options trader thinks that the price of the underlying asset will go up moderately in the near term. Bull put spreads can be implemented by selling a higher striking in-the-money put option and buying a lower striking out-of-the-money put option on the same underlying Nifty with the same expiration date. Bull Put Spread Trading Position in the month of July at Nifty level 5300 for July, 2010 series: Buy 1 OTM Nifty Put (OPTIDX NIFTY 29JUL2010 PE 5200) Sell 1 ITM Nifty Put (OPTIDX NIFTY 29JUL2010 PE 5400) The bull put spread options strategy is also known as the bull put credit spread as a credit is received upon entering the trade. Limited Upside Profit Potential If the Nifty Index level closes above the higher strike price on expiration date, both options expire worthless and the bull put spread option strategy earns the maximum profit which is equal to the credit taken in when entering the position. The formula for calculating maximum profit is given below: Max Profit = Net Premium Received - Commissions Paid Max Profit Achieved When Price of Underlying >= Strike Price of Short Put Limited Downside Risk If the Nifty Index level drops below the lower strike price on expiration date, then the Nifty Option bull put spread strategy incurs a maximum loss equal to the difference between the strikes prices of the two puts minus the net credit received when putting on the trade. The formula for calculating maximum loss is given below: Max Loss = Strike Price of Short Put - Strike Price of Long Put Net Premium Received + Commission Paid Max Loss Occurs When Nifty Index Level <= Strike Price of Long Put Breakeven Point(s) The Nifty Index level at which break-even is achieved for the bull put spread position can be calculated using the following formula. Breakeven Point = Strike Price of Short Put - Net Premium Received 10 Nifty Option Bull Put Spread Example: An options trader believes that Nifty Index trading at 5300 is going to rally soon and enters a bull put spread by buying 1 OPTIDX NIFTY 29JUL2010 PE 5000 for Rs.100.00 and selling 1 OPTIDX NIFTY 29JUL2010 PE 5500 for Rs.300.00. Thus, the trader receives a net credit of Rs.200.00 per unit when entering the spread position. The Nifty Index level begins to rise and closes at 5600 on expiration date. Both options expire worthless and the options trader keeps the entire credit of Rs.200.00 as profit, which is also the maximum profit possible. If the Nifty Index level had declined to 4800 instead, both options expires in-the-money with the OPTIDX NIFTY 29JUL2010 PE 5000 having an intrinsic value of Rs.200.00 and the OPTIDX NIFTY 29JUL2010 PE 5500 put having an intrinsic value of Rs.700.00. This means that the spread is now worth Rs.500.00 at expiration. Since the trader had received a credit of Rs.200.00 when he entered the spread, his net loss comes to Rs.300.00. This is also his maximum possible loss. 4) Nifty Option Bull Call Ratio Back spread: The Nifty Option Call Ratio Back spread trading is a bullish strategy in options trading that involves selling a number of call options and buying more call options of the same underlying stock and expiration date at a higher strike price. It is an unlimited profit, limited risk options trading strategy that is taken when the options trader thinks that the underlying Nifty will experience significant upside movement in the near term. Call Back Spread Trading Position in the month of July at Nifty level 5300 for July, 2010 series: Sell 1 ITM Call (OPTIDX NIFTY 29JUL2010 CE 5200) Buy 2 OTM Call (OPTIDX NIFTY 29JUL2010 CE 5400) A 2:1 call back spread can be implemented by selling a number of calls at a lower strike and buying twice the number of calls at a higher strike. Unlimited Profit Potential The call back spread profits when the Nifty Index makes a strong move to the upside beyond the upper breakeven point. There is no limit to the maximum possible profit. The formula for calculating profit is given below: Maximum Profit = Unlimited Profit Achieved When Price of Underlying >= 2 x Strike Price of Long Call - Strike Price of Short Call +/- Net Premium Paid/Received Profit = Price of Underlying - Strike Price of Long Call - Max Loss 11 Limited Risk Maximum loss for the call back spread is limited and is taken when the Nifty Index at expiration is at the strike price of the long calls purchased. At this price, both the long calls expire worthless while the short call expires in the money. Maximum loss is equal to the intrinsic value of the short call plus or minus any debit or credit taken when putting on the spread. The formula for calculating maximum loss is given below: Max Loss = Strike Price of Long Call - Strike Price of Short Call +/- Net Premium Paid/Received + Commissions Paid Max Loss Occurs When Strike Price of Long Call Breakeven Point(s) There are 2 break-even points for the call back spread position. The breakeven points can be calculated using the following formulae. Upper Breakeven Point = Strike Price of Long Call + Points of Maximum Loss Lower Breakeven Point = Strike Price of Short Call Nifty Option Bull Call Ratio back spread Example: Suppose Nifty Index level is trading at 5300 in July at the time of building our position for next month July series. An options trader executes a 2:1 call back spread by selling 1 OPTIDX NIFTY 29JUL2010 CE 5000 for Rs.400.00 and buying 2 OPTIDX NIFTY 29JUL2010 CE 5500 for Rs.200.00 each unit. The net debit/credit taken to enter the trade is zero. On expiration in July, if Nifty Index is trading at 5500 level, both the OPTIDX NIFTY 29JUL2010 CE 5500 expire worthless while the short OPTIDX NIFTY 29JUL2010 CE 5000 expires in the money with Rs.500.00 in intrinsic value. Buying back this call to close the position will result in the maximum loss of Rs.500.00 for the options trader. If Nifty Index rallies and is trading at 6000 level on expiration in July, all the options will expire in the money. The short OPTIDX NIFTY 29JUL2010 CE 5000 is worth Rs.1000.00 and needs to be bought back to close the position. Since the OPTIDX NIFTY 29JUL2010 CE 5500 bought is now worth Rs.500.00 each, their combined value of Rs.1000.00 is just enough to offset the losses from the shorted call. Therefore, he achieves breakeven at Nifty Index level 6000. Beyond 6000 level of Nifty index though, there will be no limit to the gains possible. For example, at 7000, the long OPTIDX NIFTY 29JUL2010 CE 5500 will be worth Rs.1500.00 each or Rs.3000.00 in total while his single short OPTIDX NIFTY 29JUL2010 CE 5000 is only worth Rs.2000.00, resulting in a profit of Rs.1000.00 (Rs.3000.00-Rs.2000.00). If the Nifty Index level had dropped to 5000 or below at expiration, all the options involved will expire worthless. Since the net debit to put on this trade is zero, there is no resulting loss. 12 5) Nifty Option Bull Call Calendar Spread: Using Nifty Calls, the bull calendar spread strategy can be setup by buying long term slightly OTM Nifty Calls and simultaneously selling an equal number of near month Nifty Calls with the same strike price. The Nifty options trader applying this strategy is bullish for the long term and is selling the near month calls with the intention to ride the long term calls for free. Bull Calendar Spread Trading Position in the month of July at Nifty level 5300 for July, 2010 series: Sell 1 Near-Term OTM Nifty Call (OPTIDX NIFTY 29JUL2010 CE 5600) Buy 1 Long-Term OTM Nifty Call (OPTIDX NIFTY 30SEP2010 CE 5600) Unlimited Upside Profit Potential Once the near month options expire worthless, this strategy turns into a discounted long call strategy and so the upside profit potential for the bull calendar spread becomes unlimited. Limited Downside Risk The maximum possible loss for the bull calendar spread is limited to the initial debit taken to put on the spread. This happens when the Nifty Index goes down and stays down until expiration of the longer term call. Nifty Option Bull Call Calendar Example: In July, an options trader believes that Nifty Index which is trading at 5000 level is going to rise gradually over the next 3 months. He enters a bull calendar spread by buying 1 OTM call as OPTIDX NIFTY 30SEP2010 CE 5500 for Rs.200.00 and Selling 1 OTM call as OPTIDX NIFTY 29JUL2010 CE 5500 for Rs.100.00. The net investment required to put on the spread is a debit of Rs.100.00. In July, Nifty Index goes up to 5200 level and the OPTIDX NIFTY 29JUL2010 CE 5500 expires worthless. Subsequently, Nifty Index level rises to 5900 level in September. The OPTIDX NIFTY 30SEP2010 CE 5500 expires in the money and is worth Rs.400.00 on expiration. Since the initial debit taken to enter the trade is Rs.100.00, his profit comes to Rs.300 (Rs.400-Rs.100). Suppose the Nifty Index did not raise much and remains at or below 5500 all the way until expiration of the long term call in September, the trader will lose the initial debit of Rs.100.00 as both calls expire worthless. 13 Bearish Nifty Trading Strategies:- Nifty Option Long Put Nifty Option Bear Put Spread Nifty Option Bear Call Spread Nifty Option Bear Put Ratio Back Spread Nifty Option Bear Put Calendar Spread 1) Nifty Option Long Put The long put option strategy is a basic strategy in options trading where the investor buy put options with the belief that the price of the underlying Nifty will go significantly below the striking price before the expiration date. Long Put Trading Position in the month of July at Nifty level 5300 for July, 2010 series: Buy 1 ITM or ATM or OTM Put (OPTIDX NIFTY 29JUL2010 PE 5400/5300/5200) Put options have a limited lifespan. If the underlying stock price does not move below the strike price before the option expiration date, the put option will expire worthless. Unlimited Profit Potential Since Nifty Index level in theory can reach zero at expiration date, the maximum profit possible when using the long put strategy is only limited to the striking price of the purchased put less the price paid for the option. The formula for calculating profit is given below: Maximum Profit = Unlimited Profit Achieved When Nifty Index level = 0 Profit = Strike Price of Long Put - Premium Paid Limited Risk Risk for implementing the long put strategy is limited to the price paid for the put option no matter how high the Nifty index level is trading on expiration date. The formula for calculating maximum loss is given below: Max Loss = Premium Paid + Commissions Paid Max Loss Occurs When Nifty Index level >= Strike Price of Long Put Breakeven Point(s) The Nifty Index level at which break-even is achieved for the long put position can be calculated using the following formula. Breakeven Point = Strike Price of Long Put - Premium Paid 14 Nifty Option Long Put Example: Suppose the stock of Nifty Index is trading at 5000 level in July, 2010. A put option contract OPTIDX NIFTY 29JUL2010 PE 5000 expiring in July month is being priced at Rs.200.00. You believe that Nifty index level will fall sharply in the coming weeks and so you paid Rs. 10000.00 to purchase 1 lot of OPTIDX NIFTY 29JUL2010 PE 5000 covering 50 units. Say you were proven right and the Nifty Index crashes to 4000 level on option expiration date. With underlying Nifty index at 4000, you can sell them immediately in the open market for Rs.1000.00 a unit. This gives you a profit of Rs.800.00 per unit. As 1 lot of Nifty call option contract covers 50 units, the total amount you will receive from selling the OPTIDX NIFTY 29JUL2010 PE 5000 is Rs.50000.00. Since you had paid Rs. 10000.00 in total to purchase the Nifty call option, your net profit for the entire trade is therefore Rs.40000.00 However, if you were wrong in your assessment and the Nifty Index level had instead rallied to 6000, your Put option will expire worthless and your total loss will be the Rs.200.00 per unit or Rs.10000.00 in total that you paid to purchase the Nifty Put ATM Option. 2) Nifty Option Bear Put Spread The Nifty option bear put spread option trading strategy is employed when the options trader thinks that the Nifty Index level will go down moderately in the near term. Bear put spreads of Nifty Options can be implemented by buying a higher striking in-the-money (ITM) Nifty put option and selling a lower striking out-of-the-money (OTM) Nifty put option with the same expiration date. Bear Put Spread Trading Position in the month of July at Nifty level 5300 for July, 2010 series: Buy 1 ITM Put (OPTIDX NIFTY 29JUL2010 PE 5500) Sell 1 OTM Put (OPTIDX NIFTY 29JUL2010 PE 5000) By shorting (selling) the out-of-the-money (OTM) Nifty put, the options trader reduces the cost of establishing the bearish position but forgoes the chance of making a large profit in the event that the Nifty index level plummets. The bear put spread options strategy is also know as the bear put debit spread as a debit is taken upon entering the trade. Limited Downside Profit To reach maximum profit, Nifty index level need to close below the strike pri ce of the out-of- the-money (OTM) Nifty put on the expiration date. Both options expire in the money but the higher strike put that was purchased will have higher intrinsic value than the lower strike put that was sold. Thus, maximum profit for the bear put spread option strategy is equal to the difference in strike price minus the debit taken when the position was entered. 15 The formula for calculating maximum profit is given below: Max Profit = Strike Price of Long Put - Strike Price of Short Put - Net Premium Paid - Commissions Paid Max Profit Achieved When Nifty Index Level <= Strike Price of Short Put Limited Upside Risk If the Nifty Index level rise above the in-the-money (ITM) Nifty put option strike price at the expiration date, then the bear put spread strategy suffers a maximum loss equal to the debit taken when putting on the trade. The formula for calculating maximum loss is given below: Max Loss = Net Premium Paid + Commissions Paid Max Loss Occurs When Nifty Index Level >= Strike Price of Long Put Breakeven Point(s) The Nifty Index level at which break-even is achieved for the bear put spread position can be calculated using the following formula. Breakeven Point = Strike Price of Long Put - Net Premium Paid Nifty Option Bear Put Spread Example: Suppose Nifty Index level is trading at 4800 in July. An options trader bearish on Nifty decides to enter a Nifty option bear put spread position by buying 1 OPTIDX NIFTY 29JUL2010 PE 5000 for Rs.300.00 and sell 1 OPTIDX NIFTY 29JUL2010 PE 4500 for Rs.100.00 at the same time, resulting in a net debit of Rs.200.00 for entering this position. The Nifty index level subsequently drops to 4400 at expiration. Both puts expire in-the-money with the OPTIDX NIFTY 29JUL2010 PE 5000 bought having Rs.600.00 in intrinsic value and the OPTIDX NIFTY 29JUL2010 PE 4500 sold (shorted) having Rs.100.00 in intrinsic value. The spread would then have a net value of Rs.500.00 (the difference in strike price). Deducting the debit taken when he placed the trade, his net profit is Rs.300.00 (Rs.500.00-Rs.200.00). This is also his maximum possible profit. If the Nifty index had rallied to 5200 level instead, both options expire worthless, and the options trader loses the entire debit of Rs.200.00 taken to enter the trade. This is also the maximum possible loss. 16 3) Nifty Option Bear Call Spread The Nifty option bear call spread option trading strategy is employed when the options trader thinks that the price of the underlying asset will go down moderately in the near term. The bear call spread option strategy is also known as the bear call credit spread as a credit is received upon entering the trade. Bear call spreads can be implemented by buying call options of a higher strike price and selling the same number of call options of lower strike price on the same underlying nifty expiring in the same month. Bear Call Spread Trading Position in the month of July at Nifty level 5300 for July, 2010 series: Buy 1 OTM Call (OPTIDX NIFTY 29JUL2010 CE 5600) Sell 1 ITM Call (OPTIDX NIFTY 29JUL2010 CE 5100) Limited Downside Profit The maximum gain attainable using the bear call spread options strategy is the credit received upon entering the trade. To reach the maximum profit, the Nifty index level needs to close below the strike price of the lower striking call sold at expiration date where both options would expire worthless. The formula for calculating maximum profit is given below: Max Profit = Net Premium Received - Commissions Paid Max Profit Achieved When Nifty Index Level <= Strike Price of Short Call Limited Upside Risk If the Nifty Index level rise above the strike price of the higher strike call at the expiration date, then the bear call spread strategy suffers a maximum loss equals to the difference in strike price between the two options minus the original credit taken in when entering the position. The formula for calculating maximum loss is given below: Max Loss = Strike Price of Long Call - Strike Price of Short Call - Net Premium Received + Commissions Paid Max Loss Occurs When Nifty Index Level >= Strike Price of Long Call Breakeven Point(s) The Nifty Index level at which break-even is achieved for the bear call spread position can be calculated using the following formula. Breakeven Point = Strike Price of Short Call + Net Premium Received 17 Nifty Option Bear Call Spread Example: Suppose Nifty Index is trading at 4700 in July. An options trader bearish on Nifty Index decides to enter a Nifty option bear call spread position by buying 1 OPTIDX NIFTY 29JUL2010 CE 5000 for Rs.100.00 and selling 1 OPTIDX NIFTY 29JUL2010 CE 4500 for Rs.300.00 at the same time, giving him a net Rs.200.00 credit for entering this trade. The Nifty index level subsequently drops to 4400 at expiration. As both options expire worthless, the options trader gets to keep the entire credit of Rs.200.00 as profit. If the Nifty index had rallied to 5200 instead, both calls will expire in-the-money with the OPTIDX NIFTY 29JUL2010 CE 5000 bought having Rs.200.00 in intrinsic value and the OPTIDX NIFTY 29JUL2010 CE 4500 sold having Rs.700.00 in intrinsic value. The spread would then have a net value of Rs.500.00 (the difference in strike price). Since the trader have to buy back the spread for Rs.500.00, this means that he will have a net loss of Rs.300.00 after deducting the Rs.200.00 credit he earned when he put on the spread position. 4) Nifty Option Bear Put Ratio Back spread The Nifty option put back spread (reverse put ratio spread) is a bearish strategy in options trading that involves selling a number of put options and buying more put options of the same underlying stock and expiration date at a lower strike price. It is an unlimited profit, limited risk options trading strategy that is taken when the options trader thinks that the underlying Nifty will experience significant downside movement in the near term. Put Back Spread Trading Position in the month of July at Nifty level 5300 for July, 2010 series: Sell 1 ITM Put (OPTIDX NIFTY 29JUL2010 PE 5500) Buy 2 OTM Puts Put (OPTIDX NIFTY 29JUL2010 PE 5000) A 2:1 put back spread can be implemented by buying a number of puts at a higher strike and buying twice the number of puts at a lower strike. Unlimited Profit Potential This strategy profits when the stock price makes a strong move to the downside beyond the lower breakeven point. There is no limit to the maximum possible profit for the put back spread. The formula for calculating profit is given below: Maximum Profit = Unlimited Profit Achieved When Nifty Index Level < 2 x Strike Price of Long Put - Strike Price of Short Put + Net Premium Received Profit = Strike Price of Long Put - Nifty Index Level - Max Loss 18 Limited Risk Maximum loss for the put back spread is limited and is incurred when the underlying Nifty Index Level at expiration is at the strike price of the long puts purchased. At this price, both the long puts expire worthless while the short put expires in the money. Maximum loss is equal to the intrinsic value of the short put plus or minus any debit or credit taken when putting on the spread. The formula for calculating maximum loss is given below: Max Loss = Strike Price of Short Put - Strike Price of Long Put - Net Premium Received + Commissions Paid Max Loss Occurs When Nifty level = Strike Price of Long Put Breakeven Point(s) There are 2 break-even points for the put back spread position. The breakeven points can be calculated using the following formulae. Upper Breakeven Point = Strike Price of Short Put Lower Breakeven Point = Strike Price of Long Put - Points of Maximum Loss Nifty Option Bear Put Ratio Back spread Example: Suppose Nifty Index level is trading at 4800 in July. An options trader executes a 2:1 put back spread by selling 1 OPTIDX NIFTY 29JUL2010 PE 5000 for Rs.400.00 and buying 2 OPTIDX NIFTY 29JUL2010 PE 4500 for Rs.200.00 each unit. The net debit/credit taken to enter the trade is zero. On expiration in July, if Nifty Index level is trading at 4500, both the OPTIDX NIFTY 29JUL2010 PE 4500 puts expire worthless while the short OPTIDX NIFTY 29JUL2010 PE 5000 put expires in the money with Rs.500.00 in intrinsic value. Buying back this put to close the position will result in the maximum loss of Rs.500.00 for the options trader. If Nifty Index drops to 4000 level on expiration in July, all the options will expire in the money. The short OPTIDX NIFTY 29JUL2010 PE 5000 is worth Rs.1000.00 and needs to be bought back to close the position. Since the 2 OPTIDX NIFTY 29JUL2010 PE 4500 bought is now worth Rs.500.00 each, their combined value of Rs.1000.00 is just enough to offset the losses from the s horted put. Therefore, he achieves breakeven at Nifty level of 4000. Below 4000 level though, there will be no limit to the gains possible. For example, at 3000 level, each long OPTIDX NIFTY 29JUL2010 PE 4500 will be worth Rs.1500.00 while his single short OPTIDX NIFTY 29JUL2010 PE 5000 is only worth Rs.2000.00, resulting in a profit of Rs.1000.00 (Rs.3000-Rs2000). If the Nifty Index had rallied to 5000 level or higher at expiration, all the options involved will expire worthless. Since the net debit to put on this trade is zero, there is no resulting loss. 19 5) Nifty Bear Calendar Put Spread: Using Nifty Puts, the bear calendar spread strategy can be setup by buying long term slightly OTM Nifty Calls and simultaneously selling an equal number of near month Nifty Calls with the same strike price. The Nifty options trader applying this strategy is bullish for the long term and is selling the near month calls with the intention to ride the long term calls for free. Bull Calendar Spread Trading Position in the month of July at Nifty level 5300 for July, 2010 series: Buy 1 Long-Term OTM Nifty Put (OPTIDX NIFTY 30SEP2010 PE 4800) Sell 1 Near-Term OTM Nifty Put (OPTIDX NIFTY 29JUL2010 PE 4800) Unlimited downside Profit Potential Once the near month options expire worthless, this strategy turns into a discounted long put strategy and so the downside profit potential for the bear calendar spread becomes unlimited. Limited Upside Risk The maximum possible loss for the bear calendar spread is limited to the initial debit taken to put on the spread. This happens when the Nifty Index goes up and stays up until expiration of the longer term put. Nifty Option Bear put Calendar Example: In July, an options trader believes that Nifty Index which is trading at 5000 level is going to fall gradually over the next 3 months. He enters a bear calendar spread by buying 1 Longer term OTM put as OPTIDX NIFTY 30SEP2010 PE 4500 for Rs.200.00 and Selling 1 OTM call as OPTIDX NIFTY 29JUL2010 PE 4500 for Rs.100.00. The net investment required to put on the spread is a debit of Rs.100.00. In July, Nifty Index goes down to 4800 level and the OPTIDX NIFTY 29JUL2010 PE 4500 expires worthless. Subsequently, Nifty Index level slides to 4100 level in September. The OPTIDX NIFTY 30SEP2010 PE 4500 expires in the money and is worth Rs.400.00 on expiration. Since the initial debit taken to enter the trade is Rs.100.00, his profit comes to Rs.300 (Rs.400-Rs.100). Suppose the Nifty Index did not fall much and remains at or below 4500 all the way until expiration of the long term call in September, the trader will lose the initial debit of Rs.100.00 as both puts expire worthless. 20 Nifty Option Trading Strategies on highly volatile market:- Nifty Option Long Straddle Nifty Option Long Strangle 1) The Nifty Option Long Straddle The long straddle, also known as buy straddle or simply "straddle ", is a neutral strategy in options trading that involve the simultaneously buying of a put and a call of the same underlying stock, striking price and expiration date. Long Straddle Trading Position in the month of July at Nifty level 5300 for July, 2010 series: Buy 1 ATM Call (OPTIDX NIFTY 29JUL2010 CE 5300) Buy 1 ATM Put (OPTIDX NIFTY 29JUL2010 PE 5300) Long straddle options are unlimited profit, limited risk options trading strategies that are used when the options trader thinks that the underlying securities will experience significant volatility in the near term. Unlimited Profit Potential By having long positions in both call and put options, straddles can achieve large profits no matter which way the underlying stock price heads, provided the move is strong enough. The formula for calculating profit is given below: Maximum Profit = Unlimited Profit Achieved When Nifty Index Level> Strike Price of Long Call + Net Premium Paid OR Nifty Index Level < Strike Price of Long Put - Net Premium Paid Profit = Nifty Index Level - Strike Price of Long Call - Net Premium Paid OR Strike Price of Long Put - Nifty Index Level - Net Premium Paid Limited Risk Maximum loss for long straddles occurs when the Nifty Index Level on expiration date is trading at the strike price of the options bought. At this price, both options expire worthless and the options trader loses the entire initial debit taken to enter the trade. The formula for calculating maximum loss is given below: Max Loss = Net Premium Paid + Commissions Paid Max Loss Occurs When Nifty Index Level = Strike Price of Long Call/Put 21 Breakeven Point(s) There are 2 break-even points for the long straddle position. The breakeven points can be calculated using the following formulae. Upper Breakeven Point = Strike Price of Long Call + Net Premium Paid Lower Breakeven Point = Strike Price of Long Put - Net Premium Paid The Nifty Option Long Straddle Example: Suppose Nifty Index level is trading at 5000 in July. An options trader enters a long straddle by buying 1 OPTIDX NIFTY 29JUL2010 CE 5000 for Rs.200.00 and 1 OPTIDX NIFTY 29JUL2010 PE 5000 for Rs.200.00. The net debit taken to enter the trade is Rs.400.00, which is also his maximum possible loss. If Nifty Index level is trading at 6000 on expiration in July, the OPTIDX NIFTY 29JUL2010 PE 5000 will expire worthless but the OPTIDX NIFTY 29JUL2010 CE 5000 expires in the money and has an intrinsic value of Rs.1000.00. Subtracting the initial debit of Rs.400.00, the long straddle trader's profit comes to Rs.600.00. On expiration in July, if Nifty Index level is still trading at 5000, both the OPTIDX NIFTY 29JUL2010 CE 5000 and the OPTIDX NIFTY 29JUL2010 PE 5000 will expire worthless and the Nifty option long straddle trader suffers a maximum loss which is equal to the initial debit of Rs.400.00 taken to enter the trade. 2) The Nifty Option Long Strangle The Nifty option long strangle, also known as buy strangle or simply "strangle", is a neutral strategy in options trading that involve the simultaneous buying of a slightly out-of-the-money put and a slightly out-of-the-money call of the same underlying stock and expiration date. Long Strangle Trading Position in the month of July at Nifty level 5300 for July, 2010 series: Buy 1 OTM Call (OPTIDX NIFTY 29JUL2010 CE 5500) Buy 1 OTM Put (OPTIDX NIFTY 29JUL2010 PE 5100) The long options strangle is an unlimited profit, limited risk strategy that is taken when the options trader thinks that the underlying stock will experience significant volatility in the near term. Long strangles are debit spreads as a net debit is taken to enter the trade. 22 Unlimited Profit Potential Large gains for the long strangle option strategy are attainable when the underlying Nifty Index makes a very strong move either upwards or downwards at expiration. The formula for calculating profit is given below: Maximum Profit = Unlimited Profit Achieved When Nifty Index Level > Strike Price of Long Call + Net Premium Paid OR Nifty Index Level < Strike Price of Long Put - Net Premium Paid Profit = Nifty Index Level - Strike Price of Long Call - Net Premium Paid OR Strike Price of Long Put - Nifty Index Level - Net Premium Paid Limited Risk Maximum loss for the long strangles options strategy is hit when the Nifty Index Level on expiration date is trading between the strike prices of the options bought. At this price, both options expire worthless and the options trader loses the entire initial debit taken to en ter the trade. The formula for calculating maximum loss is given below: Max Loss = Net Premium Paid + Commissions Paid Max Loss Occurs When Price of Underlying is in between Strike Price of Long Call and Strike Price of Long Put Breakeven Point(s) There are 2 break-even points for the long strangle position. The breakeven points can be calculated using the following formulae. Upper Breakeven Point = Strike Price of Long Call + Net Premium Paid Lower Breakeven Point = Strike Price of Long Put - Net Premium Paid The Nifty option long strangles Example: Suppose Nifty Index level is trading at 5000 in July. An options trader executes a long strangle by buying 1 OPTIDX NIFTY 29JUL2010 CE 5200 for Rs.100.00 and 1 OPTIDX NIFTY 29JUL2010 PE 4800 for Rs.100.00. The net debit taken to enter the trade is Rs.200.00, which is also his maximum possible loss. If Nifty Index level rallies and is trading at 6000 on expiration in July, the OPTIDX NIFTY 29JUL2010 PE 4800 Put will expire worthless but the OPTIDX NIFTY 29JUL2010 CE 5200 Call expires in the money and has an intrinsic value of Rs.800.00. Subtracting the initial debit of $200, the options trader's profit comes to Rs.600.00. On expiration in July, if Nifty Index level is still trading at 5000, both the OPTIDX NIF TY 29JUL2010 PE 4800 and the OPTIDX NIFTY 29JUL2010 CE 5200 expire worthless and the options trader suffers a maximum loss which is equal to the initial debit of Rs.200.00 taken to enter the trade. 23 Short-Term Simple Nifty Option Intra-Day Trading Strategies:- If Nifty index is bullish at current level of 5300 in July, then the following Nifty options can be taken as Nifty Long Call Position: OPTIDX NIFTY 29JUL2010 CE 5200 OPTIDX NIFTY 29JUL2010 CE 5300 OPTIDX NIFTY 29JUL2010 CE 5400 OPTIDX NIFTY 29JUL2010 CE 5500 OPTIDX NIFTY 29JUL2010 CE 5600 If Nifty index is bearish at current level of 5300 in July, the following Nifty options can be taken as Nifty Long Put Position: OPTIDX NIFTY 29JUL2010 PE 5400 OPTIDX NIFTY 29JUL2010 PE 5300 OPTIDX NIFTY 29JUL2010 PE 5200 OPTIDX NIFTY 29JUL2010 PE 5100 OPTIDX NIFTY 29JUL2010 PE 5000 If Nifty is stagnant or inactive at current level of 5300 in July, the following Nifty Options of higher strike price calls (OTM Calls) and lower strike price puts (OTM Puts) can be shorted:- OPTIDX NIFTY 29JUL2010 CE 5500 OPTIDX NIFTY 29JUL2010 CE 5600 OPTIDX NIFTY 29JUL2010 CE 5700 OPTIDX NIFTY 29JUL2010 PE 4900 OPTIDX NIFTY 29JUL2010 PE 4800 OPTIDX NIFTY 29JUL2010 PE 4700 Here is the link to interactive strategy scanner on www.888optionsnet.com site. Here you can click on the strategy name to find further details about it including risk graph and a corresponding example. Another great option resources and education online spot from the same family as the above website is http://www.optionseducation.org 24 The Universally Proven Dos of Successful Option Trading 1. Know the current market conditions by watching business news on popular channels 2. Understand the building blocks of option theory 3. Do not force strategy and apply them on every trade 4. Understand the effect of time decay and volatility on option price 5. Choose the fair priced options check http://www.option-price.com and calculate yourself 6. Plan the trade completely with Buy, Stop Loss and Sell targets with strictest discipline 7. Realize that Nifty option trading is not a daily cup of tea which you can do everyday 8. Never ever think that you will win the second time after you won the first time 9. If you win big, then stay away from the market for a few days and divert some money to other investments which are secured like Fixed Deposits and Bonds. 10. As soon as you book profit for the whole position, close the trading terminal and call it a day 11. Option traders are like sea farers who only sail when the ocean is calm and the sky is bright 12. Always watch global markets mainly American, European and Asian closings 13. Do not initiate a trade instantly in the early hours on a huge gap openings 14. Watch recovery traits of Nifty index in a huge gap down opening 15. In an oversold market, it’s wise to trade Nifty options by buying ATM calls on the expiry week 16. It’s better to operate the trader terminal by yourself rather than calling your broker to buy and sell Nifty options. Since a delay in 1 or 2 minutes can make a significant change in the price of Nifty options. 17. Always compare and choose the best broker who charges the least commissions because even though a Nifty options may cost Rs.10.00 or Rs.20.00, but the brokerage will be calculated with the underlying Nifty index which cost around Rs.5000.00 that easily charge you Rs.2.00 to Rs.3.00 for an unit per transaction. 18. If you are buying the current month’s options, then see the underlying future (Nifty July Future) of the same month whether: Buy volume>Sell volume & If Nifty Index is also going up, then Nifty Long Call is considerable Sell volume>Buy volume & If Nifty Index is also going down, then consider Nifty Long Put 19. Listen to Business news about FIIs positions in the expiry week; if they are short then most likely they will cover up their shorts, so consider buying Calls. If they are long, then buy puts. 20. From 2:30 P.M to 3:25 P.M on the expiry day, watch the market closely and try to buy Calls if the market is seen recovering from earlier lows, and try to buy Puts if the market is seen breaking down from earlier highs. Buy only options with maximum price of Rs.5.00-Rs.10.00. Do this trade only with the money which you can afford to loose like 2 to 4 lots only. 25 Happy Trading Please do not hesitate to e-mail us in case of any unclear explanations in the e-book admin@niftyoptionsprofit 26

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