PROJECT REPORT ON OPTIONS THEORY AT CENTRUM

IN PARTIAL FULFILLMENT OF THE AWARD OF PDBM SUBMITTED TO

WLCI COLLEGE

BY ACL-2

M.NARESH REDDY 06120071

WLCI COLLEGE HYDERABAD

ACKNOWLEDGEMENT

I take this opportunity to express my deep and sincere gratitude to the Management of CENTRUM for their gesture of allowing me to undertake this project and its various employees who lent their hand towards the completion of this study. The Co-operation I received from the wide cross-section of employee of CENTRUM makes it difficult to style out individuals for acknowledgment. However, I am particularly indebted to Mr. R D RAJAN, Project Manager for allowing me to carry out my project work in the organization.

M.NARESH REDDY

INTRODUCTION:
A Derivative is a security whose value depends on the value of to gather more basic underlying variable. These are also known as contingent claims. Derivative securities have been very successful innovation in capital market.
Derivative is a product whose value is derived from the value of one or more basic variables, called bases (underlying asset, index, or reference rate), in a contractual manner. The underlying asset can be equity, forex, commodity or any other asset. In the Indian context the Securities Contracts (Regulation) Act, 1956 (SC(R) A) defines "derivative" to include: 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. A contract which derives its value from the prices, or index of prices, of

underlying securities. Derivatives are securities under the SC(R) A and hence the trading of derivatives is governed by the regulatory framework under the SC(R) A.

Introduction to Derivatives:
The emergence of the market for derivative products, most notably forwards, futures and options, can be traced back to the willingness of risk-averse economic agents to guard themselves against uncertainties arising out of fluctuations in asset prices. By their very nature, the financial markets are marked by a very high degree of volatility. Through the use of derivative products, it is possible to partially or fully transfer price risks by locking-in asset prices. As instruments of risk management,

these generally do not influence the fluctuations in the underlying asset prices. However, by locking in asset prices, derivative products minimize the impact of fluctuations in asset prices on the profitability and cash flow situation of risk-averse investors.

Emergence of financial derivative products:

Derivative products initially emerged as hedging devices against fluctuations in commodity prices, and commodity-linked derivatives remained the sole form of such products for almost three hundred years. Financial derivatives came into spotlight in the post-1970 period due to growing instability in the financial markets. However, since their emergence, these products have become very popular and by 1990s, they accounted for about two-thirds of total transactions in derivative products. In recent years, the market for financial derivatives has grown tremendously in terms of variety of instruments available, their complexity and also turnover. In the class of equity derivatives the world over, futures and options on stock indices have gained more popularity than on individual stocks, specially among institutional investors, who are major users of index-linked derivatives. Even small investors find these useful due to high correlation of the popular indexes with various portfolios and ease of use.

Factors Driving the Growth of Derivatives:

Over the last three decades, the derivatives market has seen a phenomenal growth. A large variety of derivative contracts have been launched at exchanges across the world. Some of the factors driving the growth of financial derivatives are: Increased volatility in asset prices in financial markets, Increased integration of national financial markets with the international markets, Marked improvement in communication facilities and sharp decline in their costs, Development of more sophisticated risk management tools, providing

economic agents a wider choice of risk management strategies, and Innovations in the derivatives markets, which optimally combine the risks and

returns over a large number of financial assets leading to higher returns, reduced risk as well as transactions costs as compared to individual financial assets.

OBJECTIVES OF STUDY:
To study various trends in derivative market. 1. Comparison of the profits/losses in cash market and derivative market. 2. To find out profit/losses position of the option writer and option holder. 3. To study in detail the role of the options

4. To study the role of derivatives in Indian financial market. 5. To seek the knowledge in Derives 6. To know about the Options Trading Procedure 7. To know the Methods/Strategies/Styles in Options Trading 8. To know to whom it is useful 9. To know the players in Options World

SCOPE OF THE STUDY:

The study is limited to derivatives with special reference to options in the Indian context the study is not based on the international perspective of derivative markets. LIMITATIONS OF THE STUDY: As the information related to option strategies are very confidential in nature because these are the techniques that the investor will use the strategies to get profit by exercising the options. So, I did analysis of option strategies only two common strategies that are used by the investors regularly i.e., LONG PUT and LONG COMBO.

Company profile Centrum Centrum is jointly promoted by Mr. Chandir Gidwani, a Chartered Accountant, having more than a decade of experience in the financial services industry & The Cassinath Group, promoted by late Mr. Khushroo P. Byramjee. Centrum was incorporated in 1977. It is a SEBI registered Category I Merchant Banker, listed on The Stock Exchange, Mumbai (BSE). Over the last two decades, it has expanded into a full-service investment banking company. Today its primary role is that of a responsible intermediary with a strong professional base. Its forte is providing advisory and innovatively structured financial solutions in the area of fund raising, infrastructure development, government borrowing, corporate restructuring and money market intermediation. Centrum has the experience of raising over Rs.8,05,000 million (US $ 17,300 million) through equity, bonds and credit syndication in the last 5 years. This can be attributed to its excellent relationship across a wide spectrum of private and public sector banks, FIs, provident funds, charitable organizations and institutional investors across India. Centrum Capital Ltd. and its group subsidiaries, FCH CentrumDirect Ltd, Centrum Broking Pvt. Ltd., FCH Centrum Wealth Managers Limited and Centrum Infrastructure & Realty Ltd. provide value added products and services to corporates and individuals across the country in both the Private and the Public sector. Centrum Services comprise investment banking, wealth management, portfolio management, stock broking, foreign exchange, travel services and infrastructure & real estate advisory services. As a leading financial services firm it

strives to promote a corporate culture promoting world-class banking services for our clients and value for our shareholders. Centrum Group of Companies: Centrum Capital Ltd. (CCL) is a leading investment bank offering comprehensive financial services comprising fund raising by way of equity and debt for corporates, Government undertakings and state entities. CentrumDirect Ltd. (CDL) is amongst the top retail money changers in the country authorized by the Reserve bank of India. It does money changing for retail and corporate travelers and is also involved in wholesale foreign exchange business like export of currency. Centrum Broking Private Ltd. (CBPL) is an associate of CCL, has set-up an integrated stock broking business in the last few years. The Company is a member of BSE and National Exchange (NSE) on both cash and derivatives segments. It is also a Depository Participant under Central Depository Services Limited (CDSL) and a Portfolio Manager registered with Securities Exchange Board of India (SEBI). Your window to the Stock Market Centrum is a full-service Broking House having memberships in the Cash and F&O segments of the Bombay Stock Exchange Limited (BSE), the National Stock Exchange of India Ltd (NSE) and the NCDEX, offering comprehensive personal financial solutions to a cross-section of clients comprising of High Net Worth Individuals, Corporates, NRIs, FIIs, Mutual Funds, Insurance Companies, Banks and other Financial Institutions. Centrum is also a Depository participant with CDSL and a SEBI registered Portfolio Manager.

Minimizing Risks, Maximizing Returns Centrum is dedicated to creating growth-oriented investment solutions tailored to suit your individual financial needs and goals. It is committed to minimizing the risks involved in investing in the stock markets through careful fundamental, quantitative and technical analysis of the various investment options available and selecting the ones that optimize client returns. Centrums adherence to high ethical standards along with its credible relationships with major leading banks and financial institutions has made it the most preferred broker with many clients for institutional trading and derivatives. It also has a dedicated team focusing on hedging and arbitrage strategies for investors with special needs. Moreover, Centrums dedicated HNI Cell offers research-based advice to affluent individuals and families to help them manage and multiply their wealth. The products and services covered are mutual funds, IPOs, insurance, forex, fixed income, discretionary and non-discretionary PMS, equity and commodities trading in India and Dubai. Centrum Wealth Managers Ltd. (CWML) is the Retail broking, Distribution, Insurance & Portfolio management arm of CCL. Centrum Infrastructure & Realty Ltd. (CIRL) it offers infrastructure and real estate advisory services to facilitate investment, development and setting up of infrastructure facilities including real estate projects. Casby Logistics Pvt. Ltd. (CLPL) is a firm incorporated in 1857, is one of the largest Stevedores of the Bombay Port. The business interests of the firm span

transportation, clearing & forwarding, couriers, logistics and supply chain management services. They are the local partner for P&O Ports, Australia. Our mission

To become the first-choice investment banker To provide uniquely tailored solutions for 100% of the financial services needs of both corporate and individuals

To challenge the obvious solutions and provide financial consultancy and syndicated products, which deliver value beyond customer expectations To this end Centrum has over the years built a very strong foundation by

investing heavily for the future. It has invested in high quality talent, technology that drives business and state- of-the art infrastructure to extend its reach further. Centrum today is not only amongst Indias top 10 fund mobilisers but also has the distinction of being amongst the top 3 retail money changers in the country. It is also one of the fastest growing wealth managers in the country. Centrum has reached the position of being a unique financial services company that draws strength from each one of its business units and builds on it.

Centrum products & services Centrum broking A full-service broking house, Centrum offers comprehensive financial solutions to a cross-section of clients comprising high net-worth individuals, corporates, NRIs, FIIs, Mutual Funds, Insurance Companies, Banks and other financial institutions.

Its research-based advice on potential investment options ensures the best possible returns on investments. Moreover, through its dedicated HNI Cell, Centrum provides both, discretionary and non-discretionary Portfolio Management Services to investors. Its association with various stock exchanges and organizations facilitate their operations:

Cash and F&O segments of the Bombay Stock Exchange Limited (BSE) and the National Stock Exchange of India Limited (NSE).

Depository participant with CSDL. SEBI registered portfolio manager. Membership on NCDEX. In a nutshell, Centrum is a one-stop shop for all your stock market needs:

stock broking, portfolio management and depository services. Centrum capital Equity Centrum provides complete financial solutions to companies in high-growth markets on their capitalization/re-capitalization strategies. It has raised funds for both, public and private corporates and is adept in dealing with the issues specific to each of these environments. From advising on capital structuring, to raising equity, preparation of the prospectus to post-issue assistance, Centrum provides comprehensive services that has made it one of the most preferred financial services providers.

Suggesting an optimal mix of debt and equity Advising on capital structuring Advising on the best options to raise equity and the instrument Public Issues (IPOs), Follow on Offerings and Right Issues Private Placement of Equity Corporate Advisory Services Share Buyback and Open Offers

Credit syndicate Centrum has been instrumental in arranging loans for Corporate, PSUs, State Finance Corporations, etc. across India with the principal focus being infrastructure funding. Over the last 5 years, it has successfully syndicated over Rs. 1, 20,000 million (US$ 2600 million) for blue chip clients. Empowered by a team of experienced management professionals spread across seven major states, Centrum has syndicated loans across diverse sectors, which include Power, Roadways, Irrigation, Urban Development, Processed Foods, Specialty Chemicals, Renewable Energy, FMCG, Mining, Pharmaceuticals, Entertainment and Media. Fixed income Centrums core expertise lies in arranging resources for clients comprising major Public and Private Banks, PSUs, Government Undertakings, and Private Sector Corporate. In the last 5 years, it has successfully structured, distributed and placed public and private debts of over Rs. 6,50,000 million (US$ 14,000 million) and is ranked the 4th highest mobilize of funds on all-India basis for the FY 2005-2006 (Source: League Tables - Prime Database).

Centrums team of management professionals helps its clients to structure their debts to meet short and long term financial objectives. Reputable and longstanding relationships with the investing community: Banks, Mutual Funds, Provident funds, etc., enables Centrum to raise debts on competitive terms in record time, irrespective of its size. Centrum direct Forex Centrum is one of the leading RBI authorised moneychangers in India. With its team of highly trained and experienced professionals, Centrum serves leading Multinationals, PSUs, Government establishments and Banks and large Tour Operators across the country through its branches located in all major cities. It serviced over 300,000 clients in FY 2005-06 resulting in a turnover of US$ 187 million. Centrum, with its presence at Airports, has positioned its branches in all major tourist destinations to provide encashment facilities to inbound travellers. It understands the needs of outbound travellers and is the countrys largest retailer of Co-branded Prepaid Travel Cards. At the same time, Centrum provides option to the travellers for the American Express Traveller Cheques in 6 destination currencies: USD, GBP, EURO, JPY, AUD and CAD. Investments Centrum understands the needs of customized investment solutions for its affluent clients, their families and businesses. Through its dedicated HNI Cell, it assiduously analyzes clients financial objectives and creates a customized strategy to

meet those targets. The process draws on its effective research capabilities that are resilient to changing market conditions. Centrums investment discipline recognizes the importance of strategic asset allocation and the flexibility to select from diverse investment strategies to achieve short and long term financial goals. Relying on this principle, its team of experienced professionals, which includes MBAs, CAs and CFAs, determine an ideal investment plan that achieves: the best possible returns, an acceptable level of risk, and sufficient financial freedom to accommodate ones future growth plans. Insurance Insurance is now emerging as an integral part of any investment plan. It not only protects you from the uncertainties of life but also gives you competitive stipulated returns. Centrum offers insurance advisory services that help its clients to balance risk as well as achieve their financial goals in the event of an unexpected occurrence. After analyzing the risk profile, expected cover, and anticipated returns, Centrum designs an ideal insurance plan that provides a simple, cost-effective solution to a wide range of business needs, from risk management and compensation to business continuation. It combines long-term stability with the flexibility to respond as the needs change. Life Insurance Unit Linked Insurance Plans (ULIP): Unique combination of security from life insurance and earnings from investments.

Money Back Plans: Periodic payment of certain percentage of sum assured is made at regular intervals.

Endowment Plans: Covers life for a predetermined amount i.e. the sum assured.

Whole-life plans: Provides insurance cover till 100 years of age or death whichever is earlier.

Pension Plans: Regular pension comes to policyholder after retirement till his/her death.

Children Plans: Designed to secure your childs future by giving your child (the beneficiary) a guaranteed lump sum, on maturity or in case of unfortunate demise of the policy-holder.

Term Plans: Offers high death benefit at low premium but no maturity benefit.

Derivative Products:
Derivative contracts have several variants. The most common variants are forwards, futures, options and swaps. We take a brief look at various derivatives contracts that have come to be used. Forwards: A forward contract is a customized contract between two entities, where settlement takes place on a specific date in the future at today's pre-agreed price. Futures: A futures contract is an agreement between two parties to buy or sell an asset at a certain time in the future at a certain price. Futures contracts are special types of forward contracts in the sense that the former are standardized exchange-traded contracts. Options: Options are of two types - calls and puts. Calls give the buyer the right but not the obligation to buy a given quantity of the underlying asset, at a given price on or before a given future date. Puts give the buyer the right, but not the obligation to sell a given quantity of the underlying asset at a given price on or before a given date. Warrants: Options generally have lives of upto one year; the majority of options traded on options exchanges having a maximum maturity of nine months. Longer-dated options are called warrants and are generally traded over-the-counter. LEAPS: The acronym LEAPS means Long-Term Equity Anticipation Securities. These are options having a maturity of upto three years.

Baskets: Basket options are options on portfolios of underlying assets. The underlying asset is usually a moving average of a basket of assets. Equity index options are a form of basket options. Swaps: Swaps are private agreements between two parties to exchange cash flows in the future according to a prearranged formula. They can be regarded as portfolios of forward contracts. Interest rate swaps: These entail swapping only the interest related cash flows between the parties in the same currency. Currency swaps: These entail swapping both principal and interest between the parties, with the cash flows in one direction being in a different currency than those in the opposite direction. Swaptions: Swaptions are options to buy or sell a swap that will become operative at the expiry of the options. Thus a swaption is an option on a forward swap. Rather than have calls and puts, the swaptions market has receiver swaptions and payer swaptions. A receiver swaption is an option to receive fixed and pay floating. A payer swaption is an option to pay fixed and receive floating.

Participants in the Derivatives Markets:

The following three broad categories of participants: Hedgers, Speculators, and Arbitrageurs.

HEDGERS:
Hedgers face risk associated with the price of an asset. They use futures or options markets to reduce or eliminate this risk.

SPECULATORS:
Speculators wish to bet on future movements in the price of an asset. Futures and options contracts can give them an extra leverage; that is, they can increase both the potential gains and potential losses in a speculative venture.

ARBITRAGEURS:
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.

NSE'S Derivatives Market:

The derivatives trading on the NSE commenced with S&P CNX Nifty Index futures on June 12, 2000. The trading in index options commenced on June 4, 2001 and trading in options on individual securities commenced on July 2, 2001. Single stock futures were launched on November 9, 2001. Today, both in terms of volume and turnover, NSE is the largest derivatives exchange in India. Currently, the derivatives contracts have a maximum of 3-month expiration cycles. Three contracts are available for trading, with 1 month, 2 months and 3 months expiry. A new contract is introduced on the next trading day following the expiry of the near month contract...

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. The salient features of forward contracts are: They are bilateral contracts and hence exposed to counter-party risk. Each contract is custom designed, and hence is unique in terms of contract size, expiration date and the asset type and quality. The contract price is generally not available in public domain. On the expiration date, the contract has to be settled by delivery of the asset. Forward markets world-wide are afflicted by several problems: Lack of centralization of trading, Illiquidity, and Counterparty risk In the first two of these, the basic problem is that of too much flexibility and generality. The forward market is like a real estate market in that any two consenting adults can form contracts against each other. This often makes them design terms of the deal which are very convenient in that specific situation, but makes the contracts non-tradable. Counterparty risk arises from the possibility of default by any one party to the transaction. When one of the two sides to the transaction declares bankruptcy, the

other suffers. Even when forward markets trade standardized contracts, and hence avoid the problem of illiquidity, still the counterparty risk remains a very serious issue.

Introduction to Futures:
Futures markets were designed to solve the problems that exist in forward markets. A futures contract is an agreement between two parties to buy or sell an asset at a certain time in the future at a certain price. But unlike forward contracts, the futures contracts are standardized and exchange traded. To facilitate liquidity in the futures contracts, the exchange specifies certain standard features of the contract. It is a standardized contract with standard underlying instrument, a standard quantity and quality of the underlying instrument that can be delivered, (or which can be used for reference purposes in settlement) and a standard timing of such settlement. A futures contract may be offset prior to maturity by entering into an equal and opposite transaction. More than 99% of futures transactions are offset this way. The standardized items in a futures contract are: Quantity of the underlying Quality of the underlying The date and the month of delivery The units of price quotation and minimum price change Location of settlement

Introduction To Options:
Options are fundamentally different from forward and futures contracts. An option gives the holder of the option the right to do something. The holder does not have to exercise this right. In contrast, in a forward or futures contract, the two parties have committed themselves to doing something. Whereas it costs nothing (except margin requirements) to enter into a futures contract, the purchase of an option requires an up-front payment. Option Terminology: Index options: These options have the index as the underlying. Some options are European while others are American. Like index futures contracts, index options contracts are also cash settled. Stock options: Stock options are options on individual stocks. Options currently trade on over 500 stocks in the United States. A contract gives the holder the right to buy or sell shares at the specified price. 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 of an option: The writer of a call/put option is the one who receives the option premium and is thereby obliged to sell/buy the asset if the buyer exercises on him. Types of Options: Call Options and Put Options.

Call option: A call option gives the holder the right but not the obligation to buy an asset by a certain date for a certain price. Put option: A put option gives the holder the right but not the obligation to sell an asset by a certain date for a certain price. Option Styles: American options: American options are options that can be exercised at any time up to the expiration date. Most exchange-traded options are American. European options: European options are options that can be exercised only on the expiration date itself. European options are easier to analyze than American options, and properties of an American option are frequently deduced from those of its European counterpart. 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). 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.

Option Strategy:

In finance an option strategy is the purchase and/or sale of one or various option positions and possibly an underlying position. Options strategies can favor movements in the underlying that are bullish, bearish or neutral. In the case of neutral strategies, they can be further classified into those that are bullish on volatility and those that are bearish on volatility. The option positions used can be long and/or short positions in calls and/or puts at various strikes. Bullish strategies Bullish options strategies are employed when the options trader expects the underlying stock price to move upwards. It is necessary to assess how high the stock price can go and the time frame in which the rally will occur in order to select the optimum trading strategy. Bearish strategies Bearish options strategies are the mirror image of bullish strategies. They are employed when the options trader expects the underlying stock price to move downwards. It is necessary to assess how low the stock price can go and the time frame in which the decline will happen in order to select the optimum trading strategy.

Option Strategies: There are 22 option strategies dealing with options they are as follows:

STRATEGY 1 : LONG CALL STRATEGY 2 : SHORT CALL STRATEGY 3 : SYNTHETIC LONG CALL STRATEGY 4 : LONG PUT STRATEGY 5 : SHORT PUT STRATEGY 6 : COVERED CALL STRATEGY 7 : LONG COMBO STRATEGY 8 : PROTECTIVE CALL STRATEGY 9 : COVERED PUT STRATEGY 10 : LONG STRADDLE STRATEGY 11 : SHORT STRADDLE STRATEGY 12 : LONG STRANGLE STRATEGY 13. SHORT STRANGLE STRATEGY 14. COLLAR STRATEGY 15. BULL CALL SPREAD STRATEGY STRATEGY 16. BULL PUT SPREAD STRATEGY STRATEGY 17 : BEAR CALL SPREAD STRATEGY STRATEGY 18 : BEAR PUT SPREAD STRATEGY STRATEGY 19: LONG CALL BUTTERFLY STRATEGY 20 : SHORT CALL BUTTERFLY STRATEGY 21: LONG CALL CONDOR STRATEGY 22 : SHORT CALL CONDOR

1. Long Call strategy:

Buying a call is the most basic of all options strategies. It constitutes the first options trade for someone already familiar with buying / selling stocks and would now want to trade options. Buying a call is an easy strategy to understand. When you buy it means you are bullish. Buying a Call means you are very bullish and expect the underlying stock / index to rise in future. When to Use: Investor is very bullish on the stock / index. Risk: Limited to the Premium. (Maximum loss if market expires at or below the option strike price). Reward: Unlimited Breakeven: Strike Price + Premium

2. Short Call
A Call option means an Option to buy. Buying a Call option means an investor expects the underlying price of a stock / index to rise in future. Selling a Call option is just the opposite of buying a Call option. Here the seller of the option feels the underlying price of a stock / index is set to fall in the future. When to use: Investor is very aggressive and he is very bearish about the stock / index. Risk: Unlimited Reward: Limited to the amount of premium Break-even Point: Strike Price + Premium

3: SYNTHETIC LONG CALL: BUY STOCK, BUY PUT:

When to use: When ownership is desired of stock yet investor is concerned about near-term downside risk. The outlook is conservatively bullish. Risk: Losses limited to Stock price + Put Premium Put Strike price Reward: Profit potential is unlimited. Break-even Point: Put Strike Price + Put Premium + Stock Price Put Strike Price

4: Long Put Strategy:

A long Put is a Bearish strategy. To take advantage of a falling market an investor can buy Put options. When to use: Investor is bearish about the stock / index. Risk: Limited to the amount of Premium paid. (Maximum loss if stock / index expires at or above the option strike price). Reward: Unlimited Break-even Point: Stock Price Premium

5: Short put
When to Use: Investor is very Bullish on the stock / index. The main idea is to make a short term income. Risk: Put Strike Price Put Premium. Reward: Limited to the amount of Premium received. Breakeven: Put Strike Price Premium

6: Covered Call: When to Use: This is often employed when an investor has a short-term neutral to moderately bullish view on the stock he holds. He takes a short position on the Call option to generate income from the option premium. Since the stock is purchased simultaneously with writing (selling) the Call, the strategy is commonly referred to as buy-write. 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 rises 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

Strategy: 7: Long Combo: Sell a put and buy a call: A Long Combo is a Bullish strategy. If an investor is expecting the price of a stock to move up he can do a Long Combo strategy. It involves selling an OTM (lower strike) Put and buying an OTM (higher strike) Call. This strategy simulates the action of buying a stock (or futures) but at a fraction of the stock price. It is an inexpensive trade, similar in pay-off to Long Stock, except there is a gap between the strikes (please see the payoff diagram). As the stock price rises the strategy starts making profits. When to Use: Investor is Bullish on the stock.

Risk: Unlimited (Lower Strike+ net debit) Reward: Unlimited Breakeven: Higher strike + net debit

Strategy 8: Protective Call / Synthetic Long Put This is a strategy wherein an investor has gone short on a stock and buys a call to hedge. This is an opposite of Synthetic Call. An investor shorts a stock and buys an ATM or slightly OTM Call. The net effect of this is that the investor creates a pay-off like a Long Put, but instead of having a net debit (paying premium) for a Long Put, he creates a net credit (receives money on shorting the stock). In case the stock price falls the investor gains in the downward fall in the price. However, incase there is an unexpected rise in the price of the stock the loss is limited. 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. When to Use: If the investor is of the view that the markets will go down (bearish) but wants to protect against any unexpected rise in the price of the stock. Risk: Limited. Maximum Risk is Call Strike Price Stock Price + Premium Reward: Maximum is Stock Price Call Premium Breakeven: Stock Price Call Premium

Strategy 9: Covered Put:

This strategy is opposite to a Covered Call. A Covered Call is a neutral to bullish strategy, whereas a Covered Put is a neutral to Bearish strategy. You do this strategy when you feel the price of a stock / index is going to remain range bound or

move down. Covered Put writing involves a short in a stock / index along with a short Put on the options on the stock / index. The Put that is sold is generally an OTM Put. The investor shorts a stock because he is bearish about it, but does not mind buying it back once the price reaches (falls to) a target price. This target price is the price at which the investor shorts the Put (Put strike price). Selling a Put means, buying the stock at the strike price if exercised. If the stock falls below the Put strike, the investor will be exercised and will have to buy the stock at the strike price (which is anyway his target price to repurchase the stock). The investor makes a profit because he has shorted the stock and purchasing it at the strike price simply closes the short stock position at a profit. And the investor keeps the Premium on the Put sold. The investor is covered here because he shorted the stock in the first place. When to Use: If the investor is of the view that the markets are moderately bearish. Risk: Unlimited if the price of the stock rises substantially Reward: Maximum is (Sale Price of the Stock Strike Price) + Put Premium Breakeven: Sale Price of Stock + Put Premium

Strategy 10: Long Straddle

A Straddle is a volatility strategy and is used when the stock price / index is expected to show large movements. This strategy involves buying a call as well as put on the same stock / index for the same maturity and strike price, to take advantage of a movement in either direction, a soaring or plummeting value of the stock / index. If the price of the stock / index increases, the call is exercised while the put expires worthless and if the price of the stock / index decreases, the put is exercised, the call

expires worthless. Either way if the stock / index shows volatility to cover the cost of the trade, profits are to be made. With Straddles, the investor is direction neutral. All that he is looking out for is the stock / index to break out exponentially in either direction. When to Use: The investor thinks that the underlying stock / index will experience significant volatility in the near term. Risk: Limited to the initial premium paid. Reward: Unlimited Breakeven: Upper Breakeven Point = Strike Price of Long Call + Net Premium Paid Lower Breakeven Point = Strike Price of Long Put - Net Premium Paid

Strategy 11: Short straddle:

A Short Straddle is the opposite of Long Straddle. It is a strategy to be adopted when the investor feels the market will not show much movement. He sells a Call and a Put on the same stock / index for the same maturity and strike price. It creates a net income for the investor. If the stock / index does not move much in either direction, the investor retains the Premium as neither the Call nor the Put will be exercised. However, incase the stock / index moves in either direction, up or down significantly, the investors losses can be significant. So this is a risky strategy and should be carefully adopted and only when the expected volatility in the market is limited. If the stock / index value stays close to the strike price on expiry of the contracts, maximum gain, which is the Premium received is made. When to Use: The investor thinks that the underlying stock / index will experience very little volatility in the near term.

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

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

Strategy 12: Long Strangle:

A Strangle is a slight modification to the Straddle to make it cheaper to execute. This strategy involves the simultaneous buying of a slightly out-of-themoney (OTM) put and a slightly out-of-the-money (OTM) call of the same underlying stock / index and expiration date. Here again the investor is directional neutral but is looking for an increased volatility in the stock / index and the prices moving significantly in either direction. Since OTM options are purchased for both Calls and Puts it makes the cost of executing a Strangle cheaper as compared to a Straddle, where generally ATM strikes are purchased. Since the initial cost of a Strangle is cheaper than a Straddle, the returns could potentially be higher. However, for a Strangle to make money, it would require greater movement on the upside or downside for the stock / index than it would for a Straddle. As with a Straddle, the strategy has a limited downside (i.e. the Call and the Put premium) and unlimited upside potential. When to Use: The investor thinks that the underlying stock / index will experience very high levels of volatility in the near term.

Risk: Limited to the initial premium paid Reward: Unlimited Breakeven: Upper Breakeven Point = Strike Price of Long Call + Net Premium Paid Lower Breakeven Point = Strike Price of Long Put - Net Premium Paid

Strategy 13: Short strangle

A Short Strangle is a slight modification to the Short Straddle. 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. This strategy involves the simultaneous selling of a slightly out-of-the-money (OTM) put and a slightly out-of-the-money (OTM) call of the same underlying stock and expiration date. This typically means that since OTM call and put are sold, the net credit received by the seller is less as compared to a Short Straddle, but the break even points are also widened. The underlying stock has to move significantly for the Call and the Put to be worth exercising. If the underlying stock does not show much of a movement, the seller of the Strangle gets to keep the Premium. When to Use: This options trading strategy is taken when the options investor thinks that the underlying stock will experience little volatility in the near term. Risk: Unlimited Reward: Limited to the premium received Breakeven: Upper Breakeven Point = Strike Price of Short Call + Net Premium Received Lower Breakeven Point = Strike Price of Short Put - Net Premium Received

Strategy 14: Collar:

Collar is buying a stock, insuring against the downside by buying a Put and then financing (partly) the Put by selling a Call. The put generally is ATM and the call is OTM having the same expiration month and must be equal in number of shares. This is a low risk strategy since the Put prevents downside risk. However, do not expect unlimited rewards since the Call prevents that. It is a strategy to be adopted when the investor is conservatively bullish. When to Use: The collar is a good strategy to use if the investor is writing covered calls to earn premiums but wishes to protect himself from an unexpected sharp drop in the price of the underlying security. Risk: Limited Reward: Limited Breakeven: Purchase Price of Underlying Call Premium + Put Premium

Strategy 15: Bull call spread strategy:

In this strategy the investor will Buy call option, sell call option A bull call spread is constructed by buying an in-the-money (ITM) call option, and selling another out-of-the-money (OTM) call option. Often the call with the lower strike price will be in-the-money while the Call with the higher strike price is out-ofthe-money. Both calls must have the same underlying security and expiration month. When to Use: Investor is moderately bullish.

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

Strategy 16: Bull put spread strategy:

In this strategy the investor will Sell put option, buy put option A bull put spread can be profitable when the stock / index is 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 an 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 (further OTM) is cheaper than the Put sold. When to Use: When the investor is moderately bullish. 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

Strategy 17: Bear Call Spread Strategy:

In this the investor will sell ITM call, buy OTM call The Bear Call Spread strategy can be adopted when the investor feels that the stock / index is 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 (OTM) call options while simultaneously selling in-the-money (ITM) call options on the same underlying stock index. This strategy can also be done with both OTM calls with the Call purchased being higher OTM strike than the Call sold. If the stock / index falls both Calls will expire worthless and the investor can retain the net credit. If the stock / index rises then the breakeven is the lower strike plus the net credit. Provided the stock remains below that level, the investor makes a profit. Otherwise he could make a loss. The maximum loss is the difference in strikes less the net credit received. When to use: When the investor is mildly bearish on market. 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

Strategy 18: Bear Put Spread Strategy:

In this strategy the investor will Buy Put, Sell Put This strategy requires the investor to buy an in-the-money (higher) put option and sell an out-of-the-money (lower) put option on the same stock with the same

expiration date. This strategy creates a net debit for the investor. The net effect of the strategy is to bring down the cost and raise the breakeven on buying a Put (Long Put). The strategy needs a Bearish outlook since the investor will make money only when the stock price / index falls. The bought Puts will have the effect of capping the investors downside. While the Puts sold will reduce the investors costs, risk and raise breakeven point (from Put exercise point of view). If the stock price closes below the out-of-the-money (lower) put option strike price on the expiration date, then the investor reaches maximum profits. If the stock price increases above the in-the-money (higher) put option strike price at the expiration date, then the investor has a maximum loss potential of the net debit. When to use: When you are moderately bearish on market direction 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

Strategy 19: long call butterfly:

In this strategy the investor sell 2 ATM call options, buy 1 ITM call Option and buy 1 OTM call option. 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. The strategy offers a good risk / reward ratio, together with low cost. A long butterfly is similar to a Short Straddle except your losses are limited. The strategy can be done by selling 2 ATM Calls, buying 1 ITM Call, and buying 1

OTM Call options (there should be equidistance between the strike prices). The result is positive incase the stock / index remains range bound. The maximum reward in this strategy is however restricted and takes place when the stock / index is at the middle strike at expiration. The maximum losses are also limited. When to use: When the investor is neutral on market direction and bearish on volatility. Risk Net debit paid. Reward Difference between adjacent strikes minus net debit Break Even Point: 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

Strategy 20: short call butterfly:

In this strategy the investor buy 2 ATM call options, sell 1 ITM call option and sell 1 OTM call option. 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-themoney Calls and selling another higher strike out-of-the-money Call, giving the investor a net credit (therefore it is an income strategy). There should be equal distance between each strike. The resulting position will be profitable in case there is a big move in the stock / index. The maximum risk occurs if the stock / index is at the middle strike at expiration. The maximum profit occurs if the stock finishes on either

side of the upper and lower strike prices at expiration. However, this strategy offers very small returns when compared to straddles, strangles with only slightly less risk. When to use: You are neutral on market direction and bullish on volatility. Neutral means that you expect the market to move in either direction - i.e. bullish and bearish. Risk Limited to the net difference between the adjacent strikes (Rs. 100 in this example) less the premium received for the position. Reward Limited to the net premium received for the option spread. Break Even Point: Upper Breakeven Point = Strike Price of Highest Strike Short Call - Net Premium Received Lower Breakeven Point = Strike Price of Lowest Strike Short Call + Net Premium Received

Strategy 21: long call condor:

In this strategy the investor will buy 1 ITM Call option (lower strike), sell 1 ITM call Option (lower Middle), sell 1 OTM call Option (higher middle), buy 1 OTM call Option (higher strike) The strategy is suitable in a range bound market. The Long Call Condor involves buying ITM Call (lower strike), selling 1 ITM Call (lower middle) , selling 1 OTM call (higher middle) and buying 1 OTM Call (higher strike). The long options at the outside strikes ensure that the risk is capped on both the sides. The resulting position is profitable if the stock / index remains range bound and shows very little volatility. The maximum profits occur if the stock finishes between the middle strike prices at expiration.

When to Use: When an investor believes that the underlying market will trade in a range with low volatility until the options expire. Risk Limited to the minimum of the difference between the lower strike call spread less the higher call spread less the total premium paid for the condor. Reward Limited. The maximum profit of a long condor will be realized when the stock is trading between the two middle strike prices. Break Even Point: Upper Breakeven Point = Highest Strike Net Debit Lower Breakeven Point = Lowest Strike + Net Debit

Strategy 22: short call condor:

In this strategy the investor will short 1 ITM call option (lower strike), long 1 ITM Call option (lower middle), long 1 OTM call Option (higher middle), short 1 OTM call Option (higher strike). The strategy is suitable in a volatile market. The Short Call Condor involves selling 1 ITM Call (lower strike), buying 1 ITM Call (lower middle) , buying 1 OTM call (higher middle) and selling 1 OTM Call (higher strike). The resulting position is profitable if the stock / index shows very high volatility and there is a big move in the stock / index. The maximum profits occur if the stock / index finishes on either side of the upper or lower strike prices at expiration. When to Use: When an investor believes that the underlying market will break out of a trading range but is not sure in which direction.

Risk Limited. The maximum loss of a short condor occurs at the center of the option spread. Reward Limited. The maximum profit of a short condor occurs when the underlying stock / index is trading past the upper or lower strike prices. Break Even Point: Upper Break even Point = Highest Strike Net Credit Lower Break Even Point = Lowest Strike + Net Credit

LONG CALL OPTION: LONG CALL strategy (BUY CALL OPTION): When the investor is bullish in the Market/Sector/Stock in the

Market/Sector/Stock then investor will use this strategy and enjoys the unlimited profits and at the same time there may be chance of limited risk. The investor will pay the premium on call option. If the market goes beyond the BEP then investor will starts making profits and if market falls below the BEP then the investor will lose only the premium. In the current scenario the investor is bullish in the index / stock in future to purchase put option. When the investor is bullish in INDEX the investor will enter into the contract. When the buyer of the call option is bullish and expect the underlying stock/index to rise in future then the investor will use this strategy. BEP: Strike price + premium; Risk: limited Reward: unlimited; INDEX Spot price: Rs.5225 as on 2010, Jan 1st. Strike price: Rs.5200 Call Option Premium: Rs.134.70 /-

In this case investor is always expecting to rise the INDEX price by assuming this the investor bought one call option at Rs. 134.70/- with strike price Rs.5200/-.

BEP= Strike Price + Premium. BEP=5200(Strike price) + 134.7/-(Premium). BEP= 5334.70. If the price of INDEX falls below 5334.70 then investor will lose only the

premium and if the price of INDEX moves above 5334.70 then investor will starts making profits.

SPOT

STRIKE

PREMIUM

PAY OUT LOT SIZE

TOTAL

PRICE 4500 4800 4850 5200 5335 5800 6000

PRICE 5200 5200 5200 5200 5200 5200 5200 134.7 134.7 134.7 134.7 134.7 134.7 134.7

PER UNIT (134.7) (134.7) (134.7) (134.7) 0.30 465.3 665.3 50 50 50 50 50 50 50

PAYOUT (6735) (6735) (6735) (6735) 15 23265 33265

SPOT

UNLIMITED PROFITS

BEP POINT
LOSS LIMITED TO PREMIUM

STRIKE

SPOT

ASSUMPTIONS: CASE I: When the investor is bullish in INDEX the investor will enter into the contract. When the buyer of the call option is bullish and expect the underlying stock/index to rise in future then the investor will use this strategy. BEP: Strike price + premium; Risk: limited Reward: unlimited; INDEX Spot price: Rs.5225 as on 2010, Jan 1st. Strike price: Rs.5200 Call Option Premium: Rs.134.70 /Closing date: 2010, jan 28th. Market price: 4850 Lot size: 50 BEP: 5334.70 If the INDEX falls to 4500 then what will be net payout amount for the Investor? Call Option: The spot INDEX on Expiry date is below the strike price then the investor will not exercise the transaction. Net payout/pay-in: In this case the market price on the expiry date is less than strike price of call option so, the investor of the call option will loss only the premium. The net loss of call option: Rs.134.7 Therefore total net loss = 134.7*50(lot size) = 6735.

BEP: 5334.7 Strike price: 5200 A Spot price: 4500

LOSS IS LIMITED TO PREMIUM

In this diagram strike price is Rs.5200 and BEP is Rs.5334.7 and current marketing price is Rs.4500 and marketing price is less than BEP therefore the investor of the call option will lose only the premium that means his loss is limited to loss. So, the investor will get losses so in graph the line A B determines that investor is making losses.

CASE II: When the investor is bullish in INDEX the investor will enter into the contract. When the buyer of the call option is bullish and expect the underlying stock/index to rise in future then the investor will use this strategy. BEP: Strike price + premium; Risk: limited Reward: unlimited; INDEX Spot price: Rs.5225 as on 2010, Jan 1st. Strike price: Rs.5200 Call Option Premium: Rs.134.70 /Closing date: 2010, jan 28th. Market price: 4850 Lot size: 50 BEP: 5334.70 If the INDEX Moves to 4800 then what will be net payout amount for the Investor? Call Option: The spot INDEX on Expiry date is below the strike price then the investor will not exercise the transaction. Net payout/pay-in: In this case the market price on the expiry date is less than strike price of call option so, the investor of the call option will loss only the premium. The net loss of call option: Rs.134.7 Therefore total net loss = 134.7*50(lot size) = 6735.

BEP: 5334.7 Strike price: 5200 A Spot price: 4800

LOSS IS LIMITED TO PREMIUM

In this diagram strike price is Rs.5200 and BEP is Rs.5334.7 and current marketing price is Rs.4800 and marketing price is less than BEP therefore the investor of the call option will lose only the premium that means his loss is limited to loss. So, the investor will get losses so in graph the line A B determines that investor is making losses.

CASE III: When the investor is bullish in INDEX the investor will enter into the contract. When the buyer of the call option is bullish and expect the underlying stock/index to rise in future then the investor will use this strategy. BEP: Strike price + premium; Risk: limited Reward: unlimited; INDEX Spot price: Rs.5225 as on 2010, Jan 1st. Strike price: Rs.5200 Call Option Premium: Rs.134.70 /Closing date: 2010, jan 28th. Market price: 4850 Lot size: 50 BEP: 5334.70 If the INDEX Moves to 4850 then what will be net payout amount for the Investor? Call Option: The spot INDEX on Expiry date is below the strike price then the investor will not exercise the transaction. Net payout/pay-in: In this case the market price on the expiry date is less than strike price of call option so, the investor of the call option will loss only the premium. The net loss of call option: Rs.134.7 Therefore total net loss = 134.7*50(lot size) = 6735.

BEP: 5334.7 Strike price: 5200 A Spot price: 4850

LOSS IS LIMITED TO PREMIUM

In this diagram strike price is Rs.5200 and BEP is Rs.5334.7 and current marketing price is Rs.4850 and marketing price is less than BEP therefore the investor of the call option will lose only the premium that means his loss is limited to loss. So, the investor will get losses so in graph the line A B determines that investor is making losses.

CASE IV: When the investor is bullish in INDEX the investor will enter into the contract. When the buyer of the call option is bullish and expect the underlying stock/index to rise in future then the investor will use this strategy. BEP: Strike price + premium; Risk: limited Reward: unlimited; INDEX Spot price: Rs.5225 as on 2010, Jan 1st. Strike price: Rs.5200 Call Option Premium: Rs.134.70 /Closing date: 2010, jan 28th. Market price: 4850 Lot size: 50 BEP: 5334.70 If the INDEX Moves to 5200 then what will be net payout amount for the Investor? Call Option: The spot INDEX on Expiry date is below the strike price then the investor will exercise the transaction based on the investors choice. Net payout/pay-in Call Option= 5200 5200 = 0 In this case the investor as the market price is equal to the strike price so there is no loss but the investor is already paid a premium so, the investor loss is limited to the premium only i.e., Rs.134.70/Therefore total net loss = 134.7*50(lot size) = 6735.

BEP: 5334.7 Strike price & spot price: 5200 A

LOSS IS LIMITED TO PREMIUM

In this diagram strike price is Rs.5200 and BEP is Rs.5334.7 and current marketing price is Rs.5200 and marketing price is less than BEP therefore the investor of the call option will lose only the premium that means his loss is limited to loss. So, the investor will get losses so in graph the line A B determines that investor is making losses.

CASE V: When the investor is bullish in INDEX the investor will enter into the contract. When the buyer of the call option is bullish and expect the underlying stock/index to rise in future then the investor will use this strategy. BEP: Strike price + premium; Risk: limited Reward: unlimited; INDEX Spot price: Rs.5225 as on 2010, Jan 1st. Strike price: Rs.5200 Call Option Premium: Rs.134.70 /Closing date: 2010, jan 28th. Market price: 4850 Lot size: 50 BEP: 5334.70 If the INDEX Moves to 5335 then what will be net payout amount for the Investor? Call Option: The spot INDEX on Expiry date is above the strike price then the investor will exercise the transaction. Net payout/pay-in Call Option= 5335 5200 = 135 will be the actual profit in call option. In this case he makes actual profit of Rs.135 but initially he paid a premium for call option i.e., Rs.134.7 therefore net profit is Rs.0.3 Therefore total net profit = 0.3*50(lot size) = 15.

UNLIMITED PROFITS Spot price: 5335

BEP:5334.7

Strike price: 5200

In this diagram strike price is Rs.5200 and BEP is Rs.5334.7 and current marketing price is Rs.5335 and marketing price is more than BEP therefore the investor of the call option will get profits. So, the investor will get profits so in graph the line from A determines that investor is making unlimited profits.

CASE VI: When the investor is bullish in INDEX the investor will enter into the contract. When the buyer of the call option is bullish and expect the underlying stock/index to rise in future then the investor will use this strategy. BEP: Strike price + premium; Risk: limited Reward: unlimited; INDEX Spot price: Rs.5225 as on 2010, Jan 1st. Strike price: Rs.5200 Call Option Premium: Rs.134.70 /Closing date: 2010, jan 28th. Market price: 4850 Lot size: 50 BEP: 5334.70 If the INDEX Moves to 5800 then what will be net payout amount for the Investor? Call Option: The spot INDEX on Expiry date is above the strike price then the investor will exercise the transaction. Net payout/pay-in Call Option=5800 5200 = 600 will be the actual profit in call option. In this case he makes actual profit of Rs.600 but initially he paid a premium for call option i.e., Rs.134.7 therefore net profit is Rs.465.3 Therefore total net profit = 465.3*50(lot size) = 23265.

Spot price: 5800

UNLIMITED PROFITS

BEP:5334.7

Strike price: 5200

In this diagram strike price is Rs.5200 and BEP is Rs.5334.7 and current marketing price is Rs.5800 and marketing price is more than BEP therefore the investor of the call option will get profits. So, the investor will get profits so in graph the line from A determines that investor is making unlimited profits.

CASE VII: When the investor is bullish in INDEX the investor will enter into the contract. When the buyer of the call option is bullish and expect the underlying stock/index to rise in future then the investor will use this strategy. BEP: Strike price + premium; Risk: limited Reward: unlimited; INDEX Spot price: Rs.5225 as on 2010, Jan 1st. Strike price: Rs.5200 Call Option Premium: Rs.134.70 /Closing date: 2010, jan 28th. Market price: 4850 Lot size: 50 BEP: 5334.70 If the INDEX Moves to 6000 then what will be net payout amount for the Investor? Call Option: The spot INDEX on Expiry date is above the strike price then the investor will exercise the transaction. Net payout/pay-in Call Option=6000 5200 = 800 will be the actual profit in call option. In this case he makes actual profit of Rs.800 but initially he paid a premium for call option i.e., Rs.134.7 therefore net profit is Rs.665.3 Therefore total net profit = 665.3*50(lot size) = 33265.

Spot price: 5800

UNLIMITED PROFITS

BEP:5334.7

Strike price: 5200

In this diagram strike price is Rs.5200 and BEP is Rs.5334.7 and current marketing price is Rs.6000 and marketing price is more than BEP therefore the investor of the call option will get profits. So, the investor will get profits so in graph the line from A determines that investor is making unlimited profits.

SHORT CALL SHORT CALL strategy (SALE CALL): When the investor is very aggressive and bearish in the Market/Sector/Stock in the Market/Sector/Stock then investor will use this strategy and enjoys the limited profits up to the premium and at the same time there may be chance to bear unlimited risk. The seller of the call option will receive the premium on put option by entering into the contract with buyer of the call option. If the market goes beyond the BEP then seller of the call option will lose entire premium and if market falls below the BEP then the seller of the call option will starts gain up to the premium only. In the current scenario the investor is bearish in the index / stock in future to sale the call option. When the investor is bearish in INDEX/STOCK the investor will enter into the contract. When the investor of the call option is bearish and expect the underlying stock/index to fall in future then the investor will use this strategy. BEP: Strike price + premium; Risk: unlimited Reward: limited; RELIANCE Spot price: Rs.1075 as on 2010, Jan 5th. Strike price: Rs.1110/Call Option Premium: Rs.25 /-

In this case seller is always expecting to fall the RELIANCE Stock price by assuming this the investor sold one call option at Rs. 25/- with strike price Rs.1110/-. BEP= Strike Price + Premium. BEP=1110(Strike price) + 25/-(Premium). BEP= 1135/If the price of RELIANCE Stock falls below 1135/- then seller gain only up to the premium and if the price of RELIANCE Stock moves above 1135/- then seller will starts making losses.

SPOT PRICE 1100 1000 900 1135 1200 1300 1550

STRIKE PRICE 1110 1110 1110 1110 1110 1110 1110

PREMIUM

NET PAY OUT LOT SIZE TOTAL PER UNIT

25 25 25 25 25 25 25

25 25 25 0 (65) (165) (415)

1000 1000 1000 1000 1000 1000 1000

25000 25000 25000 0 (65000) (165000) (415000)

UNLIMITED LOSSES SPOT BEP STRIKE PROFIT LIMITED TO PREMIUM

SPOT

ASSUMPTIONS: CASE I: When the investor is bearish in RELIANCE Stock then seller will enter into the contract. When the seller of the call option is bullish and expect the underlying stock/index to rise in future then the investor will use this strategy. BEP: Strike price + premium; Risk: unlimited Reward: limited to the premium; INDEX Spot price: Rs.1075 as on 2010, Jan 5th Strike price: Rs.1110/Call Option Premium: Rs.25 /Closing date: 2010, jan 28th. Market price 1120/Lot size: 1000 BEP: 1135/If the INDEX Moves to 1100 then what will be net payout amount for the Investor? Call Option: The spot RELIANCE Stock on Expiry date is below the strike price then the seller will exercise the transaction.

Net payout/pay-in In this case the market price on the closing date is less than strike price of the call option so, the seller will receive the profit which is limited to the premium only.i.e. Rs.25 which is received during entering into the transaction. Therefore total net profit =25*1000 (lot size) = 25000/-

BEP: 1135 1110 Profit is limited to premium

1100

CASE II: When the investor is bearish in RELIANCE Stock then seller will enter into the contract. When the seller of the call option is bullish and expect the underlying stock/index to rise in future then the investor will use this strategy. BEP: Strike price + premium; Risk: unlimited Reward: limited to the premium; INDEX Spot price: Rs.1075 as on 2010, Jan 5th Strike price: Rs.1110/Call Option Premium: Rs.25 /Closing date: 2010, jan 28th. Market price 1120/Lot size: 1000 BEP: 1135/If the INDEX falls to 1000 then what will be net payout amount for the Investor? Call Option: The spot RELIANCE Stock on Expiry date is below the strike price then the seller will exercise the transaction. Net payout/pay-in In this case the market price on the closing date is less than strike price of the call option so, the seller will receive the profit which is limited to the premium only.i.e. Rs.25 which is received during entering into the transaction. Therefore total net profit =25*1000 (lot size) = 25000/-

BEP: 1135 1110 Profit is limited to premium

1000

CASE III: When the investor is bearish in RELIANCE Stock then seller will enter into the contract. When the seller of the call option is bullish and expect the underlying stock/index to rise in future then the investor will use this strategy. BEP: Strike price + premium; Risk: unlimited Reward: limited to the premium; INDEX Spot price: Rs.1075 as on 2010, Jan 5th Strike price: Rs.1110/Call Option Premium: Rs.25 /Closing date: 2010, jan 28th. Market price 1120/Lot size: 1000 BEP: 1135/If the INDEX Moves to 900 then what will be net payout amount for the Investor? Call Option: The spot RELIANCE Stock on Expiry date is below the strike price then the seller will exercise the transaction. Net payout/pay-in In this case the market price on the closing date is less than strike price of the call option so, the seller will receive the profit which is limited to the premium only.i.e. Rs.25 which is received during entering into the transaction. Therefore total net profit =25*1000 (lot size) = 25000/-

BEP: 1135 1110 Profit is limited to premium

1000

CASE IV: When the investor is bearish in RELIANCE Stock then seller will enter into the contract. When the seller of the call option is bullish and expect the underlying stock/index to rise in future then the investor will use this strategy. BEP: Strike price + premium; Risk: unlimited Reward: limited to the premium; INDEX Spot price: Rs.1075 as on 2010, Jan 5th Strike price: Rs.1110/Call Option Premium: Rs.25 /Closing date: 2010, jan 28th. Market price 1120/Lot size: 1000 BEP: 1135/If the INDEX Moves to 1135 then what will be net payout amount for the Investor? Call Option: The spot RELIANCE Stock on Expiry date is below the strike price then the seller will exercise the transaction. Net payout/pay-in In this case the market price on the closing date is equal to strike price of the call option so, the seller will receive the profit which is limited to the premium only.i.e. Rs.25 which is received during entering into the transaction. Therefore total net profit =25*1000 (lot size) = 25000/-

BEP: 1135 1110 Profit is limited to premium

1000

CASE V: When the investor is bearish in RELIANCE Stock then seller will enter into the contract. When the seller of the call option is bullish and expect the underlying stock/index to rise in future then the investor will use this strategy. BEP: Strike price + premium; Risk: unlimited Reward: limited to the premium; INDEX Spot price: Rs.1075 as on 2010, Jan 5th Strike price: Rs.1110/Call Option Premium: Rs.25 /Closing date: 2010, jan 28th. Market price 1120/Lot size: 1000 BEP: 1135/If the INDEX Moves to 1200 then what will be net payout amount for the Investor? Call Option: The spot RELIANCE Stock on Expiry date is below the strike price then the seller will exercise the transaction.

Net payout/pay-in Call Option=1200-1110 = 90 will be the actual loss in call option. In this case when the market price is more than strike price then the seller of the call option start making losses here the seller made actual loss of Rs.90 and seller received a premium only i.e., Rs.25 during entering into the transaction therefore the net profit is 90(net loss in the call option) 25(premium received) = 65 Therefore total loss = 65*1000 (lot size) =65000/-

Unlimited loss 1200

BEP: 1135

1110

CASE VI: When the investor is bearish in RELIANCE Stock then seller will enter into the contract. When the seller of the call option is bullish and expect the underlying stock/index to rise in future then the investor will use this strategy. BEP: Strike price + premium; Risk: unlimited Reward: limited to the premium; INDEX Spot price: Rs.1075 as on 2010, Jan 5th Strike price: Rs.1110/Call Option Premium: Rs.25 /Closing date: 2010, jan 28th. Market price 1120/Lot size: 1000 BEP: 1135/If the INDEX Moves to 1300 hen what will be net payout amount for the Investor? Call Option: The spot RELIANCE Stock on Expiry date is below the strike price then the seller will exercise the transaction.

Net payout/pay-in Call Option=1300 -1110 = 190 will be the actual loss in call option. In this case when the market price is more than strike price then the seller of the call option start making losses here the seller made actual loss of Rs.190 and seller received a premium only i.e., Rs.25 during entering into the transaction therefore the net profit is 190(net loss in the call option) 25(premium received) = 165 Therefore total loss =165*1000 (lot size) =165000

Unlimited loss 1300

BEP: 1135

1110

CASE VII: When the investor is bearish in RELIANCE Stock then seller will enter into the contract. When the seller of the call option is bullish and expect the underlying stock/index to rise in future then the investor will use this strategy. BEP: Strike price + premium; Risk: unlimited Reward: limited to the premium; INDEX Spot price: Rs.1075 as on 2010, Jan 5th Strike price: Rs.1110/Call Option Premium: Rs.25 /Closing date: 2010, jan 28th. Market price 1120/Lot size: 1000 BEP: 1135/If the INDEX Moves to 1550 then what will be net payout amount for the Investor? Call Option: The spot RELIANCE Stock on Expiry date is below the strike price then the seller will exercise the transaction.

Net payout/pay-in Call Option=1550-1110 = 440 will be the actual loss in call option. In this case when the market price is more than strike price then the seller of the call option start making losses here the seller made actual loss of Rs.440 and seller received a premium only i.e., Rs.25 during entering into the transaction therefore the net profit is 440(net loss in the call option) 25(premium received) = 415 Therefore total loss = 415*1000 (lot size) =415000/-

Unlimited loss 1550

BEP: 1135

1110

Conclusions:
Options are useful to only Speculators and Speculators can take the risk to increase the profits: High Risk: High Returns Investor may loose entire premium amount if their assumptions are go wrong Risk is limited in case of Buyer of the Call Options and Buyer of the Put options and at the same time they may get unlimited profits with their limited Premium/Investment. Risk is unlimited in case of Seller of the Call Options and Seller of the Put Options and at the same time they may get unlimited losses if their assumptions are go wrong. Buyer of the Call Option/Put Option = Risk is limited to premium Reward is unlimited if the market moves with their assumptions Seller of the Call Options/Put Options = Reward is limited to premium which received from the buyers Risk is unlimited if the markets moves opposite directions to their assumptions.

Recommendations:
It is advisable to trade speculators It is not advisable for long-term investors and small investor The investor may loose the entire principle amount in Options The Options life expires in one month i.e. expiry date. Investors can not rollover/extend the contract to next month, that means buyer as well as seller needs to excise the contract on expiry date and it is depend on the buyer of the call options.