SGX Nifty meaning what is it

SGX Nifty Explained – How it affects Indian Share Market?

Understanding SXG Nifty meaning & its impact on Indian share market: If you are an active stock market trader in India, I’m sure that you would have definitely have heard of the term ‘SGX Nifty’. If you open any business news channel, then before the opening of the Indian equity market, all you will see is an hour-long discussion on the SGX Nifty and its implications on the opening of the Nifty for that day.

The importance of understanding this terminology can be seen from the fact that it is one of the most popular hashtags followed or searched over different social media platforms like Twitter, if one wants to have a better picture of the Indian Equity market. In this post, we are going to discuss what exactly is SGX nifty and how it affects Indian share market.

What is SGX Nifty?

The word SGX is an acronym for the Singapore Stock Exchange. Further, Nifty is the benchmark index of the National Stock Exchange (NSE) of India and it is comprised of the top 50 companies listed on NSE. Overall, if we were to add these two constituents, we can say that SGX Nifty is the Indian Nifty trading on the Singapore Stock Exchange. It is an actively traded futures contract on Singapore Exchange.

sgx nifty price chart

(Source: Sgx.com)

Who is allowed to trade SGX Nifty?

Any investor who is interested in trading Nifty, but is not able to access Indian Markets, finds trading SGX Nifty a very good alternative to trade. Even the big hedge funds who have big exposure in the Indian market find SGX Nifty as a good alternative to hedge their positions.

Further, an Indian citizen is not allowed to trade SGX Nifty contracts. For that matter, Indian citizens are not allowed to trade derivatives in any other country.

Difference between Nifty and SGX Nifty?

1. SGX nifty is Nifty futures contract trading in Singapore Stock Exchange and in India, Nifty contract trades on NSE.

2. The contract size of SGX Nifty is different compared to Nifty. In India, we have 75 shares in every Nifty contract Lot whereas the SGX nifty does not have a contract with shares in it. SGX Nifty is denominated in terms of US dollars. Say, if Nifty is trading at 9500, then the contract size of SGX Nifty will be 9500*(2 USD) i.e., 19000 USD.

For example, if the Nifty moves up by 100 points for the day, then make a profit of 100 rupees per share.  Therefore, total profit in case of Nifty will be 100*75 = Rs 7,500. But in the case of SGX Nifty, we will be making a profit of 100*2 = 200 USD per contract.

3. Now, In India, in the case of Nifty, we see Open Interest as the ‘number of shares’ outstanding. But in the case of SGX Nifty the Open Interest shows the ‘number of contracts’ outstanding. Both Nifty and SGX Nifty are highly liquid and a very high volume of trading happens in that.

Also read: What is India VIX? Meaning, Range, Implications & More!

Trading Hours of SGX Nifty

SGX Nifty Futures

(Source: SGX Nifty)

The above figure is the value of SGX Nifty from the website on the Singapore Stock Exchange. It shows the value of SGX Nifty futures traded on SGX. In Singapore Nifty trades in two tranches. One part during the day time and it is denoted by ‘T’ (as seen in the picture above). The other half during the evening time and it is denoted by ‘T+1’. The trades happening in the evening will be considered in the next day settlement prices.

SGX Nifty Trading Timings

(Source: SGX Nifty)

Now, the above picture gives you details about the trading hours of SGX Nifty. The Trading hours mentioned here are Singapore time and the difference between Indian Standard Time and Singapore time is 2 hr 30 minutes. Therefore, we can see that in the Morning (T) session, it trades from 9 am to 6:10 pm Singapore Standard time.

So, in Indian Standard time, the trading happens at SG Nifty from 6:30 AM to 3:40 PM. And the Evening (T+1) session, it trades from 6:40 pm to 5:15 am Singapore Standard Time, which if converted to Indian Standard time will have timings of 4.10 pm to 2:45 am.

Contract Settlements in SGX Nifty

SGX Nifty has two serial monthly contracts and it has Quarterly contracts. The contract expires on the last Thursday of Every expiring month and if the last Thursday is an Indian holiday, then it expires the preceding business day. The SGX Nifty contracts are cash-settled and the final settlement price is derived from the official closing of S&P CNX Nifty.

How SGX Nifty Impacts Indian Equity Market?

Looking at the current global scenario, with the continuous onslaught of COVID-19 pandemic or the rising tensions between US-China over trade deal, we see a continuous inflow of information and news. And these inflow of information has a direct impact on the Global Financial markets.

SGX Nifty still trading way after the closure of the Indian Nifty market, we see an impact of these global news on the SGX Nifty price movement. This further directly impacts the opening pricing of Nifty, the very next day. And that is one of the reasons we see the Indian Nifty market opening at a premium or discount over the previous day’s close.

Note: Many analysts use SGX Nifty as one of the factors to predict whether the Indian stock market will open higher or lower on a trading session.

Closing Thoughts

In this post, we explained what is SGX Nifty and its impact on Indian share market. The SGX Nifty is a perfect substitute for investors and traders looking to trade in the Indian equity market but are not able to do so. It is a perfect hedging instrument if you are already exposed to the Indian equity market.

One unique advantage that SGX Nifty has longer trading hours compared to the Indian Equity market. And all these points make it a lucrative investment and trading avenue.

March 19, 2021 Market, Options Trading, Trading 20 comments
INDIA VIX MEANING

What is India VIX? Meaning, Range, Implications & More!

Understanding what is India Vix, its meaning & importance: Ever heard of India Vix? If you’re involved in the market for some time and particularly active in the share market during the COVID19 Pandemic, then I’m sure that you would definitely have come up with this term “India Vix” at least a couple of times mentioned on different financial news channels and websites.

In this post, we are going to discuss, what exactly is India Vix, its meaning, and how exactly it is important for the traders and investors to understand this term. Let’s get started.

What is India Vix?

India VIX is a short form for India Volatility Index. It is the volatility index that measures the market’s expectation of volatility over the near term. In other words, it explains the volatility that the traders expect over the next 30 days in the Nifty50 Index.

The India VIX value is derived by using the Black & Scholes (B&S) Model. The B&S Model uses five important variables like strike price, the market price of the stock, time to expiry, the risk-free rate, and volatility. India VIX was introduced by NSE in the year 2008, but the concept of VIX is quite old and is a trademark of CBOE (Chicago Board Options Exchange).

One simple way of understanding India VIX is that it is the expected annual change in the NIFTY50 index over a period of 30 days. For example, if the India VIX is currently at 11, this simply means that the traders expect 11% volatility for the next 30 days.

Further, for example, if the current index is trading at 9,000 and India VIX trading at 20. Then, expected volatility over next year over 30 days will be:

  • Index spot: 9,000
  • India Vix: 20
  • The expected downside for the year = 9000 – 20% of 9000 = 7200
  • The expected upside for the year = 9000+ 20% of 9000 = 10,800

Here, the expected range for the year is between (7,200 and 10, 800) for that index.

Quick Note: Before moving further, let me mention that one should not confuse India VIX with Market Index. Market Index gives information about the direction of the market. However, on the other hand VIX measures the volatility of the market.

Why is India VIX so important?

All the major directional moves in the market are usually preceded by a lot of choppiness or a lot of range play in the market. India VIX plays a very major role in understanding the confidence or fear factor amongst traders.

  • A lower VIX level usually implies that the market is confident about the movement and is expecting lower volatility and a stable range.
  • A higher VIX level usually signals high volatility and lower trader confidence about the current range of the market. A major directional move can be expected in the market and a quick broadening of range can be expected.

For example, during the sub-prime crisis, India VIX was trading at 55-60 (high of 90) levels and the market was in a state of panic and indecisiveness and hence the moves were erratic and hostile. Volatility and India VIX have a positive correlation. High volatility indicated high India VIX and vice-versa.

Similarly before COVID-19. India VIX had stayed below 30 (Since 2014). But since the epidemic disease broke out, the VIX has crossed the 30 level and is trading near 50 levels (trading above 80 for few days) and we have seen the Indian equity Index losing nearly 40 percent of its value and is trading near 8000 levels.

Overall, India VIX plays a major role in understanding the sentiment of the market.

But be aware of the fact, India VIX does not give any indication of the directional move in the market, it simply indicates the volatility in the market. So, anyone with a huge investment in Equities should keep a close eye on the movement of India VIX coz a similar movement in the shares of his portfolio cannot be ruled out.

Is there an ideal range for India VIX?

Theoretically speaking, VIX ranges between 15-35. But there have been outliers case of as low as 8 (very tight range) and as high as 90 (extreme volatility). If VIX moves close to Zero, then theoretically either the index can double or come to 0. However, usually, VIX has a tendency to revert back to mean.

india vix historical chart tradingview

(Source: Tradingview)

The figure above is the India Vix chart for the last 10 years. During the break of the global crisis of COVID-19 (March-April 2020), the global markets have faced a lot of heat and extreme volatility, and all the major global indices have lost nearly 35% from their recent highs and Indian equity market was no exception. With this level of volatility, India VIX had climbed up to all-time high levels of 90 for those couple of days.

Later, it seemed to stabilize after June-July 2020. For stability to return, the global factors will have to improve and the India Vix level should ideally come around 20 levels. The Current VIX level is 22 (March 2021) and the market seems to be stabilizing for now. But for the long-term stability of the market, sub 20 levels of VIX is desired.

What do these extreme Vix levels mean for Options Writers?

India VIX also plays a very major role in the pricing of Options. A higher India Vix levels usually signal more volatile prices for options and a stable range would mean that the options are priced reasonably cheaper.

Simply put, high VIX levels expose option writers to unlimited risk with limited rewards (Premium). A deep in out of money Put/Call option can become at the money or even In the money option in a matter of a couple of trading sessions.

ALSO READ:

Options Trading 101: The Big Cat of Trading World

For Example, the stock price of XYZ shares is Rs. 300, and a trader has sold 280 put option contract (2,000 shares) for a premium of Rs. 10 and the contract has still 7 days to expiry. So, with current volatility, the share price can come to Rs. 240 in 2 trading sessions. So the loss for option writer with still 5 days to expiry will be:

  • Strike price: Rs. 280
  • Spot price: Rs. 240
  • Premium Earned: Rs. 10

Here, the loss for option writer: Rs. (240+10-280) i.e., Rs. 30 loss per lot, which is a loss of Rs. 60,000 (2000*30) per lot. Therefore, ideally, the option writer should avoid writing contacts and even if they do, the premium charged should also be higher.

Summary

To summarize, India Vix is the volatility index that measures the market’s expectation of volatility over the near term. It can be said that India Vix is a silent yet very effective indicator to gauge the range play for Index, which in turn gives us a clear view of the expected movement of the share price.

Historically, large Vix levels have always been followed by a large movement in the indexes and share prices. Even the option pricing, the premiums charged also increase or decrease because of the Vix level changes.

March 15, 2021 Options Trading, Technical Analysis, Trading 8 comments

Option Trading Strategies For Beginners

A Beginners Guide to Basics Option Trading Strategies For Beginners: Imagine having the power to own something at a price you want and not worry about the future uncertainties. Options trading gives you this power. Before dwelling deeper into the Ocean of Option trading strategies, let us have a quick snapshot of the concept of Options and its types.

Basics of Options Trading

“Options can be defined as a derivative instrument whose value is derived from the value of some other underlying Asset or Security. Options give the Buyer the right to buy or sell the underlying asset, and the seller is obligated to bind/honor the contract.” And as mentioned above, there are two types of options – Call Options (right to buy) and Put Options (right to sell)

  • A call option gives the right to option buyer to buy the underlying security at a pre-decided price. The buyer of the option is expecting the price to increase in the future.
  • A put option gives the right to option buyer to sell the underlying security at a pre-decided price. The buyer of the option is expecting the price to decrease in future

Before understanding the options strategies, let us understand the concept of Moneyness of an option.

Moneyness of an Option

The Moneyness of an option simply means the amount of money the option contract would make if they were to be exercised today. Moneyness of options are of three types-

  • In the Money – An In the Money Option contract is one, which would make money if they were to be exercised today.
  • At the Money – An At the Money Option contract is one, whose strike price is the closest to the current/spot price.
  • Out of Money – An Out of Money Option contract is one, which would be worth nothing if they were to be exercised today.

Say, the spot price of Nifty is 10540, then the strike price of Call option 10400 would be called as In the money, the strike price of 10550 would be At the money and the strike price of 10650 would be an Out of Money Option.

Option Trading Strategies

Having understood the basics of options and various types of Options, let us try and understand some of the most basic and commonly used option trading strategies.

Basic Premise used while explaining these option strategies

  • We will be discussing strategies which work in both bullish and bearish markets
  • The strategies discussed here will have a minimum of two option position running simultaneously
  • The underlying asset which will be consistently used while discussing this strategy will be the Nifty Index
  • The strategies mentioned here does not guarantee to make money, nothing in the market guarantees to make money.

Option Trading Strategies – Bull Call Strategy:

Hypothesis while using this strategy:

  • Bull Call Spread is a two-legged strategy i.e., it has two option positions running simultaneously.
  • This strategy is used when one has a bullish view on the market.
  • The simple assumption while executing this strategy is that there will be an upside catalyst in the Underlying Asset and one is expecting strength in it, in near future. So, the overall sentiment is bullish in the market

Scenarios under which this strategy is used:

  • The Fundamental perspective – Say, if we are positive about the government announcing certain stimulus to boost the economy in these uncertain times of COVID-19 pandemic, but the previous announcements have not bought too much joy out of the market. So, any announcement made will be positive, but the uncertainty lingers in the market regarding the quantum of the impact of these announcements on the market
  • The Technical Perspective – Say, the market has been bearish and the weakness is expected to continue. But the market is coming near the technical supports of moving averages and is also nearing the all-time lows. So a relief rally is expected but again the extent of the up move is uncertain. So employing this strategy would make sense.
  • Quantitative Perspective – Say, if the stock price was trading at a certain range but due to some reason the market showed weakness and broke the range lows. But it is not making any fundamental and technical sense to break the range lows. So to play the pullback within the range again, this strategy can be employed and used.

Implementing Bull Call Spread:

So to implement this strategy, one has to buy One At the Money call option and sell/write one Out of money call option:

i.e., Buy One ATM call option and Sell One OTM call option.

The following are the assumptions under this strategy:

  • All the strikes belong to the same underlying
  • Both the options have the same expiry
  • And both the legs have the same number of contracts

Let us understand it with the help of an Example:

Say, the Spot price of Nifty is 9310

  • An At The Money call option bought = 9300 CE, Premium paid =75 units
  • An Out of Money call option sold = 9400 CE. Premium received = 20 units
  • So the net transfer of option units = 20-75 = -55 units.
  • So, in general, at the initiation of this trade, the P/L always shows negative as one has to buy ITM option and sell OTM option

Now, let us understand the impact on the P/L at various levels of expiry:

Say, if the Nifty expires at 9200, then –

So, the Net Payoff using this strategy is -55 units (-75+20)

Say, if the Nifty expires at 9300, then –

So, the Net Payoff using this strategy is -55 units (-75+20)

Say, if the Nifty expires at 9400, then –

So, the Net Payoff using this strategy is 45units (25+20)

Say, if the Market expires at 9500, then –

Graphical Representation of payoff:

Breakeven Point for this Strategy:

The Breakeven Point (BEP) for this strategy is the point when the spot price equals the summation of At the money strike price and the maximum loss (Net debit) in this strategy

i.e., BEP = Strike price of ATM + Maximum loss = 9300 + 55 = 9355. So, when the spot price reaches 9355, this strategy reaches its breakeven point.

Option Trading Strategies – Bear Put Strategy:

Hypothesis while using this strategy:

  • Bear Put Spread is a two-legged strategy i.e., it has two Put positions running simultaneously
  • This strategy is used when one has a moderately bearish view of the market
  • The simple assumption while executing this strategy is, there is negativity expected in the market, and selling in the market is due

Implementation of Bear Put Strategy:

To implement this strategy:

  • We have to buy One In the Money Put Option
  • Sell One Out of Money Put Option

Both the Options should have the same expiry date and same underlying Asset

The choice of option strikes depends on the aggressiveness of the trader.

Let us understand it with the help of an example:

  • Say the Nifty spot is trading at 10050 today.
  • So, any In the Money (ITM) Put Option will be 10200 PE.
  • And, an out of Money (OTM) Put Option will be 10000 PE.
  • The premium for 10200 PE is 180 units
  • The premium for 10000 PE is 60 units
  • So, this is a ‘Net Debit’ strategy
  • So, the P/L at the beginning of this strategy is -120 units(60-180)

Say, if the Nifty expires at 10400, then –

So, the total P/L (net payoff) in this case is -120 units (-180+60)

Say, if the Nifty expires at 10300, then –

So, the total P/L (net payoff) in this case is -120 units (-180+60)

Say, if the Nifty expires at 10080, then –

So, the total P/L (net payoff) in this case is 0 units (-60+60). This is also the BEP for this strategy

Say, if the Nifty expires at 10000, then –

So, the total P/L (net payoff) in this case is 80units (20+60)

Say, if the Nifty expires at 9800, then –

So, the total P/L (net payoff) in this case is 80units (220-140)

Graphical Representation of Payoff-

To Conclude the Option Trading Strategies…..

  • Options trading strategy is one of the most effective ways of hedging and having consistent return without taking too much risk
  • A Bull Call Strategy is best suited when one has a moderately bullish view on the market
  • A Bear Put Strategy is best suited when one has a moderately bearish view of the market
  • The two strategies are best suited if you are a risk-averse trader and don’t mind having a cap on the profit potential
February 5, 2021 Market, Options Trading No comments yet
BASICS OF HEDGING - What is Hedging in Stock Market

Basics of Hedging – What is Hedging in Stock Market?

Understanding Basics of Hedging and How it can be used to reduce stock market risk: If you are an investor in the capital markets, I am sure you have across days where your portfolio has shown wild moves up or down. These fluctuations in the stock market are always something that creates a lot of anxiety and stress for the investors, Although the pundits advise ignoring such fluctuations, for a layman, it is hard to look away when things are bumpy. It is easy to become obsessive when things are on a downward slide.

In times like these, many of us may wish there was a way to insure our investment in a downturn in the same way we insure other assets like a car or a house. Hopefully, there may be some sort of an agreement where we stand to be compensated in case something bad happens. In this case, a large monetary loss in our investment amount due to some factor that was totally out of our control.

Well, the truth is that sort of thing does exist in the real world, only that it is known by a different name – Hedging. When we hedge an investment, we reduce or eliminate certain risks including but not limited to stock market crashes as a whole. It is a popular practice in investment management and some funds, known as hedge funds, even purport offering such investments through which investors can totally eliminate certain kinds of risk. 

Even though globally most hedge funds tend to underperform the broader market, the allure of avoiding certain known risks from their portfolios have not stopped big and wealthy investors from loosening their purse strings for investment in these hedge funds.

But Buyer Beware! Although these are pretty handy when it comes to protecting your investment in a crash, a poorly managed hedge or a hedge fund can lead to investors losing more money than taking on the complete risk themselves. So let’s learn about hedging and it’s pros and cons in today’s article.

Basics of Hedging – What is Hedging?

When you hear the word hedging, you probably imagine your neighbor pruning his brushes in his backyard. But, the name actually originates from an older meaning for the word. The Hedge is actually synonymous with a fence, as in we are trying to contain a herd of cows or perhaps the downside of our investments within a limited space. 

While the term is now commonly used to refer to financial strategies, the truth is we practice its principles on day to day basis. As mentioned earlier, a car insurance hedges your financial risk since you pay a premium to avoid a larger cost that you might incur in the case of a car accident. While a seat belt might hedge your risk of having a serious injury. Heck!, this is what you do when you adjust the time on your watch so that you leave early to work by ten minutes  ( you are hedging against your impunctuality )

basics of hedging stocks

In each case, you are taking some sort of cost or nuisance to avoid or prevent a greater problem, be it financial or otherwise. When it comes to investing, however, the practice refers to reducing some sort of risk or exposure in our portfolio. It can be the risk of a specific stock or industry experiencing a decline, or perhaps against the interest rate rising and sometimes against inflation rising higher than expected.

How does a Hedge work and How do we employ it?

Hedging is done by adding investments in our portfolio that move in the opposite direction to the risk that we are trying to manage.  In the language of mathematics, we are trying to achieve a correlation of -1 to exposure, although technically we are looking for something called the erudite quants would call a negative delta. 

Negative delta is just a measure of how one asset moves whenever the other changes by a unit price. This ensures that if a risky event were to happen and our holdings lose value the hedge we invested in should appreciate in value to offset the loss.

As an oversimplified example, an investor could hedge their exposure to a specific stock by shorting the same position. By doing this, they offset their downside. If the stock falls in value then the short position will gain value and hence canceling out the loss.

Now, investors rarely prefer to have perfect hedges like this, after all, you protected yourself from any downside but you have also prevented the portfolio from gaining any profits either. This fact alone certainly might convince you why it’s not the smartest move when you are investing in the market.

So instead of taking protection against every single down move in the market, smart investors instead focus on only protecting themselves against specific risks in a way that doesn’t completely eliminate their upside but they are still protecting themselves from losses they don’t want exposure to.

As an example, assume the case of an Indian mutual fund that invests stocks in the US stock exchange. Any investor who parks their money in a foreign stock would also by default expose themselves to differences in interest rates, inflation, and currency exchange rates between the two countries. 

Since differences in interest rates and inflation are usually reflected in the currency, an investor may choose to buy certain investments that will appreciate in value when the exchange rates fall. This particular arrangement would now enable them to earn returns similar to what they would gain if they were investing as Americans.

How to do Intraday Trading for Beginners In India?

What are Investments/Tools most commonly used for hedging?

While technically it is possible to hedge a portfolio through traditional techniques such as diversification or investment in alternate assets, explicit hedges in the market are performed through the extensive use of instruments called derivatives.

On a high level, a derivative is simply a contract whereby you as an investor enters into a bet or an arrangement with another investor to buy or sell an asset at a fixed price in the future.

There are lots of interesting things you could do with derivatives. For example, at the time of writing the article the market is significantly overvalued and there is a lot of uncertainty about the budget in the coming weeks. An investor who has exposure to equities could theoretically buy a put option that expires in two or three weeks for a premium paid upfront and could hedge against a market fall while also standing to gain from his stock holdings.

While these seem to be very simple tactics an individual could make use of, it would surprise many to learn that these are exactly the same strategies that hedge funds employ for their wealthy clients. Among other things, hedge funds also frequently use derivatives to long certain assets while shorting certain others with the intent of making a profit regardless of market conditions. 

What are the cons of hedging?

While the pros of the industry may espouse hedging as some holy grail in investing, the truth is this is not without any downsides.

Firstly, the hedge most often requires an upfront investment which is lost if the market goes up. This is something that eats up your returns in a market that is trending upwards or is moving sideways, a possible implication of this is that it becomes much harder for you as an investor to beat the benchmark index in the long term.

Secondly, hedging is an imperfect science. Professionals in the industry may tell you that it is something that requires a lot of skill and experience. But truth be told, they will also agree that hedging at the end of the day is an “educated guess” based on probabilities.

Thirdly, even if you have a hedge it may still not protect you. Imagine if you bought a put (an option that gives insurance against downside) to hedge your investment if the asset were to fall by 10%. Now, if the market were to fall by 8% by your expiry date, the option would expire worthlessly and your investment in buying the hedge would be entirely lost.

For these factors, many conservative fund managers prefer to stay away from complex hedging and instead focus more on long term returns than short term losses. In their view, if you are a long-term investor short term market crashes are only an opportunity to buy more stock into your holdings and hence it doesn’t make sense to spend extra cash on a crash that may or may not happen.

Basics of Hedging – Key Takeaways

In this post, we covered the basics of hedging and how investors can employ it. While Hedge funds may not be accessible for many individuals, investors can theoretically carry out the same strategies, but the performance of their portfolios may depend a lot on the individual’s ability to make active calls and evaluate the market. 

Hence, Any investor hoping to venture into actively being involved in the markets would do well to acquaint themselves with erudite concepts of hedging before employing them. However daunting it may seem, the fruits of such labor have rewarded market players with immense wealth and success.

January 27, 2021 Options Trading, Technical Analysis No comments yet
how to trade options in India 2020

How to Trade Options In India? Step-by-Step Guide!

A Beginner’s Guide on How to Trade Options in India: Options Trading has been quite popular in India in recent days. Because of the pandemic situation, a lot of new and existing traders have been able to understand and learn this new craft of trading (Options Trading).

Nonetheless, as the skills and steps required to trade Options is not taught in schools or academics, most beginners find it difficult to learn how to trade options in India. Therefore today, we are going to explain the step by step process on how to trade options in India in the easiest possible words. Let’s get started.

Brief Overview of Options Trading

The most common concept that most of you must have heard about trading via options is the power to leverage.

Leveraging in terms of Options trading would simply mean, the power to trade at higher capacity then what the direct value of trade would allow. Let us understand this with the help of a simple scenario from day-to-day life.

Say, Ram has a wedding in his house two months down the line and for the purpose of the wedding, he needs to get 100 grams of Gold. The current price of 10gms of Gold is Rs. 50,000. However, Ram is a little skeptical about the volatility in the market and wants to lock in the current price of Gold, to be bought two months down the line. Therefore, with the objective of freezing the price of gold, he visits the jewelry shop and puts forward his proposition of buying the gold at the current price, two months down the line.

Why are Gold prices skyrocketing? Is it a good time to buy?

But looking at the current volatility, the jewelry shop owner is a little skeptical of taking the risk of fixing the price of Gold. Therefore, to incentivize the Jewelry shop, Ram pays him certain token money (say, Rs. 2000 per 10 gm of Gold) to fix the price of Gold. Therefore, the total money paid by Ram to enter the agreement with the jewelry shop owner is Rs. 20,000.

Let’s suppose, if upon expiry (i.e. after two months) if the price of gold goes above Rs 50,000 (per 10 gm), then Ram will exercise his right to buy the gold at Rs. 50,000. However, if the price of gold after two months remains unchanged or goes down, then Ram is not obligated to honor the agreement. He merely stands to lose the token money (Rs. 20000), which he paid to enter into the agreement. And that becomes the income of the Jewelry shop owner.

For example, if the price of Gold were to increase to Rs. 57,000 for 10 grams, then the overall benefit of Ram will be –

= Total gold * (Price after two months – Current price – Premium paid) = 10*10*(57,000-50,000-2,000) = Rs. 50,000.

Now, if I were to relate this example to options, then the Ram is the Option buyer, the Jewelry shop owner is the option seller, Gold is the underlying asset, the current price of gold is the Strike price and token money paid is the option premium.

A similar scenario is also applicable to the stock market. Here, if the option buyer believes that the price of a share may go higher in the future (through his analysis or study), he/she may pay a premium to the options seller to enter in a contract to buy the stocks at the pre-decided value. Further, the premium paid might be an expense, however, if the share price goes way above the pre-decided agreement price, then the option buyer will make profits.

Basic Options Trading Definition

To define in financial terms, Options are a derivative instrument that gives the right to option buyer to buy the underlying asset at a pre-decided price from the option seller, on or before expiry.

However, the option buyer is not obligated to honor the contract upon expiry. He has the right to buy the asset if he chooses to. However, if he does not wants to buy (in case the current price goes below the pre-decided value), he will simply lose the premium paid beforehand.

Nevertheless, the Option seller is obligated to honor the contract as he/she has taken a premium at the starting of the agreement. And the option seller is compensated in the form of this fee (or premium) to give up his right on underlying assets till the expiry of the contract.

Also read: Options Trading 101: The Big Cat of Trading World!

How to Trade Options In India?

Now that you have understood the basics of Options Trading, we’ll be covering how to trade options in India next.  For the sake of reference and explanation, I will be using the trading portal of Zerodha (Kite) in this article, as it is the most commonly used trading platform in India. Following are the step by step procedure to trade options in India.

Step 1: You need to have a trading account with one of the brokers (For example, Zerodha, Angel broking, 5Paisa, etc.). If you don’t have one, here’s an article on the best discount brokers in India so that you can pick the one that suits you the best. The steps to trade options in India are almost same in any trading platform you chose.

Step 2: We need to have a margin in our trading to be able to trade options. Based on the position taken by the investor, the margin requirement varies. Option buyer needs margin to pay for the premium required to trade options. And option seller needs margin as they have to keep certain money with brokers to account for Marked to Market (M2M).

Step 3: Next, we need to understand as to what is our view on the underlying asset. If we have a bullish view, then we can buy a call option (or sell put option) and if we have a bearish view, then we can express the same by either buying a put option (or selling a call option).

“Buying a Call option gives us the right to buy the underlying asset on or before expiry. And Buying a Put option gives us the right to sell the underlying asset on or before expiry”

Step 4: Select the underlying asset you chose to trade and also select the various strike prices that we choose to trade upon. For example, here’s a screenshot from Zerodha Kite where you can choose the asset and strike price.

zerodha kite astrike price

Now, say we are looking to trade Nifty 50 Contract via Option and we have a bullish stance on the market. Therefore, we could trade In the Money Call Option (Nifty 11450 CE), At the Money Call Option (Nifty 11500 CE) or Out of Money Call Option.

An In the Money Option is one that would make money if we were to exercise it right now at current spot levels. An Out of Money option is one that would be worthless if we were to expire it right now and an At the Money option is one that is the closest strike price to the current spot price levels.

It is advised to not to go too out of money while buying an option as the chances of them expiring in the money by expiry, is very less and more often than not, they expire worthlessly.

Step 5: Let’s say, we decide to go ahead and buy an At the Money option. Then, the next step in this process is to place an order to buy the option. We can choose to buy the option at the existing price and we can also choose to place the order at a specified price by placing a limit order.

options trading in zerodha kite

Therefore, if you look at the ticket in the image above, we have two options to buy the contract from i.e. Market or Limit.

If we choose the option of market order then the order is executed at the current market price. And if we choose Limit order, then we can choose the price at which we want to buy the contact. In the image above, the current rice of the contract 11500 call option is 90.65, but the price at which we want to buy the contract is 80.

The total number of shares in one contract of nifty is 75. If the option premium is 60, then the total amount of premium required to buy the contract will be = 75*60 = 4500. And this information is directly available on the ticket shown above.

Step 6: The next step while trading options is to check in the order book if the order has been placed.  We can do that by simply clicking on the orders tab and we can see the list of all the order which have been placed or canceled or executed.

Step 7: The last but the most important step while trading options is to monitor the existing position in the market. It is always advised to have a stop loss for every trade as it will help us in having good risk management and also prolong one’s trading career.

That’s all. This is how you trade options in India. If you still have any doubts, I will strongly recommend you to also watch the below video on how to trade options using Zerodha kite Demo. This video will help you even more to learn the steps for Options trading in India. Watch it Now!!

Closing Thoughts

In this article, we discussed how to trade options in India through a step-by-step guide. Here are the key takeaways from this article:

  • Options are derivative products that derive their value form the value of the underlying asset.
  • Call options give us the right to buy the underlying asset upon expiry. On the other hand, Put options give us the right to sell the underlying asset upon expiry
  • Bullish views can be expressed by either buying a call option or selling a put option.
  • Bearish views can be expressed by wither buying a put option or selling a call option.
  • One can use the Zerodha platform to trade option as it is very user friendly and there is rarely any delay in the order execution.

If you still have any doubts on how to trade options in India, feel free to comment below. I’ll be happy to answer all your queries. Have a great day and happy trading!

October 6, 2020 Options Trading, Trading 2 comments
What Are Futures Contract meaning

What Are Futures Contract? And How are they traded in India?

Understanding Futures Contract and their importance: The Futures and Forward Contracts are a financial instrument that derives their value from the value of the underlying asset. Basically, the futures contract are contracts between buyers and sellers, where the buyer agrees to buy a fixed number of shares from the sellers, at a specified time in the future and at a pre-determined price. The futures contract derive their value directly from the value of the underlying asset. Moreover, they are one of the highest traded derivative instruments in the world.

In this article, we are going to discuss futures contract in detail including the importance of these contracts and how to trade in futures contract in India. Let’s get started.

Difference between Futures contract and Forward contract

There are two major points of difference between Futures and Forward contract. Firstly, futures are a legally binding contract to buy or sell the underlying asset or a specific date. Secondly, the futures contract are done via Futures exchange i.e., they are regulated.

A standardized contract specifies the time, quantity, value, quality, time, and location of the underlying asset. The product can be a commodity, currency, stocks, index, etc. The standardization of contract sets the same rules, specification of contract for all the participants. And because of the standardization, the ownership of the contract can be passed to any other trade by way of a trade.

As the Futures contracts are exchange-traded, it guarantees the parties involved that the contract will be honored. All the futures contracts are centrally cleared via exchanges thus eliminating the counterpart risk.

How are Futures contract traded in India?

In India, the futures contract are mainly traded in two forms – Stock Futures and the Index Futures.

— Index Futures

The index is the grouping of stocks. It simply measures the change in the prices of group stocks over time. Say, for instance, Bank Nifty represents the top 12 banks in the Indian Banking system. These banks are from both the public and private sectors. And any movement in the share price of these banks directly impacts the index. Future contracts are also available for these indexes. They directly derive their value from the value of the index. The following are some of the characteristics or traits of these indexes:

  • Size of the contract: Each and every contract in the futures contract have a specified fixed size. Anyone willing to trade will have to buy the full contract or multiples of it. Say, for instance, if I am trading Nifty 50 Index, then each lot has 75 shares in it. And in the Bank Nifty, each future lot has 25 shares in it. These are the two most actively traded Index futures in the Indian equity market.
  • Expiry: Each and every index futures have a specified date of expiry. All the Index futures are settled on the last trading Thursday of the month. If the last Thursday is a holiday, then the expiry happens on the previous working day. Since the index are the culmination of various stocks, hence there is no physical delivery of the shares on the index. Only the cash differential is to be paid.
  • Time frame: The Index futures have three contracts running simultaneously all the time i.e., the near month (1-month), the middle month (2-month), and the far month (3-month). As and when the near month contract expires, a new far month contract is added to the series.
  • Margin Required: The margin required to trade the futures contract is comparatively high, as the position are exposed to market to market (M2M) risk and the brokers and exchanges will have to safeguard their interest in case the index becomes very volatile on a particular day.

— Stock Futures

The basic premise of trading stock futures is very similar to Index futures. Stock futures are the derivative instruments, that derives their value from the value of the underlying security/stock. The contracts have a specific size, fixed price, and specified date. Once the contract is entered, it will have to be honored. Following are some of the characteristics of Stock futures:

  • The size of the contract: All the stocks trading in the futures market, have a different number of shares in each lot. We can’t trade just one share to trade futures. A minimum of one lot has to be traded. For example, one lot of futures contract of Reliance industries has 505 shares, one lot of Maruti has 100 shares, one lot of ICICI bank has 1375 shares etc.
  • Expiry: All the stock futures contract have a fixed maturity. They expire on the last trading Thursday of the month. And if the last Thursday is a holiday, then they expire on the previous trading day. The stocks have three expiring contracts – near month (1-month), middle month (2-month), and far month (3-month).
  • Margin: The margin required to trade stock futures contract is very high to cover for Mark to Market (M2M) losses. This is basically done to protect the interest brokers and the exchange.

How Are Futures contract Priced?

Futures contract derive their value from the value of the underlying assets. There is always a variation/difference in the prices of the cash segment and derivatives segment. There are basically two methods of pricing the futures contract: The Cost of Carry Method & The Expectancy Method.

— The Cost Of Carry Model

Under this method, the market is assumed to be perfectly efficient. There is no difference in the value of cash market and futures contract. So, the profit made by trading the cash segment or futures segment is same, as the movement in the prices are aligned. Following is the process of calculating the prices under the Cost of Carry model

Futures Price = Cash Price + Cost of Carry

The cost of carry here refers to the cost of holding the futures contract till maturity.

— The Expectancy Method

Under this method, the futures prices are the expected cash price of the underlying asset in the Future. So, if the market is positive/conducive for the underlying asset, then the futures price will be higher than the cash price. And if the market has a weak sentiment towards the underlying asset, then the futures price will be lower than the underlying asset.

Advantages of Trading Futures contract

Here are a few of the major advantages while trading in the futures contract:

  • Futures contract are one of the safest mode to hedge one’s exiting position in the market i.e., if I am long in shares of a particular company, I can hedge my position by taking short in futures contract of the same underlying Asset
  • The futures contract are high leverage instruments i.e., to trade futures contract we have to pay only a fraction of the total value. In general, the margin amount is just 10% if total value. This margin money acts as a collateral, in case the value of the underlying asset goes opposite to the views of the investor and he incurs losses. Say, if one futures lot of XYZ company has 1000 shares. And if the price of one share is Rs.100. So, if one were to buy 1000 shares, then the total value to be invested will be Rs. 100000 (1000*100). But, to trade futures contract, one has to keep only Rs. 10000 (10% of total value) as margin.
  • Because the futures contract are regulated by exchange, liquidity is never a factor while trading futures contract. One can exit their position anytime from the market.
  • Because of the low margin requirement, small players and speculators get to be a part of bigger game
  • Short selling becomes very easy while trading Futures contract. And one can legally short position in the shares of the company, by shorting futures contract.
  • The buying or selling pressure in on particular underlying asset can help us to gauge the future demand and supply of the shares

Key Takeaways

In this article, we tried to cover what are futures contract, how they differ from forward contracts, how are futures contract traded in India, and the advantages of trading futures contracts. Here are a few of the key points to remember from this post.

  • Futures contract derive their value from the value of the underlying assets.
  • Because of the low margin requirement, the futures trading is very popular amongst traders
  • The futures contract are exchange regulated, there is never the question of trust amongst the traders
  • One can exit their existing futures contract position anytime from the market by taking an opposite position in the futures market.
  • It is also a very popular hedging instrument for already existing long position in the cash market
  • The Index futures are cash-settled
  • There are two methods of calculating the futures contract value – The cost of carry method or the Expectancy method

That’s all for this post. I hope this article on what are futures contract is useful to you. If you’ve got any queries related to this concept, feel free to ask below in the comment section. I’ll be happy to help. Happy trading and investing.

August 10, 2020 Options Trading, Trading 3 comments
Option Greeks Basics - The Gods In Option Trading

Option Greeks Basics: The Gods In Option Trading

Introduction to Option Greeks Basics: What are the makings of a great cricket match? Is it just that brilliant hundred by a batsman, or one 5 wicket haul by a bowler or is it that sparkling catch or run-out by the fielder. Or is a combination of all of these along with some crucial moments in the game.

Let us take the example of the inaugural World T20 final 2007. The biggest match of the tournament. The Arch rivals, “India Vs Pakistan”. No bigger setup in the world of cricket. But what made this match memorable was the quality of cricket played. India did eventually win the world cup final by 5 runs.

But what made this match unforgettable? Was it the innings by Gautam Gambhir (75 off 54 deliveries), was it the dash by Rohit Sharma (30 off 16 deliveries) that propelled India to a competitive score, was it the genius of Robin Uthappa to get a direct hit run-out of rampaging Imran Nazir, was it the onslaught by Misbah-ul-Haq or was it the masterstroke by none other, but M S Dhoni, to give last over to Joginder Sharma and seal the deal. I guess it was a mix of everything that made it an event to remember.

What are Greek Options?

Similarly, the Option Greeks are the ingredients of the recipe which eventually helps in pricing the options. Option Greeks are various factors which help option trader in trading options. With the help of these Greeks, one is able to price the options premium, understand volatility, manage risk, etc. These Greeks also have a major impact on each other.

There are majorly four different types of option Greeks – Delta, Gamma, Theta, Vega, and Rho. We will be discussing all of them in this post.

Quick Note: If you’re new to options trading, you can read our series of articles on options here.

Delta of an Option

In simple terms, Delta measures the change in the value of premium with respect to change in the value of underlying. For a call option, the value of Delta varies between 0 and 1 and for a Put option, the value of Delta varies between -1 and 0.greek options basics Delta of an Option

The above Option chain is for Nifty at 09:57 am. Nifty spot is trading at 9320.

delta of an option nifty option greeks

The above Option chain is for Nifty at 10:07 am. Nifty spot is trading at 9316.

Now, form the above two tables, it is clear that with a small change in the value of Nifty, the premium for the option changes. The premium for 9100 CE in the first option chain is 291.65 and in the second option chain is 289.40.

Now, say if I were bullish on the market, so how would I find the premium for all the strike price if I were to expect the Nifty spot to be trading at 9400 by End of Day. So, this is where Delta comes into the picture.

For a call option, assume the delta for a strike price is 0.40. So for every 1 point change in the value of underlying, the value of premium will change by .40 points. Say, if I had bought 9350 CE at a premium of 142.70. The Nifty spot price is 9316 and the Delta for this option is .40. And if by the End of the day, the spot price of Nifty jumps to 9350.

So the change in the Premium will be = (9350-9316)*0.40 = 14.4 points. So the new Premium will be = 157.1. Similarly, if the spot price were to come down to 9250, then the change in the Premium will be = (9250-9316)*0.40 = 26.4 points. So the new premium in this case will be = 142.7-26.4 = 116.3.

Delta value dependency on the Moneyness of an Option

The value of the Delta is derived using the Black & Scholes model. Delta is one of the output form this model. The Moneyness of the contract helps in deciding the value of Delta:

MoneynessDelta Value (Call Option)Delta Value (Put Option)
In the Money0.6 to 1-0.6 to -1
At the Money0.45 to 0.55-0.45 to -0.55
Out of Money0 to 0.450 to -0.45

Delta of a Put Option: The delta of a Put option is always negative. The value ranges between -1 to 0. Let us understand it with the help of a situation. Say the spot price of Nifty 9450. And the strike price in consideration is 9500 PE (Put option). The Delta for this option is (-) 0.6 and the premium is 110.

Now, in Scenario 1, if the spot price of Nifty goes up by 80 points, then

New Spot price = 9530

Change in Premium = 80*(-.6) = -48 points

So the New Premium = 110-48 = 62. In case of Put options if the spot price of underlying asset goes up, then the premium is reduced (the premium and spot price of Put option are negatively co-related)

In Scenario 2, if the Spot price goes down by 90 points, then

New Spot price = 9360

Change in Premium = 90*(-.6) = 54 points

The New premium = 110+54 = 164 points

Risk profiling for choosing Delta

The risk taking ability of a trader has an impact in choosing the right strike price. It is always advisable to avoid trading in Deep out of Money Options as the chances of those options expiring In the money is like their Delta (5% to 10%). For a Risk Taker trader, a slight out of Money or At the Money contracts are the best strategy. A Risk Averse trader should always avoid trading Out of Money contracts. They should always trade At the Money or In the Money contracts as the chances of trade expiring in their favour is significantly higher than Out of Money contracts.

Gamma of an Option

As we have seen, the Delta of an option measures the change in the value of premium with respect to change in the value of underlying. The value of delta also changes with the change in the value of underlying. But how does one measure the change in the value of delta? We introduce you to ‘GAMMA’.

Gamma measures the change in the value of Delta with respect to change in the value of underlying. Gamma calculates the Delta gained or lost for a one-point change in the value of underlying. One important thing to remember here is that Gamma for both Call and Put option is positive. Let’s understand:

Spot price of Nifty: 10000

Strike price: 10100 CE

Call Premium: 25

Delta of option: .30

Gamma of option: .0025.

Now if Nifty goes up by 100 points, then

New Premium = 25 + 100(.3) = 55

Change in Delta will be = Change in Spot price * Gamma = 100*.0025 = .25

New Delta will be = .30+.25 = .55 (Option is now an At the Money contract)

Similarly if Nifty goes down by 70 points, then

New premium = 25 – 70(0.3) = 4

Change in Delta will be = Change in Spot Price * Gamma = 70*.0025 = 0.175

New Delta Will be = .30-.175 = 0.125 (Option is now a Deep Out of Money contract)

Gamma Movement

The movement of the gamma changes and varies with the change in the Moneyness of a contract. Just like Delta, the movement in Gamma is the highest for At the Money contracts and it is least for Out of Money contracts. So, one should ideally avoid selling/writing At the Money contracts. Out of money contracts are the best ones to write as they have a very good chance of expiring worthless for option buyer and the seller can pocket the premium.

Also read: Introduction to Candlesticks – Single Candlestick Patterns

Theta of an Option

Theta is an important factor in deciding option pricing. They uses time as an ingredient in deciding the premium for a particular strike price. Time decay eats into the option Premium as it nears expiry. Theta is the time decay factor i.e., the rate at which option premium loses value with the passage of time as we near expiry.  If we could recall, Premium is simply the summation of Time Premium and Intrinsic value.

Premium = Time premium + Intrinsic value.

Say, The Nifty spot is trading at 9450 and the strike taken into consideration is 9500 CE (call option). So the option is currently out of Money. There are 15 days to expiry and the premium charged for this option is 110. Now, the Intrinsic Value (IV) of this option = 9450-9500 = -50 = 0 (Since IV cannot be negative)

Now, Premium = Time value + IV

=> 110 = Time value + 0, hence the time value for this Out of Money option is 110 i.e., the buyer is willing to pay a premium for an Out of Money option. So, the analogy “TIME IS MONEY” holds true in case of options pricing.

Let’s take another example:

  1. Say, Time to expiry = 15 days, Spot price of share of XYZ company = Rs. 95, Strike price = 100 CE, Premium = 5.5
  2. Now, if the spot price of XYZ = 96.5, time to expiry = 7 days, then for the same strike the Premium reduces to 3
  3. Again if the share price increases to 98.5, for same strike price and with just 2 days to expiry, the premium reduces to 1.75
  4. Therefore, from the above example it is clear that even though the spot price is moving towards the strike price, the premium is reduced as the time remaining to make a substantial move above strike price is reduced. The option has less chances of expiring In the Money. The Greek Theta is a friend to Option writers. It is advisable for option writers to write/sell the option at the starting of contract as they will be able rise the premium erosion with passage of time.

So from the above example, it is clear that the value of Premium is Depreciating with the passage of time.

Vega of an Option

Vega as a Greek is sensitive to the current volatility. It is one of the most important factors in determining the option pricing. Volatility is simple terms is the rate of change. Vega simply signifies the change in the value of an option for 1% change in the price of underlying asset. Higher the volatility of underlying asset, the more expensive it is to buy the option and vice versa for lower volatility.

Say the spot price of XYZ Company is Rs. 250 on 5th May and the 270 call option is trading at a premium of 8.

Let’s assume that the Vega of the option is 0.15. And the volatility of the XYZ Company is 20%.

If the volatility increases from 20 % to 21%, then the price of the option will be 8+0.15 = 8.15

And similarly, if the volatility goes down to 18%, then the price of the option will drop to 8 – 2(0.15) = 7.7

Key Takeaways

If options is a team, then it has various players are Option Greeks like Delta, Gamma, Theta, Vega, volatility, etc. Each and every Greek has its own pivotal role in finding the exact pricing of the option. They play a pivotal role in deciding the Moneyness of the option.

A simple and clear understanding of all the Greeks goes a long way in deciding the right strike price and right option strategy. Risk Management both for option writers can be handled with a better understanding of the Greeks. Option buyers should ideally avoid trading Out of Money options and Option sellers should ideally write/sell Out of Money Options.

May 11, 2020 Options Trading, Trading 1 comment
Futures vs Options Trading What is More Profitable

Futures vs Options Trading: Which is More Profitable?

Futures vs Options Trading – before we dwell deeper into this debate, let us first understand what each of these financial instruments implies. However, before that, it is important that you understand what does owning an equity share implies –

“Owning an Equity is like owning an ownership stake in the company. The holders of Equity shares have voting rights and have ownership say in the management and working of the company. Equity shareholders are partners in the growth and tough times of the company. They are entitled to receive dividends”

Now that you know the meaning of owning equity, let me define the basics definition of futures vs options trading:

“Futures are like a forward contract whose value is derived from the value of the underlying asset. In the case of companies, the underlying asset is equity share values and in the case of Index, the spot price of Index. The futures contract owners don’t have an ownership right on the asset they are underlined with”

“Options, as the name suggests, gives an option to the buyer, if wants to buy (Call option) or sell (Put option) on or before the expiry of the contract. He buys this right from the option seller by paying a fee (Premium) and the seller is obligated to honor his promise”

Read more: Options Trading 101: The Big Cat of Trading World

Benefits of Futures Contract

Here are a few key benefits of future contracts:

  1. Since Futures derive its value directly from an underlying asset, so any movement in the underlying price has equally proportionate movement in the value futures contract.
  2. The futures contract can be rolled over to next month contract at the same price as the expired contract expiry price.
  3. Futures contract do not face time decay problems as the value is direct proportional to the value of underlying and expiry does not affect its pricing.
  4. Liquidity is one of the most important factor in futures trading. The standing bids and offers make it easier for interested parties to exit and enter positions.
  5. The margin required for trading via futures haven’t changed much in years. They are changed a little bit when the market becomes volatile. So, a trader is always aware of the margin required before taking positions.
  6. The pricing is easier to understand as the values are based on Cost to carry model i.e., the futures price should be the same as the current spot price plus the cost of carry.

Benefits of Options Contract

Here are a few key benefits of Options contracts:

  1. As the name would suggest, the Options contract gives the right to option buyer to exercise his contract if he wishes to. If the Spot price doesn’t go in favor of the buyer of the contract he does not have to exercise his right, he stands to lose just the premium.
  2. One time premium is the only fee that option buyer has to pay to ride the momentum of underlying price and be a part of a bigger game.
  3. If an option seller is of the opposite view to that of option buyer, he can just sell the option contract and pocket premium income.
  4. The options are less risky than equities. Say for example if a trader wants to buy 1000 shares of Reliance, then at CMP (Rs 1400 per share), one has to shed out Rs 14,00,000 (fourteen lakhs). But one can express the same view by buying 2 Call option contracts (500 shares each). Say if he buys At the Money contract of 1410 CE by paying a premium of 35 per lot. Then, his total cost would be = (500*35*2)= Rs. 35000 only. So, now If option were to expire Out of Money for option buyer, he just stands to lose premium only. But, if the share price of Reliance Industries comes down to Rs. 1300, then total loss of equity shareholders will be Rs. 1,00,000 (1000*100).
  5. Return on investment for an option buyer is very high because the cost paid is just the premium and the potential return is unlimited.

Also read: Options Trading Definitions – Must Know Terms for Beginners

Futures vs Options Trading: Which strategy is better?

There is no right answer as to which instrument is better. It all depends on one’s risk appetite, and view on the market. However, here are a few key points to compare which strategy is better:

  1. Options are optional financial derivatives whereas Futures are compulsory derivatives instruments.
  2. The seller of an option is exposed to unlimited risk but the buyer’s risk is limited to the premium paid. But in the case of Futures, both buyer and seller have equal risk associated with their trades.
  3. The options although they can be rolled but have a different premium for different expiry, but in case of futures, they are rolled over at the same price in the next contract.

For example, if someone has bought the Future contract of XYZ Company at Rs. 110 and if upon expiry the price of XYZ is Rs. 105, he can simply roll over the position to next expiry at Rs. 105 and his entry price is not changed. But in case of Option, if an investor bought 110 call options of XYZ Company by paying a premium of Rs. 5 and it expires worthless, then he again has to buy next expiry contract by paying a fresh premium (Say Rs. 7). So to reach the breakeven, the spot price of XYZ Company has to go above Rs. 122(110+5+7).

From the discussion above it is clear that both financial derivatives instruments, Futures vs Options Trading, have their own advantages and disadvantages. One has to be rational, bias-free, use his/her judgment, and have proper risk management to survive long in the trading World. Happy Investing and Happy Money making.

May 1, 2020 Options Trading, Technical Analysis, Trading 2 comments
Multi Candlesticks Patterns cover

Understanding Candlesticks – Multi Candle Patterns

Multi Candlesticks Patterns: Hi traders! In the previous article, we discussed the various single candlestick patterns and their importance in understanding the pricing patterns. Here, in this article, we will be talking about various multi candlesticks patterns.

These are patterns generated by a series of prior candles. Single candlesticks patterns along with multiple candlestick study goes a long way in understanding and giving better trade signals in the market.

Here is a list of Multi candlesticks patterns we will be having a discussion on in this chapter: The Engulfing Patterns (Bullish Engulfing pattern and Bearish Engulfing patterns), The Piercing pattern, The Dark cloud cover, The Harami Pattern (Bullish Harami & Bearish Harami), The Candles Gaps, The Morning star, The Evening star, Three White soldiers & Three Black crows.

The Engulfing Pattern

The Engulfing pattern is the most basic two candlestick pattern. The first candle is a relatively small one and the second candle is a bigger one as it engulfs the first candle. If this pattern happens at the bottom of a trend, then it’s called bullish engulfing and if this happens at the top of a trend then it’s called bearish engulfing.

— Bullish Engulfing

Here are a few characteristics

  1. The Bullish engulfing pattern shows Long (buy) trade
  2. The prior trend should be bearish.
  3. The prior candle should be Red.
  4. The engulfing candle should be bigger than previous and covering the whole body of a red candle and should be green.

bullish engulfing - Multi Candlesticks Patterns

In the figure above we see bearish trend prior to the engulfing green candle. Once the engulfing pattern took over, we saw a long bullish trend. One important point to observe here is that the engulfing candle attempts to continue bearish pattern but constant buying and rejection at lows brings in more buyers and ultimately the candle closes green.

The trades to be taken here depends on one’s risk appetite. A risk-taker will execute the trade on the day the trend is made but the risk-averse will wait for confirmation and execute his trade the next day. The Stop loss for this trade has to be below the body of the engulfing candle. In the figure above, the trader with both kinds of a risk appetite would have made a substantial profit.

— Bearish Engulfing

bearish engulfings - Multi Candlesticks Patterns

As the name suggests, the bearish engulfing pattern gives an opportunity for short trades. The prior pattern here has to be a bullish one and the engulfing pattern candle should also give an indication of continuing bullish pattern but due to constant selling pressure, the sellers eventually take over and the candle closes red. The engulfing red candle has to bigger than the prior green candle.

The buying pressure gets exhausted by constant selling. It is advisable to exit long trades when this pattern happens and enter fresh short trades. The risk-taking trader enters short trade on the same day while the risk-averse trade waits for the pattern confirmation and enters into trade the next day. The figure shown below is a classic example of Bearish Engulfment with the engulfing body bigger than previous green candle and substantial bearish trend post that.

The Piercing Pattern

The Piercing pattern is very similar to a bullish pattern with a minor difference. In the case of the piercing pattern, the size of the green candle should be between 50-100 % of the red candle. Say if the size of the red candle is of 100 points, then the piercing candle length should be more than 50 points but less than 100 points. This candlestick pattern has a similar characteristics like Bullish engulfing but the confidence level on trades via piercing pattern is little lesser compared to bullish engulfing.

The Dark Cloud Cover

A mini version of the Bearish Engulfing pattern. A bearish pattern indicator and uptrend halter. Here, unlike the bearish engulfing pattern, the red candle size should be between 50-100 % of the previous green candle. Say, if the size of the green candle is 150 points, then the dark cloud candle should be anywhere between 75-150 points.

The Harami Pattern

I know what comes to mind when you hear the word ‘Harami”. But Harami here is a Japanese word meaning Pregnant. This is generally a trend reversal pattern. The first candle is a big one followed by a candle with a small body. And the color of the second candle is generally different from the first candle. If the second candle turns out to be a Doji candle, the chances of reversal increases.

— The Bullish Harami

the bullish harami - Multi Candlesticks Patterns

In the figure above, we see a bullish Harami encircled. It is a two-day pattern. Following are some of its characteristics:

  1. The prior trend of the market is bearish and on the previous day, the market has made a new low.
  2. On the next day, the candle opens in green as against the expected red candle and hence the panic and shorts start to get covered and the day ends with a green or a Doji candle.
  3. The idea here is to go long at the formation of this pattern.
  4. The risk-taking trader can go long near the close of the day and the risk-averse trader can wait for pattern confirmation and go long the next day.
  5.  The Stop Loss for the trade is below the low of blue or Doji candle.
  6. In an ideal scenario, it is always best to keep trailing stop loss and ride the reversal move.

— The Bearish Harami

the bearish harami - Multi Candlesticks Patterns

In the figure above, we can notice that the bearish Harami in a squared box. It is a trend reverser. The strong bullish trend is halted and a new bearish trend starts. Few characteristics of this pattern:

  1. The prior trend is a strong bullish trend.
  2. The prior candle makes a new high and the next candle opens low against an expectation of new high and hence the panic selling.
  3. One should look to exit his existing longs and enter fresh short trades.
  4. The risk-taker will execute the trade close to the end of the day and the risk-averse trader will wait for the confirmation and enter a trade on the next day.
  5. The stop loss for the trade will be the high of the first red candle.
  6. Here also one should keep trailing the stop losses and ride the full move.

The Candle Gaps

The Gaps are formed when the candle for the next day opens significantly opens up or below the previous day closing.

the candle gap - Multi Candlesticks Patterns

If the market gap ups, it shows buyers enthusiasm. They are willing to pay a higher price. The Image above shows Nifty gaps up and buyers are willing to pay a higher price and the momentum continues. This pattern emerges when we see some overnight positive news and the markets react with a gap up. If the share price of some company gap ups, it usually means some positive management news or good quarterly results or firm receiving some substantial orders, etc.

Similarly, in the case of a Bearish Gap down, we see the market opening below the previous day’s close and selling pressure. In the figure above we see a bearish gap down in nifty index and continued negative momentum post that.

One important thing to keep in mind is that candle gaps are more news-driven or event-based but it has a strong bearing on changing the technical set up of the market.

The Morning Star

The Morning star is a bullish candlestick pattern. It’s a three candlestick pattern. This pattern usually indicates a trend reversal. A sustainable bullish trend is on cards.

the morning star - Multi Candlesticks Patterns

Following is the pattern setup:

  1. The market is in a bearish trend and it’s continuously making new lows.
  2. In the image above, we can see the first candle in the circle is a red candle and a new low is formed.
  3. The next candle starts by making new lows and looks set to go down. But with regular buying, the candle closes by making Doji. It starts to set panic amongst the bears.
  4. The next candle starts above the close of the Doji candle (Gap up opening) and shorts start to exit their position and fresh long positions re-initiated in the market.
  5. The best way to trade this pattern is by entering the market near the close of the third day and by then the trend reversal confirmation is also given by the market. The Stop Loss for this trade is the low of the third candle. Trailing Stop losses is the best strategy to ride this move.

The Evening Star

The evening star is the exact opposite of Morning star. It’s a strong bearish reversal pattern. Similar to the morning star, evening star is also a three candlestick pattern.

the evening star - Multi Candlesticks Patterns

  1. The market is in a bullish trend and it’s continuously making new highs.
  2. In the image above, we can see the first candle in the circle is a green candle and a new high is made.
  3. The next candle starts by making new high and looks set to go higher. But with regular selling, the candle closes by making Doji. It starts to set panic amongst the bulls.
  4. The next candle starts below the close of the Doji candle (Gap down opening) and longs start to exit their position and fresh short positions are initiated in the market.
  5. The best way to trade this pattern is by entering the market near the close of the third day and by then the trend reversal confirmation is also given by the market. The Stop Loss for this trade is the high of the third candle. Trailing Stop losses is the best strategy to ride this move.

Three White Soldiers

The three white soldiers is a bullish reversal candle. The trend prior to the formation of this pattern is bearish. This trend has three green candles formed. The opening of every candle is slightly below the previous days close and it closed above the previous day’s high. One can exit their existing short positions and enter fresh longs to initiate a new trade.

A risk-taking trader can execute trade before the close of the third candle and a risk-averse can execute his trade after the confirmation of the trend. The stop loss for this trade is the low of the first candle.

three white solders - Multi Candlesticks Patterns

Three Black Crows

Three black crows is a bearish reversal pattern. The prior trend is a bullish trend with new highs been made every day. The opening of the candle is slightly above the previous day but the closes is lower than the previous day low. Fresh shorts can be initiated with stop loss over the high of the first candle. One should keep trailing his stop losses as the trade starts to move in their favor.

Also read:

Conclusion

From the discussion above, we see various multi candlesticks patterns which can be useful barometers in the trade execution. There are some patterns that are frequent and followed more regularly and other not so frequent but very reliable patterns.

But by no means, these technical indicators to be followed blindly. One should see the technical factors going around and use informed judgment in executing their trade. “Happy Trading and Money Making!”

April 28, 2020 Options Trading, Technical Analysis, Trading 2 comments
Introduction to Candlesticks - Single Candlestick Patterns cover

Introduction to Candlesticks – Single Candlestick Patterns

A Guide to Single Candlestick Patterns: If you want to become a successful stock market trader, it is very important that you learn to read and understand candlesticks or candles. These candlesticks are basically a style of technical chart used to describe price movements of a stock, derivative, or currency. Understanding candlesticks and their patterns can help you to decide the entry and exit points for your trades.

“I just wait until there is money lying in the corner, and all I have to do is go over there and pick it up. I do nothing in the meantime.” – Jim Rogers

In this article, we are going to discuss what are candlesticks and then look into the popular single candlestick patterns that every trader should know. Let’s get started.

What are Candlesticks or Candles?

Candlesticks are the most common form to gauge the market trends, historical analysis, forecasting future. They are the most potent form of technical indicators. Just like a burning candle throws light to present and future, candlesticks with their patterns throw light on the present and goes a long way in understanding the future trends.

A simple candlestick shows the events which transpired within the selected timeframe. It shows us the open, high, low, close of the day (within the timeframe selected). The length of the candle helps us in understanding the volatility of the day. The longer the length of the candle, the more volatile the day and shorter the candle, the less volatile the day.

candlestick high low open close

The candlestick can be said to be a historical indicator as the candlesticks are formed on the already happened market action. But the candlesticks formed goes a long way in understanding the future trends and price patterns.

Before we start understanding the various candlesticks patters, I would recommend keeping the following factors in mind:

  1. “Trend is your friend.” Avoid going against the trend.
  2. One should be very flexible with his views. Stubbornness generally leads to disasters.
  3. Historical data analysis goes a long way in understanding future price patterns.
  4. Avoid taking directional trades on small size candles. Generally, trends are formed after substantially long sized candles.

Single Candlestick Patterns

In simple words, a single candlestick pattern is formed by just one candle. Here, we do not look into multiple or group of candles and the trading signal is generated based on a single day’s trading action. The following are some of the popular Single candlestick patterns we would be discussing in this article: The Spinning top, The Marubuzo, The Doji, The Hammer, The Hanging Man, The Shooting Star.

— The Spinning Top

The Spinning Top unlike any other candlestick formation does not give any clear direction of the trend but has a lot of price action associated with it. A Spinning candle looks like the candle shown below:

the spinning top candlestick

Following are the initial observation looking at the candle:

  1. The body of the candle is very small compared to upper and lower wicks.
  2. The wicks on both sides are generally of similar size.

The spinning although looks like a plain candle but has a lot of price action associated with it. The small main body would imply that the open and close of the candle are very close to each other. Because the open and close are so close to each other, the colour of the candle usually does not signal any trend.

The upper body shows the high for the day. This simply signifies that the bulls did make an attempt to go up but to no avail.

The lower body has similar characteristics like the upper body. This simply signifies that the bears tried to push the market down but were not successful in doing it.

— The Marubuzo

The Marubuzo is again a single candlestick pattern. It is probably the only candlestick pattern in which the prior trend is not given much importance. Only the last candle is given importance.

the marubuzo candlestick

The green line above explains Bullish Marubuzo and the red line represents Bearish Marubuzo.

— Bullish Marubuzo

In Bullish Marubuzo, the open of the candle is low for the day and the close of the candle is high for the day. There are no wicks in this candlestick pattern. This candlestick can also be said to be a trend changing one. The intensity of the buying is so high that the traders are willing to buy the stock at the high of the day. This candlestick patterns simply implies that the buying will continue for the days to come. The recommended buying price is the closing price of the Marubuzo candle.

Theoretically, the open should be low and the close should be high. But in reality, a little bit of variation is allowed.

Let us understand it with the help of a hypothetical example: The XYZ company share price has formed a Marubuzo candle with: Open = 403, High = 450, Low = 400, Close = 449.

Now the trader’s risk profile defines the time of execution of the trade. A Risk-taker would be taking the trade on the day the Marubuzo is formed. So how does this Risk-taking trader gets confirmation about the formation of Marubuzo? The trader basically does that by taking the trade very close to the end of the day.

On the other hand, a Risk-averse trader would be taking the trade the next day once the trend is confirmed. So, a risk-averse trader entry price might be higher than the risk-taking trader but has a better assurance about the pattern formation.

One very important thing to be kept in mind is that one has to be very mindful of the fact that the trade has to be executed with a stop loss in mind. Stop loss helps the trader to minimize the losses because of the inherent risks associated with the trade.

— Bearish Marubuzo

In a Bearish Marubuzo, the open of the candle is high for the day and the low of the candle is close for the day. A bearish Marubuzo indicates that the selling pressure is so high that the trader is willing to sell the share at the lows of the day expecting more negativity in the price of the share. This candle indicates a change in momentum and this changed momentum is set to last over some time.

One should bear in mind that this kind of trades are generally not meant for scalping purposes, they are to held until the trade reaches its desired price. Trailing stop losses is the best strategy.

— The Doji

The Doji is a candle formation that does not have a real body. It just has wicks on either side. So, the opening and closing price of the candles are one and same.

the doji candlestick - Single Candlestick Patterns

The Doji pattern can sometimes be similar to a spinning top except for the fact that Doji does not have any real body. Dojis are generally momentum changer or momentum halter. These candles clearly show the indecisiveness amongst the traders about the momentum and the direction of the market. Let’s examine it with the help of the following situation.

Say the market is in a bullish momentum and has had green candles over a series of days. So, if a Doji candle is formed, it could simply imply the dwindling momentum in the market or could mean an end in current momentum and signal trend reversal. Therefore, it is advisable in this scenario to be cautious and exit the long position or at least one should have stop losses in place. This is generally a time to wait and watch before entering new trades.

Also read: Options Buying vs Selling: Which Strategy to Use?

— The Hammer

The Hammer pattern is one of the most convincing trading patterns simply because of its formation pattern.

the hammer candlestick

The hammer pattern occurs when the candle opens at high but is not able to sustain there and it falls considerably but with continuous buying interest is able to recover and the candle closes in green and near the opening price. The length of the wick here has to be at least twice the size of the body.

In the diagram above, a bullish hammer has formed at the bottom of the bearish trend and the momentum changes significantly after the hammer formation. One Important thing to be kept in mind is that the hammer can be of any colour (green to red) as long as it meets the body to wick ratio. Few characteristics of hammer trade:

  1. The hammer formation generally gives a bullish or a long trade.
  2. The execution time of trade depends on the risk appetite. A risk-taker would execute the trade on the same day and a risk-averse will wait for the confirmation of the trade.
  3. The Stop loss for this trade is generally below the low of the hammer candle.

— The Hanging Man

According to Investopedia, “A hanging man uptrend and warns that prices may start falling. The candle is composed of a small real body, a long lower shadow, and little or no upper shadow. The hanging man shows that selling pressure is starting to increase”.

One important criterion for a candle to be called as a hanging man is that the market has to be in a bullish trend. Just like Hammer, a Hanging man can be of any colour as long as it meets the body to wick criteria. The Stop Loss for the short trades executed via hanging man pattern is the high of the candle.

the hanging man candlestick - Single Candlestick Patterns

— The Shooting Star

As the saying goes, save the best for the last. Probably the most influencing of the single candlestick pattern. The shooting star just looks like an inverted hammer or hanging man. It gives very strong trend reversal signals.

shooting star candlestick

The basic characteristics of the Shooting star are:

  1. The shooting star candle has a long upper wick. Generally, the size of the wick is twice the size of the candle body. The longer the wick, the stronger the pattern.
  2. The shooting star is a bearish reversal pattern, so the preceding trend is bullish.
  3. In general, the shooting star happens on the day when the existing bullish trend is expected to continue.
  4. Once a shooting star candle is formed, it is advisable to exit the long trades or at least put a stop loss and if possible reverse the long positions.
  5. One has to be bias-free when trading this type of formation.

Closing Thoughts

In conclusion, the above discussion should give us a clear picture of the various single candlestick patterns. All the patterns have their individual strengths. One has to be very aware of the basic mantra in the market: “Trend is your friend, always trade bias-free and always trade with a proper stop loss to be a long survivor in this marathon of trading”.

In the next article, we will be talking about Multi candlesticks patterns along with examples. “Happy Trading and Money Making”

April 27, 2020 Options Trading, Technical Analysis, Trading No comments yet
Options Buying and Selling - Two sides of Option Coin cover

Options Buying vs Selling: Which Strategy to Use?

Options Buying vs Selling: Every transaction, right from the days of the Barter system always has had a counterparty. Every seller got to have a buyer to consume the supply. Similarly, in Options too, every option buyer needs to have a counter option seller willing to give his right on the underlying asset.

An options buyer is one who is willing to pay a premium in advance, for having a right to buy/sell (depending on Call/Put) underlying asset on expiry. And an option seller is one who receives a premium as a fee for surrendering his right on Asset till expiry.

Benefits of Options Buying

  1. Options give you the power of Leveraging, as with limited capital one is able to ride the bigger move.
  2. The Risk involved here is to the tune of Premium paid. Say, if someone is buying a Nifty call option by paying a premium of 40. And a Nifty lot consists of 75 units. Therefore, the total premium paid will be equal to 40*75 = Rs. 3,000. So, by paying a premium of Rs. 3000 one is able to ride the full move.
  3. The option buyer has the opportunity of earning unlimited profit by just paying a premium and the loss is limited to premium invested.

Benefits of Options Selling

To understand this, let us understand the scenarios option contracts move to at expiry:

  1. When the Spot price moves above the strike price at expiry, the option expires In The Money. Options buyers gains and makes money.
  2. When the Spot price is at or near the strike price at expiry, the option expires At The Money. The Option seller earns the premium received as his income as the contract expires worthless for the buyer.
  3. When the Spot price is below the strike at expiry, the option expires Out Of Money. The Options sellers earns the premium received as income as the contract expires worthless for buyer.

So, from the three scenarios mentioned above, the Option Buyer makes money in one of the scenarios and the option seller stands to make money in two scenarios. Let us understand more on options buying vs selling with the help of an example:

call put option buying and selling sides of coin 2

Take for example if the Nifty spot is trading at 9325, and the option buyer buys weekly call option of 9400 by paying a premium of 120, then the

— Calculation for In the Money Call option P/L

  • Spot price at Expiry: 9700 (Say)
  • Premium: 120
  • Strike Price: 9400
  • Profit for Option Buyer: (9700-9400-120)*75 = Rs. 13,500
  • Loss for Option Seller: Rs. 13,500

— Calculation for At the Money Call option P/L

  • Spot price at Expiry: 9405 (Say)
  • Premium: 120
  • Strike price: 9400
  • Loss for option Buyer: (9405-9400-120)*75 =Rs. 8,625 loss
  • Profit of Option Seller: Rs. 8,625

— Calculation for Out of Money Call option P/L

  • Spot price at Expiry: 9275 (say)
  • Premium: 120
  • Strike Price: 9400

Here, loss for option Buyer: (9275-9400-120)*75 = Rs. 18375 loss. But the maximum loss for an option buyer is to the tune of premium paid. So the maximum loss to Option Buyer in Out of Money Call option is Rs. 9000

  • Profit of Option Seller: Rs. 9000

The option buyer starts making money once he reaches a breakeven point on his trade. The Breakeven point is calculated as follows: Breakeven Point = Strike price + premium paid

Also read: Options Trading Definitions – Must Know Terms for Beginners

Margin Calculation

There is no Margin required to buy an option. Just the premium is required to be paid to option seller. Say, to buy a Nifty call option, the premium required to be paid is 40. Then, the total premium to be paid will be = 40*75 = Rs. 3,000.

But in case of selling options, margin along with exposure has to kept with the broker, to account for day to day volatility. The margin is required to be deposited here because seller of an option is exposed to unlimited risk.

Margin for selling option = Initial Margin + Exposure Money

Which strategy to use?

There is no straight answer as to which is better: Buying or Selling. Each have their own benefits and negatives:

1. In case of buying, the buyers risk is limited to premium paid and in return, he gets right on underlying asset till maturity. But selling has its own benefit of receiving income (premium) beforehand and have to pay anything only if the spot price goes above the strike price. Even in that case also the seller has the protection of premium beyond strike price. Therefore, the real loss for seller happens (in case of call option) when: (strike price + premium) < spot price.

2. The option buyer is always in the game to make money, as long as the option does not expire but his probability reduces as the contracts keep moving closer to expiry. And option seller is always exposed to unlimited risk but his risk reduces with time because of less time for the individual assets to make substantial movement in a particular direction.

3. Both option buyers and sellers have the option to exit their trades before expiry. If the option buyer sees that the premium of his position is more than what he paid and he wants to book profit, he can easily do that via options market. And similarly, the option seller can get out of his position if he sees a substantial move of premium in his favour or sees a position going against him.

Also read: What is India VIX? Meaning, Range, Implications & More!

Closing Thoughts

From the above discussion, we can easily conclude by saying that there is no right strategy as to buying or selling options. And there are arguments both in favour and against options buying vs selling.

Choosing the right strategy depends on one’s objective, rational, and risk-taking appetite.

April 26, 2020 Options Trading, Trading No comments yet
Options Trading Definitions - Must Know Terms for Beginners cover

Options Trading Definitions – Must Know Terms for Beginners

Options Trading Definitions: Options as the name would suggest, gives you the right but not an obligation to own a financial instrument. But, before going deep into the technicalities of this instrument, let’s have an understanding of some of the key terminologies (jargon) used while trading options. Today, we will be covering jargon like Strike price, Underlying price, In The Money, At The Money, Out Of Money, etc.

Options Trading Definitions – Must Know Terms for Beginners

— Strike Price

The strike is the exercisable price of the options contract. The call option holder makes money if upon expiry the spot price is above the agreed strike price. And similarly, put option holder makes money if the spot price is below the agreed strike price.

The strike price is fixed in the options contract. Say, a trader has bought a call option contract (assuming 1,000 shares in a lot) of ABC Company for Rs. 75 strike price. So, over the duration of the contract, the call option holder has the right to buy 1,000 shares at Rs. 75. If the price of the share goes to Rs. 125, the option holder stands to make Rs. 50,000 (=50*1000) on the trade. And Vice versa for the Put option holder.

Also read: Options Trading 101: The Big Cat of Trading World

— Underlying Price

Underlying price is the spot price of the underlying asset of a derivative. For example, if someone owns a call option to buy one lot of ABC Enterprises. If ABC Enterprises is currently trading at Rs 15 per share, the underlying price is Rs 15. The difference between the underlying price and strike price greatly influences the option premium.

— In The Money (ITM)

As the name would suggest, ITM would simply mean something which already is making money. In options terminology, ITM means an option contract whose spot price of the underlying asset is above the strike price for call option and below the strike price in case of the Put option.

For Example, if the spot price of the ABC Company is Rs 50 then the strike price of the ITM Put option will have to be Rs. 51 or more. The premium cost as a factor must also be considered.

— At The Money (ATM)

An At The Money Option contract is one whose spot price and the strike price of the underlying asset are same. The options premiums are at their most crucial stage when the options contract are trading ATM. For example, if XYZ stock’s spot price is Rs.75, then the XYZ 75 call option (CE) is at the money and even the XYZ 75 put option (PE).

An ATM contract has no intrinsic value but has time value before expiry. For Example, on 10 April 2020, ABC share has a spot price of Rs. 100 and the 100 CE (for April Expiry) is trading ATM but still has a premium of 10. The reason for this is simply the fact that the contract still has 20 days to expiry. As and when the contract moves towards expiry, the premium erosion will happen in this contract because of less time available for the stock price to make a substantial move in any direction.

— Out of Money (OTM)

A contract is called OTM when the strike price of a call option is above the spot price of the underlying asset. In case of a Put option, a contract is called Out of Money when the strike of the underlying asset is below the spot price of an option contract. For example, if the spot price of the ABC Company is Rs. 70 then the strike price for the OTM call option will be Rs. 69 or less.

Relationship between various terminologies

For call options, the further away the strike price from the spot price, the economical the option. The following table shows the various strike price and the premiums and other factors for a stock trading at Rs 50.

Strike PriceMoneynessCall option premiumIntrinsic valueTime Value
35ITM15.5150.5
40ITM11.25101.25
45ITM752
50ATM4.504.5
55OTM2.502.5
60OTM1.501.5
65OTM0.7500.75

Conversely, for put options, the following table shows the various strike price and the premiums and other factors for a stock trading at Rs 50.

Strike PriceMoneynessCall option premiumIntrinsic valueTime Value
35OTM0.7500.75
40OTM1.501.5
45OTM2.502.5
50ATM4.504.5
55ITM752
60ITM11.25101.25
65ITM15.5150.5

— Moneyness

Moneyness in simple terms explains the amount of money the option holder was to make if he were to exercise his right immediately. It simply explains the intrinsic value (i.e., the amount received by the buyer) of an option.

— Options Expiry

In financial terms, the expiration date of an option contract is the last date on which the holder of the option may exercise it. A call/put option will be in-the-money if the stock is above/below the strike price and will be executed by the option buyer upon expiration.

If the stock price is above the Put option strike price, the option expires worthless. The weekly options expire every Thursday in Indian Equity Market and the monthly options expire on the last trading Thursday of every month. If Thursday is a holiday, then the options expire the previous day.

options expiry buyer and seller

— Options Premium

The option premium is the fees paid to the option seller by the option buyer for having a right on an underlying asset before expiry. If the option expires In the Money then the option buyer has the right to exercise the option contract. If the option expires Out of money, then the option buyer stands to lose to money i.e., the premium paid. The premium is the income generated by an option writer/seller.

Say, the stock price of XYZ Company on 10th April 2020 is Rs 500. An option buyer buys 530 call at Rs. 15 from option seller. Upon expiry, if the price of XYZ id 575, then the income made by the buyer is Rs 30 (Spot price – strike price – option premium).

Further, let’s assume upon expiry if the spot price of XYZ Company is Rs. 520, then the option will expire worthless for option buyer and the premium will be income earned by the option writer/seller.

Again if the price of XYZ shares upon expiry is Rs. 540, then the contract expires ITM for option buyer but he still stands to lose money. Following is the calculation to explain:

  • Strike Price: Rs 530
  • Option premium: Rs 15
  • Spot Price upon expiry: Rs. 540.

Here, the total Income of Option Buyer: Rs. (540- 530-15) i.e. Rs. -5. So the intrinsic value will be 0.

On the other hand, the total Income of Option Seller: Rs. (530+15-540) i.e. Rs. 5.

— Options Settlement

Let’s understand this with the help of an example: There is a call option to buy XYZ at Rs.50. The expiry is 30th Jan 2020 (last Thursday). The premium is Rs 4 and one market lot has 7,000 shares.

Assume there are two traders – Trader A and Trader B. Trader A wants to buy (option buyer) and trader B wants to sell (write) this agreement. Here is how the money movement will happen

Since the premium is Rs 4 per share, Trader A is required to pay a total of 7,000 * 4 = Rs 28,000 as a premium amount to Trader B.

Now because Trader B has received this Premium form Trader A, he is obligated to sell Trader A, 7000 shares of XYX on 30th Jan 2020, if Trader A decides to exercise his agreement. However, this does not mean that Trader B should have 7000 shares with him on 30th Jan. Options are cash-settled in India. This simply means on the last day if Trader A wants to use his right to exercise his option then Trader B is obligated to pay just the cash differential.

To help you understand this better, consider on the last Thursday (expiry day) of January XYZ is trading at Rs.65/-. This means the option buyer (Trader A) will exercise his right to buy 7000 shares of XYX at 50/-. In other words, he is getting to buy XYZ at 50/- when the same is trading at Rs.65/- in the open market.

Another way to look at it is that the option buyer is making a profit of Rs.15/- per shares (65-50) per share. Because the option is cash-settled, instead of giving the option buyer 7000 shares, the option seller directly gives him the cash equivalent of the profit he would make, which means Trader A would receive

= 15*7,000 = Rs 1,05,000/- from Trader B.

Of course, the option buyer had initially spent Rs.28,000/- towards purchasing this right, hence his real profit would be –

= Rs (1,05,000-28,000) = Rs 77,000 /-

The fact that one can make such a large exponential return is what makes options an attractive instrument to trade. This is one of the reasons why Options are one of the most favorite trading instruments amongst Traders.

Also read: What is Bank Nifty? The Index That Summarizes Economic Health

Key Takeaways

In this article, we discussed a few of the frequently used stock options trading definitions or jargon like Strike price, Underlying price, In The Money, At The Money, Out Of Money. Here are the key takeaways from this post:

  • It is advisable to buy a call option only when one anticipates an increase in the price of an asset.
  • The strike price should be as close as possible to the current price to avoid quick premium decay because of the time factor.
  • The underlying price is simply the spot price of the asset.
  • Weekly options contact expire every Thursday and monthly Option contracts expire on the last Thursday of every month. If Thursday is a holiday then it expires the previous day.
  • Options are cash-settled in India

In conclusion, a clear understanding of the complexity of the instrument goes a long way in making use of the financial instrument for meeting one’s own financial goals and financial independence.

April 24, 2020 Options Trading, Trading 1 comment
what is bank nifty meaning

What is Bank Nifty? Index That Summarizes Economic Health

What Is Bank Nifty? Bank Nifty is the Index that comprises of the most liquid banks listed on the National Stock Exchange (NSE). Bank Nifty comprises the twelve leading banks (inclusive of both the Public sector and Private sector) that are publically listed on NSE. Following is the list of 12 banks included:

  1. Axis Bank Ltd
  2. Bank of India
  3. HDFC Bank Limited
  4. ICICI Bank Limited
  5. Bank of Baroda
  6. Canara Bank
  7. Kotak bank limited
  8. IDBI Bank Limited
  9. Oriental Bank of Commerce
  10. State Bank of India
  11. Punjab National Bank
  12. Union Bank of India

The Bank Nifty index is the highest traded Index in Futures and Options Market. In fact, Bank Nifty and Nifty Index have a very high positive correlation because of a very high weightage of Bank Nifty in Nifty 50 Index.

A Brief History on Bank Nifty

The Bank nifty was introduced in September 2003 but its base year is considered to be January 01, 2000. The base value in the year 2000 was taken to be 1000. So, if Bank Nifty right now is trading at 20,000, that means it’s given returns of 20 times over the last 20 years.

The Bank Nifty values are available on the real-time market and its volume of trading is more than that of Nifty index. It’s the first Index with weekly expiring options with the highest volume of trading and hence very liquid.

Nifty Bank Top constituents by weightage

Here is the weightage of the top ten banks constituting Bank Nifty As on March 31, 2020:

Nifty Bank Top constituents by weightage

Source: (NSE India)

Looking at the above representation above we notice that the top 5 banks constitute almost 85% of the Bank Nifty. So naturally, any movement in one of these 5 banks have a lot of bearing on Bank nifty and even the Nifty 50 Index.

Private sector banks have a major portion in Bank Nifty and very few public sectors make the cut. This could also be because Private sector banks (unlike the public sector banks) are more modernized and technologically better equipped to tackle the needs of modern banking system. And hence the trading activity in Private sector banks are also higher.

Even if we were to see the breakup of the Nifty 50 index, we can see that Bank Nifty occupies about 28.5% share (highest for a sector), followed by Technology (18%) and Oil & Gas (14.5%). Therefore, if we see a substantial move in Index, we can safely assume that banking sector must have played a part in it and index move must have also impacted the Bank Nifty Index.

Also read: What is Nifty and Sensex? Stock Market Basics (For Beginners)

How Weightage is decided in Bank Nifty?

To simply put, the weightage of banks in Bank Nifty is purely dependent on the free-float market capitalization of banks. The Free float market capitalization does not mean the full capitalization method. It basically means the market value of the total number of shares (excluding promoter holding, government and insiders) actively trading at exchange.

The free float method is the best way to judge a banks weightage in the Bank Nifty Index. The current share price decides the weightage and the banks day to day performance has a lot of bearing on their share price and which in turns also impacts the Bank Nifty movement. The corporate policies, the innovation, the products, bank-specific news, corporate policies etc., impact the share price which in turn impacts their weightage.

Therefore, from the above discussion, we can easily conclude that HDFC bank is not guaranteed top position in the Bank Nifty index. It can be taken over by any bank if that bank share price starts to outperform that of HDFC banks share price over a period of time.

Trading Bank Nifty Futures

A futures contract is a forward with fixed expiry date and the contracts expired can be rolled over to next contract. The Bank Nifty futures contracts are derivative instruments deriving value from the Bank Nifty Index.

The Bank Nifty futures contract have three contracts running simultaneously. The 1st month (near one), the next month (the two month contract) and the far month (three month).

When the near month contract expires, a new far month contract is introduced. So at any point of time, there are three active contracts in Bank Nifty futures. Bank nifty futures contract expire on last working Thursday (or previous day if the last working Thursday is a holiday) every month

Trading Bank Nifty Options

As discussed in my previous article, options are contractual rights (not obligation) of the option buyer and obligatory duty of option seller. The Bank nifty option contracts are cash settled. Bank Nifty options contract derive their value front he Bank Nifty Index (Underlying asset).

Just like the futures contract, even the bank nifty options contract have three monthly contracts (Near one, two month one and a far one). And once with the expiry of the near month contract, a new far month contract is added. Bank Nifty has 7 weekly expiring contracts. At the expiry of near week, a new serial weekly contract is introduced.

The weekly expiry contract expire every Thursday of the week and if that Thursday is a holiday, then the contract expires the previous day. Similarly, the monthly Bank Nifty options contract expire on the last Thursday every month and again if the last Thursday is a holiday then the contract expires on the previous day.

Also read: Options Trading 101: The Big Cat of Trading World

Closing Thoughts

To Summarize this article, we can conclude by saying that the overall health of the economy can be gauged by looking at the health of its banking system. Bank Nifty goes a long way in explaining it. Bank Nifty constitutes 12 of the major public and private banks in the Indian Banking system. Bank Nifty options contract form a majority in the Indian Options market and they have a series of weekly and monthly expiring contracts.

April 20, 2020 Options Trading, Trading 1 comment
Option Trading 101 Call Put Options cover

Options Trading 101: The Big Cat of Trading World

Introduction to Options Trading: Options are financial instruments whose value is derived from the value of an underlying (aka involved) asset like security or an asset. An options deal offers the buyer the opportunity to buy or sell depending on one’s view on the value of involved security. Owning a call option gives the right to buy shares on expiration at strike price and owning a put option gives right to sell at strike price at expiry.

The options when bought or sold need not necessarily be exercised at the Expiry and at strike price. They can be exercised anytime until the options expiry. So if used judiciously the options are considered less risky than stocks or futures contract. Because of this system, options are considered derivative securities – which means their price is derived from involved assets. However, options, do not represent ownership in the company.

Let’s understand with an example

Imagine Mohan has a wedding in his house after four months and wants to buy gold for the same. However, he is fearful of the fact that the gold price might go up in the future. Therefore, to protect himself from the risk of price fluctuations, he goes to a Jewelry shop, and enters into an agreement with the shop owner whereby he fixes the price for jewelry for buying four months down the line, at the current price of Gold.

options trading gold example

But, you must be wondering as to, what is the incentive here for the Jewelry shop owner to fix the price because he is potentially taking a big price risk. If the price goes up after four months, still he’ll have to sell the jewelry at the pre-determined price. Here, his incentive is a small fee (i.e. Premium/Token) that he will be charging to Mr. Mohan for fixing the price of gold. And this fee here is non-refundable.

Say, four months down the line if the price of gold goes up then Mr. Mohan has the right to buy gold at the pre-decided price. On the other hand, if for some reason if the price of gold comes down then he does not have to exercise his right, i.e. he may choose to buy jewelry from some other shop at the discounted current price. He merely stands to lose his premium/token.

Why would an investor use options?

When an investor or trader is buying an options contract, he/she is betting on the stock price to go in his favour (up for call option and down for pit option). The price at which one agrees to buy the involved asset via the option is called the “strike price,” and the price paid for having this right is called the “options premium.”

Benefits of Options Contract

Here are a few key benefits of Options contracts:

  1. As the name would suggest, the Options contract gives the right to option buyer to exercise his contract if he wishes to. If the Spot price doesn’t go in favor of the buyer of the contract he does not have to exercise his right, he stands to lose just the premium.
  2. One time premium is the only fee that option buyer has to pay to ride the momentum of underlying price and be a part of a bigger game.
  3. If an option seller is of the opposite view to that of option buyer, he can just sell the option contract and pocket premium income.
  4. The options are less risky than equities. Say for example if a trader wants to buy 1000 shares of Reliance, then at CMP (Rs 1400 per share), one has to shed out Rs 14,00,000 (fourteen lakhs). But one can express the same view by buying 2 Call option contracts (500 shares each). Say if he buys At the Money contract of 1410 CE by paying a premium of 35 per lot. Then, his total cost would be = (500*35*2)= Rs. 35000 only. So, now If option were to expire Out of Money for option buyer, he just stands to lose premium only. But, if the share price of Reliance Industries comes down to Rs. 1300, then total loss of equity shareholders will be Rs. 1,00,000 (1000*100).
  5. Return on investment for an option buyer is very high because the cost paid is just the premium and the potential return is unlimited.

Call and Put Options

call and put options

The Call/Put options are financial derivative instrument, meaning that their movement is dependent on the price movement of the involved asset or security. The real purpose of buying a call option is that the trader/investor is expecting the price of the involved security to move up in the near future and vice versa for the call option seller.

A Put option is bought by the trader or investor when he expects the price of an involved asset to fall in near future and vice versa for put option seller or writer. The option writer although earns premium while selling but runs the risk of giving up the involved asset in case the options goes in favor of option buyer.

Breaking down Call Options

For U.S. style options, a call option buying contract gives the buyer to buy the involved asset at strike price anytime till the expiry date of contract. In case of an European style option, the call option owner has the power to exercise only on the expiry date.

It is beneficial for the call buyer to power his right to sell his call option if the spot price moves above strike price before expiry and call option writer to bind by his promise.

The premium paid by the option buyer gives him the right to buy the involved stock or security at strike price until the expiry of options agreement. If the price of the asset moves beyond the strike price, the option will be In the money

The options writer receives the premium. The premium received is the way of generating income for the option writer or seller. But the option writer’s income is limited to the money received as premium and runs the unlimited risk of paying up the option buyer in case the involved security going above the strike price.

Call options can be In, At, or Out of the money. For example, If the Index is currently trading at 9500, an In the money call option will be to buy the option with the strike below 9500 (say 9400 CE), An At the money call option will be to buy an option will the strike price at 9500 and an Out of money call option will be to but strike price above 9500 (say 9600 CE). An In the money call option are the most expensive ones and the out of money options are the cheapest but they carry the most risk of expiring worthless.

Breaking down Put Options

Options contract duration can vary from very short term (weekly) to long term (monthly contracts). It is profitable for the put option buyer to exercise or sell his option if the spot price of the involved security comes below the strike price.

The premium paid by the put option buyer gives him the right to sell the involved stock or security at strike price until the expiry of options agreement.

The options writer receives the premium. The premium received is the way of generating income for the option writer or seller. But the put option writers income is limited to the money received as premium and runs the unlimited risk of paying up the option buyer in case the involved security going below the strike price.

Just like Call option, even Put options can be In, At, or Out of the money. For example, If the Index is currently trading at 9500, an In the money put option will be to buy the option with the strike above 9500 (say 9600 PE), An At the money Put option will be to buy an option will the strike price at 9500 and an Out of money Put option will be to but strike price below 9500 (say 9400 PE).

An In the money pall option are the most expensive ones and the out of money put options are the cheapest but they carry the most risk of expiring worthless.

Also read: 3 Best Sites to Learn Virtual Stock Trading in India (Without Risking Your Money)

Various Option strategies depending on one’s view on Market

Market viewOptionPosition NameOther trading AlternativesPremium
BullishCall Option (Buy)Buy CEBuy Futures(Spot)Pay
BearishPut Option (Buy)Buy PESell FuturesPay
Flattish or BullishPut Option (Sell)Sell PEBuy Futures (Spot)Receive
Flattish or BearishCall Option (Sell)Sell CESell FuturesReceive

Closing Thoughts

In this article, we have discussed two basic options types: Call Options and Put options. But from the graph above, we see there are four different options trading players i.e., Call Option Buyer, Call option seller, Put option buyer, Put Option Seller.

Call option and put option buyers have limited risk to the tune of option premium but have unlimited gains potential. But the call and put options writer’s risks are unlimited and the maximum reward is the premium charged from option buyers.

To Summarize, an option is a contract which is optional i.e., it is not obligatory for the buyer to buy or sell the involved security or asset at pre decided strike price within the stipulated/expiration time. Because they’re cheaper to purchase (compared to buying same number of shares), they have the power of leveraging limited money of the investor.

April 16, 2020 Beginner's guide, Options Trading, Trading 10 comments
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