Futures and options trading basics


Clearly the international markets have evolved a great deal since the OTC days. However in India from the time of inception, the options market was facilitated by the exchanges. The badla system no longer exists, it has become obsolete. Here is a quick recap of the history of the Indian derivative markets —. Though the options market has been around since , the real liquidity in the Indian index options was seen only in ! I remember trading options around that time, the spreads were high and getting fills was a big deal.

However in , the Ambani brothers formally split up and their respective companies were listed as separate entities, thereby unlocking the value to the shareholders. In my opinion this particular corporate event triggered vibrancy in the Indian markets, creating some serious liquidity. However if you were to compare the liquidity in Indian stock options with the international markets, we still have a long way to catch up.

There are two types of options — The Call option and the Put option. You can be a buyer or seller of these options. In fact the best way to understand the call option is to first deal with a tangible real world example, once we understand this example we will extrapolate the same to stock markets. Consider this situation; there are two good friends, Ajay and Venu.

Ajay is actively evaluating an opportunity to buy 1 acre of land that Venu owns. The land is valued at Rs. Ajay has been informed that in the next 6 months, a new highway project is likely to be sanctioned near the land that Venu owns.

If the highway indeed comes up, the valuation of the land is bound to increase and therefore Ajay would benefit from the investment he would make today. So what should Ajay do? Clearly this situation has put Ajay in a dilemma as he is uncertain whether to buy the land from Venu or not. While Ajay is muddled in this thought, Venu is quite clear about selling the land if Ajay is willing to buy. Ajay wants to play it safe, he thinks through the whole situation and finally proposes a special structured arrangement to Venu, which Ajay believes is a win-win for both of them, the details of the arrangement is as follows —.

So what do you think about this special agreement? Who do you think is smarter here — Is it Ajay for proposing such a tricky agreement or Venu for accepting such an agreement?

Well, the answer to these questions is not easy to answer, unless you analyze the details of the agreement thoroughly. I would suggest you read through the example carefully it also forms the basis to understand options — Ajay has plotted an extremely clever deal here!

In fact this deal has many faces to it. Now, after initiating this agreement both Ajay and Venu have to wait for the next 6 months to figure out what would actually happen. However irrespective of what happens to the highway, there are only three possible outcomes —. Remember as per the agreement, Ajay has the right to call off the deal at the end of 6 months. Now, with the increase in the land price, do you think Ajay will call off the deal?

This means Ajay now enjoys the right to buy a piece of land at Rs. Clearly Ajay is making a steal deal here. Venu is obligated to sell him the land at a lesser value, simply because he had accepted Rs.

Another way to look at this is — For an initial cash commitment of Rs. Venu even though very clearly knows that the value of the land is much higher in the open market, is forced to sell it at a much lower price to Ajay. The profit that Ajay makes Rs. It turns out that the highway project was just a rumor, and nothing really is expected to come out of the whole thing.

People are disappointed and hence there is a sudden rush to sell out the land. As a result, the price of the land goes down to Rs. So what do you think Ajay will do now? Clearly it does not make sense to buy the land, hence he would walk away from the deal. Here is the math that explains why it does not make sense to buy the land —. Remember the sale price is fixed at Rs. Hence if Ajay has to buy the land he has to shell out Rs.

Which means he is in effect paying Rs. Clearly this would not make sense to Ajay, since he has the right to call of the deal, he would simply walk away from it and would not buy the land. However do note, as per the agreement Ajay has to let go of Rs. For whatever reasons after 6 months the price stays at Rs. What do you think Ajay will do? Well, he will obviously walk away from the deal and would not buy the land. Why you may ask, well here is the math —.

Clearly it does not make sense to buy a piece of land at Rs. Do note, since Ajay has already committed 1lk, he could still buy the land, but ends up paying Rs 1lk extra in this process. For this reason Ajay will call off the deal and in the process let go of the agreement fee of Rs. I hope you have understood this transaction clearly, and if you have then it is good news as through the example you already know how the call options work!

But let us not hurry to extrapolate this to the stock markets; we will spend some more time with the Ajay-Venu transaction. I would suggest you be absolutely thorough with this example. If not, please go through it again to understand the dynamics involved. Also, please remember this example, as we will revisit the same on a few occasions in the subsequent chapters. Do note, I will deliberately skip the nitty-gritty of an option trade at this stage.

The idea is to understand the bare bone structure of the call option contract. Assume a stock is trading at Rs. You are given a right today to buy the same one month later, at say Rs. Obviously you would, as this means to say that after 1 month even if the share is trading at 85, you can still get to buy it at Rs.

In order to get this right you are required to pay a small amount today, say Rs. If the share price moves above Rs. If the share price stays at or below Rs. All you lose is Rs. After you get into this agreement, there are only three possibilities that can occur. Case 1 — If the stock price goes up, then it would make sense in exercising your right and buy the stock at Rs.

Case 2 — If the stock price goes down to say Rs. Case 3 — Likewise if the stock stays flat at Rs. This is simple right?

If you have understood this, you have essentially understood the core logic of a call option. What remains unexplained is the finer points, all of which we will learn soon. At this stage what you really need to understand is this — For reasons we have discussed so far whenever you expect the price of a stock or any asset for that matter to increase, it always makes sense to buy a call option!

Now that we are through with the various concepts, let us understand options and their associated terms. Hi Sir, Options is like greek and latin to me. Thanks for the analogies. No, all derivative contracts are routed via the exchanges. You cannot enter into an OTC arrangement, even if you do, it would not be regulated hence quite dangerous. What benefit would Ajay get by calling off the deal before the expiry of 6 months? He will instead wait for the whole 6 months for any chance of the highway project.

My first question Karthik is this: The dropdown value on the NSE website does not contain all months expiries — after 18th May we have 25th June followed by 24th Sept and then 31st Dec What happened to the other months? For to only June and Dec contracts are available. What happened to the remaining? Saurabh, glad you noticed it! For all stocks options the expiry is very similar to futures.

Hence we have current month, mid month, and far month contracts. However for Nifty there are several different expiry options. Leaps are good if you have a super long term view on markets. However the problem with leaps in India is that they are not liquid, there are hardly any trading activity here. But there is hardly any liquidity here — http: The interest rate is an input variable here — please note this is a critical input for implied volatility model.

As usual, nice and simple explanation…I am not trading in options as I could not understand it well. Now, I think I am clear. Whether profit will be 3 or -2 can u clarify the profit based on premium not SP? You can exercise the option only on the expiry day, however you can book your profit due to the increase in premium. Sir, thanks for the easy concept on option. What I understand we can square off any position in option too before expiry date if profit is decent or stop loss set is triggered, in liquid stocks.

Only the thing is that we have to pay the brokerage twice. Is it that we can not put SL for options? One more clarification I want to get is that the options are exercised means we have buy the underlying asset or the price difference will be adjusted in cash in case of the share market? You are right — you can square off anytime you wish…if you let the option for expiry there is no brokerage…otherwise you need to pay twice. I read somewhere if option exercise by exchange then we have to pay a huge penalty.

What do u mean by exercise the option. Yes, please do check this — http: That means we can square off at any point of time before or on expiry 1. Before expiry we have to pay the brokerage twice. On the expiry no brokerage but we have to do it by our own 3. Else exchange will exercise that option on our behalf and charge huge penalty. Is there any specific process on zerodha to buy a XYZ stock at strice price or exercise the options.

OR a normal stock purchase transaction on expiry day will be treated as exercise? To exercise, you simply have to hold the position and let it expire.

Check this — http: As usual Karthik at his best starting with options…only concern is the time taken to upload other chapters Thanks once again Karthik for your splendid efforts…. Thanks Krishnan, it takes a bit of a time to upload chapters apologies for that.. Will include it towards the end of this module. However check this link for option calculator — http: I have been following the lessons for months now and heartfully thank you for them..

I wait for the each chapter to be published with great enthusiasm.. I found your TA chapters very helpful and easy to understand.. It would have been great if beginners like me could have had a paper trading platform where they could try their hands before with TA based trading.. Thanks for the kind words Rohit. It is gratifying for us to know that people are indeed benefiting from these modules.

We try and do something about this. Karthik sir Thank for Ur valuable effort Waiting for Ur other valuable chapter about option trading. Selecting the strike price is a function of time, volatility, and expectation on market movement.

So in options at expiry.. All derivative contracts are cash settled in India, hence the actual movement of stocks does not happen. Nifty is a well diversified basket of stock with representation of nealry 21 sectors.

Bank Nifty is sector specific index hence more volatile. You can trade stock options, there is no issue with that. Hi, Superb Explanation Karthik…Really it is great help full to beginners like me…Thank you very much for making educated us about all these things….

I would suggest you try out Zerodha Margin calculator for this — https: Since PE is out of the money option you will not get much margin benefit, however if you select in the money option PE there is margin benefit for the same. In fact the margin to buy 1 lot Tata steel is approximately 20K, add to this PE, you get about Rs. If some one tells buy infy equity since shortage of funds can we buy Call option Infy ? Generally speaking buying a call option should not be an alternative to buying in spot market.

However if the decision is to buy Infy for a short term few days then maybe one can explore the idea of buying the call options. I have a couple of questions today unrelated to options: There is such a relationship between the two indices, right? On sites like moneycontrol. As you may know Beta of Nifty Index is 1 because Nifty is a market portfolio.

However Bank Nifty beta should not be considered as 1 as based on market portfolio theory , the reasons for this are as follows —. Given this, Bank Nifty on the other hand, even though is an index , it cannot have a beta of 1 like Nifty. This simply because it is not a market index. Bank Nifty is just a representation of the banking sector, which is a subset of Nifty.

Hence for this reason it makes sense to calculate beta of Bank Nifty. If you have gone through this chapter — http: Request you to go through the same. But this is not set in stone, their guess or estimate is as good as yours or mine. In fact nothing is set in stone when it comes to market. So please keep an open mind and adapt to events and markets as it evolves. So please keep an open mind and adapt to events and markets as it evolves……. We should never listen to anyone on Tv…trades should be done only according to TA….

I just want to know that buying a call or selling a put is same thing from the point of view that when market goes up you will be in profit. But how to select that buying a call is appropriate or selling a put? Same thing is for selling a call and buying a put. Is it not correct to buy a put rather selling a call to make loss limited? Well, this depends on the premium. If the premiums are too high then probably selling a Put maybe more profitable than buying a call.

Else if the premiums are low buying calls may make more sense than selling a put. There are many factors that drives the premiums…we will understand all these shortly in this module. Nice to see that you have started option education series. Since option is complex I am sure most of us will be benefitted from This. Nice work, keep it up. Hi Karthik, I am a newbie to options , In india when we trade options, we never buy the stock right?

Absolutely, all options in India is cash settled. I hope Varsity will help you understand options completely! Lot size is fixed by NSE — suggest you start from this module http: Likewise if the price goes below Rs.

The agreement is to buy the stock at 75, which is also called the strike price. So when the price drops to 65 — you still need to honor the agreement and buy it at The 2nd scenario is supposed to be flat…will make that change.

Thanks for point that out. NEST Plus is free to use. Whom did you speak to? Just finished reading the Futures module. Is it possible to provide all the modules in a PDF format? We are working on converting these topics in PDF and iBooks. It will be available very soon. I request you to add information about required certifications for making a career in the field of trading. Do have a look at this — http: Premium increased to 10 rupees. How we will come to know whether the options are trading at correct premium?

They may be trading at high valuations are low valuations right? Is there any tool to find out that? For this you need an options calculator. We will discuss the same towards the end of this module. Please explain it with an example.

Its explained here — http: I do not like to avail of service and pay. Is there any method which i learn so that i trade in options profitably by my self. Suggest me a reading or explain yourself about how to trade profitably in options. I shall read all your chaptrs.

I started reading your this site only today on 31St july Hi Usha — please do not pay for or opt for such services. They are all useless. Starting reading from chapter 1 and progress along…reading and understanding the subject is a 1 time lifetime effort…and after that you will never think of opting for such services.

Sarath — there are two things here. One is receiving the buying and selling options on the same day or anytime before expiry …in this case you will receive or lose money as applicable. The other thing is buying or selling an option and holding it till expiry…if you do this, then it is deemed that you are exercising your options.

When you excercise your options you will receive a settlement price if any as applicable. I trade in commodities and there we may or may not have profit but the turn over is in crores. Do i need to fill ITR What type of account data i need to hold for incometax purposes. Usha, everything answered in this module: Sir,I have gone through your TA it is excellent and superb, simple to understand with real time examples.

One doubt remains in me regarding Support and Resistance and Trend Analysis. And how to differentiate between them? What is meant by option will expire worthless on expiry. Suppose if I bought Nifty CE for strike price of and on expiry Nifty closed at level then whether the option buyer will get profit or not.

Can you please clarify the logic behind option pricing. Hi, many thanks for the above chapter. Nifty call bought at Rs 35 On expiry nifty is The call option is trading at Do We need to square off the position on expiry day to exercise the option or is it automatic if we are in the money? Why is ITM option is not trading at intrinsic price on the expiry day?

Why is it trading a little less than that? Its automatic upon expiry, if you are long options contracts. Could you please eloborate the above explaination in terms of the lot size of 75 and actual Profit earned.

No PDF because the module is still not complete. Chapters between 6 and 10 are there. Are you referring to the modules as such? Working on one module at a time…Module 5 just got done…starting 6th soon.

By the way 7th module is complete…you may want to check that. If suppose i square of this today, what will be my profit. The break-even calculation is right. Since you are closing the trade before the expiry your profits will be the amount of premium you pay to buy minus the amount of premium you received while selling it. So in this it would Rs. After August , all data including for strikes XX50 type is available.

Or there is some other reason. My question is …… can we sell the option call any time before the expiry date or only on the date is fixed??????? Karthik, Which ones less risky options or day trading? Can you please lay down the perks of day trading compared to that of options?

For this particular call option, to buy a lot, am I supposed to pay Hi sir pls tell me how much margin i need to deposit to short a call option..? Option shorting margins is similar to futures margin. Check this — https: HI, sir I have read this module….

Yes as long your option does not have any intrinsic value your short option position will make money. How can we consider It is high or Low? Hi, sir There are are different Iv in all strikes, according to Option theory when IV is high Option Premium would be high and vice versa.

Hi, sir Please explain this Interpretation when Iv is high premium would be high and vice versa. Volatility is one of the key drivers for the premium.

Higher the volatility, higher the premium…vice versa. Suggest you read the chapter on Vega. Hi,sir We are very great full to you for giving such precious informations.

Now confident level is increasing……. Thank you so much. All our content is made available for free online. I have a query. Will I be profitable I. You can sell the option if you choose on the very next day and take home the profit i. There is no requirement for you to hold on to this till expiry. When calculated the profit is negative.. Thank you Karthik and also would like to say you have a wonderful module and you make learning very simple.

Options sounded like greek when people spoke about it now it makes sense after reading first 3 chapters. Guess i got a long way to go.

Hello Karthik, I am a newbie just trying to get into the markets. I have been reading various articles and have just started going through your lessons. The explanations are extremely lucid. There are so many different ways and means of playing the markets that it really is confusing for a newbie just trying to figure out where to start and what to do or not to do.

Basically I need to know the following: In Chapter 19 you have suggested that a beginner start with Swing Trading and then graduate to Intraday. Should a newbie trade in individual stock after doing required research as per your suggestion or should one trade in NIFTY Index Lots 3. Can a newbie start with Options as I found the concept interesting But is it advisable to start Options as your first step in Trading? Would be much grateful if you could give me a clear Roadmap on what to start off with so that I can get a sense of direction!

Option payoff is non linear, unlike futures which is linear. This holds true for both option buying and selling. One needs to be aware of this along with its characteristics in its entirety..

Hi Karthik, Plz suggest me regarding nifty index option that which strike price should I choose from related to spot price otm,ATM,inm. I also want to know whether the premium of call option will get reduced nearing to expirydate, if it so can I exercise my contract and make profit out of it?

Since i am a newbie to share market as a whole, plz clarify me about this. From where I can read your options lessons? Request you to kindly read through the same. The feeling I get from going through your modules is similar to someone bringing you a bottle of chilled water after knowing that you have been stuck in some desert for two or three days without any water or food.

Keep up the good work. I pray for your well being. Its very impressive exaplanation abt options. However if you are particular about intraday, then derivatives is the best option.

Also, to minimize losses you could try hedged position in options. We have discussed various strategies here — http: But then it depends on how and why you are writing options. Hi, i am new to option…. I little bit understood the concept but i do not know how to implement like … say my prediction for the next week is that Buy at tgt and if short then short at with the target of now who me to place this in the option…… what to choose in CE and PE Need you support Mr.

As you read through this module, you will realize that we discuss everything with respect to strike selection.

So my suggestion for you is you should read through the entire content and you will be clear on selecting the right strike. Sir, I just want to know how to exercise call option on expiry, whether it is automatically done broker or i have to do something. Request to think about that please let me know if I can do it for you…Thanks. That will depend on the premium of the put option.

When markets crash, the put premiums tend to go up and therefore your futures position is hedged. What happens to premium of a call and put option if underlying prices move up? I think you explain better in the comments section!

I seriously learn more from the comments section. Which one do you think is more appropriate for analyzing the positions to be taken in options contracts? Should I be indifferent between the two?

The underlying is Nifty 50 index, so it always makes sense to look at the underlying and develop your point of view. But immediately after this, mtm loss is shown as I purchased 2 lots of December contract. When I asked, I was told that this is due to bid ask spread. The reason why I purchased is because of low vix. Will the bid ask spread narrow down? Or to break even how much should the premium rise to? Sir, in order to escape significant time decay, I wish to buy options whose expiry is 45 to 60 days away.

Under the Indian context, which options are liquid for even otm strikes? Sir, how do we measure liquidity? Suppose I want to buy 20 lots.

Then roughly what should be the minimum lots in open interest and minimum lots in bid and ask prices to be called as sufficiently liquid? One way to look at liquidity is by looking at the bid ask spread and impact cost. I m confused with the date. After knowing above Call option basics , i think to deal with Future Trade is more suitable than Call option.

Well, both these instruments are very different. Remember, a buy call and a sell call works differently and has different pay off features. This versatility is not there in futures. I have discussed this in multiple places, request you to please go through the contents.

Both of them are closely interconnected, you will understand this better as you progress reading through the material. Expiry day is fixed by the exchanges which is the last Thursday of the month. Profit will be difference between the premiums i. Be careful of what you buy on expiry day, especially due to the STT trap on options. Check this post — http: If I dont buy this option and closing price of maruti on 30 march is above for e.

What will be my profit or loss? Hello sir, Thank you so much for teach us in this systematic and logical way it sir as i am reading through this module i have lots of misunderstanding one of such is this Suppose i short a OTM CE option say Delta at 0. I mean can he close his position before expiry and benefit from premium fluctuations or he has only two way to stay in trade 1. I have to say understanding options from sellers prospective is confusing for me may be due to i knew to options.

Sir i request you please try to upload some extra supplementry notes for shorting options regarding their pay-off Lastly i cant explain in words my thanks to you for every thing you teach me Stay healthy and keep rocking….. Ankit, the same is applicable for sellers also. They can write or sell option and get of the the trade very next minute or they can choose to hold on to the trade till expiry.

The best way to learn this is by experiencing it once. Will i get 8 rs profit on the same day? However, before the expiry your profitability is the difference in premium. So yes, you can pocket the profit of Rs.

Dear Karthik, I just got to know about options. I trying to fully understand it. Hi Karthik, I have a query , Strike prize should be a price which is min. Strike selection is a very tricky process.

It is not just about the price, it also depends on volatility and speed at which the market moves. Suggest you read through this module to get a fair sense of how it works. Dear Sir, Who makes options or futures contract?

The stock market or the respective companies? We know that companies releases shares in the market when they have requirement of funds. But who releases the option and future contract to be traded in market? Sir, In the example given above if Venu decides to settle the deal with cash instead of selling the land directly, Ajay will be getting 4 lacs and Venu gets to keep the land right?

Now from Venu side, these are the calculations right, Amount received as premium is 1 lac Amount paid as a part of the deal is 4 lacs Now he still gets to keep the land and if he sells it to some third party, then he would be getting 10 lacs and subtracting whatever he spent earlier, he would be left with exactly 5 lacs.

But instead if he choose to give away the land, he will get to keep only 1 lac and 5 lacs paid to him as a part of the deal. Now finally he gets to keep 6 lacs with him. Should this mean he should always sell the land instead of settling it with cash? He can choose to do that, this is an example to convey the concept along with introducing the concept of cash settlement.

In India all options are cash settled, hence it makes sense to stick to cash settlement. OK thanks… I read options theory part 1 up to chapter You are doing extremely good job. Please provide rest of the module as soon as possible. Hi, A question related to options traidng. How much funds will be required for this call buy transaction?

Is the current price shown for the options for a single contract or for a single LOT 75 contracts? Please explain the meaning of LOT and how its related to current quote price. I have never done any transaction in options so wanted to get my following calculations clarified. If I wait till expiry and spot trades below strike say Premium must be trading at higher levels compared to 3.

Is this reasoning correct? Say if there is 1 day to expiry and spot is at , then CE is likely to trade below 3. He had paid Rs 1L 6 months in advance. We should also consider Time Value of Money. Hence the Interest cost opportunity cost should also be factored. So effective profit would be Rs — Rs which is Rs Again if he can put the 1L to much more productive use in other avenues say his business , profits would further reduce to that extent.

Is that all and no Margin is blocked? For buying options there are no margins, you only pay the premium in full. So with , you can initiate the position. Very useful write ups provided by u. We could not even learn in class paying huge amount. Thanks for providing such detailed information. I have 1 querry i. Secondly If i buy a call at Rs. Whether my premium also will be credited? What categories to be applied.

If you have an account with us, then you get access to charting on Kite. Check out more details on charting here — https: You may also want to check out the module on TA for drawing inference on price movement — https: If i buy a call rs 8. If the above scenario happens on last closing day, whether option buyer will loose his entire premium of Rs. Pl correct me if anything narrated above is wrong and pl explain about the situation of settlement.

In this example, the option buyer will neither make or lose money. Of course, he will have to pay for the charges incurred like brokerage, transaction charges etc. Really thanks for your valuable guidance. U r taking so much efforts to make us learning and encouraging us for trading. CE purchased on 3rd Oct. Now I have a question that I purchased a call Rs.

Now the premium price for same lot , and price on 4 th of Oct expiring on 26 th Oct. In this Decreased or increased situation can i sell my option CE on Rs. If profit made, profit and premium paid will be credited to my account on 4 th Oct or on 26 the Oct.. Yes, you can sell the option at 11 and make a profit of 8, no need to wait till expiry.

Yes, you will get the profit credited to your trading account on 4th. Recently I am going thru your Technical Analysis Module which gives pleasure in reading and understanding. Your modules are as good as you are teaching in class, that much effective information is provided and hence a Lay Man like me can get understand the tricks of trading.

It is now 8 days and sent 3 email reminders. Can you please ask why they are showing so unprofessional behavior. No one contacted me till now: Sorry to say but very unprofessional behavior.

I noticed one more issue in Kite. Please tell me where I am wrong. Since these are intraday trade, you lost 13 points in the first trade and now on the 2nd trade, you; ve made 11 points. So net-net you are losing 2 points. You replied below query but not mine. I am still learning after studying all the theoretical now I am doing practical. And I am noticing bugs in profit calculation therefore asking you to clarify my doubt. Now I am stuck what should I do?

We answer ALL queries that come in here. Really very nicely explained chapters, I am still going through the chapters. I had just a simple query regarding Bank Nifty. Bank Nifty as the name suggests is group of banks that decide Bank Nifty Index.

Will you please indicate different parameters , stocks etc. Everything about Nifty Bank is here — http: For this reason, its available only in English. The article is super and your patience in answering each comment here is commendable too.

This is the first article I read on your site and am interested enough to start at Module 1, chapter 1! Thank you, Karthik, for your efforts in creating and maintaining this varsity.

If Ajay pays Rs. Hey In the case that the land price remains 5L, Ajay should be neutral and not opposed to buying the land. In fact, the amount paid as premium should not factor into his decision on whether to buy or sell the land. Can a stop loss be placed for options? Entry into the field involves mastery over its often opaque jargon and complex concepts. At Lightspeed Trading, we strive to design trading tools that assist everyone from the most experienced traders to those just looking to get started.

Part of that endeavor involves education. To that end, we have provided a short glossary of some basic stock market terminology to help beginning traders on their way. Those with more experience can always stand to review their knowledge, as well. These assets represent investments. Subsequently, they allow companies, commercial enterprises, and municipalities to raise new capital. These securities denote ownership in a corporation. Generally, stocks consist of two different types:.

On the stock market, ETFs trade like stocks but more closely resemble mutual funds. They hold stocks, commodities, and other assets while remaining tradeable themselves. Because they reflect an index, their prices change throughout the day.

In contrast, mutual funds have their net-asset values NAV calculated at the end of the business day.