Contents

Objective/s .............................................................................................................................................. 3 Nature and scope of the study .................................................................................................................. 3 Data collection......................................................................................................................................... 3 Derivatives .............................................................................................................................................. 4 Derivative Market .................................................................................................................................... 4 Types of Derivative Markets .................................................................................................................... 5 Classification of Derivatives .................................................................................................................... 5 Forward Contracts ............................................................................................................................... 6 Future Contract .................................................................................................................................... 6 Swaps: - ............................................................................................................................................... 6 Interest rate swaps:........................................................................................................................... 7 Currency swaps:............................................................................................................................... 7 Financial swaps:............................................................................................................................... 7 Options ................................................................................................................................................ 7 Call option: ...................................................................................................................................... 7 Put option: ....................................................................................................................................... 8 Participants in derivative market .............................................................................................................. 8 Options vs. Stocks ................................................................................................................................... 9 Advantages of options: .......................................................................................................................... 10 Limited Risk ...................................................................................................................................... 10 Flexibility .......................................................................................................................................... 10 Option styles.......................................................................................................................................... 11 Option strategies .................................................................................................................................... 11 Long Call........................................................................................................................................... 11 Short Call .......................................................................................................................................... 12 Long Put ............................................................................................................................................ 12 Short Put............................................................................................................................................ 12 Covered Call ...................................................................................................................................... 12 Collar ................................................................................................................................................ 13

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Protective Call/ Synthetic Long Put.................................................................................................... 13 Long Straddle .................................................................................................................................... 14 Short Straddle .................................................................................................................................... 14 Long Strangle .................................................................................................................................... 15 Short Strangle .................................................................................................................................... 15 Bull Call Spread................................................................................................................................. 16 Bull Put Spread .................................................................................................................................. 16 Bear Call Spread ................................................................................................................................ 16 Bear Put Spread ................................................................................................................................. 17 Long Call Butterfly ............................................................................................................................ 17 Short Call Butterfly............................................................................................................................ 18 The Economics Times (Data Collected) ................................................................................................. 18 Major factors responsible for the growth of derivatives .......................................................................... 33 Findings ................................................................................................................................................ 33 Recommendations & Suggestions .......................................................................................................... 34 Conclusion ............................................................................................................................................ 34 Bibliography.......................................................................................................................................... 35 Webliography ........................................................................................................................................ 35 Annexure ............................................................................................................................................... 35

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Objective/s
Primary Objective:
y To analyse the performance of Derivatives Trading with special reference to Options and different Option strategies. y The application of these strategies in Real Market.

Secondary Objectives:
y y y To understand the concept of Derivatives. To know different types of Derivatives products available specially Options. To know the role of derivatives trading in India.

Nature and scope of the study

The project covers the Derivatives. The project also covers Derivative market and types of Derivative market. It also covers various option strategies available and its application in the market with a real time example.
There are several trading strategies associated with options. Depending on the investors or traders risk perception, these strategies are chosen and executed. Some of the most common strategies are covered like call, put, straddle, strangle, etc. Apart from these, here are some spread strategies too. There spread strategies as their name suggest, enable the traders to limit profit and loss. Some of the strategies discusses are bull, bear, butterfly spread etc. This report can be a reference material for investor who wishes to invest in options and earn returns with minimal risk.

Data collection
The data collected is Primary. The data collected is Qualitative in Nature. The Project is made by taking the help of Secondary data. It includes data from the various sources such as News papers, Books, Internet etc.

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Derivatives
Section 2(ac) of Securities Contract Regulation Act (SCRA) 1956 defines Derivative as:

a) A security derived from a debt instrument, share, loan whether secured or unsecured, risk instrument or contract for differences or any other form of security;

b) A contract which derives its value from the prices, or index of prices, of underlying securities.

Derivative Market
The market where exchange of derivative takes place is known as the derivative market. Derivatives are the securities whose price is derived from the underlying assets and the value is derived by the fluctuation in the underlying assets. These underlying assets are mostly bonds, stocks, currencies, interest rates, market indices and commodities. Derivatives are merely a contract between two or more parties. These contracts are legally binding agreements, made on the trading screen of stock exchanges, to buy or sell an asset in future.

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Types of Derivative Markets

Derivative Markets

Exchange Traded Derivatives

Over The Counter (OTC) Derivatives

National Stock Exchange

Bombay Stock Exchange

National Commodity & Derivative Exchange

Index Future
Figure.1 Types of Derivatives Market

Index option

Stock option

Stock future

Classification of Derivatives

The main four types of derivatives are, Derivatives

Forwards

Futures

Swaps

Options

Figure.2 Types of Derivatives

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Forward Contracts
A forward contract is an agreement to buy or sell an asset on a specified date for a specified price. One of the parties to the contract assumes a long position and agrees to buy the underlying asset on a certain specified future date for a certain specified price. The other party assumes a short position and agrees to sell the asset on the same date for the same price. Other contract details like delivery date, price and quantity are negotiated bilaterally by the parties to the contract. The forward contracts are normally traded outside the exchanges.

Future Contract
In finance, a futures contract is a standardized contract, traded on a futures exchange, to buy or sell a certain underlying instrument at a certain date in the future, at a pre-set price. The future date is called the delivery date or final settlement date. The pre-set price is called the futures price. The price of the underlying asset on the delivery date is called the settlement price. The settlement price, normally, converges towards the futures price on the delivery date. A futures contract gives the holder the right and the obligation to buy or sell, which differs from an options contract, which gives the buyer the right, but not the obligation, and the option writer (seller) the obligation, but not the right. To exit the commitment, the holder of a futures position has to sell his long position or buy back his short position, effectively closing out the futures position and its contract obligations. Futures contracts are exchange traded derivatives. The exchange acts as counterparty on all contracts, sets margin requirements, etc.

Swaps: Swaps are private agreements between two parties to exchange cash flows in the future according to a prearranged formula. One party makes a payment to the other depending upon whether a price is above or below a reference price specified in the swap contract. They can be regarded as portfolios of forward contracts. The two commonly used swaps are:

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Interest rate swaps: Interest rate swaps is an arrangement by which one party agrees to exchange his series of fixed rate interest payments to a party in exchange for his variable rate interest payments. The fixed rate payer takes a short position in the forward contract whereas the floating rate payer takes a long position in the forward contract.

Currency swaps: Currency swaps is an arrangement in which both the principle amount and the interest on loan in one currency are swapped for the principle and the interest payments on loan in another currency. The parties to the swap contract of currency generally hail from two different countries. This arrangement allows the counter parties to borrow easily and cheaply in their home currencies. Under a currency swap, cash flows to be exchanged are determined at the spot rate at a time when swap is done. Such cash flows are supposed to remain unaffected by subsequent changes in the exchange rates.

Financial swaps: Financial swaps constitute a funding technique which permit a borrower to access one market and then exchange the liability for another type of liability. It also allows the investors to exchange one type of asset for another type of asset with a preferred income stream.

Options
A derivative transaction that gives the option holder the right but not the obligation to buy or sell the underlying asset at a price, called the strike price, during a period or on a specific date in exchange for payment of a premium is known as option. Underlying asset refers to any asset that is traded. The price at which the underlying is traded is called the strike price. There are two types of options i.e., CALL OPTION and PUT OPTION. Call option: A contract that gives its owner the right but not the obligation to buy an underlying assetstock or any financial asset, at a specified price on or before a specified date is known as a Call

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option. The owner makes a profit provided he sells at a higher current price and buys at lower future price. Suppose you have a right to buy 7,000 shares of Hindustan Lever at Rs160 per share on or before May 31, 2010. In other words you are a buyer of a call option on Hindustan Lever. The option gives you the right to buy 7,000 shares. You have the right to buy Hindustan Lever shares at Rs160 per share. The seller of this call option who has given you the right to buy from him is under obligation to sell 7,000 shares of Hindustan Lever at Rs160 per share on or before May 31, 2010 whenever asked. Put option: A contract that gives its owner the right but not the obligation to sell an underlying assetstock or any financial asset, at a specified price on or before a specified date is known as a Put option. The owner makes a profit provided he buys at a lower current price and sells at higher future price. Hence, no option will be exercised if the future price does not increase. Suppose you have the right to sell 700 shares of RIL at Rs1200 per share on or before May 31, 2010. In other words you are a buyer of a put option on RIL. The option gives you the right to sell 700 shares. You have the right to sell RIL shares at Rs1200 per share. The seller of this put option who has given you the right to sell to him is under obligation to buy 700 shares of RIL at Rs1200 per share on or before May 31, 2010 whenever asked.

Participants in derivative market

HEDGERS use futures or options markets to reduce or eliminate the risk associated with price of an asset.

SPECULATORS use futures and options contracts to get extra leverage in betting on future movements in the price of an asset. They can increase both the potential gains and potential losses by usage of derivatives in a speculative venture.

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ARBITRAGEURS are in business to take advantage of a discrepancy between prices in two different markets. If, for example, they see the futures price of an asset getting out of line with the cash price, they will take offsetting positions in the two markets to lock in a profit.1

Options vs. Stocks

Similarities:1. Listed Options are securities, just like stocks. 2. Options trade like stocks, with buyers making bids and sellers making offers. 3. Options are actively traded in a listed market, just like stocks. They can be bought and sold just like any other security. Differences:1. Options are derivatives, unlike stocks (i.e., options derive their value from something else, the underlying security). 2. Options have expiration dates, while stocks do not. 3. There are not a fixed number of options, as there are with stock shares available. 4. Stock owners have a share of the company, with voting and dividend rights. Options convey no such rights. When you only trade the underline assets, you can only benefit from directional movement. But with options you can benefit from other market conditions.

Trading opportunities with only the Underling Assets Market is Moving Higher Market is Moving Lower

Trading opportunities with Options

Market is Moving Higher Market is Moving Lower Quiet Market Little Movement Active Market Direction Unclear Volatility Increasing Volatility Decreasing

International Research Journal of Finance and Economics - Issue 37 (2010)

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Advantages of options:
y y

Limited risk Flexibility

Limited Risk
A trader who buys a call option will make a profit if the price rises above the strike price. The buyer of an option will never lose more than the option premium. Hence, buyer of the option has limited risk. As compare to futures contract, holder of futures positions are required to pay up losses as the market moves against them. Their losses are theoretically unlimited. The losses will keep growing as the market continues to move against them until the futures contract is closed out. An option is a good tool for those (such us hedgers and speculators) who desire to manage risk since it imposes limited risk For the hedgers, the options perform the function of setting either a maximum buying price or minimum selling price for a future transaction without locking in this price. If the market price is better at the time the transaction takes place, the hedger can take full advantage of the option. For the speculators, option allows them to trade the maximum amount of money they can lose. Option sellers or writers earn the premium. As compare to the buyers, the option sellers do not have limited risk. Their risk position is more like that of the holder of an ordinary future contract.

Flexibility
A trader of an option can take advantage of a favorable move in the market in one of two ways: 1. The trader can ask his broker to exercise the option 2. Any favorable move in the price of the underlying asset would be reflected in a higher option premium. So the trader can lock in the profit by selling the option to third party in the marketplace. This flexibility allows existing options positions to be closed without exercising the option. It allows new buyers to come into the market even if there is no fresh option writer.

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Option styles
y

European option - An option that can only be exercised at the end of its life, at its maturity. European options tend to sometimes trade at a discount to its comparable American option. This is because American options allow investors more opportunities to exercise the contract.

American option -.An option that can be exercised anytime during its life i.e. on any trading day on or before expiry. The majority of exchange-traded options are American.

Bermudan option - A type of option whose payoff depends on whether or not the underlying asset has reached or exceeded a predetermined price. Means an option that may be exercised only on specified dates on or before expiration.

Barrier option - any option with the general characteristic that the underlying security's price must pass a certain level or "barrier" before it can be exercised

Exotic option -An option that differs from common American or European options in terms of the underlying asset or the calculation of how or when the investor receives a certain payoff. These options are more complex than options that trade on an exchange, and generally trade over the counter.

Vanilla option - A normal option with no special or unusual features. A plain vanilla option is your plain run-of-the-mill option, with your standard expiry and strike price

Option strategies
Long Call
Purchasing calls has remained the most popular strategy with investors since listed options were first introduced. Buying a Call means you are very bullish and expect the underlying stock / index to rise in future. Risk: Limited to the Premium Reward: Unlimited Breakeven: Strike Price + Premium

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Short Call
When you buy a Call you are hoping that the underlying stock / index would rise. When you expect the underlying stock / index to fall you do the opposite. When an investor is very bearish about a stock / index and expects the prices to fall, he can sell Call options. Risk: Unlimited Reward: Limited to the amount of premium Break-even Point: Strike Price+ Premium

Long Put
Long put can be an ideal tool for an investor who wishes to participate profitably from a downward price move in the underlying stock. Before moving into more complex bearish strategies, an investor should thoroughly understand the fundamentals about buying and holding put options. Risk: Limited to the amount of Premium paid. (Maximum loss if stock / index expire at or above the option strike price). Reward: Unlimited Break-even Point: Stock Price Premium

Short Put
Selling a Put is opposite of buying a Put. An investor buys Put when he is bearish on a stock. An investor Sells Put when he is Bullish about the stock expects the stock price to rise or stay sideways at the minimum. When you sell a Put, you earn a Premium. Risk: Put Strike Price Put Premium. Reward: Limited to the amount of Premium received. Breakeven: Put Strike Price - Premium

Covered Call
The covered call is a strategy in which an investor writes a call option contract while at the same

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time owning an equivalent number of shares of the underlying stock. If this stock is purchased simultaneously with writing the call contract, the strategy is commonly referred to as a "buywrite." If the shares are already held from a previous purchase, it is commonly referred to an "overwrite." In either case, the stock is generally held in the same brokerage account from which the investor writes the call, and fully collateralizes, or "covers," the obligation conveyed by writing a call option contract. This strategy is the most basic and most widely used strategy combining the flexibility of listed options with stock ownership. Risk: If the Stock Price falls to zero, the investor loses the entire value of the Stock but retains the premium, since the Call will not be exercised against him. So maximum risk = Stock Price Paid Call Premium Upside capped at the Strike price plus the Premium received. So if the Stock raises beyond the Strike price the investor (Call seller) gives up all the gains on the stock. Reward: Limited to (Call Strike Price Stock Price paid) + Premium received Breakeven: Stock Price paid - Premium Received

Collar
A collar can be established by holding shares of an underlying stock, purchasing a protective put and writing a covered call on that stock. The option portions of this strategy are referred to as a combination. A Collar is similar to Covered Call but involves another leg buying a Put to insure against the fall in the price of the stock.Generally, the put and the call are both out-of- themoney when this combination is established, and have the same expiration month. Both the buy and the sell sides of this spread are opening transactions, and are always the same number of contracts. Risk: Limited Reward: Limited Breakeven: Purchase Price of Underlying Call Premium + Put Premium

Protective Call/ Synthetic Long Put

An investor who purchases a put option while holding shares of the underlying stock from a previous purchase is employing a "protective put."

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This is a strategy wherein an investor has gone short on a stock and buys a call to hedge. The net effect of this is that the investor creates a pay-off like a Long Put. The pay-off from the Long Call will increase thereby compensating for the loss in value of the short stock position. This strategy hedges the upside in the stock position while retaining downside profit potential. Risk: Limited. Maximum Risk is Call Strike Price Stock Price + Premium Reward: Maximum is Stock Price Call Premium Breakeven: Stock Price Call Premium

Long Straddle
A Straddle is a volatility strategy and is used when the stock price / index is expected to show large movements. It is a strategy of trading options whereby the trader will purchase a long call and a long put with the same underlying asset, expiration date and strike price. The strike price will usually be at the money or near the current market price of the underlying security. The strategy is a bet on increased volatility in the future as profits from this strategy are maximized if the underlying security moves up or down from present levels. Risk: Limited to the initial premium paid. Reward: Unlimited Breakeven: y y Upper Breakeven Point = Strike Price of Long Call + Net Premium Paid Lower Breakeven Point = Strike Price of Long Put - Net Premium Paid

Short Straddle
A Short Straddle is the opposite of Long Straddle. An options strategy carried out by holding a short position in both a call and a put that have the same strike price and expiration date. The maximum profit is the amount of premium collected by writing the options.

Risk: Unlimited Reward: Limited to the premium received Breakeven:

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y y

Upper Breakeven Point = Strike Price of Short Call + Net Premium Received Lower Breakeven Point = Strike Price of Short Put - Net Premium Received

Long Strangle
A Strangle is a slight modification to the Straddle to make it cheaper to execute. The long strangle is a neutral-outlook options trading strategy that involve the simultaneous buying of a slightly out-of-the-money put and a slightly out-of-the-money call of the same underlying security and expiration date. Risk: Limited to the initial premium paid Reward: Unlimited Breakeven: y y Upper Breakeven Point = Strike Price of Long Call + Net Premium Paid Lower Breakeven Point = Strike Price of Long Put - Net Premium Paid

Short Strangle
The short strangle is a neutral-outlook options trading strategy that involves the simultaneous selling of a slightly out-of-the-money put and a slightly out-of-the-money call of the same underlying security and expiration date. The short strangle is a credit spread as a net credit is taken to enter the trade. It tries to improve the profitability of the trade for the Seller of the options by widening the breakeven points so that there is a much greater movement required in the underlying stock / index, for the Call and Put option to be worth exercising. Risk: Unlimited Reward: Limited to the premium received Breakeven: y y Upper Breakeven Point = Strike Price of Short Call + Net Premium Received Lower Breakeven Point = Strike Price of Short Put - Net Premium Received

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Bull Call Spread

A bull call spread is constructed by buying an in-the-money call option, and selling another outof-the-money call option. Mostly the call with the lower strike price will be in-the-money while the Call with the higher strike price is out-of-the-money. Both calls must have the same underlying security, same number of contracts and expiration month. Risk: Limited to any initial premium paid in establishing the position. Maximum loss occurs where the underlying falls to the level of the lower strike or below. Reward: Limited to the difference between the two strikes minus net premium cost. Maximum profit occurs where the underlying rises to the level of the higher strike or above Break-Even-Point (BEP): Strike Price of Purchased call + Net Debit Paid

Bull Put Spread

A bull put spread can be profitable when the stock / index are either range bound or rising. The concept is to protect the downside of a Put sold by buying a lower strike Put, which acts as insurance for the Put sold. The lower strike Put purchased is further OTM than the higher strike Put sold ensuring that the investor receives a net credit, because the Put purchased is cheaper than the Put sold. This strategy is equivalent to the Bull Call Spread but is done to earn a net credit and collect an income. Risk: Limited. Maximum loss occurs where the underlying falls to the level of the lower strike or below Reward: Limited to the net premium credit. Maximum profit occurs where underlying rises to the level of the higher strike or above. Breakeven: Strike Price of Short Put - Net Premium Received

Bear Call Spread

The Bear Call Spread strategy can be adopted when the investor feels that the stock / index are either range bound or falling. The concept is to protect the downside of a Call Sold by buying a Call of a higher strike price to insure the Call sold. In this strategy the investor receives a net credit because the Call he buys is of a higher strike price than the Call sold. The strategy requires the investor to buy out-of-the-money call options while simultaneously selling in-the-money call
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options on the same underlying stock index. This strategy can also be done with both out-of-themoney calls with the Call purchased being higher out-of-the-money strike than the Call sold. Risk: Limited to the difference between the two strikes minus the net premium. Reward: Limited to the net premium received for the position i.e., premium received for the short call minus the premium paid for the long call. Break Even Point: Lower Strike + Net credit

Bear Put Spread

This strategy requires the investor to buy an in-the-money (higher) put option and sell an out-ofthe-money (lower) put option on the same stock with the same expiration date. Establishing a bear put spread involves the purchase of a put option on a particular underlying stock, while simultaneously writing a put option on the same underlying stock with the same expiration month, but with a lower strike price. Both the buy and the sell sides of this spread are opening transactions, and are always the same number of contracts. Risk: Limited to the net amount paid for the spread i.e. the premium paid for long position less premium received for short position. Reward: Limited to the difference between the two strike prices minus the net premium paid for the position. Break Even Point: Strike Price of Long Put Net Premium Paid

Long Call Butterfly

A Long Call Butterfly is to be adopted when the investor is expecting very little movement in the stock price / index. The investor is looking to gain from low volatility at a low cost. A long butterfly is similar to a Short Straddle except your losses are limited. Risk Net debit paid. Reward Difference between adjacent strikes minus net debit Break Even Point: y y Upper Breakeven Point = Strike Price of Higher Strike Long Call Net Premium Paid Lower Breakeven Point = Strike Price of Lower Strike Long Call + Net Premium Paid

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Short Call Butterfly

A Short Call Butterfly is a strategy for volatile markets. It is the opposite of Long Call Butterfly, which is a range bound strategy. The Short Call Butterfly can be constructed by Selling one lower striking in-the-money Call, buying two at-the-money Calls and selling another higher strike out-of-the-money Call, giving the investor a net credit Risk Limited to the net difference between the adjacent strikes less the premium received for the position. Reward Limited to the net premium received for the option spread. Break Even Point: y Upper Breakeven Point = Strike Price of Highest Strike Short Call - Net Premium Received y Lower Breakeven Point = Strike Price of Lowest Strike Short Call + Net Premium Received

The Economics Times (Data Collected)

03 December, 2010

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Nifty may face pressure at 6k

ON Thursday; the Nifty gained 51 points to close at 6011, sustaining an important level of 6000.While the Sensex gained 143 points to close at the 19992 level, shying away from the 20000 mark. Oil & gas, financial, metal, technology, realty shares were on buyers radar. IT benefited more where Infosys, Wipro and IT gained 1.5-2.3% points. Sugar stocks further sweetened the deal for traders as prospect of possible exports in already inflamed international sugar markets acted as a propellant. The December series Nifty futures added OI of 22.80 lakh shares (8.56% increase), while closing at a premium of 16.55 points against Wednesdays 25 points. Decreasing premium of the futures series over the spot value is a sign that investors are losing confidence in upside from this level. The December series Put-Call Ratio has increased to 1.20 from Wednesdays 1.02 level. Currently, we see maximum open interest at 6000 strike on the Call side and 5800 on the Put strike, implying that the Nifty may see an immediate selling pressure at the 6000 level while finding support at 5800.Thursday saw Nifty VIX at 18.80% level, down by 2.08% from 19%, implying that people are comfortable with the upside. Increasing Put-Call ratio accompanied by decreasing VIX points towards options writing by market participants. At the money-call IV

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stands at 15.75% and Put IV is at 17.64% while the next month at-the-money IVs are at 16.32% and 17.86% for Call and Put, respectively. We have seen volatility smile return in options pricing in the recent past, where the out-of-money options are becoming dearer to at-the money options. We are of the view that the Nifty would face an immediate technical resistance at 6075, which, if broken, would see resistance at 6132.Immediate technical support is seen at 5800. We suggest to go long on the December series Nifty futures at 6025 while at the same time go short on the 6100 December series Call (.65), where we keep a further 75-point upside in futures, and if the market falls, we have cushion of decreasing call price of about 30 points, we advocate closing the position at level of 5935 spot level. We advise to go long on December Series Renuka Sugars 90 Strike Call (.5) and Sell 100 Strike Call (.1.85) of same series.

Strategy: Nifty 6016 (Spot) Buy December series Nifty Future at 6025 Sell December series Nifty 6100 Call

Pay Off on 03/12/10 Buy Nifty at 6016 (initial margin= 75,315) Sell Nifty 6100 Option Call at 65/lot= 3,250

Pay off on 30/12/10 Profit on Long Nifty = 4,250 Profit on Short Nifty Option= 3,182 Total Pay off= 7,432

06 December, 2010

Nifty resistance seen at 6050-6070 THE market undertone is cautious in wake of heavy selling in mid-cap and small-cap stocks.

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However, the fall in open interest, along with an increase in cost-of-carry, points to short covering in the market. Technically, the Nifty has strong resistance around 6050-6070 levels and traders do anticipate the index to break it in this week. The maximum concentration of puts continues to be at 5800, suggesting this level could be a strong support for the Nifty.

The Nifty CMP: 5992.80 Strategy: Short strangle Sell 1 December 5800 put @ 37.1,850 Sell 1 December 6100 call @ 65.3,250 Net premium received (50*102).5, 100 This is a limited profit strategy, in which the maximum profits would be to the extent of the premium received (.5, 100), if the Nifty expires between the two strike prices sold, as the trader gets to pocket the entire premium. This strategy will fetch maximum profits if held till expiry. However, losses would be unlimited, if the Nifty moves sharply on either side. Buying a plain vanilla Nifty 5900 put option at.59,a lot could also work, if the index sheds a part of past weeks late gains. Traders could buy this for this week.

Bank Nifty CMP: 12349.20 Strategy: Short Strangle Sell 1 December 12800 call @ 135.3375 Sell 1 December 11800 put @ 106.2650 Net premium received (25*241).6025 After past weeks rally, the Bank Nifty is likely to move in a thin band. With implied volatility expected to fall in the coming trading sessions, traders can bet on this using this strategy. Traders would pocket a premium by selling this combination of options. However, losses would be unlimited, if the Bank Nifty moves sharply on either side.

Strategy: Nifty 6001 (Spot) Short Strangle Sell December series Nifty 5800 Put Sell December series Nifty 6100 Call

Pay Off on 06/12/10

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Sell Nifty 5800 Option Put at 37/lot= 1,850 Sell Nifty 6100 Option Call at 65/lot= 3,250

Pay off on 30/12/10 Profit on Short Nifty Option 5800 Put= 1,850 Profit on Short Nifty Option 6100 call= 3,182 Total Pay off = 5,032

07 December, 2010 Nifty likely to find support at 5800 level NIFTY futures closed 0.41% lower at 5992 and the Banking Nifty closed at 12061,down by 2.80% on Monday. As long as Banking Nifty remains weak, the Nifty may face more selloff. Banking Nifty has minor support at the 12000-mark.If it trades below, then, it may test 11874 and 11513 levels. Many of the frontline banking stocks in the future segment have added open interest along with a price decline. Nifty futures have an immediate support at 5925 levels. On the put options segment, open interest of various strike prices starting from 5900 to 6200 have raised from the previous close, showing investors belief that the market may trade lower on Tuesday and may find support around 5800 levels. The declining PC ratio of both open interest PC ratio and volume PC ratio will further support the down trend. Call writing was visible on the call option segment, especially above the 6200 strike price. On the Nifty option segment, put ratio spread is a safe strategy. Buy 1 lot of Nifty 6000 Nifty put option at.105 and Sell 2 lots of 5800 put option at around.44.If the Nifty closes at around 5800 on expiry, one will make a profit of.9, 150.Minimum loss of.850, if the Nifty closes above 6000 on expiry and unlimited loss can arise below 5617.An alternative strategy would be selling out of the money call option, especially above 6200 levels is advisable.

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On the stock futures segment Sun pharma futures added nearly 25625 shares as open interest, the stock gained nearly 2.40% and is likely to move up further. A plain vanilla strategy can be adopted. Stop loss can be placed below.449.In the stock options segment, a long call strategy can be adopted in the case of Tata Steel. The 640 call options are liquid enough to create long positions, the implied volatility of the call remains at around 31.50 and options premium is.19.The position can be held on for seven trading days. Strategy: Nifty 6009 (Spot) Buy December series Nifty 6000 Put Sell December series Nifty 5800 put (2 Lots)

Pay Off on 07/12/10 Buy Nifty 6000 Option Put at 105/lot= 5,250 Sell Nifty 5800 Option Put at 44/lot= 4,400

Pay off on 30/12/10 Loss on Buy Nifty Option 6000 Put= 5,250 Profit on Sell Nifty Option 5800 Put= 4,400 Total Pay off = (850)

09 December, 2010

Nifty expected to get strong support at 5800 AFTER hitting a two-month low of 5690.35, on November 26, 2010, the Nifty has given a pullback rally of almost 380 points and reached a high of 6069.45 in just six trading sessions. Thereafter, it showed some weakness in the past two days and finally, the Nifty was able to maintain above 5900 levels on Wednesday. We expect the Nifty to trade in the 5820-6070 bands in the extreme short term. In the current month options segment, maximum open interest build up in call option of strike

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6000 followed by 6100.However,in case of put option, profit booking was seen on 5900 and 5800 strikes on Wednesday. The data suggest that a strong support is likely at 5800. Talking stocks specific, Tata Motors and oil & gas companies, like Reliance Industries, BPCL, IOC and HPCL, appear to be relatively strong. However, some further correction is expected in Cipla, IDFC, UCO Bank and Vijaya Bank in the short term. We recommend initiating bull spread strategy in the Nifty by buying 5900 December call options at around.110 & selling 6100 December call options around 35.The strategy will be profitable, if the Nifty is able to close above 5975 on expiry. The maximum potential profit from the strategy is 6250 per lot. However the maximum loss is 3750 per lot.

Strategy: Nifty 5792 (Spot) Bull Spread Strategy Buy December series Nifty 5900 Call Sell December series Nifty 6100 Call

Pay Off on 09/12/10 Buy Nifty 5900 Option Call at 110/lot= 5,500 Sell Nifty 6100 Option Call at 35/lot= 1,750

Pay off on 30/12/10 Profit on Buy Nifty Option 5900 Call= 4,350 Loss on Sell Nifty Option 6100 call= 3,100 Total Pay off = 1,250

10 December, 2010 Nifty faces crisis of confidence after the selloff THE market had a bad session and closed at 5766 with a loss of 137 points and the December Nifty futures quoting at 5792 at a premium of 26 points. India VIX, which hit a high of 24.95 two weeks ago, had subsided to 18 and is again heading

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higher and trading at 22.60.The market selloff saw sharp build-up in puts of 5600-700 strike prices. On the derivatives front, selling has been across the board in the past few days with banks, sugar, fertilisers and metals hugely hit. On the other hand, the pharma sector has seen some resilience and some of the bright spots are Cipla and Dr Reddys. The oil & gas has shown some buying interest emerging in ONGC and GAIL. The oil marketing pack of BPCL, HPCL and IOC has had mixed sessions in the past few days. The metal pack, notably Hindalco and Tata Steel after a firm trend in the past few days, lost heavily in Wednesdays trade. The software sector has seen some buying support in counters, like Infosys, TCS and HCL Tech. Going forward; the market is looking for some leadership, after the banking selloff. Some scrip, which looks positive in the Nifty, is ONGC, GAIL, HCL Tech, Dr Reddys, Hindalco and Tata Steel. Coming back to banks, most of the counters are nearing oversold levels. However, any substantial bounce back appears difficult, as most of them have breached some critical levels. Nifty Strategy: The current scenario, with the scam-related news surfacing on a day-to-day basis, has undermined confidence. A sharp swing on either side is expected in the next 8-10 days. A strangle strategy may be suitable for this situation. Buy a December call of 5900 strike price quoting at around 60 and a December put of 5600 strike price at around .50.Positions can be exited, if the same transpires or else exit positions. Strategy: SBI: The scrip, though weak, is nearing oversold zone and some short covering at 2650-75 levels should emerge. Buy a 2900 call around.42 for a holding period of maximum 8-10 days. Exit on any bounce-back to levels of 2800 and above.

Strategy: Nifty 5879 (Spot) Strangle Strategy Buy December series Nifty 5900 Call Buy December series Nifty 5600 Put

Pay Off on 10/12/10 Buy Nifty 5900 Option Call at 60/lot= 3,000 Buy Nifty 5600 Option Put at 50/lot= 2,500

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Pay off on 30/12/10 Profit on Buy Nifty Option 5900 Call= 6,875 Loss on Buy Nifty Option 5600 Put= 2,500 Total Pay off = 4,375

14 December, 2010

Nifty may face resistance at 5950-6100 range NIFTY exhibited a huge volatility on Monday, with alternate bouts of buying and selling. The index finally closed 50 points higher to around the 5907-mark.The market breadth was much better, with small- and mid-cap indices performing better than the Nifty. After many trading sessions, some sense of confidence seems to be returning in the mid-cap segment. The premium in the Nifty futures also improved to 24 points. The put-call ratio also showed an improvement. Indias Volatility Index or VIX, a measure of traders expectations of market risks in the near term, rose by almost 4.35% to 22.57, indicating increased volatility. On the call side, the Nifty 6000 series witnessed a good increase in open interest, adding 5.74 lakh shares. Nifty 6100 and 6200 strikes witnessed a reduction in open interest by almost 1.58 and 1.92 lakh shares. On the put side, Nifty 5800 and 5600 strike witnessed good build-up in open interest by about 7.11 and 8.20 lakh shares. From the technical perspective, the Nifty seems to be in for a short rally with resistance placed around 5950 and 6100 marks. The index has support around 5800 and 5700 marks. This is substantiated by heavy build-up seen around Nifty 6000 call strike and 5800 and 5600 put strikes. Given the uncertain environment and volatile market condition, a bullish call spread may be relatively safer strategy. One can buy 5900 call at.122 with a stop loss of.70 and sell 6100 call at.38.5.The maximum loss in this strategy is.13.5 while the maximum gain would be.116.5.

Strategy: Nifty 5960 (Spot) Bull Call Spread Strategy

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Buy December series Nifty 5900 Call Sell December series Nifty 6100 Call

Pay Off on 14/12/10 Buy Nifty 5900 Option Call at 122/lot= 6,100 Sell Nifty 6100 Option Call at 38.5/lot= 1,925

Pay off on 30/12/10 Profit on Buy Nifty Option 5900 Call= 3,775 Profit on Sell Nifty Option 6100 Call= 1,925 Total Pay off = 5,700

20 December, 2010

Nifty may not see sharp downside THE Nifty may face a hurdle at around 6000, if the build-up in contracts in the indexs options is any indication. The run-up in the Nifty is more due to short-covering rather than fresh buying since there has been a significant increase in the cost-of-carry, along with a reduction in open interest. However, Nifty options IV has dipped to the years average range, showing options traders dont expect a sharp downside. Also, put writing in 5800 contracts suggests the Nifty may find support at this level.

The Nifty CMP: 5948.75 Strategy: Short Strangle Sell 1 December 5900 put @ 52.2600 Sell 1 December 6000 call @ 56.2800 Net premium received (50*108).5400 This strategy was earlier recommended in the first week of December for (5800-6100 ) levels.

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Traders, who had taken positions, would have made returns of.2, 450 per lot. With resistance expected for the Nifty at 6000, traders can hold this strategy till expiry. But losses will be unlimited, if the Nifty moves sharply on either side.

Sterlite Industries CMP: 173.50 Strategy: 1:1 bull call spread Buy 1 December 180 call @ 2.25.2250 Sell 1 December 190 call @ 0.65.650 Net premium paid (1000*1.6).1600 Sterlite shares have been range bound in the past few trading sessions, but technical analysts expect the stock to touch.190, if it closes above.175.Downside for the stock seems limited since its futures has seen a build-up in open interest at.170 levels. The sale of 190 call option will finance the purchase of 180 calls.

Strategy: Nifty 5948 (Spot) Short Strangle Strategy Sell December series Nifty 5900 Put Sell December series Nifty 6000 Call

Pay Off on 20/12/10 Sell Nifty 5900 Option Put at 52/lot= 2,600 Sell Nifty 6000 Option Call at 56/lot= 2,800

Pay off on 30/12/10 Profit on Sell Nifty Option 5900 Put= 2,600 Loss on Sell Nifty Option 6000 Put= 2,050 Total Pay off = 550

21 December, 2010 Nifty expected to consolidate in a 5750-6050 range THE Nifty touched a high of 5985 on Monday, but shed gains in the second half of the day,

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closing down marginally at 5947.The fact that the government has kept the repo rate, reverse repo rate and CRR unchanged in the recent RBI policy meet hints at the confidence to contain inflation while maintaining GDP growth. According to NSE data, FIIs have sold to the tune of.657 crore. While domestic institutions bought to the tune of.682 crore in the cash segment on a weekly basis. India VIX, which measures the immediate expected volatility, closed at 20.78, up 2.67%, on Monday. Volatile movement in the Nifty in the past few trading sessions has led the VIX to remain above 20 levels. Put concentration has shifted from 5700 to 5800, after RBI did not raise rates on December 16.5800 Put open interest (OI) now stands at 8.6 million, indicating a near-term support. Calls concentration is highest at 6000, with call writers active in 6000 and 6100 strike hinting at the new trading range of 5800-6000. Overseas, the focus is now on US GDP, personal income & spending and US home sales data, scheduled later this week. Back home, EGoM is likely to meet on Wednesday to decide on diesel price hike. Technically, the short-term trend has become sideways, as the Nifty is trading in a wide range of 5750-6050.On the lower side, we see a strong support at 5860 which is its 100 DMA. And on the upper side, we see a resistance at 6040 which is a 50-DMA.The market could see a consolidation in the range of 5750-6050 and any fresh move could be seen on breakout on either side. However, MACD and RSI have bounced back from oversold zone, suggesting some strength in the market. Strategy: Construct a Put Butterfly spread for the Nifty at 5900 by buying 5800 puts (premium 26),selling two 5900 puts (premium 50/each) and again buying 6000 puts (premium 94).The strategy can give maximum returns of.4,000/lot with a breakeven at 5820 & 5980,while the loss is limited to 1000/lot on both sides. Strategy: Nifty 5947 (Spot) Put Butterfly Spread Strategy Buy December series Nifty 5800 Put Sell December series Nifty 5900 Put (2 lots) Buy December series Nifty 6000 Put

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Pay Off on 21/12/10 Buy Nifty 5800 Option Put at 26/lot= 1,300 Sell Nifty 5900 Option Put at 50/lot= 5,000 Buy Nifty 6000 Option Put at 94/lot= 4,700

Pay off on 30/12/10 Loss on Buy Nifty Option 5800 Put= 1,300 Profit on Sell Nifty Option 5900 Put= 5,000 Loss on Buy Nifty Option 6000 Put= 4,700 Total Pay off = (1,000)

22 December, 2010

Nifty may face resistance at 6030-6060 level THE Nifty has recovered 4.3% from a major support level of 5750 and is approaching a critical resistance zone of 6030-6060.The continuance of the uptrend may be confirmed only if the Nifty is able to overcome and sustain these levels. Nifty 5900 PE has witnessed an increase in open interest to 7.5 million shares, suggesting strong support at these levels. However, in spite of the Nifty trading at around 6000 levels, Nifty 6000 CE has not witnessed major closure of open interest. This indicates selling pressure in the Nifty at higher levels. On the positive side, the Nifty has seen three successive closings above 20 Day Moving Average, which was not seen since November 12,2010.India VIX has also shown signs of cooling off and may follow the trend of low volatility prevailing in major global indices. Both ferrous and non-ferrous metals witnessed addition of fresh long positions, indicating positive momentum in the sector. Hindalco has moved above its critical resistance of 226 and the stock is likely to continue its unmoved. Banking heavyweights hold the key for further strength in the market.SBI has sustained above the 200-day EMA of.2, 690.SBI has accumulated short positions in the December series and may witness short-covering near expiry, if it is able to hold. 2, 690 levels. The ATM IV spread of SBI has also seen a reversal from the resistance of 37%,

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which indicates further downside in the stock may be limited in the short term. On the global front, recent US data, like retail sales and manufacturing output, have exceeded expectations. In addition, the short term US bond yields are moving up, suggesting the likelihood of recovery in the US economy. The market will take further cues from US Q3 GDP figures to be announced in this week. Nifty Strategy: The Nifty may spend some more time in the 5900-6060 range before taking a decisive direction. As we approach the expiry of the December series, we suggest a shortstraddle strategy to benefit from the time decay.

Strategy: Nifty 6000 (Spot) Short Straddle Strategy Sell December series Nifty 6000 Put Sell December series Nifty 6000 Call

Pay Off on 22/12/10 Sell Nifty 6000 Option Put at 52/lot= 2,600 Sell Nifty 6000 Option Call at 58/lot= 2,900

Pay off on 30/12/10 Profit on Sell Nifty Option 6000 Put= 2,900 Loss on Sell Nifty Option 6000 Call= 2,250 Total Pay off = 650

23 December, 2010 Buying interest in Nifty likely to be broad-based THE market had a volatile session, with a strong opening before profit-booking ensured a low closing at 5985,with a loss of 16 points and the December Nifty futures quoting at 5995,at a premium of 10 points.

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India VIX, which was on an upswing, has again subsided to 19.50.This has been due to the cautious uptrend we have witnessed in the past couple of weeks after the sharp sell-off. On the derivative front, after the domination of auto and banks in the previous rally, the buying interest has become more broadbased, with sectors like metals, software, sugar, fertilisers and pharma attracting attention. Auto and banking sectors appear to be taking a breather though scrips, like SBI, ICICI and M&M, which are expected to revive. Tata Motors continues to rise relentlessly. In the software sector, after the initial strength in pivotals, like Infosys, TCS and Wipro, select shares like Hexaware, MphasiS BFL have also strengthened. The metal pack has been the strong feature of the recent rally, with Hindalco and Tata Steel leading the uptrend. Several underperformers, like Sterlite and SAIL, have also shown buying emerging at lower levels.RIL, which has been range bound for months, appears to be finding buying interest and could boost the index if it manages to break past.1, 100, which looks likely. Sugar and fertilizers have had alternate bouts of strength and weakness. However, both these sectors should to outperform in the long run. Nifty Strategy: The index is expected to touch 6100 by expiry. Buy 6000 December call, quoting at around.52.ICICI Bank: The stock has shown relative strength in the banking sector and should advance to near.1, 200 levels. Buy call of December 1100 strike price at around.43.Alternatively buy Jan 1150 strike price at around.40-45, for a holding period of maximum 20 days.

Strategy: Nifty 5996 (Spot) Buy December series Nifty 6000 Call Pay Off on 23/12/10 Buy Nifty 6000 Option Call at 43/lot= 2,150

Pay off on 30/12/10 Profit on Buy Nifty Option 6000 Call = 2700 Total Pay off = 2700

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Major factors responsible for the growth of derivatives

 Integration of international markets with national financial markets  Increased volatility in asset prices in financial markets.  Development of more sophisticated risk management tools, providing economic agents a wider choice of risk management strategies.

 Innovations in the derivatives markets have led to the diversification of risk over a large number of financial assets, leading to higher returns. Improvement in technology and communication facilities and sharp decline in costs

 In todays scenario people have become more educated and aware about the derivative instruments and its applications.

Findings

 The main factors that are driving the growth of Derivative Market are Market improvement in communication facilities as well as long term saving & investment is also possible through entering into Derivative Contract. So these factors encourage the Derivative Market in India.

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 As per the analysis it is found that even if the market is bullish in the month of December 2010 an investor can use combination of call and put strategies on each day depending upon the prevailing market conditions and industry as a whole.

Recommendations & Suggestions

 The decision about whether to use derivatives should be driven, not by the company's size, but by its strategic objectives.

 It is important that all users of derivatives understand how their contracts are structured, the unique price and risk characteristics of those instruments, and how they will perform under stressful and volatile economic conditions.

Conclusion

Derivatives allow firms and individuals to hedge risks and to take risks efficiently. They also can create risk at the firm level, especially if a firm uses derivatives episodically and is inexperienced in their use. Therefore the risks of derivatives positions have to be measured and understood. Trading strategies of options are combinations of basic option positions. Investors adopt those strategies to get most out of the market based on their risk tolerance level and market outlook.

The Project outlines some of the commonly used popular trading strategies and the spread strategies of option.

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Bibliography
Hull. C, John, Options, Futures and Other Derivatives, Prentice Hall, New Delhi, 2009 Durbin, Michael, All about Derivatives, Tata McGraw-Hill, New Delhi, 2006 Varma, Rama Jayanth, Derivatives& Risk Management, Tata McGraw-Hill, New Delhi, 2008 International Research Journal of Finance and Economics

Webliography

http://www.investopedia.com/terms/ http://en.wikipedia.org/wiki/Option (finance) http://en.wikipedia.org/wiki/Options_strategies http://www.commodityworld.com/options_strategies http://www.theoptions.net/tag/basic-option-strategies/ http://www.derivativesindia.com/ http://www.nse-india.com http://www.bseindia.com

http://www.derivativesindia.com/scripts/glossary/indexobasic.asp

Annexure

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Index options: These options have the index as the underlying. In India, they have European style settlement. E.g. Nifty options, Mini Nifty options etc.

Stock options: Stock options are options on individual stocks. A stock option contract gives the holder the right to buy or sell the underlying shares at the specified price. They have an American style settlement.

Buyer of an option: The buyer of an option is the one who by paying the option premium buys the right but not the obligation to exercise his option on the seller/writer.

Writer / seller of an option: The writer / seller of a call/put option are the one who receives the option premium and is thereby obliged to sell/buy the asset if the buyer exercises on him.

Option price/premium: Option price is the price which the option buyer pays to the option seller. It is also referred to as the option premium.

Expiration date: The date specified in the options contract is known as the expiration date, the exercise date, the strike date or the maturity.

Strike price: The price specified in the options contract is known as the strike price or the exercise price.

In-the-money option: An in-the-money (ITM) option is an option that would lead to a positive cash flow to the holder if it were exercised immediately. A call option on the index is said to be in-the-money when the current index stands at a level higher than the strike price (i.e. spot price > strike price). If the index is much higher than the strike price, the call is said to be deep ITM. In the case of a put, the put is ITM if the index is below the strike price.

At-the-money option: An at-the-money (ATM) option is an option that would lead to zero cash flow if it were exercised immediately. An option on the index is at-the-money when the current index equals the strike price (i.e. spot price = strike price).

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Out-of-the-money option: An out-of-the-money (OTM) option is an option that would lead to a negative cash flow if it were exercised immediately. A call option on the index is out-of-themoney when the current index stands at a level which is less than the strike price (i.e. spot price < strike price). If the index is much lower than the strike price, the call is said to be deep OTM. In the case of a put, the put is OTM if the index is above the strike price.

Intrinsic value of an option: The option premium can be broken down into two components intrinsic value and time value. The intrinsic value of a call is the amount the option is ITM, if it is ITM. If the call is OTM, its intrinsic value is zero. Putting it another way, the intrinsic value of a call is Max [0, (St K)] which means the intrinsic value of a call is the greater of 0 or (St K). Similarly, the intrinsic value of a put is Max [0, K St], i.e. the greater of 0 or (K St). K is the strike price and St is the spot price.

Time value of an option: The time value of an option is the difference between its premium and its intrinsic value. Both calls and puts have time value. An option that is OTM or ATM has only time value. Usually, the maximum time value exists when the option is ATM. The longer the time to expiration, the greater is an option's time value, all else equal. At expiration, an option should have no time value.

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