options and futures

1. FUTURES & OPTIONS PRIMER
PROFIT YOUR TRADE EDUCATION Series
Presented by Cherukuri Kutumba Rao
07-02-2021

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Futures – Understanding the Basics
Futures are derivative financial contracts that obligate the parties to transact an asset at a predetermined future date and price.
The buyer must purchase or the seller must sell the underlying asset at the set price, regardless of the current market price at
the expiration date. Underlying assets include physical commodities or other financial instruments. Futures contracts detail the
quantity of the underlying asset and are standardized to facilitate trading on a futures exchange. Futures can be used
for hedging or trade speculation.
Understanding Futures
Futures—also called futures contracts—allow traders to lock in the price of the underlying asset or commodity. These contracts
have expiration dates and set prices that are known upfront. Futures are identified by their expiration month. For example, a
February futures contract expires on last Thursday of the month.
Traders and investors use the term "futures" in reference to the overall asset class. However, there are many types of futures
contracts available for trading including:
 Commodity futures such as crude oil, natural gas and others
 Stock index futures such as the Nifty Index, Bank Nifty
 Currency futures including those for the dollar, euro and the British pound
 Precious metal futures for gold and silver

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It's important to note the distinction between options and futures. American-style options contracts give the holder the right (but
not the obligation) to buy or sell the underlying asset any time before the expiration date of the contract; with European
options you can only exercise at expiration but do not have to exercise that right. The buyer of a futures contract, on the other
hand, is obligated to take possession of the underlying stock (or the cash equivalent) at the time of expiration and not any time
before. The buyer of a futures contract can sell their position at any time before expiration and be free of their obligation. In this
way buyers of both options and futures contracts benefit from leverage holder's position is closed before the expiration date.
Pros:
• Investors can use futures contracts to speculate on the direction in the price of an underlying asset.
• Companies can hedge the price of their raw materials or products they sell to protect from adverse price movements.
• Futures contracts may only require a deposit of a fraction of the contract amount with a broker.
Cons:
• Investors have a risk that they can lose more than the initial margin amount since futures use leverage.
• Investing in a futures contract might cause a company that hedged to miss out on favourable price movements.
• Margin can be a double-edged sword, meaning gains are amplified but so too are losses.

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Using Futures
The futures markets typically use high leverage. Leverage means that the trader does not need to put up 100% of the contract's
value amount when entering into a trade. Instead, the broker would require an initial margin amount, which consists of a
fraction of the total contract value. The amount held by the broker in a margin account can vary depending on the size of the
contract, the creditworthiness of the investor, and the broker's terms and conditions. The exchange where the futures contract
trades will determine if the contract is for physical delivery or if it can be cash-settled. However, most futures contracts are from
traders who speculate on the trade. These contracts are closed out or netted—the difference in the original trade and closing
trade price—and are a cash settlement.
Futures Speculation
A futures contract allows a trader to speculate on the direction of movement of a stock’s price. If a trader bought a futures
contract and the price of the stock rose and was trading above the original contract price at expiration, then they would have a
profit. Before expiration, the buy trade—the long position—would be offset or unwound with a sell trade for the same amount at
the current price, effectively closing the long position. The difference between the prices of the two contracts would be cash-
settled in the investor's brokerage account, and no physical product will change hands. However, the trader could also lose if
the stock’s price was lower than the purchase price specified in the futures contract. Speculators can also take a short or sell
speculative position if they predict the price of the underlying asset will fall. If the price does decline, the trader will take
an offsetting position to close the contract. Again, the net difference would be settled at the expiration of the contract. An
investor would realize a gain if the underlying asset's price was below the contract price and a loss if the current price was
above the contract price. It's important to note that trading on margin allows for a much larger position than the amount held by
the brokerage account. As a result, margin investing can amplify gains, but it can also magnify losses

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Futures Hedging
Futures can be used to hedge the price movement of the underlying asset. Here, the goal is to prevent losses from potentially
unfavourable price changes rather than to speculate. Many large proprietary brokerages that enter hedges are using—or in
many cases having—the underlying asset. In commodities, for example, corn farmers can use futures to lock in a specific price
for selling their corn crop. By doing so, they reduce their risk and guarantee they will receive the fixed price. If the price of corn
decreased, the farmer would have a gain on the hedge to offset losses from selling the corn at the market. With such a gain and
loss offsetting each other, the hedging effectively locks in an acceptable market price.
Real World Example of Futures
Let's say a trader wants to speculate on the price of Reliance Inds by entering into a futures contract in February with the
expectation that the price will be higher in next three months. The Reliance Inds futures contract is trading at Rs1950 and the
trader locks in the contract. Since Reliance is traded in lots of 250 shares, the investor now has a position worth Rs487500
(1950 x 250 = Rs487500). However, the trader will only need to pay a fraction of that amount up-front—the initial margin that
they deposit with the broker. In India stock futures are available for three months only. Positions can be rolled over every month.
From February to April, the price of Reliance Inds fluctuates as does the value of the futures contract. If price gets too volatile,
the broker may ask for additional funds to be deposited into the margin account—a maintenance margin. At the end date of the
contract is approaching, which is on the last Thursday of the month, the price of Reliance Inds has risen to Rs2000, and the
trader sells the original contract to exit the position. The net difference is cash-settled, and they earn Rs12500, less any fees and
commissions from the broker (Rs2000 – Rs1950) = Rs50 x 250 = Rs12500). However, if the price of Reliance Inds had fallen to
Rs1900 instead, the investor would have lost Rs12500 (Rs1900 – Rs1950 = negative Rs50 x 250 = negative Rs12500).

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Options —Understanding the Basics
There are two basic types of options: calls and puts. The purchase of a call option provides the buyer with the right—but not the
obligation—to purchase the underlying stock (or other financial instrument) at a specified price, called the strike price or exercise
price, at any time up to and including the expiration date. A put option provides the buyer with the right—but not the obligation—to
sell the underlying stock at the strike price at any time prior to expiration. (Note, therefore, that buying a put is a bearish trade,
whereas selling a put is a bullish trade.) The price of an option is called premium. As an example of an option, an Reliance Feb
2000 call gives the purchaser the right to buy 250 shares of Reliance at Rs2000 per share at any time during the life of the option.
The buyer of a call seeks to profit from an anticipated price rise by locking in a specified purchase price. The call buyer's maximum
possible loss will be equal to the rupee amount of the premium paid for the option. This maximum loss would occur on an option
held until expiration if the strike price were above the prevailing market price. For example, if Reliance were trading at Rs1900
when the 2000 option expired, the option would expire worthless. If at expiration the price of the underlying market was above the
strike price, the option would have some value and would hence be exercised. However, if the difference between the market price
and the strike price was less than the premium paid for the option, the net result of the trade would still be a loss. In order for a call
buyer to realize a net profit, the difference between the market price and the strike price would have to exceed the premium paid
when the call was purchased (after adjusting tor commission cost). The higher the market price, the greater the resulting profit.

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The buyer of a put seeks to profit from an anticipated price decline by locking in a sales price. Like the call buyer, his maximum
possible loss is limited to the rupee amount of the premium paid for the option. In the case of a put held until expiration, the trade
would show a net profit if the strike price exceeded the market price by an amount greater than the premium of the put at
purchase (after adjusting for commission cost).
Whereas the buyer of a call or put has limited risk and unlimited potential gain, the reverse is true for the seller. The option seller
(often called the writer) receives the rupee value of the premium in return for undertaking the obligation to assume an opposite
position at the strike price if an option is exercised. For example, if a call is exercised, the seller must assume a short position in
the underlying market at the strike price (because, by exercising the call, the buyer assumes a long position at that price).
The seller of a call seeks to profit from an anticipated sideways to modestly declining market. In such a situation, the premium
earned by selling a call provides the most attractive trading opportunity. However, if the trader expected a large price decline, he
would be usually better off going short the underlying market or buying a put—trades with open ended profit potential. In a similar
fashion, the seller of a put seeks to profit from an anticipated sideways to modestly rising market.
Some novices have trouble understanding why a trader would not always prefer the buy side of the option (call or put, depending
on market opinion), since such a trade has unlimited potential and limited risk. Such confusion reflects the failure to take
probability into account. Although the option seller's theoretical risk is unlimited, the price levels that have the greatest probability
of occurrence, (i.e., prices in the vicinity of the market price when the option trade occurs) would result in a net gain to the option
seller. Roughly speaking, the option buyer accepts a large probability of a small loss in return for a small probability of a large
gain, whereas the option seller accepts a small probability of a large loss in exchange for a large probability of a small gain. In an
efficient market, neither the consistent option buyer nor the consistent option seller should have any significant advantage over
the long run.

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The option premium consists of two components: intrinsic value plus time value. The intrinsic value of a call option is the
amount by which the current market price is above the strike price. (The intrinsic value of a put option is the amount by which the
current market price is below the strike price.) In effect, the intrinsic value is that part of the premium that could be realized if the
option were exercised at the current market price. The intrinsic value serves as a floor price for an option. Why? Because if the
premium were less than the intrinsic value, a trader could buy and exercise the option and immediately offset the resulting market:
position, thereby realizing a net gain (assuming that the trader covers at least transaction costs).
Options that have intrinsic value (i.e., calls with strike prices below the market price and puts with strike prices above the market
price) are said to be in the money. Options that have no intrinsic value are called out of the money options. Options with a strike
price closest to the market price are called at the money options.
An out of the money option, which by definition has an intrinsic value equal to zero, will still have some value because of the
possibility that the market price will move beyond the strike price prior to the expiration date. An in the money option will have a
value greater than the intrinsic value because a position in the option will be preferred to a position in the underlying market. Why?
Because both the option and the market position will gain equally in the event of a favourable price movement, but the option's
maximum loss is limited. The portion of the premium that exceeds the intrinsic value is called the time value.

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The three most important factors that influence an option's time value are the following:
1. Relationship between the strike price and market price. Deeply out of the money options will have little time value, since
it is unlikely that the market price will move to the strike price—or beyond—prior to expiration. Deeply in the money options
have little time value because these options offer positions very similar to the underlying market—both will gain and lose
equivalent amounts for all but an extremely adverse price move. In other words, for a deeply in the money option, risk being
limited is not worth very much because the strike price is so tar from the prevailing market place.
2. Time remaining until expiration. The more time remaining until expiration, the greater the value of the option. This is true
because a longer life span increases the probability of the intrinsic value increasing by any specified amount prior to
expiration.
3. Volatility. Time value will vary directly with the estimated volatility (a measure of the degree of price variability) of the
underlying market for the remaining life span of the option. This relationship results because greater volatility raises the
probability of the intrinsic value increasing by any specified amount prior to expiration. In other words, the greater the
volatility, the greater the probable price range of the market.
Although volatility is an extremely important factor in the determination of option premium values, it should be stressed that the
future volatility of a market is never precisely known until after the fact. (In contrast, the time remaining until expiration and the
relationship between the current market price and the strike price can be exactly specified at any juncture.) Thus, volatility
must always be estimated on the basis of historical volatility data. The future volatility estimate implied by market prices (i.e.,
option premiums), which may be higher or lower than the historical volatility, is called the implied volatility.

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WEEKLY NIFTY AND BANK NIFTY FUTURES & OPTIONS
Fear of volatility has created a big shift towards the options segment of the derivatives markets across exchanges
globally. Traders and investors have been showing more confidence in options, which allow them to substantially
mitigate the risks that financial markets have become so prone to.
Weekly options in Nifty and Bank Nifty indices were launched in last year and have witnessed a meaningful rise in
volumes. And it may be safely inferred that traders are getting inclined to such structuring of derivatives instruments. To
be precise, weekly options allow better participation by traders in a particular binary event, where one is required pay
low premium to get the binary advantage over monthly options in which premiums are high and gamma risk – i.e. the
risk in long duration option contracts expiring in-the-money or out-of-money is extremely high.
Additionally, in the absence of any major event, traders can receive the premium by writing weekly option contracts.
However, the receivable will be less compared with the monthly premium. At the same time, uncertainty or volatility of
these contracts are low due to their short duration, which can help traders enjoy a premium with low, adjustable risk-
reward ratio. Another important advantage of weekly options is the utilisation of hedging strategies.
In uncertain times like the ones we are going through currently, an investor may get caught on the wrong foot in a
particular Nifty stock because of a sudden negative development. To mitigate such overnight or weekly risks, one can
get into a risk-reversal strategy by buying weekly Puts to take care of unsystematic risks. Also, weekly options allow
traders to structure their trades in a more enhanced way in options spread trading. For instance, when one is
anticipating a moderate upside in a stock or the index, one can use a Call Spread strategy and buy weekly Call options
at low premium and sell monthly contracts to receive higher premium, leading to negligible outflow. If the stock or index
remains in the chosen strike range, traders can make decent profit by utilising the weekly contracts.
As volumes are ticking higher and higher, we can extrapolate that the weekly index option market is going to make
substantial contributions to the Indian derivative markets in the days to come.

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Nifty 50 Companies List 2021 (January) weightage wise
HDFC BANK Ltd has the highest weightage having 11.21% weightage in Nifty 50 Stocks Companies list 2021,
whereas Reliance Inds remains at second place having 11.17% weightage & HDFC is on third spot having 7.23% in Nifty
50 Companies list 2020 based on closing prices of July 2020. Top 10 Nifty Stocks are also called Nifty Heavy Weights
Stocks.
1. HDFC Bank Ltd.– 11.21%
2. Reliance Industries Ltd. – 11.17%
3. Housing Development Finance Corporation Ltd. – 7.23%
4. Infosys Ltd. – 7.21%
5. ICICI Bank Ltd. – 5.84%
6. Tata Consultancy Services Ltd. – 5.04%
7. Kotak Mahindra Bank Ltd. – 5%
8. Hindustan Unilever Ltd. – 3.42%
9. ITC Ltd. – 3.03%
10. Axis Bank Ltd. – 2.67%
Interestingly Automobile Majors and Pharma leaders are at
16. Maruti Suzuki India Ltd. – 1.67%
43. Tata Motors Ltd. – 0.58%
22. Sun Pharmaceutical Industries Ltd. – 0.99%
21. Dr. Reddy’s Laboratories Ltd. – 1.05%
Nifty Lot Size: 75 units

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Bank Nifty Stock Companies List with Weightage
Below is the list of Companies that are included in Bank Nifty Weightage Index (Nifty Bank Index Stocks) as
released by NSE India on basis of closing prices of January 31, 2021.
1.HDFC Bank – 26.89%
2.ICICI Bank – 20.01%
3.Axis Bank – 16.59%
4.Kotak Mahindra Bank – 13.55%
5.State Bank of India (SBI) – 10.93%
6.InduSind Bank – 4.85%
7.Bandhan Bank – 2.11%
8.Federal Bank – 1.46%
9.IDFC First Bank Ltd. – 1.00%
10.RBL Bank – 0.97%
11.Bank of Baroda – 0.83%
12.Punjab National Bank (PNB)- 0.81%
HDFC Bank has the highest weightage having 26.89% weightage in Bank Nifty Stock Companies index List,
whereas ICICI Bank remains at second having 20.01% weightage & Axis Bank on third having 16.59% in Bank Nifty
Companies Index List. HDFC Bank, ICICI Bank & Kotak Mahindra Bank are also called Bank Nifty Heavy Weights
stocks. Punjab National Bank (PNB) has the least weightage in Bank Nifty Index with 0.81%.
Bank Nifty Lot Size: 25 units.

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How to Read Options Chain?
Explained with Example
For a beginner in Options trading, an Options Chain Chart may look like a complex maze of data. And it may be overwhelming to
understand. Browse across forums and trading websites and you'll find Options Chain to be a subject of many discussions, with
many traders asking questions like:
"How to read a Stocks Options Chain?"
"How to find Options chain?"
"How to analyze Options chain charts?"
And so on.
Option chain is an important chart, full of vital information that helps a trader make profitable decisions. If you want to make
profitable trades in Options then mastering the Options Chain Chart is a must. I hope this explanation will help you gain a good
understanding of the Options Chain, make sense from the various data available and take the right trading decision.
What is an Option Chain?
An Option Chain Chart is a listing of Call and Put Options available for an underlying for a specific expiration period. The listing
includes information on premium, volume, Open Interest etc., for different strike prices.
Let's first see how an Option Chain looks like and understand the various data available in it. NSE provides you with Option chain
charts for all trading Options. Here's what you need to do find the desired Option Chain:

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1. Visit www.nseindia.com and search for the desired Option in the search bar available at home page.
2. On entering your Options Name, you will be taken to a specific Option page. I entered 'Nifty 50' in the search box and I was taken to
this page:

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3. On clicking the options chain, I was taken into this page. This is what we were looking for- the Option Chart.

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4. The Chart is divided into Call and Put Options. On the left side, we have data for Call Options and Put Options on the right side.

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5. At the center of the chart, we have various strike prices.

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6. On both sides of the strike prices, we have various data like OI, Chng in OI, Volume, IV, LTP, Net Chng, Bid Qty, Bid Price,
Ask Price and Ask Qty.

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7. We also see a part of data on both sides are highlighted in the pinkish shade and the rest is in white.

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Understanding an Option Chain
These are various components of an Options Chart. Let's understand each component in detail now:
Options Type: Options are of two types; Call and Put. A Call Option is a contract that gives you the right but not the obligation to buy the
underlying at a specified price and within the expiration date of the Option. A Put Option, on the other hand, is a contract that gives you
the right but not the obligation to sell the underlying at a specified price and within the expiration date of the Option. Strike price is the
price at which you as a buyer and seller of the Option agreed to exercise the contract. Your Options trade will become profitable only
when the price of an Option crosses this strike price. We can see on both sides of the strike prices, data like OI, Chng in OI, Volume, IV,
LTP, Net Chng, Bid Qty, Bid Price, Ask Price and Ask Qty. let's understand what each of them means:
OI: OI is an abbreviation for Open Interest. It is a data that signifies the interest of traders in a particular strike price of an Option. OI tells
you about the number of contracts that are traded but not exercised or squared off. The higher the number, the more is the interest
among traders for the particular strike price of an Option. And hence there is high liquidity for you to able to trade your Option when
desired.
Chng in OI: It tells you about the change in the Open Interest within the expiration period. The number of contracts that are closed,
exercised or squared off. A significant change in OI should be carefully monitored.
Volume: It is another indicator of traders interest in a particular strike price of an Option. It tells us about the total number of contracts of
an Option for a particular strike price are traded in the market. It is calculated on a daily basis. Volume can help you understand the
current interest among traders.
LTP: It is the abbreviation for Last Traded Price of an Option.
Net Chng: It is the net change in the LTP. The positive changes, means rise in price, are indicated in green while negative changes,
decrease in price, are indicated in red.

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IV: IV is an abbreviation for Implied Volatility. It tells us about what the market thinks on the price movement of the underlying. A higher IV
means the potential for high swings in prices and low IV means no or fewer swings. IV doesn't tell you about the direction, whether upward
or downward, movement of the prices.
Bid Qty: It is the number of buy orders for a particular strike price. This tells you about the current demand for the strike price of an Option.
Bid Price: It is the price quoted in the last buy order. So a price higher than the LTP may suggest that the demand for the Option is rising
and vice versa.
Ask Price: It is the price quoted in the last sell order.
Ask Qty: It is the number of open sell orders for a particular strike price. It tells you about the supply for the Option. Now let's understand
why a part of the date is highlighted in a shade while the rest is in white. To understand it, we need to first learn ITM, ATM, and OTM.
In-The-Money (ITM): A call option is in ITM if its strike price is less than the current market price of the underlying asset. A put option is ITM
if its strike price is greater than the current market price' of the underlying asset.
At-The-Money (ATM): When the strike price of a Call or Put option is equal to the current market price of the underlying asset then it is in
ATM.
Over-The-Money (OTM): A call option is OTM if the strike price is greater than the current market price of the underlying asset. A put option
is OTM if the strike price is less than the current market price of the underlying asset.
The highlighted part is in ITM while those in the white are OTM. So for Call Options, strike prices lower than the current price of the
underlying are highlighted while for Put Options strike prices greater than the current price of the underlying are highlighted.
Conclusion
A deep study of Options Chain can provide with a lot of insights on an Option and help you make an informed decision on your trade. So
master reading an Options chain to make better trading decisions.

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How to Pick the Right Strike Price
The strike price of an option is the price at which a put or call option can be exercised. It is also known as the exercise price.
Picking the strike price is one of two key decisions (the other being time to expiration) an investor or trader must make when
selecting a specific option. The strike price has an enormous bearing on how your option trade will play out.
Strike Price Considerations
Assume that you have identified the stock on which you want to make an options trade. Your next step is to choose an options
strategy, such as buying a call or writing a put. Then, the two most important considerations in determining the strike price are
your risk tolerance and your desired risk-reward payoff.
Risk Tolerance
Let’s say you are considering buying a call option. Your risk tolerance should determine whether you chose an in-the-money (ITM)
call option, an at-the-money (ATM) call, or an out-of-the-money (OTM) call. An ITM option has a higher sensitivity—also known as
the option delta—to the price of the underlying stock. If the stock price increases by a given amount, the ITM call would gain more
than an ATM or OTM call. But if the stock price declines, the higher delta of the ITM option also means it would decrease more than
an ATM or OTM call if the price of the underlying stock falls. However, an ITM call has a higher initial value, so it is actually less
risky. OTM calls have the most risk, especially when they are near the expiration date. If OTM calls are held through the expiration
date, they expire worthless.
Strike Price Points to Consider
The strike price is a vital component of making a profitable options play. There are many things to consider as you calculate this
price level

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Risk-Reward Payoff
Your desired risk-reward payoff simply means the amount of capital you want to risk on the trade and your projected profit target.
An ITM call may be less risky than an OTM call, but it also costs more. If you only want to stake a small amount of capital on your
call trade idea, the OTM call may be the best, pardon the pun, option.
An OTM call can have a much larger gain in percentage terms than an ITM call if the stock surges past the strike price, but it has a
significantly smaller chance of success than an ITM call. That means although you plunk down a smaller amount of capital to buy
an OTM call, the odds you might lose the full amount of your investment are higher than with an ITM call.
With these considerations in mind, a relatively conservative investor might opt for an ITM or ATM call. On the other hand, a trader
with a high tolerance for risk may prefer an OTM call. The examples in the following section illustrate some of these concepts.
Picking the Wrong Strike Price
If you are a call or a put buyer, choosing the wrong strike price may result in the loss of the full premium paid. This risk increases
when the strike price is set further out of the money. In the case of a call writer, the wrong strike price for the covered call may
result in the underlying stock being called away. Some investors prefer to write slightly OTM calls. That gives them a higher return
if the stock is called away, even though it means sacrificing some premium income.
For a put writer, the wrong strike price would result in the underlying stock being assigned at prices well above the current market
price. That may occur if the stock plunges abruptly, or if there is a sudden market sell-off, sending most share prices sharply lower.

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.
Implied Volatility
Implied volatility is the level of volatility embedded in the option price. Generally speaking, the bigger the stock gyrations, the
higher the level of implied volatility. Most stocks have different levels of implied volatility for different strike prices. Experienced
options traders use this volatility skew as a key input in their option trading decisions. New options investors should consider
adhering to some basic principles. They should refrain from writing covered ITM or ATM calls on stocks with moderately high
implied volatility and strong upward momentum. Unfortunately, the odds of such stocks being called away may be quite high. New
options traders should also stay away from buying OTM puts or calls on stocks with very low implied volatility.
Have a Backup Plan
Options trading necessitates a much more hands-on approach than typical buy-and-hold investing. Have a backup plan ready for
your option trades, in case there is a sudden swing in sentiment for a specific stock or in the broad market. Time decay can
rapidly erode the value of your long option positions. Consider cutting your losses and conserving investment capital if things are
not going your way. You should have a game plan for different scenarios if you intend to trade options actively.
The Bottom Line
Picking the strike price is a key decision for an options investor or trader since it has a very significant impact on the profitability of
an option position. Doing your homework to select the optimum strike price is a necessary step to improve your chances of
success in options trading.

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Using Open Interest to Find Bull/Bear Signals
Traders often use open interest is an indicator to confirm trends and trend reversals for both the futures and options markets. Open
interest represents the total number of open contracts on a security. Here, we'll take a look at the importance of the relationship
between volume and open interest in confirming trends and their impending changes.
Volume and Open Interest
Volume, which is often used in conjunction with open interest, represents the total number of shares or contracts that have
changed hands in a one-day trading session. The greater the amount of trading during a market session, the higher the trading
volume. A new student to technical analysis can easily see that the volume represents a measure of intensity or pressure behind a
price trend. According to some observers, greater volume implies that we can expect the existing trend to continue rather than
reverse.
Many technicians believe that volume precedes price. They think the end of an uptrend or a downtrend will show up in the volume
before the price trend reverses on the bar chart. Their rules for both volume and open interest are combined because of similarity.
However, even supporters of this theory admit that there are exceptions to these rules.
There are many conflicting technical signals and indicators, so it is essential to use the right ones for a given application.

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General Rules for Volume and Open Interest
The basic rules for volume and open interest:
Price Volume Open Interest Market
Rising Up Up Strong
Rising Down Down Weak
Declining Up Up Weak
Declining Down Down Strong
Price action increasing during an uptrend and open interest on the rise are interpreted as new money coming into the market. That
reflects new buying, which is considered bullish. Now, if the price action is rising and the open interest is on the decline, short
sellers covering their positions are causing the rally. Money is, therefore, leaving the marketplace—this is taken as a bearish sign.
If prices are in a downtrend and open interest is on the rise, some chartists believe that new money is coming into the market.
They think this pattern shows aggressive new short selling. They believe this scenario will lead to a continuation of a downtrend
and a bearish condition.
Suppose the total open interest is falling off and prices are declining. This theory holds that the price decline is likely being caused
by disgruntled long position holders being forced to liquidate their positions. Some technicians view this scenario as a strong
position because they think the downtrend will end once all the sellers have sold their positions.
Bullish: an increasing open interest in a rising market
Bearish: a declining open interest in a rising market
Bearish: an increasing open interest in a falling market
Bullish: a declining open interest in a falling market

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According to the theory, high open interest at a market top and a dramatic price fall off should be considered bearish. That means
all bulls who bought near the top of the market are now in a loss position. Their panic to sell keeps the price action under
pressure.
Contrarian Criticism
Other analysts interpret some of these signals quite differently, mostly because they place less value on momentum. In particular,
excessive short interest is seen by many as a bullish sign. Short selling is generally unprofitable, particularly after a significant
downward movement. However, naive price chasing often leads less informed speculators to short an asset after a decline. When
the market rises, they have to cover. The typical result is a short squeeze followed by a fierce rally.
In general, momentum investors are not nearly as good at predicting trend reversals as their contrarian counterparts. While it is
true that there is generally more buying and bullish price action all the way up, that does nothing to help investors decide when to
sell. In fact, volume often increases before, during, and after major market tops. Some of the most respected indicators are based
on contrarian views. The most relevant signal here may be the put/call ratio, which has a good record of predicting
reversals. RSI is another useful contrarian technical indicator.
KEY TAKEAWAYS
 Many technicians believe that volume precedes price.
 According to this theory, increasing volume and open interest indicate continued movement up or down.
 If volume and open interest fall, the theory holds that the momentum behind the movement is slowing and the direction of
prices will soon reverse.
 Contrarian analysts interpret some of these signals quite differently, mostly because they place much less value on
momentum.

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Time Decay
What Is Time Decay?
Time decay is a measure of the rate of decline in the value of an options contract due to the passage of time. Time decay
accelerates as an option's time to expiration draws closer since there's less time to realize a profit from the trade. Time decay is
also called theta and is known as one of the options Greeks. Other Greeks include delta, gamma, vega, and rho, and these
formulas help you assess the risks inherent with an options trade.
Time Decay—The Silent Killer
Time decay is the reduction in the value of an option as the time to the expiration date approaches. An option's time value is how
much time plays into the value—or the premium—for the option. The time value declines or time decay accelerates as the
expiration date gets closer because there's less time for an investor to earn a profit from the option. This figure, when calculated,
will always be negative, as time only moves in one direction. The countdown for time decay begins as soon as the option is initially
bought and continues until expiration.
Pricing an Option
To understand how time decay impacts an option, we must first review what makes up the value of an option. An options contract
provides an investor the right to buy (a call), or sell (a put), securities such as stocks at a specific price and time. The strike price is
the price at which the options contract changes to shares of the underlying security if the option is exercised. Each option has
a premium attached to it, which is the value and often the cost of purchasing the option. However, there are a few other
components that also drive the value of the premium. These factors include intrinsic value, extrinsic value, interest rate changes,

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Intrinsic Value
Intrinsic value is the difference between the market price of the underlying security—such as a stock—and the strike price of the
option. A call option with a strike price of Rs20, while the underlying stock is trading at Rs20, would have no intrinsic value since
there's no profit.
However, a call option with a strike price of Rs20, while the underlying stock is trading at Rs30, would have a Rs10 intrinsic value.
In other words, the intrinsic value is the minimum profit that's built into the option given the prevailing market price and the strike. Of
course, the intrinsic value can change as the stock's price fluctuates, but the strike price remains fixed throughout the contract.
Extrinsic Value and Time Decay
The extrinsic value is more abstract than the intrinsic value, and it's more difficult to measure. The extrinsic value of options factors
in the amount of time left before expiration and the rate of time decay leading up to the expiry. If an investor buys a call option with a
few months until expiry, the option will have a greater value than an option that expires in a few days. The time value of an option
with little time left until expiry is less since there's a lower probability of an investor making money by buying the option. As a result,
the option's price or premium declines.
The option with a few months until expiry will have an increased amount of time value and slow time decay since there's a
reasonable probability that an option buyer could earn a profit. However, as time passes and the option isn't yet profitable, time
decay accelerates, particularly in the last 30 days before expiration. As a result, the option's value declines as the expiry
approaches, and more so if it's not yet profitable.

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Time Decay and Moneyness
Moneyness is the level of profitability of an option as measured by its intrinsic value. If the option is in-the-money (ITM) or
profitable, it will retain some of its value as the expiration approaches since the profit is already built in and time is less of a factor.
The option would have intrinsic value, while time decay would increase at a slower rate. However, time decay and the time value of
an option are extremely important for investors to consider because they are key factors in determining the likelihood that the
option will be profitable.
Time decay is prevalent with at-the-money (ATM) options since there's no intrinsic value. In other words, the premium for an ATM
option mostly consists of time value. If the option is out-of-the-money (OTM)—or not profitable—time decay increases at a faster
rate. This acceleration is because as more time passes, the option becomes less and less likely to become in-the-money.
The loss of time value happens even if the value of the underlying asset has not changed during the same period. Another way to
look at options contracts is that they're wasting assets meaning their value declines or depreciates over time.
Essentially, investors are buying options that have the greatest probability of making a profit by expiry and how much time is left
determines the price investors are willing to pay for the option. In short, the more time left until expiry, the slower the time decay
while the closer to expiry, the more time decay increases.
Pros
 Time decay is slow early in an option's life adding to its value or premium
 When time decay is slow, investors can sell the option while it still has value
 Time decay's impact on an option's premium helps investors determine whether it's worth pursuing

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Cons
 Time decay accelerates as an option's time to expiration draws closer
 Measuring the rate of change in time decay of an option can be difficult
 Time decay occurs regardless of whether the underlying asset's price has risen or fallen
Real World Example of Time Decay
An investor is looking to buy a Nifty call option with a strike price of 15000 and a premium of Rs250 per contract. The investor
expects the Nifty to be at 15000 or higher at expiration at end of month.
However, a contract with the same strike of 15000 that's has only a week left until expiration has a premium of Rs120 per
contract. The contract costs far less than the Rs250 contract since it's unlikely the stock will move higher by 10% or more in a few
days.
In other words, the extrinsic value of the second option is lower than the first option with two months left until expiration.

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Stock futures-Arbitrage work in practice
The word arbitrage has different connotations. At a conceptual level, it refers to the differences in prices. When the NSE
commenced operations in 1994, there used be huge difference in prices of the same stock between the BSE and the NSE.
Brokers would buy the stock at a lower price on one exchange and sell at a higher price on the other exchange. This vanished
over a period of time.
With the introduction of futures, a new kind of arbitrage came into being which is referred to as cash future arbitrage strategy. As
we are aware, stock futures have a monthly expiry cycle and expire on the last Thursday of every month. At any time, there are 3
monthly contracts viz. the near month, mid-month and the far month. In stock-futures arbitrage you buy in the cash market and sell
the same stock in the same quantity in the futures market. Since the futures price will expire at the same price as the spot price on
the F&O expiry day, the difference becomes the risk-free spread for the arbitrageur. You can do arbitrage in futures and options.
Why is there a gap between cash price and futures price?
Since futures price pertain to a contract that is 1 month down the line there is a cost of carry; also, roughly known as the interest
cost. So, if the annual risk-free rate of interest is 12% then the 1-month futures price must be at a 1% premium to the cash price.
Of course, in reality the futures price is determined by a variety of other factors, but this is the key factor. Therefore, by buying in
the cash market and selling in the futures you lock in that 1% returns per month. Consider the example.

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In Reliance Industries, the cash price on 5th Feb is Rs.1924 while the March 25th Futures price is Rs.1950. So, the arbitrage
spread is {(1950-1924)/1924} which works out to 1.35%. That is the return for a period of 48 days. So, the annualized return in this
case works out to (1.35% x (365/48) = 10.26%
Normally arbitrageurs prefer an annualized return of around 12-14% as they also need to cover their cost of funding and the
transaction and statutory costs of doing the arbitrage, apart from the tax implications. So how does arbitrage work with futures.
How is the profit realized on an arbitrage transaction?
This is the most important part of the arbitrage transaction. You have locked in a riskless arbitrage profit but how do you actually
realize the profits that you have locked. In the cash market you can actually realize profits by selling your shares. In the arbitrage
market there are actually two ways of realizing the lock-in profit on the arbitrage transaction.
You can realize the profit on arbitrage by unwinding your trade; that means you reverse your long position in equity and your short
position in futures simultaneously. You can hold on to your cash market position in your portfolio, but you can roll over your futures
position to the next contract based on the spread
Let us understand both these methods in much greater detail.
Unwinding your arbitrage trade:
As we are aware, in an arbitrage trade you buy in the cash market and sell in the futures market. That means you are long in cash
market and short in the futures market on the same stock and in the same quantity. What is interesting to note is that you do not
have to wait till the date of expiry to unwind your position. You can even unwind your arbitrage earlier if the spread has come down
substantially. Let us understand this with an illustration.

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Variable (in an arbitrage trade) Amount (in an arbitrage trade)
Cash price of Reliance (purchased) on Feb 05 Rs.1925; Feb Futures price of Reliance (sold) on Feb 01 Rs.1950; Cash Futures
spread Rs.25 (1.29%) Annualized spread on arbitrage 23.5% {1.09 x (365/21)}
How will this arbitrage position get unwound
Cash price of Reliance on Feb 11 Rs.1950; Feb Futures price of Reliance on Feb 11 Rs.1960; Cash Futures spread Rs.10 Profit on
Reliance Cash PositionRs.25 (1950-1925); Loss on Reliance Futures Position Rs.(-10) (1960-1950); Net profit / loss on arbitrage
Rs.15. The net profit of Rs.15 that he realizes by unwinding the arbitrage can be either seen as the profit on the transaction or the
difference in the two spreads. It means one and the same thing. Remember, you are indifferent to the market price of cash and
futures. What matters is only the spread? You will be profitable if the spread falls below Rs.10. In this case you are earning Rs.15 in
just ten days. The downside of this strategy is that each month you need to create fresh positions and keep unwinding them. This
leads to higher transaction costs, higher statutory costs and also results in short term capital gains on your cash market profits. A
better and more popular method of realizing profits on arbitrage is rolling over your futures.
Rolling your futures position each month
You can avoid the hassles of unwinding and creating arbitrage positions each month by holding on to your cash positions and just
rolling your futures position to the next month. Example: SBI futures price for the Feb contract and the March contract. Since your
arbitrage position is long on cash market and short on Feb Futures, you can buy SBI Feb futures at Rs.396 and sell the March
Futures at Rs.398. This results in an arbitrage spread of Rs.2 (0.50%). This is your spread earning for the month, and you have
earned it without disturbing your cash market position. This is the practice most institutions follow in arbitrage.

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10 Options Strategies to Know
Traders often jump into trading options with little understanding of the options strategies that are available to them. There are many
options strategies that both limit risk and maximize return. With a little effort, traders can learn how to take advantage of the
flexibility and power that stock options can provide. Here are 10 options strategies that every investor should know.
1. Covered Call
With calls, one strategy is simply to buy a naked call option. You can also structure a basic covered call or buy-write. This is a very
popular strategy because it generates income and reduces some risk of being long on the stock alone. The trade-off is that you
must be willing to sell your shares at a set price– the short strike price. To execute the strategy, you purchase the underlying stock
as you normally would, and simultaneously write–or sell–a call option on those same shares.
For example, suppose an investor is using a call option on a stock that represents 100 shares of stock per call option. For every 100
shares of stock that the investor buys, they would simultaneously sell one call option against it. This strategy is referred to as a
covered call because, in the event that a stock price increases rapidly, this investor's short call is covered by the long stock position.
Investors may choose to use this strategy when they have a short-term position in the stock and a neutral opinion on its direction.
They might be looking to generate income through the sale of the call premium or protect against a potential decline in the
underlying stock’s value.

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2. Married Put
In a married put strategy, an investor purchases an asset–such as shares of stock–and simultaneously purchases put options for an
equivalent number of shares. The holder of a put option has the right to sell stock at the strike price, and each contract is worth 100
shares.
An investor may choose to use this strategy as a way of protecting their downside risk when holding a stock. This strategy functions
similarly to an insurance policy; it establishes a price floor in the event the stock's price falls sharply.
For example, suppose an investor buys 100 shares of stock and buys one put option simultaneously. This strategy may be
appealing for this investor because they are protected to the downside, in the event that a negative change in the stock price
occurs. At the same time, the investor would be able to participate in every upside opportunity if the stock gains in value. The only
disadvantage of this strategy is that if the stock does not fall in value, the investor loses the amount of the premium paid for the put
option.
3. Bull Call Spread
In a bull call spread strategy, an investor simultaneously buys calls at a specific strike price while also selling the same number of
calls at a higher strike price. Both call options will have the same expiration date and underlying asset. This type of vertical
spread strategy is often used when an investor is bullish on the underlying asset and expects a moderate rise in the price of the
asset. Using this strategy, the investor is able to limit their upside on the trade while also reducing the net premium spent
(compared to buying a naked call option outright).

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4. Bear Put Spread
The bear put spread strategy is another form of vertical spread. In this strategy, the investor simultaneously purchases put options
at a specific strike price and also sells the same number of puts at a lower strike price. Both options are purchased for the same
underlying asset and have the same expiration date. This strategy is used when the trader has a bearish sentiment about the
underlying asset and expects the asset's price to decline. The strategy offers both limited losses and limited gains.
5. Protective Collar
A protective collar strategy is performed by purchasing an out-of-the-money put option and simultaneously writing an out-of-the-
money call option. The underlying asset and the expiration date must be the same. This strategy is often used by investors after a
long position in a stock has experienced substantial gains. This allows investors to have downside protection as the long put helps
lock in the potential sale price. However, the trade-off is that they may be obligated to sell shares at a higher price, thereby forgoing
the possibility for further profits.
An example of this strategy is if an investor is long on 250 shares of RIL at Rs1950 and suppose that RIL rises to Rs2100 as of
February 5. The investor could construct a protective collar by selling one RIL February 2200 call and simultaneously buying one
RIL February 2000 put. The trader is protected below Rs2000 until the expiration date. The trade-off is that they may potentially be
obligated to sell their shares at Rs2200 if RIL trades at that rate prior to expiry.

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6. Long Straddle
A long straddle options strategy occurs when an investor simultaneously purchases a call and put option on the same underlying
asset with the same strike price and expiration date. An investor will often use this strategy when they believe the price of the
underlying asset will move significantly out of a specific range, but they are unsure of which direction the move will take.
Theoretically, this strategy allows the investor to have the opportunity for unlimited gains. At the same time, the maximum loss this
investor can experience is limited to the cost of both options contracts combined.
7. Long Strangle
In a long strangle options strategy, the investor purchases an out-of-the-money call option and an out-of-the-money put option
simultaneously on the same underlying asset with the same expiration date. An investor who uses this strategy believes the
underlying asset's price will experience a very large movement but is unsure of which direction the move will take.
For example, this strategy could be a wager on news from an earnings release for a company or an event related to a Food and
Drug Administration (FDA) approval for a pharmaceutical stock. Losses are limited to the costs–the premium spent–for both
options. Strangles will almost always be less expensive than straddles because the options purchased are out-of-the-money
options.

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8. Long Call Butterfly Spread
The previous strategies have required a combination of two different positions or contracts. In a long butterfly spread using call
options, an investor will combine both a bull spread strategy and a bear spread strategy. They will also use three different strike
prices. All options are for the same underlying asset and expiration date.
For example, a long butterfly spread can be constructed by purchasing one in-the-money call option at a lower strike price, while
also selling two at-the-money call options and buying one out-of-the-money call option. A balanced butterfly spread will have the
same wing widths. This example is called a “call fly” and it results in a net debit. An investor would enter into a long butterfly call
spread when they think the stock will not move much before expiration.
9. Iron Condor
In the iron condor strategy, the investor simultaneously holds a bull put spread and a bear call spread. The iron condor is
constructed by selling one out-of-the-money put and buying one out-of-the-money put of a lower strike–a bull put spread–and
selling one out-of-the-money call and buying one out-of-the-money call of a higher strike–a bear call spread. All options have the
same expiration date and are on the same underlying asset. Typically, the put and call sides have the same spread width. This
trading strategy earns a net premium on the structure and is designed to take advantage of a stock experiencing low volatility. Many
traders use this strategy for its perceived high probability of earning a small amount of premium.

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10. Iron Butterfly
In the iron butterfly strategy, an investor will sell an at-the-money put and buy an out-of-the-money put. At the same time, they will
also sell an at-the-money call and buy an out-of-the-money call. All options have the same expiration date and are on the same
underlying asset. Although this strategy is similar to a butterfly spread, it uses both calls and puts (as opposed to one or the other).
This strategy essentially combines selling an at-the-money straddle and buying protective “wings.” You can also think of the
construction as two spreads. It is common to have the same width for both spreads. The long, out-of-the-money call protects
against unlimited downside. The long, out-of-the-money put protects against downside (from the short put strike to zero). Profit and
loss are both limited within a specific range, depending on the strike prices of the options used. Investors like this strategy for the
income it generates and the higher probability of a small gain with a non-volatile stock.

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Four different ways to play markets when you are unsure of the direction
1. Long straddles and short straddles when you expect shifts in volatility
In a straddle you buy the call option and a put option of the same strike price. Effectively, you are betting that the market
index or the stock is going to give a breakout but you are not sure which direction this breakout will happen. Let us say
Infosys 1250 call option is quoting at Rs.25 and the Rs.1250 put option is quoting at Rs.28 when the current market price
of Infosys is Rs.1225. You can create a straddle by buying one lot of 1250 call option and one lot of 1250 put option.
The total cost of the straddle is Rs.53 (25 + 28), the sum of the premiums of the call and the put. You will be profitable
either if the stock price of Infosys goes above Rs.1303 or if it goes below Rs.1197. When either of these limits is breached
your straddle becomes profitable. You are betting on volatility not on the direction of Infosys price movement.
If your view is range bound you just reverse the strategy. If you expect Infosys to be range bound you can sell this
straddle. As long as the stock stays in the price range of Rs.1197 and 1303, you are going to be profitable on the short
straddle. Remember, short straddles are open-risk strategies as outside this range your losses can be unlimited. Also short
straddles entail initial margins and MTM margins when the market moves against you.
2. Tweak your costs with a strangle instead of a straddle
A slight improvement of the straddle is the strangle strategy. In a long straddle you buy the call and the put of the same
strike price. On the contrary, in a strangle strategy you buy a call of a higher strike and put of a lower strike. This offers two
advantages. Since you are widening the gap between the call strike and the put strike your premium cost comes down.
Secondly, when you are expecting range bound markets, a short strangle will give you a much wider protection range as
compared to a straddle.
In real markets, strangle strategy is a lot more popular than straddles as there are more strangle sellers than straddle
sellers.

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3. You can also use a multi-leg long Butterfly spread strategy
Butterfly strategy combines selling 2 ATM options and simultaneously buys 1 ITM option and 1 OTM option. The net result is
a small debit which is the maximum cost of the butterfly spread strategy. However, that there are 4 legs to a butterfly
strategy and 4 legs at the time of closure of the strategy, making it a total of 8 legs.
There is transaction cost and statutory cost implications and that needs to be factored into your breakeven point
calculations.
4. Extending the butterfly strategy into a condor strategy
A Condor is basically an extension of the butterfly strategy. The only difference is that instead of selling 2 ATM options, the
strategy sells 1 ITM option and 1 OTM option. Again, there are a total of 8 legs in initiating and closing out this transaction
which adds substantially to the cost. Also, the net flow can be quite complicated in such cases. Next time you are up against
volatile markets or range bound markets, don’t start fretting. Combination of call and put options can be structured in such a
way as to best capitalize on such directionless markets. Make the best of it.

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8 MISTAKES TO AVOID WHEN TRADING OPTIONS
We’re all creatures of habit — but some habits are worth breaking. Option traders of every level tend to make the same
mistakes over and over again. And the sad part is, most of these mistakes could have been easily avoided.
MISTAKE 1: NOT HAVING A DEFINED EXIT PLAN
MISTAKE 2: TRYING TO MAKE UP FOR PAST LOSSES BY DOUBLING UP
MISTAKE 3: BUYING OUT OF THE MONEY OPTIONS FREQUENTLY
MISTAKE 4: TRADING ILLIQUID OPTIONS
MISTAKE 5: FAILURE TO FACTOR IN UPCOMING EVENTS
MISTAKE 6: WAITING TOO LONG TO BUY BACK SHORT STRATEGIES
MISTAKE 7: NOT BEING OPEN TO NEW STRATEGIES.
MISTAKE 8: IGNORING INDEX OPTIONS FOR NEUTRAL TRADES

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MISTAKE 1: NOT HAVING A DEFINED EXIT PLAN
Always have a plan to work, and always work your plan. And no matter what your emotions are telling you to do, don’t
deviate from it. Planning your exit isn’t just about minimizing loss on the downside if things go wrong. You should have an
exit plan, period – even when a trade is going your way. You need to choose your upside exit point and downside exit
point in advance. But it’s important to keep in mind, with options you need more than upside and downside price targets.
You also need to plan the time frame for each exit.
Remember: Options are a decaying asset. And that rate of decay accelerates as your expiration date approaches. So if
you’re long a call or put and the move you predicted doesn’t happen within the time period expected, get out and move on
to the next trade. Time decay doesn’t always have to hurt you, of course. When you sell options without owning them,
you’re putting time decay to work for you. In other words, you’re successful if time decay erodes the option’s price, and
you get to keep the premium received for the sale. But keep in mind this premium is your maximum profit if you’re short a
call or put. The flipside is that you are exposed to potentially substantial risk if the trade goes awry.
The bottom line is: You must have a plan to get out of any trade no matter what kind of strategy you’re running, or whether
it’s a winner or a loser. Don't wait around on profitable trades because you're greedy, or stay way too long in losers
because you’re hoping the trade will move back in your favour.
What if you get out too early and leave some upside on the table?
This is the classic trader’s worry, and it’s often used as a rationale for not sticking with an original plan. Here’s the best
counterargument we can think of: What if you profit more consistently, reduce your incidence of losses, and sleep better
at night? Trading with a plan helps you establish more successful patterns of trading and keeps your worries more in
check. Sure, trading can be exciting, but it’s not about one-hit wonders. And it shouldn’t be about getting ulcers from
worry, either. So make your plan in advance, and then stick to it like super glue.

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MISTAKE 2: TRYING TO MAKE UP FOR PAST LOSSES BY DOUBLING UP
Traders always have their ironclad rules: “I’d never buy really out-of-the-money options,” or “I’d never sell in-the-money
options.” But it’s funny how these absolutes seem obvious — until you find yourself in a trade that’s moved against you.
We’ve all been there. Facing a scenario where a trade does precisely the opposite of what you expect, you’re often
tempted to break all kinds of personal rules and simply keep on trading the same option you started with. In such cases,
traders are often thinking, “Wouldn’t it be nice if the entire market was wrong, not me?”
As a stock trader, you’ve probably heard a justification for “doubling up to catch up”: if you liked the stock at 80 when you
first bought it, you’ve got to love it at 50. So it can be tempting to buy more shares and lower the net cost basis on the
trade. Be wary, though: What can sometimes make sense for stocks oftentimes does not fly in the options world.
“Doubling up” on an options strategy almost never works. Options are derivatives, which means their prices don’t move the
same way or even have the same properties as the underlying stock.
Although doubling up can lower your per-contract cost basis for the entire position, it usually just compounds your risk. So
when a trade goes south and you’re contemplating the previously unthinkable, just step back and ask yourself: “If I didn’t
already have a position in place, is this a trade I would make?” If the answer is no, then don’t do it.
Close the trade, cut your losses, and find a different opportunity that makes sense now. Options offer great possibilities for
leverage using relatively low capital, but they can blow up quickly if you keep digging yourself deeper. It’s a much wiser
move to accept a loss now instead of setting yourself up for a bigger catastrophe later.

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MISTAKE 3: BUYING OUT OF THE MONEY OPTIONS FREQUENTLY
Buying OTM calls outright is one of the hardest ways to make money consistently in option trading. OTM call options are
appealing to new options traders because they are cheap.
It seems like a good place to start: Buy a cheap call option and see if you can pick a winner. Buying calls may feel safe
because it matches the pattern you’re used to following as an equity trader: buy low and try to sell high. But if you limit
yourself to only this strategy, you may lose money consistently.
Consider selling an OTM call option on a stock that you already own as your first strategy. This approach is known as
a covered call strategy.
What’s nice about covered calls as a strategy is the risk does not come from selling the option when the option is
covered by a stock position. It also has potential to earn you income on stocks when you’re bullish but are willing to sell
your stock if it goes up in price. This strategy can provide you with the “feel” for how OTM option contract prices change
as expiration approaches and the stock price fluctuates.
The risk, however, is in owning the stock – and that risk can be substantial. Although selling the call option does not
produce capital risk, it does limit your upside, therefore creating opportunity risk. You risk having to sell the stock upon
assignment if the market rises and your call is exercised.

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MISTAKE 4: TRADING ILLIQUID OPTIONS
When you get a quote for any option in the marketplace, you’ll notice a difference between the bid price (how much
someone is willing to pay for an option) and the ask price (how much someone is willing to sell an option for).
Oftentimes, the bid price and the ask price do not reflect what the option is really worth. The “real” value of the option
will actually be somewhere near the middle of the bid and ask. And just how far the bid and ask prices deviate from the
real value of the option depends on the option’s liquidity.
“Liquidity” in the market means there are active buyers and sellers at all times, with heavy competition to fill
transactions. This activity drives the bid and ask prices of stocks and options closer together. The market for stocks is
generally more liquid than their related options markets. That’s because stock traders are all trading just one stock,
whereas people trading options on a given stock have a plethora of contracts to choose from, with different strike prices
and different expiration dates.
At-the-money and near-the-money options with near-term expiration are usually the most liquid. So the spread between
the bid and ask prices should be narrower than other options traded on the same stock. As your strike price gets further
away from the at-the-money strike and / or the expiration date gets further into the future, options will usually be less
and less liquid. Consequently, the spread between the bid and ask prices will usually be wider.
Illiquidity in the options market becomes an even more serious issue when you’re dealing with illiquid stocks. After all, if
the stock is inactive, the options will probably be even more inactive, and the bid-ask spread will be even wider. Imagine
you’re about to trade an illiquid option that has a bid price of Rs50.00 and an ask price of Rs56.25. That Rs6.25
difference might not seem like a lot of money to you. In fact, you might not even bend over to pick up a quarter if you
saw one in the street. But for a Rs50.00 option position, Rs6.25 cents is a full 12.5% of the price!

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Imagine sacrificing 12.5% of any other investment right off the bat. Not too appealing, is it?
First of all, it makes sense to trade options on stocks with high liquidity in the market. A stock that trades fewer than 1,000,000
shares a day is usually considered illiquid. So options traded on that stock will most likely be illiquid too.
When you’re trading, you might want to start by looking at options with open interest of at least 50 times the number of contacts
you want to trade. For example, if you’re trading 10 contracts, your minimum acceptable liquidity should be 10 x 50, or an open
interest of at least 500 contracts. Obviously, the greater the volume on an option contract, the closer the bid-ask spread is likely to
be. Remember to do the math and make sure the width of the spread isn’t eating up too much of your initial investment. Because
while the numbers may seem insignificant at first, in the long run they can really add up.
Instead of trading illiquid options on companies like MRF, you might as well trade the stock instead. There are plenty of liquid
stocks out there with opportunities to trade options on them.
MISTAKE 5: FAILURE TO FACTOR IN UPCOMING EVENTS
Not all events in the markets are foreseeable, but there are two crucial events to keep track of when trading options: earnings and
dividends dates for your underlying stock.
For example, if you’ve sold calls and there’s a dividend approaching, it increases the probability you may be assigned early if the
option is already in-the-money. This is especially true if the dividend is expected to be large. That’s because option owners have no
rights to a dividend. To collect, the option trader must exercise the option and buy the underlying stock.
Be sure to factor upcoming events. For example, you must know the ex-dividend date. Also steer clear of selling options contracts
with pending dividends, unless you’re willing to accept a higher risk of assignment.
Trading during earnings season typically means you’ll encounter higher volatility with the underlying stock – and usually pay an
inflated price for the option. If you’re planning to buy an option during earnings season, one alternative is to buy one option and sell
another, creating a spread.

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MISTAKE 6: WAITING TOO LONG TO BUY BACK SHORT STRATEGIES
We can boil this mistake down to one piece of advice: Always be ready and willing to buy back short strategies early.
When a trade is going your way, it can be easy to rest on your laurels and assume it will continue to do so. But
remember, this will not always be the case. A trade that’s working in your favor can just as easily turn south.
There are a million excuses traders give themselves for waiting too long to buy back options they’ve sold: “I’m betting the
contract will expire worthless.” “I don’t want to pay the commission to get out of the position.” “I’m hoping to eke just a
little more profit out of the trade”… the list goes on and on.
If your short option gets way out-of-the-money and you can buy it back to take the risk off the table profitably, then do it.
Don’t be cheap.
Here's a good rule-of-thumb: if you can keep 80% or more of your initial gain from the sale of an option, consider buying
it back immediately. Otherwise, one of these days a short option will come back and bite you when you’ve waited too
long to close your position.
For example, if you sold a short strategy for Rs100.00 and you can buy it back for Rs20 a week before expiration, you
should jump on the opportunity. Very rarely will it be worth an extra week of risk just to hang onto a measly Rs20.
This is also the case with higher-value trades, but the rule can be harder to stick to. If you sold a strategy for Rs50.00
and it would cost Rs10.00 to close, it can be even more tempting to stay in your position. But think about the risk /
reward. Option trades can go south in a hurry. So by spending the 20% to close out trades and manage your risk, you
can save yourself many painful slaps to the forehead.

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MISTAKE 7: NOT BEING OPEN TO NEW STRATEGIES.
Many option traders say they would never buy out-of-the-money options or never sell in-the-money options. These
absolutes seem silly— until you find yourself in a trade that’s moved against you. All seasoned options traders have been
there. Facing this scenario, you’re often tempted to break all kinds of personal rules.
As a stock trader, you’ve probably heard a similar justification for doubling up to catch up. For example, if you liked the
stock at 80 when you bought it, you’ve got to love it at 50. It can be tempting to buy more and lower the net cost basis on
the trade. Be wary, though: What makes sense for stocks might not fly in the options world. Doubling up as an option
strategy usually just doesn’t make sense.
Be open to learning new option trading strategies. Remember, options are derivatives, which means their prices don’t
move the same or even have the same properties as the underlying stock. Time decay, whether good or bad for the
position, always needs to be factored into your plans.
When things change in your trade and you’re contemplating the previously unthinkable, just step back and ask yourself:
Is this a move I’d have taken when I first opened this position?
If the answer is no, then don’t do it.
Close the trade, cut your losses, or find a different opportunity that makes sense now. Options offer great possibilities for
leverage on relatively low capital, but they can blow up just as quickly as any position if you dig yourself deeper. Take a
small loss when it offers you a chance of avoiding a catastrophe later.

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MISTAKE 8: IGNORING INDEX OPTIONS FOR NEUTRAL TRADES
Individual stocks can be quite volatile. For example, if there is major unforeseen news event in a company, it could rock
the stock for a few days. On the other hand, even serious turmoil in a major company that’s part of the NIFTY 50 probably
wouldn’t cause that index to fluctuate very much.
What’s the moral of the story?
Trading options that are based on indexes can partially shield you from the huge moves that single news items can create
for individual stocks. Consider neutral trades on big indexes, and you can minimize the uncertain impact of market news.
Consider trading strategies that could be profitable when the market stays still like a short spread (also called credit
spreads) on indexes. Index moves tend to be less dramatic and less likely impacted by the media than other strategies.
Short spreads are traditionally constructed to be profitable, even when the underlying price remains the same. Therefore,
short call spreads are considered “neutral to bearish” and short put spreads are “neutral to bullish.” This is one key
difference between long spreads and short spreads.
Remember, spreads involve more than one option trade, and therefore incur more than one commission. Keep this in
mind when making your trading decisions.

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The Importance of Trading Psychology
Containing fear and greed are key to making money
Many skills are required for trading successfully in the financial markets. They include the abilities to evaluate a
company's fundamentals and to determine the direction of a stock's trend. But neither of these technical skills is as
important as the trader's mindset.
Containing emotion, thinking quickly, and exercising discipline are components of what we might call trading psychology.
There are two main emotions to understand and keep under control: fear and greed.
Snap Decisions
Traders often have to think fast and make quick decisions, darting in and out of stocks on short notice. To accomplish this,
they need a certain presence of mind. They also need the discipline to stick with their own trading plans and know when to
book profits and losses. Emotions simply can't get in the way.
 Overall investor sentiment frequently drives market performance in directions that are at odds with the
fundamentals.
 The successful investor controls fear and greed, the two human emotions that drive that sentiment.
 Understanding this can give you the discipline and objectivity needed to take advantage of others' emotions.

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Understanding Fear
When traders get bad news about a certain stock or about the economy in general, they naturally get scared. They may
overreact and feel compelled to liquidate their holdings and sit on the cash, refraining from taking any more risks. If they
do, they may avoid certain losses but may also miss out on some gains.
Traders need to understand what fear is: a natural reaction to a perceived threat. In this case, it's a threat to their profit
potential.
Quantifying the fear might help. Traders should consider just what they are afraid of, and why they are afraid of it. But
that thinking should occur before the bad news, not in the middle of it.
Fear and greed are the two visceral emotions to keep in control.
By thinking it through ahead of time, traders will know how they perceive events instinctively and react to them, and can
move past the emotional response. Of course, this is not easy, but it's necessary to the health of an investor's portfolio,
not to mention the investor.
Overcoming Greed
There's an old saying on Wall Street that "pigs get slaughtered." This refers to the habit greedy investors have of
hanging on to a winning position too long to get every last tick upward in price. Sooner or later, the trend reverses and
the greedy get caught.
Greed is not easy to overcome. It's often based on the instinct to do better, to get just a little more. A trader should learn
to recognize this instinct and develop a trading plan based on rational thinking, not whims or instincts.

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Setting Rules
A trader needs to create rules and follow them when the psychological crunch comes. Set out guidelines based on
your risk-reward tolerance for when to enter a trade and when to exit it. Set a profit target and put a stop loss in place to
take emotion out of the process.
In addition, you might decide which specific events, such as a positive or negative earnings release, should trigger a
decision to buy or sell a stock.
It's wise to set limits on the maximum amount you are willing to win or lose in a day. If you hit the profit target, take the
money and run. If your losses hit a predetermined number, fold up your tent and go home.
Either way, you'll live to trade another day.
Conducting Research and Review
Traders need to become experts in the stocks and industries that interest them. Keep on top of the news, educate
yourself and, if possible, go to trading seminars and attend conferences. Devote as much time as possible to the
research process. That means studying charts, speaking with management, reading trade journals, and doing other
background work such as macroeconomic analysis or industry analysis. Knowledge can also help overcome fear.
Stay Flexible
It's important for traders to remain flexible and consider experimenting from time to time. For example, you might
consider using options to mitigate risk. One of the best ways a trader can learn is by experimenting (within reason). The
experience may also help reduce emotional influences.
Finally, traders should periodically assess their own performances. In addition to reviewing their returns and individual
positions, traders should reflect on how they prepared for a trading session, how up to date they are on the markets,
and how they're progressing in terms of ongoing education. This periodic assessment can help a trader correct
mistakes, change bad habits, and enhance overall returns.

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Key takeaways of Union Budget&Stock Recommendations
Banks including PSBs will be the key beneficiaries due to ARC and Privatization plans announced in the Budget 2021. High
spending is very positive for cyclicals like infra, construction, cement and metals. Scrappage is also positive for the auto sector. A
pick up in the infrastructure and construction space will be positive for employment as these sectors create more jobs for the lower
strata of the society. Higher capital expenditure by the government along with PLI schemes (planned outlay of Rs 1.97tn over FY22-
FY26) has the potential to spur India’s capex cycle and hence will be positive for Capital Goods, Industrials, Infra, Financials, and
Consumer Discretionary Sectors. Companies from infrastructure, capital goods, industrial, financials sectors are likely to do well.
Markets have already cheered the budget and baring some hiccups, expect it to move upwards over the next one year. Suggest
investors focus more on Investment-related sectors mentioned above as manufacturing is likely to be the main driver of growth over
the next 5 years.
Four Largecap Stocks Four Midcap Stocks Four Smallcap Stocks
Larsen & Toubro Supreme Industries H.G. Infra Engineering
Ultratech Cement Godrej Properties Vimta labs
ICICI Bank KNR Constructions Equitas Small Finance Bank
Infosys Kajaria Ceramics Indian Energy Exchange

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THANK YOU
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