Options Trading An option is a contract that gives the

Options Trading   An option is a contract that gives the buyer the right, but not the obligation, to buy or sell an underlying asset at a specific price on or before a certain date. Confers right to the holder/buyer of option to buy/sell a specified assets at a specific price on or before a specific date. Seller/Writer has an obligation to fulfil the contract if buyer/holder exercises his option BUYER SELLER Gets a RIGHT Pays PREMIUM Has an OBLIGATION Receives PREMIUM The Two Types of Options are Calls and Puts:  A Call gives the holder the right to buy an asset at a certain price within a specific period of time. Calls are similar to having a long position in a stock. Buyers of calls hope that the stock will increase substantially before the option expires. A put gives the holder the right to sell an asset at a certain price within a specific period of time. Puts are very similar to having Short Position on a stock. Buyers of puts hope that the price of the stock will fall before the option expires.  Participants in the Options Market There are four types of participants in options markets depending on the position they take: 1. Buyers of calls 2. Sellers of calls 3. Buyers of puts 4. Sellers of puts People who buy options are called holders  People who sell options are called Writers Also,  Buyers are said to have long positions,  Sellers are said to have short positions.  Important distinction between Buyers and Sellers:  Call holders and put holders (buyers) are not obligated to buy or sell. They have the choice to exercise their rights if they choose.  Call writers and put writers (sellers), however, are obligated to buy or sell. This means that a seller may be required to make good on a promise to buy or sell.    Strike Price     The price at which a specific derivative contract can be exercised. Strike prices is mostly used to describe stock and index options, in which strike prices are fixed in the contract. For call options, the strike price is where the security can be bought (up to the expiration date), while for put options the strike price is the price at which shares can be sold. The difference between the underlying security's current market price (Settlement price) and the option's strike price represents the amount of profit per share gained upon the exercise or the sale of the option. This is true for options that are in the money; the maximum amount that can be lost by the buyer of an option is the premium paid. Also known as the "exercise price". Strike prices are established when a contract is first written Terminologies  The amount by which an option is in-the-money is referred to as intrinsic value The total cost (the price) of an option is called the premium This price is determined by factors including the stock price, strike price, time remaining until expiration (time value) and volatility. Strike prices are one of the key determinants of the premium, which represents the market value of options contract. Because of all these factors, determining the premium of an option is complicated     Options – Advantages  Very high leverage. Requires just fraction of the total lot value to be paid as premium Losses to the buyer are limited to the extent of premium with unlimited profit potential Options positions can be kept open up to 3 months    CALL OPTIONS :    Buyer gets a RIGHT, To BUY underlying shares at a price. On or before a determined date.  PUT OPTIONS :    Buyer gets a RIGHT, To SELL underlying shares at a price. On or before a determined date. Options-Positions  BUY CALL: Buyer gets right to BUY underlying at the strike price BUY PUT: Buyer gets right to SELL underlying at the strike price SELL CALL: Seller has an obligation to SELL the underlying at strike price SELL PUT: Seller has an obligation to BUY the underlying at strike price    Option Features :  BUYER of CALL / PUT options  Maximum loss : PREMIUM Maximum Gain : UNLIMITED   SELLER of CALL / PUT options  Maximum loss : UNLIMITED Maximum Gain : PREMIUM    Only In the Money (ITM) options are allowed to be exercised Buyer/Holder receives the difference  Call Option: Settlement price-Strike price  Put Option: Strike price-Settlement price Writer/Seller pays the difference  Call Option : Settlement price-Strike price  Put option: Strike price-Settlement price All At the Money (ATM) and Out of the Money (OTM) contracts expires worthless on expiry date Assigned to seller/writer who is Out of the Money (OTM)    EXERCISE Difference between STRIKE PRICE and SETTLEMENT PRICE of underlying on exercise day SQUARE-OFF Difference between PREMIUM Amounts at the time of Square-off.  EXERCISE can be done only by the BUYER. SQUARE-OFF can be made by both BUYER & SELLER  Option Strategies  Bullish  Buy Call  Sell Put Bearish  Sell Call  Buy Put  Example  Buy Nifty Call Spot Nifty: 4827.85 One month call Strike price: 4900 Premium: Rs. 71 Loss limited to premium Breakeven: strike plus premium : 4900 + 71 (4971)       Sell Nifty Put What is Sell Put? –Selling a right to sell-Have an obligation to buy  Why Sell Nifty Put ? –Market expectations - Neutral to bullish –Index will not go down! –Motive : to receive premium income –Premium is the profit –Limited profit and substantial loss - Premium collected over a period of time can help acquire the stock at lesser cost  Example Sell Nifty Put      Spot Nifty 4827.85 Strike price 4850 Premium = 88 Break-Even is strike price minus premium :4850 - 88 (4762) i.e. if Nifty closes above 4762, this position will be in profit and if Nifty closes below 4762, this position will be in loss If Nifty closes at any price above 4850 there is a fixed profit of Rs. 88 Buy Nifty Put Option What is it?  Buy the right to sell Why Buy a Put Option?  If you think that the market will fall.  The strike price should be a price which the underlying would definitely fall below - since profits would start once underlying falls below the strike price.  Buyer’s Risk : Loss limited to premium paid Example : Buy Nifty Put Option Spot Nifty: 4827.85       One month put Strike price: 4800 Premium: Rs. 108 Loss limited to premium (i.e. 108) Max gain: if Nifty becomes 0 (Gain is 4800 - 108) Breakeven: strike minus premium : 4692 (4800 - 108) Sell Nifty Call What is it?  Sell the right to buy-have an obligation to sell Why Sell Call?  Neutral to bearish  Index will not go up !  Motive : to receive premium income  Premium is the profit  Limited profit and maximum loss Options Spread :      Adopting a Limited Risk Strategy Limited Profits Limited Loss Or Defined Profits Defined Loss Option Spreads         Options spreads are options trading strategies that involve taking simultaneous opposing positions at different exercise prices or strike prices or expiration dates Vertical Spread : The simplest of options spreads is the vertical. A vertical consists of one long option, and one short one. Both must have the same expiration date, but will have different strike or exercise prices. Depending on which strikes are bought and sold, a vertical can be either bearish or bullish. Selling (or buying) a lower priced put (or call) option while buying (or selling) a higher priced one is bullish; taken in reverse, the vertical will be bearish. Vertical options spreads have limited risk but have limited profit potential      It can be a Bull Spread or a Bear Spread depending on Options Selected Depending on which Option is Purchased and which is written vertical Spread can be Bullish or Bearish Spread Bullish  Long Call Strike Short Call Strike  Long Put Strike> Short Put Strike Example Long July 60 Call @ 4.77 Short July 65 Call @ 2.77 Cost Of the Contract : 4.77- 2.77 = 2 Scenario 1 Spot Price 60 Profit :0 Max Loss : Rs.2 Net Loss :Rs.2 Scenario 2 Spot Price :65 Profit : Rs.0.23 (+5- 4.77) Max Loss : Rs.2.77 Net Gain : Rs.3 Scenario 3 : Spot price Price : Rs.70 Profit :0 Max Loss : Rs.2 Net Loss :Rs.2 * pls Note the at the time of settlement the Average of last 5 Spot Prices is considered For explanation above Spot price is used to Indicate when would be the right time to Sell/But the Contract Sample Of Research Advice Nifty Bull Call Spread (MILDLY BULLISH VIEW) Nifty spot 4515 Strategy Buy Call 4500 @ 145 Sell Call 4700 @ 61 Total cost – 4200 (difference 84) Execution – Strategy to be executed only when difference is less then 100 pts. Max Profit – 5800 Max Loss - 4200 Graphical Representation P&L at Expiration 6,000.00 5,000.00 4,000.00 3,000.00 2,000.00 1,000.00 0.00 -1,000.00 -2,000.00 -3,000.00 -4,000.00 -5,000.00 4,200 4,400 4,600 4,800 5,000 5,200 5,400 5,600 5,800 6,000 6,200 To Learn More on the Options Spread and Research Calls : Register for Training Sessions at Our Centre Closest to You Disclaimer Adequate efforts have been taken to ensure that material contained is error free. The material given is only intended to provide general information to the investors and is neither designed nor intended to be a substitute for professional investment advice. The material is not exhaustive and is not intended to be advice on any particular matter. Kindly read the Risk Disclosure Documents carefully before investing in Derivatives or other instruments traded on the Stock Exchanges. The contents herein above shall not be considered as an invitation or persuasion to trade or invest. 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