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stock+option x press

Learn about the basics of stock options and how they derive value from underlying assets. Explore different types of options and the risks and benefits of trading them.

danielanderson
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stock+option x press

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  1. stock+optionxpress Derivatives Basics

  2. stock+optionxpress INTRODUCTION

  3. stock+optionxpress Akhir kya hai derivative! • It’s a contract which does not have any value on its own. • It derives its value from underlying • Underlying can be index, stock, commodity, interest, currency. • Derivatives can be futures or options contract.

  4. Features Forward Futures Trading Non SE traded SE traded Size Non standard Standard Liquidity Poor Very High Risk Exists Safety thru SE Clg Settlement Non standard Standard as per SE stock+optionxpress • Forward vs. futures • Futures = Traded Forward Contract.

  5. stock+optionxpress What is option • Or privilege is a contract giving buyer right but not obligation to buy/sell a stock/index/ asset (underlying). • Trading started in in 2 indices & 31 equities from 2nd July 01. • Derivative traded on NSE & BSE.

  6. stock+optionxpress THE WORLD OF OPTIONS • Options are used worldwide everyday. • Car insurance is well known example. • ESOP, Convertible Debentures & Warrants are options created by Companies. • Risk containing instrument. • Traders wouldn’t have lost heavily had options were available post budget. • Range of choices which were not available previously.

  7. stock+optionxpress OPTIONS Vs STOCKS Similarities • Both are securities • Both trade like stocks. • Both trade in different market segments.

  8. stock+optionxpress OPTIONS Vs STOCKS Differences • Options derive value from underlying stock. • Options have expiry date & strike prices. • No corporate benefits to holders directly but reflected in price.

  9. stock+optionxpress TYPES OF OPTIONS Only of two types: • Call Options • Put Options

  10. stock + option xpress CALL OPTION • Is an option to buya stock at a specified price on or before a certain date. • Option holder has the right but not the obligation to honour the contract. • Holder has to pay a premium as you pay for insurance.

  11. stock+optionxpress • Call Option Simplified 1: • “A” agrees to buy 125 Infy @ 2200 on or before 28th Feb. from “B”. • “A” pays a premium @ Rs 50 /share. • SCENE 1:Infosys rises to Rs 2450 • “A” enforces the option • “A” gets Rs 250 (2450-2200) per share or Rs 31,250/contract • Net Profit to “A” Rs 200 (250-50) or Rs 31,250 per contract on Rs 6,250.

  12. stock+optionxpress • Call Option Simplified 2: • “A” agrees to buy 125 Infy @ Rs 2200 on or before 28th Feb from “B” & pays Rs 50 per share (Rs 6,250/contract) premium. • SCENE 2: • Infy falls to Rs 2000 • “A” is not obliged to honour contract • Premium forfeited & net loss is Rs 50/Eq. • Call holder therefore enjoyslimited losses but unlimited profits.

  13. stock+optionxpress Infosys 2200 call 125 @ Rs 50 premium

  14. stock+optionxpress TERMS FREQUENTLY USED • Price paid to buy an option is premium. We actually trade in premium on option terminal. • Price at which the option is agreed upon is the strike price. • Date till which option is valid is called the expiry date. • Option buyer is option holder. • Option Seller is option writer.

  15. stock+optionxpress

  16. stock+optionxpress PUT OPTION • Is right to sell at a strike price on/before expiry date. • “X” buys a put option from “Y” @ Rs 20 premium to sell 500 Tata Steel for Rs 400 on or before 30th August. • If Tata Steel is 350, “X” can enforce the contract. • If Tata St rises to 450, “X” is not obliged to honour the contract & loses premium.

  17. stock+optionxpress 500 Tata St 400 put @ 20 premium

  18. stock+optionxpress PREMIUM MOVEMENT :

  19. Call buyer Buyer of Security Right holder to exercise & get Delivery Put Buyer Seller of Security Right holder to exercise & make Delivery Call Seller Seller of Security Obliged for making delivery Put Seller Buyer of Security Obliged for receiving delivery stock+optionxpress Lets Crystallise-1

  20. stock+optionxpress Lets Crystallise -2

  21. stock+optionxpress CALL WRITING • You own 500 RIL, CMP 750 • Sell 500 RIL 780 call @ Rs 10 • Premium earned Rs 5000. • Margin invested @ 25% of contract value = Rs 94,000. • Return = 6 % per month.

  22. stock+optionxpress PUT WRITING • RIL CMP Rs 750 • Sell 500 RIL 700 Put @ Rs 9 • Premium earned Rs 4500. • Margin invested @ 25% of contract value = Rs 87,500 return = 5 % per month.

  23. stock+optionsxpress • SELLING OR WRITING OPTIONS • For Novice selling an option is too risky as it has limited profits & unlimited losses as against buying where reverse is the case. • It does not actually make much sense. • Than one natural question arises- who is taking this unlimited risk. • If selling option is that risky as it looks than why options are so popular & recording volumes 10 times of cash market in USA.

  24. stock+optionsxpress • Writing is avoided by most option traders when they trade first time for fear of unlimited losses. • This fear is also because of not being educated on the strategy. • Further most traders are bulls. • Lets study this strategy in a great detail.

  25. stock+optionsxpress • Let me answer who is selling option at this juncture. • PROFESSIONAL TRADERS are option sellers & profit majority of time. • These professional traders are in minority on any option exchange but takes away majority of the profit. • This is like 80:20 real life ratio. 80% of the profits are taken by 20% traders.

  26. stock+optionsxpress Why writer take majority of profits. • FACTORS THAT FAVOUR WRITING: • TIME DECAY • Wasting asset as it comprises time value. • You are actually intend to buying assets at a far discounts to prevailing market rate at the time of writing. • It’s like a 100 meter race & writer is starting 4 steps ahead & buyer 4 steps behind the start line. Who is likely to win?

  27. stock+optionsxpress Why writer take majority of profits. • FACTORS THAT FAVOUR WRITING: • TIME DECAY One constant in universe is passage of time. Time is most valuable component in option pricing. Option are a wasting asset which is loosing its value every moment. Adding insult to injury is the rate of decay increases as expiration draws near. The majority of this disappear in final 1/3 rd of its life. During last 1/3rd underlying must move substantially in your favor just to offset time value loss in an OTM & ATM option.

  28. stock+optionsxpress • Time Value Trading Facts: • ATM Option are most expensive in term of TV & is best for writing on TV consideration alone. • OTM options are cheapest in term of time value & is the worst for option writing but safest. • DELTA is the measure of the amount that an option moves in relation to underlying movement in cash market. This is stated in % from 0 to 100. • Delta for ATM is typically 50 • Delta for OTM is less than 50 • Delta for ITM is more than 50

  29. stock+optionsxpress Why writer make majority of profits-2 • Stakes are against option buyer from day one as buyer has to meet following conditions to become a winner: • Reaching Strike Price • Within expiry period • With higher break even • Daily erosion in option value • In the money option looses time value.

  30. stock+optionxpress Sample Portfolio as on 14/2

  31. stock+optionxpress OPTIONS Salient features: • Limited losses unlimited profits. • Right, not obligation to enforce contract. • Cash settlement. • Various strike prices. • Various expiry dates. • Value of contract & specified lot. • Premium = intrinsic + time value. • American/ European option.

  32. stock+optionxpress Strike Price • The price at which the stock can be bought/sold as specified in the option contract. • At a time trading in option can be done at 5 strike prices. • However all the Strike prices are displayed & traded for applicable month.

  33. stock+optionxpress

  34. stock+optionxpress EXPIRY DATE • Date on which option ceases to exist. • Expiry date on NSE is last Thursday of the month. • Option available for 3 consecutive months.

  35. stock+optionxpress Value of Premium = Intrinsic value +Time value • Premia never in negative. • e.g. RCom call 65 Strike @ 3 CMP 64. • Built in intrinsic value = Rs 1 (65-64) • Intrinsic value = in the money price • Time Value = 2 (3-1) which depends on: • Time till expiry & interest. High interest leads to call & put premium. • Volatility & market sentiments • View taken as on expiry date.

  36. 60 Call premia 7 65Call Premia 5 70 Call premia 2 Intrinsic Value 5 Intrinsic Value 0 Intrinsic Value 0 Time Value 2 Time Value 5 Time Value 2 CMP Rs 65 RCom Intrinsic Time 70 60 IN AT OUT

  37. stock+optionxpress EXERCISE • Option buyer have a right which they can exercise. ASSIGNMENT • When option holder exercises his right to buy/sell, a seller/buyer is chosen to make good his/her obligation. • So it is assigned on seller/writer.

  38. stock+optionxpress STYLES OF OPTION • American Option Can be exercised any time before expiry. Stock Options are American Options • European Options Can only be exercised on predetermined expiry date only. Index Options are European options.

  39. stock+optionxpress OPTION CASH FLOW A call/put option is : • In the MoneyCMP is higher/lower than strike price. • At the MoneyCMP= to strike price. • Out of Money CMP is lower / higher than strike price. • Option can be exercised only when “in” or “at” the money.

  40. stock+optionxpress TERMINATION OF CONTRACT • On exercise by holder. • On squaring up of premium. • On expiry date.

  41. stock+optionxpress Value of Contract • Benchmark is Rs 2 lacs. • Lot size per contract is different for different stocks. Example:

  42. stock+optionxpress Why Options? • Risk limited to premium. • High leverage. • Low cost hedging. • Additional income like badla. • Buying stock below CMP. • Low brokerage.

  43. Difference OPTIONS FUTURES Losses Only Premium UNLIMITED Profit UNLIMITED UNLIMITED Premium Paid to SELLER NO PREMIA but MARGIN stock+optionxpress OPTIONS Vs FUTURES

  44. stock+optionxpress • Why write a call • Earning premium income. • To supplement dividend income if call expires. • Downward protection in covered writing. • Why write a put • Seeking income from premium. • Purchase stock at specifiedexercise price (usually lower than CMP) during life of contract.

  45. WRITE stock+optionxpressIdeal time for option writing. Actual sell call +call here Logical decay line TIME VALUE PATTERN

  46. stock+optionxpress Margin in Derivatives:

  47. stock+optionxpress Stock/Futures/Options Buy 1000 ITC CMP Rs 220

  48. stock+optionxpress DailyJobbing Vs Option traderPotential maximum loss Best Deal

  49. Why stock+optionxpress • Real time quotes. • Ambience. • Access to analytics. • Formulation of advanced strategies to suit your needs. • Stocks, Futures & Options on 1 desk. • Education. • Competitive. • Professional Fund Management.

  50. stock+optionxpress Derivatives in USA • CBOE, largest & 1st listed option exchange started in 1973 trades in 1332 SO & 41 indices with 1500 MM. • Daily T/O Rs 1,17,500 Cr in 10 lac contract. • Not traded on NYSE & NASDAQ. • 85% volume from retail. Rest from institution & funds.

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