1. Daily Derivatives Outlook
14 February 2013
Currency and Indices Option Trades
Nifty( February and March)
Highest Call OI at 6100
Highest Put OI at 5900 Buy Nifty 6000 Call at 52 with stop loss at 26
Equilibrium & Short Straddle at 5950
Feb Short Strangles
6000C & 5800P, 6100C & 5700P Directional Stock Bullish Option Trades
March Short Strangles
6000C & 5900P, 6100C & 5800P Buy ITC 300 CALL at 5.8
6200C & 5700P, 6300C & 5600P
April Short Strangles Buy Petronet 150 CALL at 2.75
6100C & 5900P, 6200C & 5800P
Buy HDFC 820 CALL at 10
6300C & 5700P, 6400C & 5600P
6400C & 5500P Buy Sun Pharma 780 CALL at 13
Bank Nifty( February )
Highest Call OI at 13000
Highest Put OI at 12000
Directional Stock Bearish Option Trades
Equilibrium & Short Straddle at
12400
Buy Tata Steel 380 PUT at 11.3
Feb Short Strangles
12500C & 12300P, 12600C & 12200P Buy Sesa Goa 160 PUT at 2
12700C & 12100P, 12800C & 12000P
12900C & 11900P, 13000C & 11800P Buy Reliance Infra 480 PUT at 13.5
USD/INR(February & March)
Highest Call OI at 54 Buy Mcdowell 1850 PUT at 59
Highest Put OI at 54
Buy BHEL 200 PUT at 3.45
Equilibrium & Short Straddle at 54
Feb Short Strangles Buy Hindalco 110 PUT at 2.9
54.25C& 53.75P, 54.5C & 53.5P
54.75C & 53.25P, 55C & 53P
March Short Strangles
54.5C & 53.5 P, 55 C & 53P,
55.5C & 52.5P , 56C & 52P
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2. READY RECKONER ON OPTION AND TECHNICAL STRATEGIES :
INTRODUCTION TO OPTIONS:
 Options are Wasting Assets with Option Pricing like Insurance Pricing.
 Strike Price is similar to Age of the Assets.
 OTM(Out of the Money) are Low Probability strikes (young assets), ATM (At the Money)
are equal probability strikes (average age assets) and ITM (In the Money) are High
Probability strikes ( old assets).
 Premium reduces from ITM to ATM to OTM as probability of event happening reduces.
 Mirror Image Concept : OTM for Calls is same as ITM for Puts and ITM for Calls is same as
OTM for Puts.
 View for Strike Selection : OTM - Strong conviction. ATM - Moderate conviction . ITM –
Low Conviction
 Advantages of Options – Profit from Trading range Markets, High Leverage, Built-in Stop
Loss, Higher Probability of Profit using Spread Trades, Increase in trading opportunities due
to multiple legs, Lower Margin requirements due to high gearing in options, Increase in
Reward to Risk ratio.
OPTION INTERNALS:
 Call-Put Parity : Futures Price = Strike Price + Call Premium – Put Premium
 Put Call Ratio ( Open Interest) is bullish at levels between 0.8 to 1.2 and bearish between
1.75 to 2.
 Equilibrium strike is with equal Call and Put Open interest with Highest Call Open interest
strike as resistance and Highest Put Open interest as support.
 Greeks – Delta is the Probability. Gamma is the Change in Delta. Theta is the change in
time remaining.
 Vega is the Change in Volatility (VIX) and Rho is the Change in Interest Rate.
 If VIX ( Volatility Index) is above average selling options is preferred and if VIX is below
average buying options is preferred. The long-term average of the India VIX is around 24.
 Historical Volatility (Realized Volatility) is based on the standard deviation of the
underlying asset while Implied Volatility is derived from the option premium traders are
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3. willing to pay to hedge their positions.
 The Put Implied Volatility generally trades at a premium to Call Implied Volatility with
panic or fear conditions in the market leading to expansion of the premium.
RISK MANAGEMENT:
 Risk Management using options - Quantify the maximum risk and maximum reward and
the breakeven points of a position before committing capital. A risk manager always focuses
on how much can be lost in a position. Control the losses and the profits will take care of
themselves. Determine an exit strategy in advance for every trade initiated. An exit strategy
enables closure of loss-making positions unemotionally so that there is no freeze or panic
when confronted with the loss.
 Stop Loss : Use 50% stop loss for premium paid or received for both one-leg and multiple-
leg strategies.
ONE-LEG STRATEGIES:
 Long Call and Long Put are Limited Risk and Unlimited Reward strategies.
 Short Call and Short Put are Unlimited Risk and Limited Reward strategies.
TWO LEG STRATEGIES:
 Long Synthetic ( Buy ATM Call and Sell ATM Put) and Long Combo( Buy OTM Call and
Sell OTM Put) are used to create synthetic long positions which have lower margins than
comparable futures positions.
 Short Synthetic ( Buy ATM Put and Sell ATM Call) and Short Combo( Buy OTM Put and
Sell OTM Call) are used to create synthetic short positions which have lower margins than
comparable futures positions.
 Long Straddle, Long Strangle and Long Guts are Long volatility strategies ahead of
events/results etc.
 Short Straddle, Short Strangle and Short Guts are Short volatility strategies when range-
bound action is anticipated.
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4. TWO-LEG FUTURE AND OPTION COMBINATION STRATEGIES:
 Protective Put and Protective Call protect futures positions by buying options.
 Covered Call/Ratio Call Write and Covered Put/Ratio Put Write cover futures positions
by selling options. They involve unlimited risk and limited reward.
 Collar is a combination of the Covered Call and the Protective Put or the Covered Put and
the Protective Call.
TWO-LEG AND THREE- LEG SPREAD STRATEGIES:
 Bull Call Spread, Ratio Bull Call Spread and Bull Call Ladder are bullish debit spreads
which involve buying a lower call option and selling upper call options.
 Bear Put Spread, Ratio Bear Spread and Bear Ladder are bearish debit spreads which
involve buying a upper Put option and selling a lower Put option.
 Bull Put Spread is a bullish credit spread which involves selling a upper put option and
buying a lower put option.
 Bear Call Spread is a bearish credit spread which involves selling a lower call option and
buying a upper call option.
 Call Ratio Backspread is a credit spread which involves selling one or two lower strike calls
(ITM or ATM) and buying two or three upper strike calls.(OTM).
 Put Ratio Backspread is a credit spread which involves selling one or two upper strike puts
(ITM or ATM) and buying two or three lower strike puts.(OTM).
FOUR-LEG BUTTERFLY AND CONDOR STRATEGIES:
 Long Iron Butterfly is a credit strategy using a combination of the Short Straddle and
Long Strangle, while in a Long Iron Condor the middle strikes are separated.
 Short Iron Butterfly is a debit strategy using a combination of the Long Straddle and Short
Strangle, while in a Short Iron Condor the middle strikes are separated.
 Long Call Butterfly involves buying a lower strike call (ITM), selling two middle strike calls
(ATM) and buying a upper strike call(OTM). In Long Call Condor the middle strikes are
separated.
 Long Put Butterfly involves buying a lower strike put (OTM), selling two middle strike
puts(ATM) and buying a higher strike put (ITM). In Long Put Condor the middle strikes are
separated.
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5. LONG TERM OPTIONS and CALENDAR/DIAGONAL STRATEGIES
 Long Term Options can be used to create investment grade positions using spreads,
synthetics and covered /protective positions.
 Calendar/Diagonal Calls is a debit spread involving buying a long-dated call option and
selling a short-dated call option against it ( Diagonal Calls involve different strikes).
 Calendar/Diagonal Puts is a debit spread involves buying a long-dated put option and selling
a short-dated put option against it ( Diagonal Puts involve different strikes).
DELTA HEDGING METHODS
 The distance between the current market price and the short option breakeven point is
divided into equal parts so that futures exposure is increased at consecutive delta
adjustment points to ensure that the short option position is totally hedged by the time the
breakeven point is reached.
 The size of the short option position is directly proportional to the distance of the short
breakeven point to the current market price. Position size should be maximum at deep-out-
of-the money strikes and reduce gradually as the distance to the market price reduces.
 Short gamma positions carry the maximum risk and using options instead of futures to hedge
is advisable since futures does not cover the gap risk, while using ITM options covers the
gap risk
USING OPTIONS WITH SUPPORT/RESISTANCE AND MOVING AVERAGES:
 Buy call options at Support ( Bottom-fishing) and above resistance ( Breakout) .
 Buy Put options at Resistance ( Top-picking) and Below Support ( Breakdown).
 Moving Average Crossovers – Buy call options if price crosses the moving average from
below and buy put options if price crosses moving average from above.
 The one month options can be linked to the 20dma with the three month options linked to
the 50dma and the 1 year options linked to the 200dma.
USING OPTIONS WITH OSCILLATORS:
 RSI – Buy call options when RSI is below 30 and Buy put options when RSI is above 70.
The RSI 50 crossover can be used to buy calls on the upside crossover and to buy puts on
the downside crossover.
 MACD and Parabolic SAR early warning buy signals indicate buying of calls ( bottom-
fishing) and sell signals indicate buying of puts ( top-picking).
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6.  ADX indicates the strength of the trend and whether the market is in a trending or trading
mode. When ADX is above 25 and +DI is above –DI then buy calls and if –DI is above +DI
then buy puts. When ADX is below 25, then selling strangles and straddles will be profitable.
 Widening Bollinger Bands indicate increasing volatility and option buying is advised as
a trending move is expected.
 Flat or Narrowing Bollinger Bands indicate reducing volatility and range-bound option
selling strategies are advised.
MARKET INTERNALS:
 Market Breadth Indicators – Volume and Delivery Volume Expansion, Open Interest
Expansion and Contraction, Advance/Decline Ratio, 52 Week Highs/Lows.
 Open Interest Expansion and Contraction Rules –
1. Price Up and Open Interest Up – Long Buildup
2. Price Up and Open Interest Down – Profit Taking
3. Price Down and Open Interest Up – Short Buildup
4. Price Down and Open Interest Down – Short Covering.
SECTOR AND STOCK SELECTION:
 Defensive stocks have low to moderate beta in sectors like FMCG, Healthcare, IT,
Cement, Telecom.
 Cyclical stocks have high beta like Financials and Rate Sensitives like Auto, Infrastructure,
Realty.
 Stock Selection – Invest in the constituents from broadbased indices like Nifty, Junior Nifty
and Midcap as well as constituents of Sectoral Indices like Auto, Banking, Capital Goods,
IT, FMCG, HC etc.
 Alpha Strategies - Long Stock and Short Index( Outperformance) or Short Stock and
Long Index ( Underperformance).
 Pair Strategies - Long Stock and Short Stock within the same sector.
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