Summary Slide

Dr. Anup Raj M.Com,M.A.(Eco),MBA (Fin & Markt),PGDPM,Ph.D in Derivative

Derivatives
A security whose price is dependent upon or derived from one or more underlying assets.
Contract between two or more parties. Value derived from the underlying assets. Underlying assets include stocks, bonds, commodities, currencies, interest rates and market indexes etc. High leverage Product.

Example
Person who comes with this paper can purchase a Peter England shirt at Rs.400 on or before 31st March, 12
Comes with the paper, Predetermined asset, Predetermined maturity, Predetermined rate, now find out the value of that paper, if.

Question - Answer
Price of that shirt is Rs. 500 If price changes from 500 to 700 ? If price changes from 500 to 400 ? If price comes to 300 ? If price comes to 100 ? If price comes to 1000 ? If asset does not exist ?

Pay off of Peter England Shirt

1200 1000 800

600

Value of Paper

400

200

0 0 -200 100 200 300 400 500 600 700 800 900 1000 1100

-400

-600 Price of Shirt

Call Option
An agreement that gives an investor the right (but not the obligation) to buy a stock, bond, commodity, or other instrument at a specified price within a specific time period. Buyer of Call ----- Bullish View Seller of Call ----- Bearish View

Example
Mr. X Purchases the 3000 Nifty Feb 09 Call Option at Rs.100.
If Price goes up. The value of call option will go up If Price goes down. The value of call option will go down If Price remains constant the value of call option will come down

Break Even Point

Mr. X has already paid Rs.100 to Purchase the Call option. If price goes up than he can buy Nifty at Rs.3000,,,, that means he has to pay Rs.3000. So net costing to Mr. X will be Rs.3100. Above Rs.3100, Mr. X will be in Profit Below Rs.3100, He will loose money. Max Loss to him is Rs.100 at price on or below Rs.3000 Max Profit to him is unlimited. He has to use his option on or before the maturity.

Question - Answer
Calculate the Value of Call option if Nifty Spot Price is
3100 3200 3500 3000 2950 2900 2500 3050 3025

Pay off of Call Option Buyer

Events
Price Of Nifty Value of Opti on Profit / (Los s)

Pay off of Call Option

600 500
Profit / (Loss)

1 2 3 4 5 6

2700 2750 2800 2850 2900 2950

0 0 0 0 0 0

-100 -100 -100 -100 -100 -100

400 300 200 100 0

2700 2750 2800 2850 2900 2950 3000 3050 3100 3150 3200 3250 3300 3350 3400 3450

7
8 9 10 11 12 13 14 15 16 17

3000
3050 3100 3150 3200 3250 3300 3350 3400 3450 3500

0
50 100 150 200 250 300 350 400 450 500

-100
-50 0 50 100 150 200 250 300 350 400

-100 -200

Price of Nifty

3500

Example
Mr. Y has sold the 3000 Nifty Feb 09 Call Option at Rs.100.
If Price goes up. The value of call option will go up If Price goes down. The value of call option will go down If Price remains constant the value of call option will come down

Break Even Point

Mr. Y has already received Rs.100 to sell the Call option. If price goes up than he has to sell Nifty at Rs.3000,,,, that means he will get Rs.3000. So net receipt to Mr. Y will be Rs.3100. Above Rs.3100, Mr. Y will be in Loss. Below Rs.3100, He will earn money. Max Profit to him is Rs.100 at price on or below Rs.3000 Max Loss to him is unlimited. After the date of maturity, the option will be lapsed. Mr. Y will not be forced to sell the Nifty at Rs.3000 after the maturity.

Pay off of Call Option Seller

Events Price Of Nifty Value of Optio n Profit / (Loss)

Pay Off of Call Option

600 400
Profit / (Loss)

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17

2700 2750 2800 2850 2900 2950 3000 3050 3100 3150 3200 3250 3300 3350 3400 3450 3500

0 0 0 0 0 0 0 50 100 150 200 250 300 350 400 450 500

100 100 100 100 100 100 100 50 0 -50 -100 -150 -200 -250 -300 -350 -400

200 0
2700 2750 2800 2850 2900 2950 3000 3050 3100 3150 3200 3250 3300 3350 3400 3450 3500

-200 -400 -600

Price of Nifty

Date 1-Feb

Maturity 26-Feb 26-Feb

Price 100.20 98.18

Change

Impact of Time
Price of Option comes down as the time passes. Speed of Price reduction increases as the maturity comes nearer. Here price of call was Rs.100 on 1st of the month Which comes to Rs.87 after one week, Then it comes to Rs.66 after 15 days And finally it came to 0 on maturity

2-Feb

-2.02

3-Feb
4-Feb 5-Feb 6-Feb 7-Feb

26-Feb
26-Feb 26-Feb 26-Feb 26-Feb

96.11
94.00 91.84 89.63 87.36

-2.07
-2.11 -2.16 -2.21 -2.27

8-Feb
9-Feb 10-Feb 11-Feb 12-Feb

26-Feb
26-Feb 26-Feb 26-Feb 26-Feb

85.03
82.64 80.17 77.63 74.99

-2.33
-2.39 -2.47 -2.54 -2.63

13-Feb
14-Feb 15-Feb 16-Feb 17-Feb 18-Feb 19-Feb 20-Feb 21-Feb 22-Feb 23-Feb 24-Feb 25-Feb 26-Feb

26-Feb
26-Feb 26-Feb 26-Feb 26-Feb 26-Feb 26-Feb 26-Feb 26-Feb 26-Feb 26-Feb 26-Feb 26-Feb 26-Feb

72.27
69.43 66.48 63.38 60.13 56.69 53.03 49.10 44.82 40.09 34.72 28.35 20.05 0.00

-2.73
-2.83 -2.96 -3.09 -3.25 -3.44 -3.66 -3.93 -4.28 -4.73 -5.37 -6.37 -8.30 -20.05

Price and Change

120.00 100.00 80.00 60.00 40.00 20.00 0.00

Impact of Time

Date

2/ 1/ 20 2/ 0 9 3/ 2 2/ 00 9 5/ 20 2/ 0 9 7/ 2 2/ 00 9 9/ 2/ 200 11 9 / 2/ 20 0 13 9 / 2/ 20 0 15 9 / 2/ 20 0 17 9 / 2/ 20 0 19 9 / 2/ 20 0 21 9 / 2/ 20 0 23 9 / 2/ 20 0 25 9 /2 00 9

0.00

-5.00

-25.00

-20.00

-15.00

-10.00

Put Option
An agreement that gives an investor the right (but not the obligation) to Sell a stock, bond, commodity, or other instrument at a specified price within a specific time period. Buyer of Put ----- Bearish View Seller of Put ----- Bullish View

Example
Mr. X Purchases the 3000 Nifty Feb 09 Put Option at Rs.100.
If Price goes down. The value of Put option will go up If Price goes up. The value of Put option will go down If Price remains constant the value of Put option will come down

Break Even Point

Mr. X has already paid Rs.100 to Purchase the Put option. If price goes down than he can Sell Nifty at Rs.3000,,,, that means he will receive Rs.3000. So net receipt to Mr. X will be Rs.2900. Above Rs.2900, Mr. X will be in Loss Below Rs.2900, He will earn money. Max Loss to him is Rs.100 at price on or above Rs.2900 Max Profit to him is unlimited. He has to use his option on or before the maturity.

Question - Answer
Calculate the Value of Put option if Nifty Spot Price is
2900 2500 2800 2000 3100 3200 3500 3000 2950

Pay off of Put Option Buyer

Events Price Of Nifty Value of Option Profit / (Loss) 1 2 3 4 5 6 2700 2750 2800 2850 2900 2950 300 250 200 150 100 50 200 150 100 50 0 -50

Pay off of Put Option

350 300 250 200 150 100 50 0 -50 -100 -150

7
8 9 10 11 12 13 14 15

3000
3050 3100 3150 3200 3250 3300 3350 3400

0
0 0 0 0 0 0 0 0

-100
-100 -100 -100 -100 -100 -100 -100 -100

Profit / (Loss)

2700

2750

2800

2850

2900

2950

3000

3050

3100

3150

3200

3250

3300

3350

3400

3450

16
17

3450
3500

0
0

-100
-100

Price of Nifty

3500

Example
Mr. Y has sold the 3000 Nifty Feb 09 Put Option at Rs.100.
If Price goes up. The value of Put option will come down If Price goes down. The value of Put option will go up If Price remains constant the value of Put option will come down

Break Even Point

Mr. Y has already received Rs.100 to sell the Put option. If price goes down than he has to buy Nifty at Rs.3000,,,, that means he has to pay Rs.3000. So net cost to Mr. Y will be Rs.2900. Below Rs.2900, Mr. Y will be in Loss. Above Rs.2900, He will earn money. Max Profit to him is Rs.100 at price on or above Rs.3000 Max Loss to him is unlimited. After the date of maturity, the option will be lapsed. Mr. Y will not be forced to buy the Nifty at Rs.3000 after the maturity.

Pay off of Put Option Seller

Events Price Of Nifty Value of Option Profit / (Loss)

Pay Off of Put Option

-200 -150 -100

1 2 3 4 5 6 7 8

2700 2750 2800 2850 2900 2950 3000 3050

300 250 200 150 100 50 0 0

400 300
Profit / (Loss)

-50 0 50 100 100

200 100 0
2700 2750 2800 2850 2900 2950 3000 3050 3100 3150 3200 3250 3300 3350 3400 3450 3500

9
10 11 12 13 14 15 16 17

3100
3150 3200 3250 3300 3350 3400 3450 3500

0
0 0 0 0 0 0 0 0

100
100 100 100 100 100 100 100 100

-100 -200 -300

Price of Nifty

Synthetic Option and Futures

Synthetic Call option = Buy one future and buy one put option Synthetic Put option = Sell one future and buy one call option Synthetic Future = Buy one call and sell one put option

Types of Option
As per Maturity
Current Month Option Next Month Option Far Month Option

As per Right to Exercise

European Option American Option
Short key to understand

Intrinsic Value
The intrinsic value of an option is the amount an option holder can realise by excercising the option immediately. Intrinsic value is always positive or zero. An out of the money & at the money option has zero intrinsic value. Intrinsic value of In the money call option = underlying product price strike price. Intrinsic value of In the money put option = strike price underlying product price.

Options as per Intrinsic Value

At the Money Option ATM
When the intrinsic value of the option is 0, it is called ATM
Meaning of Intrinsic Value Eg. Spot price of Nifty is 3000, the call n put of 3000 strike price is ATM Option

In the Money Option ITM

When the intrinsic value of the option is positive, it is called ITM
Eg. Spot price of Nifty is 3000, the call of 2800 strike price and put of 3200 strike price is ITM Option

Out of the Money Option OTM

When the intrinsic value of the option is negative, it is called OTM
Eg. Spot price of Nifty is 3000, the call of 3200 and put of 2800 strike price is OTM Option

Bullish Strategies
Buy Lower Strike Call Option & Sell Higher Strike Call Option Buy Lower Strike Put Option & Sell Higher Strike Put Option Buy one Future and One ATM Put and Sell one OTM Call

Purchase 2500 March Call option at Rs.100 and Sell 2700 March Call option at Rs.50
Events Price Of Nifty Value of I Option Value of II Option Profit / (Loss)

1 2 3 4 5 6 7

2200 2250 2300 2350 2400 2450 2500

-100 -100 -100 -100 -100 -100 -100

50 50 50 50 50 50 50

-50 -50 -50 -50 -50 -50 -50

Profit / (Loss)

Pay off of Bull Call Spread

500 400 300 200 100 0 -200 -300 Price of Nifty
22 00 22 50 23 00 23 50 24 00 24 50 25 00 25 50 26 00 26 50 27 00 27 50 28 00 28 50 29 00 29 50 30 00

8
9 10 11 12 13 14 15 16 17

2550
2600 2650 2700 2750 2800 2850 2900 2950 3000

-50
0 50 100 150 200 250 300 350 400

50
50 50 50 0 -50 -100 -150 -200 -250

0
50 100 150 150 150 150 150 150 150

-100

Bearish Strategies
Buy Higher Strike Call Option & Sell Lower Strike Call Option Buy Higher Strike Put Option & Sell Lower Strike Put Option

Purchase 2700 March Put option at Rs.100 and Sell 2500 March Put option at Rs.50
Events Price Of Nifty Value of I Option Value of II Option Profit / (Loss) 1 2200 400 -250 150

2
3 4 5 6 7 8 9 10 11 12 13 14 15 16 17

2250
2300 2350 2400 2450 2500 2550 2600 2650 2700 2750 2800 2850 2900 2950 3000

350
300 250 200 150 100 50 0 -50 -100 -100 -100 -100 -100 -100 -100

-200
-150 -100 -50 0 50 50 50 50 50 50 50 50 50 50 50

150
150 150 150 150 150 100 50 0 -50 -50 -50 -50 -50 -50 -50
Profit / (Loss)

Pay off of Bear Put Spread

500 400 300 200 100 0 -200 -300 Price of Nifty
22 00 22 50 23 00 23 50 24 00 24 50 25 00 25 50 26 00 26 50 27 00 27 50 28 00 28 50 29 00 29 50 30 00

-100

Long Straddle
Buy same strike price call and put option. It is beneficial when market looks very volatile. Trader has to pay time value.

Purchase 2600 March Call option at Rs.75 and 2600 March Put option at Rs.75
Events
Price Of Nifty Value of I Option Value of II Option Profit / (Loss) 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 2200 2250 2300 2350 2400 2450 2500 2550 2600 2650 2700 2750 2800 2850 2900 -75 -75 -75 -75 -75 -75 -75 -75 -75 -25 25 75 125 175 225 325 275 225 175 125 75 25 -25 -75 -75 -75 -75 -75 -75 -75 250 200 150 100 50 0 -50 -100 -150 -100 -50 0 50 100 150

Pay off of Long Straddle

400 300
Profit / (Loss)

200 100 0 -100 -200 Price of Nifty

22 00 22 50 23 00 23 50 24 00 24 50 25 00 25 50 26 00 26 50 27 00 27 50 28 00 28 50 29 00 29 50 30 00

16
17

2950
3000

275
325

-75
-75

200
250

Short Straddle
Sell same strike price call and put option. It is beneficial when market looks range bound. Trader will receive time value.

Sell 2600 March Call option at Rs.75 and 2600 March Put option at Rs.75
Events Price Of Nifty Value of I Option Value of II Option Profit / (Loss)

1 2 3 4 5 6 7 8 9 10 11 12

2200 2250 2300 2350 2400 2450 2500 2550 2600 2650 2700 2750

75 75 75 75 75 75 75 75 75 25 -25 -75

-325 -275 -225 -175 -125 -75 -25 25 75 75 75 75

-250 -200 -150 -100 -50 0 50 100 150 100 50 0

Pay off of Short Straddle 200 100

Profit / (Loss)

0 2200 -100 -200 -300 -400 Price of Nifty 2350 2500 2650 2800 2950

13
14 15 16 17

2800
2850 2900 2950 3000

-125
-175 -225 -275 -325

75
75 75 75 75

-50
-100 -150 -200 -250

Long Strangle
Buy Different strike price call and put option. It is beneficial when market looks very volatile. Trader has to pay time value.

Purchase 2700 March Call option at Rs.50 and 2500 March Put option at Rs.50
Events Price Of Nifty Value of I Option Value of II Option

Profit / (Loss)

1 2 3 4 5 6 7 8 9

2200 2250 2300 2350 2400 2450 2500 2550 2600

-50 -50 -50 -50 -50 -50 -50 -50 -50

250 200 150 100 50 0 -50 -50 -50

200 150 100 50 0

Pay off of Long Strangle

300 250 200 150 100 50 0 -50 -100 -150

-100 -100 -100

10
11 12 13 14 15 16 17

2650
2700 2750 2800 2850 2900 2950 3000

-50
-50 0 50 100 150 200 250

-50
-50 -50 -50 -50 -50 -50 -50

-100
-100 -50 0 50 100 150 200

Profit / (Loss)

-50

22 00 22 50 23 00 23 50 24 00 24 50 25 00 25 50 26 00 26 50 27 00 27 50 28 00 28 50 29 00 29 50 30 00

Price of Nifty

Short Strangle
Sell different strike price call and put option. It is beneficial when market looks range bound. Trader will receive time value.

Sell 2700 March Call option at Rs.50 and 2500 March Put option at Rs.50
Events Price Of Nifty Value of I Option Value of II Option Profit / (Loss)

1 2 3 4 5 6 7 8 9 10

2200 2250 2300 2350 2400 2450 2500 2550 2600 2650

50 50 50 50 50 50 50 50 50 50

-250 -200 -150 -100 -50 0 50 50 50 50

-200 -150 -100 -50 0

Pay off of Long Strangle

150 100 50 0 -50 -100 -150 -200 -250 -300

100 100 100 100

Profit / (Loss)

50

11
12 13 14 15 16 17

2700
2750 2800 2850 2900 2950 3000

50
0 -50 -100 -150 -200 -250

50
50 50 50 50 50 50

100
50 0 -50 -100 -150 -200

22 00 22 50 23 00 23 50 24 00 24 50 25 00 25 50 26 00 26 50 27 00 27 50 28 00 28 50 29 00 29 50 30 00

Price of Nifty

Long Butterfly
Sell same strike price call and put option & buy lower strike price put & higher strike price call (of equal distance). It is beneficial when market looks range bound. Trader will receive time value.

SELL 2600 2600 2800 2400 Price Of Nifty Value of Call Sold Value of Put Sold Value of Call Bought CE PE CE PE Value of Put Bought 100 100

BUY

25 25

Events

Profit / (Loss)

1 2 3 4 5 6 7 8 9

2200 2250 2300 2350 2400 2450 2500 2550 2600

100 100 100 100 100 100 100 100 100

-300 -250 -200 -150 -100 -50 0 50 100

-25 -25 -25 -25 -25 -25 -25 -25 -25

175 125 75 25 -25 -25 -25 -25 -25

-50 -50 -50 -50 -50 0 50 100 150

Profit / (Loss)

Pay off of Long Butterfly

200 100 0 -100 -200 -300 -400 Price of Nifty 2200 2250 2300 2350 2400 2450 2500 2550 2600 2650 2700 2750 2800 2850 2900 2950 3000

10
11 12 13 14 15 16 17

2650
2700 2750 2800 2850 2900 2950 3000

50
0 -50 -100 -150 -200 -250 -300

100
100 100 100 100 100 100 100

-25
-25 -25 -25 25 75 125 175

-25
-25 -25 -25 -25 -25 -25 -25

100
50 0 -50 -50 -50 -50 -50

Short Butterfly
Buy same strike price call and put option & sell lower strike price put & higher strike price call (of equal distance). It is beneficial when market looks volatile. Trader will pay time value.

SELL 2600 2600 2800 2400 Value of Call Bought Value of Put Bought Value of Call Sold CE PE CE PE Value of Put Sold 25 25

BUY 100 100

Events

Price Of Nifty

Profit / (Loss)

Pay off of Short Butterfly

1 2 3 4 5 6 7 8 9 10 11 12 2200 2250 2300 2350 2400 2450 2500 2550 2600 2650 2700 2750 -100 -100 -100 -100 -100 -100 -100 -100 -100 -50 0 50 300 250 200 150 100 50 0 -50 -100 -100 -100 -100 25 25 25 25 25 25 25 25 25 25 25 25 -175 -125 -75 -25 25 25 25 25 25 25 25 25 50 50 50 50 50 0 -50 -100 -150 -100 -50 0
Profit / (Loss)

400 300 200 100 0 -100 -200 Price of Nifty 2200 2250 2300 2350 2400 2450 2500 2550 2600 2650 2700 2750 2800 2850 2900 2950 3000

13
14 15 16 17

2800
2850 2900 2950 3000

100
150 200 250 300

-100
-100 -100 -100 -100

25
-25 -75 -125 -175

25
25 25 25 25

50
50 50 50 50

Calendar Spread
Sell a call or put option & buy same strike price call or put of far month. It is beneficial when disparity in volatility in different months found. Trader will receive time value.

Sell 2600 March Call option at Rs.110 and Buy 2600 April Call option at Rs.130
Events Price Of Nifty Value of Call Sold Value of Call Bought Profit / (Loss) 1 2200 110 -125 -15

Pay off of Calender Spread

400 300
Profit / (Loss)

2
3 4 5 6 7 8 9 10 11 12 13 14 15 16 17

2250
2300 2350 2400 2450 2500 2550 2600 2650 2700 2750 2800 2850 2900 2950 3000

110
110 110 110 110 110 110 110 60 10 -40 -90 -140 -190 -240 -290

-122
-117 -110 -101 -88 -72 -51 -27 1 33 67 106 146 190 233 280

-12
-7 0 9 22 38 59 83 61 43 27 16 6 0 -7 -10

200 100 0 -200 -300 -400 Price of Nifty

22 00 22 50 23 00 23 50 24 00 24 50 25 00 25 50 26 00 26 50 27 00 27 50 28 00 28 50 29 00 29 50 30 00

-100

Last day strategies

Either call or put will become zero.

Option Greeks
Option Greeks represents Dimensions of risk involved in taking a position in an option. Option Greeks are : Delta Gamma Vega Theta Rho

 Delta
The ratio comparing the change in the price of the underlying asset to the corresponding change in the price of a derivative. Means delta shows the net change in the price of option due to 1 Rs. Change in the price of underlying.
For Eg. If price of GNFC changes from Rs.100 to Rs.101 and the price of its 100 strike call option changes from Rs.5 to Rs.5.50. It shows that the delta of 100 strike call option is 0.50

Directional effect of Delta

The relationship between underlying price and call option delta is positive as the price of underlying increases, the price of call option also increases and vice versa. That means delta of call option is positive & when you sell call option it becomes negative. On Second side relationship between underlying price and put option delta is negative as the price of underlying increases, the price of put option decreases and vice versa. That means delta of put option is negative & when you sell put option it becomes positive. The positive and negative sign of delta shows the favorable and unfavorable direction of the position of option. Means whether the position is bullish or bearish can be checked by checking the net delta of the position.

Call Option Delta Behavior

Underlying Price Increases Value of Call Option Increases

Positive Delta

Underlying Price Decreases

Value of Call Option Decreases

Positive Delta

Put Option Delta Behavior

Underlying Price Increases Value of Put Option Decreases

Negative Delta

Underlying Price Decreases

Value of Put Option Increases

Negative Delta

 Normally Delta of Out of the money option lies between 0 to 0.49 Delta of At the money option lies at 0.50 Delta of In the money option lies between 0.51 to 1
Can delta go above 1 ?????????????????

 Gamma
Gamma measures the change in delta for a given change in the underlying. Eg. If a call option has a delta of 0.5 and a gamma of 0.05, this indicates that the new delta will be 0.55 if the underlying price moves up by one full point and 0.45 if underlying price moves down by one full point.

Need of Gamma
Gamma anticipates the speed of delta which is very helpful at the time of running the delta neutral strategies. Because there we need to know the effect of delta due to change in spot price from one level to another.

 Theta
Theta measures the effect of time decay on an option. As time passes, option will lose time value and the theta indicates the extent of this decay. Both call and put options are wasting assets and therefore have a negative theta. Note that the decay of options is nonlinear in that the rate of decay will accelerate as the option approaches expiry.

Eg. of theta
For Eg. If price of GNFC remains Rs.100 on Day 1 & Day 2 but the price of its 100 strike call option changes from Rs.5 to Rs.4.85. It shows that the theta of 100 strike call option is 0.15 for one day. (Annualised 54.75)

 Vega
Vega measures the effect that a change in implied volatility has on an options price. Both calls and puts tend to increase in value as the volatility increases, as this raises the probability that the option will move in the money. Both calls and puts will thus possess a positive vega.

Volatility
The volatility of an option is a measure of the spread of the price movements of the underlying instrument. The more volatile the underlying instrument, the greater the time value of the option will be. This will mean greater uncertainty for the option seller who, will charge a high premium to compensate. Option prices increase as volatility rises and decrease as volatility falls.

 Rho
Rho measures the impact on price of an option due to change in the rate of interest. It provides very less impact in short term maturity option while it is very important tool for long run maturity option.

Delta Neutral Strategies

Delta neutral strategy makes the portfolio in such a way so that the delta of complete portfolio should be Zero. That signifies that trader do not want to earn money through bull or bear market while he just want to earn either time value or volatility value.

Few eg of delta neutral strategies

Sell one call and one put option Sell one put option, buy one call option and sell one future Buy one put option, sell one call option and buy one future Buy one call and buy one put option Buy one ATM call and Sell two OTM call Buy one ATM Put and Sell two OTM Put Buy one ITM Call and sell one ATM and one OTM call Buy one ITM Put and sell one ATM and one OTM call Buy one future and sell two calls Sell one future and sell two puts

Relationship between Vega and Theta

Generally Vega and Theta are rivals of each other. If trader wants to earn theta, he must be having the risk of Vega and vice versa. For eg if you sell the option, you will get time value as the time passes, But if the volatility rises in the market, you will lose money.

Put Call Parity An Arbitrage Opportunity

Formula Finding Opportunity Risk of Exercise Transaction Charge

Volatility Smile
Sell high vol option and buy low vol option. Delta Neutral

Long Gamma Strategy

Buy options and try to reduce the costing by trading either in future or in stock. Buy at low and sell at high so that the profit accumulated should make option free.

Bhavcopy
INSTRUMEN T FUTIDX FUTIDX SYMBOL MINIFTY MINIFTY EXPIRY_DT 26-Mar-09 30-Apr-09 STRIKE_PR 0 0 OPTION_T YP XX XX OPEN 2634 2630 HIGH 2639 2631 LOW 2538.4 2527

FUTIDX
FUTIDX FUTIDX FUTIDX FUTIDX FUTIDX FUTIDX OPTSTK OPTSTK OPTSTK OPTSTK OPTSTK OPTSTK OPTSTK

MINIFTY
NFTYMCAP50 NFTYMCAP50 NFTYMCAP50 NIFTY NIFTY NIFTY TATASTEEL TATASTEEL TATASTEEL TATASTEEL TATASTEEL TATASTEEL TATASTEEL

28-May-09
26-Mar-09 30-Apr-09 28-May-09 26-Mar-09 30-Apr-09 28-May-09 26-Mar-09 26-Mar-09 26-Mar-09 26-Mar-09 26-Mar-09 26-Mar-09 26-Mar-09

0
0 0 0 0 0 0 150 155 160 165 170 175 180

XX
XX XX XX XX XX XX CA CA CA CA CA CA CA

2645
1101.3 0 0 2634.8 2618 2619 13.05 10.3 8.2 5.75 5 2.5 2.85

2645
1101.3 0 0 2639.45 2625 2625 14.95 10.9 9.15 6.45 5.4 2.5 2.85

2525
1101.2 0 0 2538.4 2527.3 2525.05 8.5 6.15 4.4 3.1 2.4 2.5 1.4

Bhavcopy II
CLOSE 2556.8 2545.15 2543.75 1101.2 1180.2 1110.85 2556.8 2545.5 2542.1 8.9 6.4 4.8 3.15 2.65 2.5 1.55 SETTLE_PR 2556.8 2545.15 2543.75 1018.9 1026.75 1032.4 2556.8 2545.5 2542.1 8.9 6.4 4.8 3.15 2.65 2.5 1.55 CONTRACTS 96215 7030 707 2 0 0 842741 20815 1347 197 30 520 12 303 1 140 VAL_INLAKH 49657.24 3612.7 363.1 6.6 0 0 1086216 26701.08 1728.48 481.01 75.12 1324.15 31.05 804.35 2.71 389.28 OPEN_INT 941780 130100 14360 600 0 0 32326450 1418400 131000 152800 169608 1326304 67232 774696 12224 764000 CHG_IN_OI 246300 28000 4180 600 0 0 1302250 233400 31700 74872 10696 155856 1528 59592 -1528 77928 TIMESTAMP 05-Mar-09 05-Mar-09 05-Mar-09 05-Mar-09 05-Mar-09 05-Mar-09 05-Mar-09 05-Mar-09 05-Mar-09 05-Mar-09 05-Mar-09 05-Mar-09 05-Mar-09 05-Mar-09 05-Mar-09 05-Mar-09

Open Interest
Meaning Use Exchange Regulation Calculation

Blunders in Derivatives Market

The 1990s saw a number of episodes in which companies using derivatives lost large amounts of money

The 1993 Metallgesellschaft oil hedging debacle The 1994 bankruptcy of Orange county The 1995 collapse of Barings bank The 1998 LTCM collapse The recent collapse of Enron

Metallgesellschaft
The Event
MGRM decided in 1991 to enter the US heating oil and gasoline markets.

To do this, it offered retailers five and ten year fixed price contracts. These gave MGRM a short position of 160 million barrels of oil. MGRM hedged this position through purchase of NYMEX crude oil futures. MGRM used a stacked hedge, rolling over 1 and 2 month contracts. This exposed MGRM to cashflow risk (margin calls, since futures position large relative to cashflow) & basis risk (change in backwardation - contango at roll).

The problems
End 1993 oil price fell and NYMEX future moved into contango. Falling crude price forced large margin payments. Move to contango made the roll expensive. MG reacted in December 1993 by taking direct control of MGRM , and liquidating the hedge position. Liquidation cost Mg $1.83bn ,around one half of the total value of the firm.

Lessons
Highly speculative to hedge long-date position with shortdated instruments. MGRM was substantially over-hedged initial short exposure become a long exposure. Size of MGRM position induced contango. MGRM viewed synthetic storage as cheaper than physical storage. The contango was the price they needed to pay the market to do this storage. MGRM was a gamble that oil prices would rise from 199192 levels. The hedge was part of a speculative strategy to become a major player in the US oil refining industry.

Orange County
The Event
Citron dominates the orange county treasury in the 1980s and 90s. He was one of the nations best known municipal treasurers, primarily because his investment strategies produced a very high average return of 9.3 %. Citrons strategies consisted primarily of large, leveraged bets that short term interest rates would not increase. Citron borrowed about $13 billion from various securities firm through arrangements known as reverse repurchase agreements, using Orange countys $7.4 billion investment pool as collateral. This gave him about $20 billion to invest. Citron used structured notes to buy large amounts of inverse floaters, bonds whose value increases rapidly when interest rates decline and vice versa.

The problems
The federal reserve increased short-term rates on February 4,1994,and five times thereafter in the same year. Orange countys investment pool began hemorrhaging. Citron was able to hide these losses during 1994, because of the way in which his derivative investments were structured and as they technically fit within Orange countys investments guidelines. On December 1, 1994 Orange countys officials held a press conference announcing losses of $1.7 billion. Orange county was unable to repay the money it had borrowed and filed the largest municipal bankruptcy petition in history on December 6, 1994.

lessons
Naked directional bets will never succeed indefinitely citrons strategy gained only till interest rates remained low and once the rates started rising ,they resulted in large losses.

Limited disclosure As citrons investments were shortterm and issued by highly rates entities. It technically fit within the orange county investment guidelines. However, The fact that they were structured notes with leveraged directional bets was never highlighted.

Barings bank
The Event
Leeson accumulated a very large long position in Nikkei stock index futures ($7b exposure) and to Japanese government bonds (JGBs) , both in Osaka and Singapore. Leeson was able to hide these losses from senior management in London. Leeson hid trading losses in an error account, the famous 88888 account.

The problems
The Nikkei fell following the kobe 1995 earthquake.
Margin calls exhausted Barings reserves. Barings was sold for 1 to ING.

Lessons
Leesons background was not in trading but in futures settlement and he used his settlement experience to hide his trading losses.

Relevant experience is essential

Bad traders are present on every major trading floor. the role of managers is to identify rogue traders before they do significant damage. baring lacked the most elementary system for risk control and facilitated leesons rogue trades by not appointing an independent manger for the Singapore back office. Barings management understood very little about derivatives. Control presupposes understanding.

LTCM
The Event
LTCM was a hedge fund involved in convergence (arbitrage) trades.
They betted on convergence of German and other European bonds long and short term corporate & emerging market bonds versus US treasuries Russian and Japanese government bonds long and short term US equity swaption straddles. LTCM had very high leverage, which was further increased by the the December 1997 decision to return capital to investors. The leverage finally reached mare than 20 in 1988 , resulting in the fact that LTCM would make (or Lose) large amounts of money on small movements in relative rates.

The problems
Leveraged convergence trade made good profits for LTCMs investors over its initial three years of operations(1994-96). September 1998 Russian default resulted in rush into quality and huge increase in volatility resulting in all the convergence trades going badly Wrong. In the rush to quality following the Russian default, there were few buyers of corporate bonds. In September 1998 , the relative spreads widened instead of narrowing as LTCM had thought would happen. LTCM lost &4.6bn and there was a significant fear on the part of the regulators that LTCM bankruptcy might trigger other bankruptcies , inducing the fed to organize a $3.6bn rescue for LTCM.

Lessons
Liquidity risk : size is not always a benefit. Leverage: LTCMs equity base was insufficient to support the degree of leverage required to generate the returns they were promising to their investors. Basis risk : Even if basis risks on the different LTCM trades were small and uncorrelated, multiplied by twenty they became quite large.