When I bought the futures of XYZ Company with great hopes of making a quick buck I had not foreseen the other side of the picture i.e. making great loss. The lot size on the contract was 950, which meant that for every single rupee up or down move in the stock I stood to gain or lose Rs. 950, a substantial amount by any standards. The market took a dip and my stock ended up lower by Rs. 40. In other words I lost Rs. 38000 in just a couple of weeks. Although I had time till the end of the month when the contract expired but I closed my position taking the loss. Another lower tick on the stock would have required additional margin money from me.
Did it leave me any wiser? I sure hope so because that is when I did some research and came up with a safer bet in the form of stock options.
Most Indian traders use stock futures due to the profit potential or lack of knowledge of stock options. The risk involved in stock futures makes options much more attractive.
The difference in buying a stock future and option is that the later is not obligatory.
The future is an agreement to buy or sell a security at a certain time in the future at a specified price, an option gives one the right but not the obligation to do the same.
This right to buy or sell in options comes at a price, which is called the premium.
Types of option: There are two types of options –call option and put option. A call option gives the buyer the right to buy a security on a future date at a predetermined price; Put option gives him the right to sell a security on a certain day at a certain price. The future price is called the strike price.
Benefits of Stock Options
• gives the buyer the right
• Not the obligation
• To buy or sell
• A specified underlying
• At a set price
• On or before a specified date
Now let us see how it works out :
The stock of xyz is trading at Rs. 100 and you expect it to go up to 150
In cash segment you buy 100 shares and pay Rs. 10000, (100 shares x Rs. 100)
If the stock reaches your target of 150 you make Rs 5000 by selling your 100 shares at Rs. 150/share
If the stock falls by Rs. 50 you make a loss of Rs. 5000 by selling your 100 shares at Rs. 50/share
In futures you buy a contract of 500 shares (lot size) of the same share for Rs. 50,000 (500 shares x Rs. 100)
If the price reaches 150 you make a profit of 25000 (500 shares x Rs. 50)
If the price falls to Rs. 50 you make a loss of 25000
In options you buy a call option (right to buy a security) for 500 shares at a strike price of Rs. 105 paying a premium of Rs. 2500 (assuming a premium of Rs. 5 per share for 500 shares)
If the price reaches 150 a profit of Rs. 45 per share (Rs. 150-Rs. 105) the net profit after deducting the premium of Rs. 5 per share paid by you gives you a profit of Rs. 40 per share or a total amount of Rs. 20000 ( 500 shares x Rs. 40)
The option shows its advantage if the price drops by Rs. 50. You have only bought the right to exercise an option to buy. Therefore if for some adverse reason the stock price plummets your loss is limited to the amount of premium you have paid in this case Rs. 2500 ( the premium paid by you for the right to buy 500 shares at Rs. 105)
As is clear from the example, options have a clear advantage in limiting your risk.
Buying a call option is a bullish stance where you expect the price of stock to rise and buying a put option is a bearish stance and you expect the price of stock to fall.
Selling options can be as risky as futures. The seller or writer of an option takes a huge risk in case of unfavorable price movements. He only profits from the premium he collects from the option buyer for providing assurance to buy or sell securities at a pre determined price.
Option Selling Strategy
By James Cordier
There are as many different option strategies today as there are traders. Vertical spreads, covered calls, ratio spreads, double ratio backspreads, the infamous butterfly spread. Complex computer programs analyze mountains of data for traders to select the precise option or combination of options for traders to sell. Unfortunately, these computers still can't tell you which way the market is going to go.
There is an approach to the market is amazingly simple. If a market is identified as having only the very clearest of long term fundamentals, be it bullish or bearish, options can be sold in the opposite direction. When selling an option, an investor statistically has an approximate 80% chance of the option expiring worthless. This is before he even selects a market or strike price to sell. Thus, if bearish a market, a trader would sell calls. If bullish, he would sell puts. He sells strike prices either far above or far below the current price of the futures market. He places a stop (I recommend 200% of the current value of the option). And then he sits back and watches.
While multiple option combinations all have their merit in the right situation, a pure option selling program can be successful based on it's sheer simplicity. The benefit of always having time value working in your favor (eroding the option on a daily basis) can be a tremendous advantage. The huge margin for error, whether it be mistiming an entry or being outright wrong the market, can allow an investor to profit in a short option trade where a long option or futures trade would have resulted in a loss.
Patience - The Underrated Virtue
In John Walsh's book, How to Trade Futures, he interviews several professional traders on the subject of trading. One particular quote struck me as extremely relevant. It is from a professional trader who has been successful over the years:
Patience is a common attribute of many experienced, successful traders. Beginners are almost never patient. They want to "do something." Often they are proactive in their business and personal lives and want to trade the same way. In futures, riches often come to those who have the discipline to wait…"
No where is patience more important than in an option writing investment portfolio. Lack of patience can result in the option seller overtrading his option portfolio, over exposing himself by putting on too many positions, over weighting his portfolio in one position, or "reaching" for a new position instead of waiting for an opportunity to arise.
While many novice traders shun option selling for fear and misunderstanding of the risks, in reality, option selling can be a consistent, relatively conservative approach to the market. Percentages and time will be on your side, but if you trade for action and excitement, option selling may not be for you.
Traders adopting a longer term strategy such as this can avoid all the daily decision making such as resetting stops, taking profits, trying to outguess the market (and the pros) can watch the market from more of an objective distance.
Most investment managers recommend that you work with an experienced professional if you wish to try your hand at option writing. I tend to agree with this view. While if utilized correctly, option writing can be an extremely effective tool for strong portfolio returns, one must not get lured into a "can't lose" mentality. This is still futures trading and there are still risks involved. Right when you start to believe you can't lose, you will.
Look to sell far out of the money options in markets with clear long term fundamentals and be aware of seasonal tendencies. Don't second guess yourself or the trade. If your risk parameter is hit, exit the position. If it is not, leave it alone. Remember that, unless the market is moving sharply against your position, time value will eventually make you a winner.
Exmaple to explain Options and Futures Difference
Options is less risker than equity & especially futures.
in option in case of Buy of Call or Put ur loss is limited only to the extent of premium paid. i.e
let say if u purchase a XYZ call option @
strick Price of = Rs.100
Current Market = 98
premium= 3 Rs
lot size = 1000.
Now let say on the day of the expiry if the value of XYZ in cash market is Rs. 90 then you wont exercise the calll option & ur loss would be onlylimited to the premium paid i.e Rs.3000( 3*1000).
Was it that you would have purhade futures of XYZ on same then ur loss would had been Rs.10,000 [(100-90)*1000]
Equity is a good bet if u r a long term investor & are reday to block money for long term.
Never go speculation and try to be rich in 1 month by trading in futures. Always go for consistenty.
Even if you earned lot of money in any speculative trade then you might lost that in another.
Try to go for those which are consitent and give you consistent returns.
I thnk call put selling or option writing is consistent method of making money.
You cannot earn huge in this but you can make decent returns.
Most important thing is on consitent basis.
If we can get 5- 25% per month on out limit that is huge. This % increases as we increase our limit.
Derivative Instruments
Option contract is a type of Derivative Instrument, which has two parties the option holder and the option writer. The option holder has the right, but not the obligation, to buy or sell an underlying asset (a stock or index) at a specific price on or before a certain date with the option issuer or option writer).
For consideration, which is called the option premium, the buyer / holder of the option, purchases the rights from the seller/writer. When the buyer / holder exercises his right, the seller / writer of an option is obligated to settle the option as per the terms of the contract.
People who buy options have a Right to Exercise
Call Options- An Option where the buyer of the option has the right but not the obligation to buy the option is called Call option. It gives the holder the right to purchase an asset for a specified price, called the exercise or strike price, on or before the expiration date.
Put Options- An option where the buyer of the option has the right but not the obligation to sell the option is called Put option. It gives its holder the right to sell an asset for a specified exercise price on or before the expiration date.
American Option- An option that is exercisable on or before the expiry date.
European Option- an option that is exercisable only on expiry date.
Exercise Price- The price at which the option is to be exercised is called Strike price or Exercise Price.
Some questions?
Is expiry date same as future i.e. last thursday of particular month?
>Yes expiry date is same as future.
Can we sell or buy call or put before expiry if we are making profits?
>Yes u can sell at anytime befor expiry.
Some Technical Terms
Options and their Uses
An option is a derivative.
That is, its value is derived from something else.
In the case of a Index option, its value is based on the underlying Index value.
In the case of a Stock option, its value is based on the underlying Stock value.
Call Option and Put Option
Call option gives the holder the right, not the obligation, to buy underlying Stock at a fixed price and for a fixed period of time.
A put option gives the holder the right, not the obligation, to sell underlying Stock for a fixed price and for a fixed period of time.
In India Stock Options are American type and settlement is by cash. Index Options are European type and settlement is by cash.
The Four Components to an Option
· The underlying Stock Value,
· The type of option (put or call),
· The strike price, and
· The expiration date.
At-The-Money(ATM), In-The-Money(ITM), Out-Of-The-Money(OTM)
If the stock is trading at a price of 100, the call option at the strike price of 100 is considered to be trading 'at-the-money'.
If the stock is trading above a price of 100, the call option at the strike price of 100 is considered to be trading 'in-the-money'
If the stock is trading below a price of 100, the call option at the strike price of 100 is considered to be trading 'out-of-the-money'
Intrinsic Value
When an option is in-the-money, the price difference between the underlying Stock and the option's strike price is the intrinsic value.
Time Value
Time value is the amount by which the price of the option exceeds its intrinsic value. The time value premium of an option declines as the expiration date approaches.
Intrinsic Value + Time Value = Option Price
Factors Influencing the Price of an Option
There are four major factors which determine the price of an option. They are:
· The price of the underlying Stock
· The strike price of the option itself
· The time remaining until the option expires
· The volatility of the underlying Stock
Volatility
Historical volatility estimates volatility based on past prices.
Implied volatility starts with the option price as a given and works backward to ascertain the theoretical value of volatility equal to the market price minus any intrinsic value.
Few Questions related to Option trading
· What is FNO Curb?
· Why FNO curb is necessary ?
· How one expert described Curb in FNO ?
· If X company paid up capital is 100 crore of 20 rs paid up shares what should be curb limit ?
· How many company in curb every month comes frequently and main question why ?
· If current month Nov is in curb then next month Dec and Jan also will be in curb and also call and put will be in curb ?
· If X company is in curb and mr Sham taken position end of the day did not squared off then what what is penalty ?
Did it leave me any wiser? I sure hope so because that is when I did some research and came up with a safer bet in the form of stock options.
Most Indian traders use stock futures due to the profit potential or lack of knowledge of stock options. The risk involved in stock futures makes options much more attractive.
The difference in buying a stock future and option is that the later is not obligatory.
The future is an agreement to buy or sell a security at a certain time in the future at a specified price, an option gives one the right but not the obligation to do the same.
This right to buy or sell in options comes at a price, which is called the premium.
Types of option: There are two types of options –call option and put option. A call option gives the buyer the right to buy a security on a future date at a predetermined price; Put option gives him the right to sell a security on a certain day at a certain price. The future price is called the strike price.
Benefits of Stock Options
• gives the buyer the right
• Not the obligation
• To buy or sell
• A specified underlying
• At a set price
• On or before a specified date
Now let us see how it works out :
The stock of xyz is trading at Rs. 100 and you expect it to go up to 150
In cash segment you buy 100 shares and pay Rs. 10000, (100 shares x Rs. 100)
If the stock reaches your target of 150 you make Rs 5000 by selling your 100 shares at Rs. 150/share
If the stock falls by Rs. 50 you make a loss of Rs. 5000 by selling your 100 shares at Rs. 50/share
In futures you buy a contract of 500 shares (lot size) of the same share for Rs. 50,000 (500 shares x Rs. 100)
If the price reaches 150 you make a profit of 25000 (500 shares x Rs. 50)
If the price falls to Rs. 50 you make a loss of 25000
In options you buy a call option (right to buy a security) for 500 shares at a strike price of Rs. 105 paying a premium of Rs. 2500 (assuming a premium of Rs. 5 per share for 500 shares)
If the price reaches 150 a profit of Rs. 45 per share (Rs. 150-Rs. 105) the net profit after deducting the premium of Rs. 5 per share paid by you gives you a profit of Rs. 40 per share or a total amount of Rs. 20000 ( 500 shares x Rs. 40)
The option shows its advantage if the price drops by Rs. 50. You have only bought the right to exercise an option to buy. Therefore if for some adverse reason the stock price plummets your loss is limited to the amount of premium you have paid in this case Rs. 2500 ( the premium paid by you for the right to buy 500 shares at Rs. 105)
As is clear from the example, options have a clear advantage in limiting your risk.
Buying a call option is a bullish stance where you expect the price of stock to rise and buying a put option is a bearish stance and you expect the price of stock to fall.
Selling options can be as risky as futures. The seller or writer of an option takes a huge risk in case of unfavorable price movements. He only profits from the premium he collects from the option buyer for providing assurance to buy or sell securities at a pre determined price.
Option Selling Strategy
By James Cordier
There are as many different option strategies today as there are traders. Vertical spreads, covered calls, ratio spreads, double ratio backspreads, the infamous butterfly spread. Complex computer programs analyze mountains of data for traders to select the precise option or combination of options for traders to sell. Unfortunately, these computers still can't tell you which way the market is going to go.
There is an approach to the market is amazingly simple. If a market is identified as having only the very clearest of long term fundamentals, be it bullish or bearish, options can be sold in the opposite direction. When selling an option, an investor statistically has an approximate 80% chance of the option expiring worthless. This is before he even selects a market or strike price to sell. Thus, if bearish a market, a trader would sell calls. If bullish, he would sell puts. He sells strike prices either far above or far below the current price of the futures market. He places a stop (I recommend 200% of the current value of the option). And then he sits back and watches.
While multiple option combinations all have their merit in the right situation, a pure option selling program can be successful based on it's sheer simplicity. The benefit of always having time value working in your favor (eroding the option on a daily basis) can be a tremendous advantage. The huge margin for error, whether it be mistiming an entry or being outright wrong the market, can allow an investor to profit in a short option trade where a long option or futures trade would have resulted in a loss.
Patience - The Underrated Virtue
In John Walsh's book, How to Trade Futures, he interviews several professional traders on the subject of trading. One particular quote struck me as extremely relevant. It is from a professional trader who has been successful over the years:
Patience is a common attribute of many experienced, successful traders. Beginners are almost never patient. They want to "do something." Often they are proactive in their business and personal lives and want to trade the same way. In futures, riches often come to those who have the discipline to wait…"
No where is patience more important than in an option writing investment portfolio. Lack of patience can result in the option seller overtrading his option portfolio, over exposing himself by putting on too many positions, over weighting his portfolio in one position, or "reaching" for a new position instead of waiting for an opportunity to arise.
While many novice traders shun option selling for fear and misunderstanding of the risks, in reality, option selling can be a consistent, relatively conservative approach to the market. Percentages and time will be on your side, but if you trade for action and excitement, option selling may not be for you.
Traders adopting a longer term strategy such as this can avoid all the daily decision making such as resetting stops, taking profits, trying to outguess the market (and the pros) can watch the market from more of an objective distance.
Most investment managers recommend that you work with an experienced professional if you wish to try your hand at option writing. I tend to agree with this view. While if utilized correctly, option writing can be an extremely effective tool for strong portfolio returns, one must not get lured into a "can't lose" mentality. This is still futures trading and there are still risks involved. Right when you start to believe you can't lose, you will.
Look to sell far out of the money options in markets with clear long term fundamentals and be aware of seasonal tendencies. Don't second guess yourself or the trade. If your risk parameter is hit, exit the position. If it is not, leave it alone. Remember that, unless the market is moving sharply against your position, time value will eventually make you a winner.
Exmaple to explain Options and Futures Difference
Options is less risker than equity & especially futures.
in option in case of Buy of Call or Put ur loss is limited only to the extent of premium paid. i.e
let say if u purchase a XYZ call option @
strick Price of = Rs.100
Current Market = 98
premium= 3 Rs
lot size = 1000.
Now let say on the day of the expiry if the value of XYZ in cash market is Rs. 90 then you wont exercise the calll option & ur loss would be onlylimited to the premium paid i.e Rs.3000( 3*1000).
Was it that you would have purhade futures of XYZ on same then ur loss would had been Rs.10,000 [(100-90)*1000]
Equity is a good bet if u r a long term investor & are reday to block money for long term.
Never go speculation and try to be rich in 1 month by trading in futures. Always go for consistenty.
Even if you earned lot of money in any speculative trade then you might lost that in another.
Try to go for those which are consitent and give you consistent returns.
I thnk call put selling or option writing is consistent method of making money.
You cannot earn huge in this but you can make decent returns.
Most important thing is on consitent basis.
If we can get 5- 25% per month on out limit that is huge. This % increases as we increase our limit.
Derivative Instruments
Option contract is a type of Derivative Instrument, which has two parties the option holder and the option writer. The option holder has the right, but not the obligation, to buy or sell an underlying asset (a stock or index) at a specific price on or before a certain date with the option issuer or option writer).
For consideration, which is called the option premium, the buyer / holder of the option, purchases the rights from the seller/writer. When the buyer / holder exercises his right, the seller / writer of an option is obligated to settle the option as per the terms of the contract.
People who buy options have a Right to Exercise
Call Options- An Option where the buyer of the option has the right but not the obligation to buy the option is called Call option. It gives the holder the right to purchase an asset for a specified price, called the exercise or strike price, on or before the expiration date.
Put Options- An option where the buyer of the option has the right but not the obligation to sell the option is called Put option. It gives its holder the right to sell an asset for a specified exercise price on or before the expiration date.
American Option- An option that is exercisable on or before the expiry date.
European Option- an option that is exercisable only on expiry date.
Exercise Price- The price at which the option is to be exercised is called Strike price or Exercise Price.
Some questions?
Is expiry date same as future i.e. last thursday of particular month?
>Yes expiry date is same as future.
Can we sell or buy call or put before expiry if we are making profits?
>Yes u can sell at anytime befor expiry.
Some Technical Terms
Options and their Uses
An option is a derivative.
That is, its value is derived from something else.
In the case of a Index option, its value is based on the underlying Index value.
In the case of a Stock option, its value is based on the underlying Stock value.
Call Option and Put Option
Call option gives the holder the right, not the obligation, to buy underlying Stock at a fixed price and for a fixed period of time.
A put option gives the holder the right, not the obligation, to sell underlying Stock for a fixed price and for a fixed period of time.
In India Stock Options are American type and settlement is by cash. Index Options are European type and settlement is by cash.
The Four Components to an Option
· The underlying Stock Value,
· The type of option (put or call),
· The strike price, and
· The expiration date.
At-The-Money(ATM), In-The-Money(ITM), Out-Of-The-Money(OTM)
If the stock is trading at a price of 100, the call option at the strike price of 100 is considered to be trading 'at-the-money'.
If the stock is trading above a price of 100, the call option at the strike price of 100 is considered to be trading 'in-the-money'
If the stock is trading below a price of 100, the call option at the strike price of 100 is considered to be trading 'out-of-the-money'
Intrinsic Value
When an option is in-the-money, the price difference between the underlying Stock and the option's strike price is the intrinsic value.
Time Value
Time value is the amount by which the price of the option exceeds its intrinsic value. The time value premium of an option declines as the expiration date approaches.
Intrinsic Value + Time Value = Option Price
Factors Influencing the Price of an Option
There are four major factors which determine the price of an option. They are:
· The price of the underlying Stock
· The strike price of the option itself
· The time remaining until the option expires
· The volatility of the underlying Stock
Volatility
Historical volatility estimates volatility based on past prices.
Implied volatility starts with the option price as a given and works backward to ascertain the theoretical value of volatility equal to the market price minus any intrinsic value.
Few Questions related to Option trading
· What is FNO Curb?
· Why FNO curb is necessary ?
· How one expert described Curb in FNO ?
· If X company paid up capital is 100 crore of 20 rs paid up shares what should be curb limit ?
· How many company in curb every month comes frequently and main question why ?
· If current month Nov is in curb then next month Dec and Jan also will be in curb and also call and put will be in curb ?
· If X company is in curb and mr Sham taken position end of the day did not squared off then what what is penalty ?
Nice Article....!!!
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