A Simple introduction to Future & Option

A Simple introduction to Future & Option

What are Derivatives A Simple introduction to Future & Option
Derivatives are financial instruments which derive their value from the underlying assets or securities. For example, if a Buyer enters into a contract with a Seller to buy a specified number of shares (or Index/ Commodity) of a particular company at a specified price after a specified period, the buyer is said to have entered into a Futures contract.
It is interesting to note that Buyer has bought the contract and not the stock of shares(or Index/ Commodity) under reference. This type of Future contract is called Derivative. There are many another type of Derivatives commonly used all over the world like Options, Convertibles and Warrants etc.
What are Futures
It is an Agreement between the Buyer and the Seller for the Purchase or Sells of a Particular Asset ( like Equity Stock/ Index etc) at a Specified Price and on a specified future date (1 Month/ 2 Months/ 3 Months). It conveys an OBLIGATION on both Buyer and Seller to Fulfill the Terms of the Agreement. Futures are Settled on Last Thursday of the Specified Month and both buyer and seller have to pay minimum Initial Margin as per the requirement of the stock exchange and account between buyer and seller is settled Everyday till the expiry of the Futures contract.
Nifty Future contract have a multiplier of 200 whereas, in case of BSE Sensex, the multiplier is 50 that means Nifty Futures contract gives rise to an obligation to deliver at settlement cash payment equal to 200 times ( 50 times in case of BSE Sensex Futures) the difference between the Nifty Index value at the close of the last trading day of the contract and the price at which the Futures Contract was negotiated.
Example
Suppose ‘A’ enters (Buys) a Nifty futures contract at 1225 for July (expiring on last Thursday of July) with ‘B’. Both ‘A’ & ‘B’ will deposit the required margin with the Stock exchange. On last Thursday of July, Nifty closes at 1267. Now ‘A’ will get Rs. 8400/- {( 1267-1225) x 200 = 8400} from ‘B’. In case Nifty closes at 1157, ‘B’ will get Rs. 13600/- {(1225-1157) x 200 = 13600 } from ‘A’. ( BSE Sensex contract will carry a multiplier of 50 instead of 200 as in case of Nifty.)
But their account will be credited or debited from their Margin Account and their position will be ‘marked to market’ at the end of the session each day. In case the Margin account falls below the maintenance level, cash is sought from the customer to replenish the margin account back to the original level. Either of the customers having surplus margin beyond the original margin can withdraw the funds.
What are the Options
An option is a contract, which gives the Buyer of Option (holder) the right, but not the obligation, to Buy or Sell specified quantity of the underlying assets, at a Specific (Strike) Price on or before a Specified Time (expiration date) i.e 1 Month/ 2 Months/ 3 Months etc. The underlying may be physical commodities like wheat/ rice/ cotton/ gold/ oil or financial instruments like equity stocks/ stock index/ bonds etc.
There are 2 types of Options i.e. Call Options and Put Options.
CALL OPTIONS
A Call Option gives the holder (buyer/ one who is long call), the right (No obligation) to buy a specified quantity of the underlying asset at the strike price on or before the expiration date. The seller (one who is short call) however, has the obligation to sell the underlying asset if the buyer of the call option decides to exercise his option to buy.
Option buyer or option holder – Buys the right (No obligation) to buy the underlying asset at the specified price
Option seller or option writer – Has the obligation to sell the underlying asset (to the option holder) at the specified price
PUT OPTIONS
A Put Option gives the holder (buyer/ one who is long Put), the right (No obligation) to sell a specified quantity of the underlying asset at the strike price on or before a expiry date. The seller of the put option (one who is short Put) however, has the obligation to buy the underlying asset at the strike price if the buyer decides to exercise his option to sell.
Option buyer or option holder – Buys (No obligation) the right to sell the underlying asset at the specified price
Option seller or option writer – Has the obligation to buy the underlying asset (from the option holder) at the specified price.

When to Buy a Call Option.

If you are Bullish on a particular Scrip/Index. For example, you are Bullish on Tata global (CMP- Rs.350/-) and expecting it to touch 450 in a month’s time (or any particular period say 2/3 months). So you will Buy Reliance Call Option for 1 month (or any particular period) by paying a premium of Rs.10/share (Say). During the course of a month, you will get Right to exercise your Call Option to Buy Reliance at 350 from the seller of Call Option. Suppose it does not move up, you are free NOT to exercise your option to Buy and your loss is limited to the Premium you have paid.
When to Buy a Put Option.
If you are Bearish on a particular Scrip/Index. For example, you are Bearish on ACC (CMP -Rs.150/-) and expecting it to touch 100/- in a month’s time. So you will Buy ACC Put Option for 1 month by paying a premium of Rs.5/share (Say). During the course of a month (you are Free to Buy ACC from the market any time at a lower price) you will get Right to exercise your Put Option to Sell ACC at 150/- to the seller of Put Option. Suppose it does not decline, you are free NOT to exercise your option to Sell and your loss is limited to the Premium you have paid.
When to Sell a Call Option.
If you are Bearish on a particular Scrip/Index. For example, you are Bearish on Infosys (CMP- Rs.3800/-) and expect that it will not move up significantly(or rather decline) in a month’s time. So you will Sell Infosys Call Option at a strike rate of Rs.3900/- (say) for 1 month and Receive the Premium. (Say Rs.100/share). During the course of month Buyer of Call Option will have Right (Not the Obligation) to take Infosys at 3900/- from you and you are obliged to honor your commitment. Remember that you are Holding risk of unlimited loss if Price of Infosys moves up significantly just at the cost of Premium you have received.(you should sell Call Option Only if you are sure that Price of Share will Fall/or not move up or you are holding shares with you to part with, if required)
When to Sell a Put Option.
If you are Bullish on a particular Scrip/Index. For example, you are Bullish on Satyam (CMP – Rs.200/-) and expect that it will not Decline significantly (or rather move up) in a month’s time. So you will Sell Satyam Put Option at a strike rate Rs.215/- (say) for 1 month and Receive the Premium. (Say Rs.12/share). During the course of month Buyer of Put Option will have Right (Not the Obligation) to Sell Satyam at 215/- to you and you are obliged to honor your commitment. Remember that you are Holding risk of unlimited loss if Price of Satyam goes down at the cost of Premium you have received. (you should Sell Put Option Only if you are sure that Price of Share will Move up or you will take Delivery of shares if required)
How are Options different from Futures
The significant differences in Futures and Options are as under:
1. Futures are agreements/contracts to buy or sell a specified quantity of the underlying assets at a price agreed upon by the buyer & seller, on or before a specified time.
Both the buyer and seller are obligated to buy/sell the underlying asset.
2. In case of Options, the buyer enjoys the right & not the obligation, to buy or sell the underlying asset.
3. Futures Contracts have asymmetric risk profile for both the buyer as well as the seller, whereas options have asymmetric risk profile. In case of Options, for a buyer (or holder of the option), the downside is limited to the premium (option price) he has paid while the profits may be unlimited. For a seller or writer of an Options, however, the downside is unlimited while profits are limited to the premium he has received from the buyer.
4. The Futures contracts prices are affected mainly by the prices of the underlying asset. The prices of Options are, however, affected by prices of the underlying asset, time remaining for the expiry of the contract & volatility of the underlying asset.
5. It costs nothing to enter into a Futures contract whereas there is a cost of entering into an Options contract, termed as Premium.
What is Assignment
When the holder of an option exercises his right to buy/ sell, a randomly selected option seller is assigned the obligation to honor the underlying contract, and this process is termed as Assignment.
What are European & American Style of options
An American style option is the one which can be exercised by the buyer on or before the expiration date, i.e. anytime between the day of purchase of the option and the day of its expiry. The European kind of option is the one which can be exercised by the buyer on the expiration day only & not anytime before that.

What is an Option Calculator

An option calculator is a tool to calculate the price of an Option on the basis of various influencing factors like the price of the underlying and its volatility, time to expiry, risk-free interest rate etc. It also helps the user to understand how a change in any one of the factors or more, will affect the option price.

Who are the likely players in the Options Market

Financial institutions, Mutual Funds, Domestic & Foreign Institutional Investors, Brokers, Retail Participants are the likely players in the Options Market.
What are Stock Index Options
The Stock Index Options are options where the underlying asset is a Stock Index for e.g. Options on S&P 500 Index/ Options on BSE Sensex etc. Index Options were first introduced by Chicago Board of Options Exchange (CBOE) in 1983 on its Index ‘S&P 100’. As opposed to options on Individual stocks, index options give an investor the right to buy or sell the value of an index which represents a group of stocks.
What are the uses of Index Options
Index options enable investors to gain exposure to a broad market, with one trading decision and frequently with one transaction. To obtain the same level of diversification using individual stocks or individual equity options, numerous decisions and trades would be necessary. Since broad exposure can be gained with one trade, transaction cost is also reduced by using Index Options. As a percentage of the underlying value, premiums of index options are usually lower than those of equity options as equity options are more volatile than the Index.
Who would use index options
Index Options are effective enough to appeal to a broad spectrum of users, from conservative investors to more aggressive stock market traders. Individual investors might wish to capitalize on market opinions (bullish, bearish or neutral) by acting on their views of the broad market or one of its many sectors. The more sophisticated market professionals might find the variety of index option contracts excellent tools for enhancing market timing decisions and adjusting asset mixes for asset allocation. To a market professional, managing the risk associated with large equity positions may mean using index options to either reduce their risk or to increase market exposure.
What are Options on individual stocks
Options contracts where the underlying asset is an equity stock, are termed as Options on stocks. They are mostly American style options cash settled or settled by physical delivery. Prices are normally quoted in terms of the premium per share, although each contract is invariably for a larger number of shares, e.g. 100.

What are Over the Counter Options

OTC (“over the counter”) options are those dealt with directly between counter-parties and are completely flexible & customized. There is some standardization for ease of trading in the busiest markets, but the precise details of each transaction are freely negotiable between buyer and seller.
What is the underlying in case of Options being introduced by BSE
The underlying for the index options is the BSE 30 Sensex, which is the benchmark index of Indian Capital markets, comprising of 30 scrips.
What will be the new margining system in the case of Options and futures
A portfolio based margining model (SPAN), would be adopted which will take an integrated view of the risk involved in the portfolio of each individual client comprising of his positions in all the derivatives contract traded on the Derivatives Segment. The Initial Margin would be based on worst-case loss of the portfolio of a client to cover 99% VaR over two days horizon. The Initial Margin would be netted at the client level and shall be on a gross basis at the Trading/Clearing member level. The Portfolio will be marked to market on a daily basis.
IMPORTANT TERMINOLOGY
Underlying – The specific security/asset on which an options contract is based.
Option Premium – Premium is the price paid by the buyer to the seller to acquire the right to buy or sell
Strike Price or Exercise Price – The strike or exercise price of an option is the specified/ pre-determined price of the underlying asset at which the same can be bought or sold if the option buyer exercises his right to buy/ sell on or before the expiration day.
Expiration date -The date on which the option expires is known as Expiration Date. On the Expiration date, either the option is exercised or it expires worthless.
Exercise Date – is the date on which the option is actually exercised. In case of European Options the exercise date is same as the expiration date while in case of American Options, the options contract may be exercised any day between the purchase of the contract & its expiration date (see European/ American Option)
Open Interest – The total number of options contracts outstanding in the market at any given point in time.
Option Holder – is the one who buys an option which can be a call or a put option. He enjoys the right to buy or sell the underlying asset at a specified price on or before the specified time. His upside potential is unlimited while losses are limited to the Premium paid by him to the option writer.
Option seller/ writer – is the one who is obligated to buy (in case of a Put option) or to sell (in case of call option), the underlying asset in case the buyer of the option decides to exercise his option. His profits are limited to the premium received from the buyer while his downside is unlimited.
Options Class – All listed options of a particular type (i.e., call or put) on a particular underlying instrument, e.g., all Sensex Call Options (or) all Sensex Put Options
Option Series – An option series consists of all the options of a given class with the same expiration date and strike price. E.g. BSXCMAY3600 is an options series which includes all Sensex Call options that are traded with Strike Price of 3600 & Expiry in May. (BSX Stands for BSE Sensex (the underlying index), C is for Call Option, May is expiry date & strike Price is 3600)

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Investment Rules

‘Investments’ is a sacred term for individuals. For many, investing means a kind of ‘compulsory’ savings from one’s earnings and getting lumpsum money later.
However, there is a lot more to investing than just that. Investing falls within a broader gamut of financial planning. It requires considerable thought and groundwork. Here, we have outlined some important guidelines to be borne in mind while planning your finances.
1. Do your homework
Before investing your money, ensure that you have done your homework well. It is ‘normal’ for sales pitches to be aggressive. Most sales executives are mainly interested in ‘commission earned’ or ‘business garnered’, which reflects in their monthly targets. That is why one only gets to hear the ‘best case scenario’ from agents/sales executives.
A lot of sales agents/consultants try to exploit the individual’s vulnerability and lack of knowledge while making a sales pitch. For instance, how else can you explain so many individuals in the low-risk category investing in high-risk ULIPs?
Or why term plans, in spite of being the cheapest form of insurance, are still not bought by most individuals? Or why mutual fund IPOs find so much favor with investors even when there is no fit in their portfolios?
One should understand his own profile in terms of income, risk appetite, and future plans and only then, make investments in tune with the same. Individuals need to know what benefits different products offer and how they fit into their financial portfolios before taking a call on investing in them.
You must listen to advise from different quarters but the final decision should rest with you alone after a careful analysis. After all, it’s your own hard-earned money.
2. Keep your eyes and ears open
Keep your eyes and ears open at all times for any investment opportunity that comes your way. The opportunity could be by way of changing market scenario or new product launches. Individuals shouldn’t lose out on any opportunity just because they didn’t know it existed.
Of course, this involves a bit of updating yourself with latest product trends, market conditions and changing economic scenario. This way, you will not be completely at the mercy of the consultant/agent to provide you with investment-related information and solutions.
3. Involve yourself
While buying any financial product, ensure that you have involved yourself at critical stages. For example, while taking life insurance, see to it that you personally fill all the details in the proposal form.
Insurance agents many times used to, themselves, fill up details like the height and weight of the insured, his age and medical history among other things, based solely on their own judgment. They merely asked the individual to sign on the form at the end.
What individuals don’t realise is that this can lead to rejection of claims at a later stage if discrepancies are found in the proposal form. The insurance company cannot be faulted for rejecting such a claim. It is a shortcoming on the agent’s part who should have requested you to fill the form yourself, else fill it himself after verifying your details.
All the necessary medical tests should also be diligently given. As mentioned earlier, any ‘false claims’ might lead to rejections at a later date.
4. Inform your near and dear ones
This is especially true in case of life insurance. Inform your near and dear ones as soon as the policy is bought. If your spouse and/or parents know that you have a life insurance cover wherein he/they are nominees, they will be better placed to follow up with the life insurance company for the claim proceeds should something happen to you.
Typically, life insurance should not be so sacred that you don’t broach the topic in the family. All related (and affected) parties must know exactly what needs to be done in your absence.
5. Maintain a logbook
Always maintain a logbook of your life insurance policies/investments. Individuals can and do have a variety of investments ranging from life insurance (endowment, term plan, ULIPs) to mutual funds and PPF/NSCs. A logbook should contain details about the same.
Over an extended period of time, it becomes difficult for one to remember or track investment details like maturity date, maturity value and rate of interest. This logbook will take care of that problem. Of course, it goes without saying that for the logbook to be really effective and useful, it should be updated periodically to reflect investments and redemptions.
This logbook should also include details of an individual’s liabilities like home loans, personal loans, the amount outstanding on such loans, the EMI and business liabilities (in case the individual runs a business) among others.

Details of the logbook should also be shared with your dependents (spouse, children, parents). An important reason for making a copy is, in case of an unfortunate eventuality, the spouse knows his/her exact financial status. Also, one wouldn’t want someone to come out of nowhere one fine day and stake a claim on the family’s assets based on some ‘fictitious’ liability.

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Technical Analysis When to Trade

Technical Analysis When to Trade

Technical Analysis When to Trade

The keys to successful Trading or Investing in the Stock Market are knowledge, discipline, and patience. Assuming that, you have some knowledge, the best way to achieve discipline and patience is doing your homework and having a plan of action ready before putting that plan to work. Though it may not guarantee success it will definitely increase the odds of winning in any financial market. When it comes to applying those technical principles, the most difficult part of the process is the actual purchase or sale in the trading.  The final decision as to when to trade, how to trade and how much to trade and the type of trading orders to imply.
Day Trading has also the same principles of any financial market. The only real difference is the timing as it covers the very short term. The time frame that concerns us here is measured in hours, minutes and seconds as opposed to days, weeks and months but the technical tools implied remains the same.
(i) Trading on the break out from Patterns
(ii) Trading in overbought/ oversold zone
(iii) Trading at support and resistance level
(iv) Trading at the breaking of trend lines
(v) Trading at the percentage replacement
(vi) Trading while making the use of gaps
(vii) Trading on negative and positive divergences 

The most effective way to formulate a trading strategy is to combine all of them. After the initial decision to buy or sell has already been made the above concepts can be used to fine-tune entry or exit points. Use of Stop Loss and applying of strict discipline will definitely help one become a successful trader. 

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