Futures & options

How to find which futures will gain or loose: Select stocks from our quarterly analysis, Daily trading, Board meetings, Institutional buying, Promoters buying, stake raise etc as explained in earlier chapters. You can view Open Interest of all stock, index futures & options by downloading the bhav copy from: http://www.nseindia.com/bhavcopy/BhavHandler?segment=1 http://nseindia.com > Put cursor on third icon F & O > Market Information > Market Today Check all details on derivative segment on right hand side column of: http://nseindia.com

Open Interest:
How to calculate Open Interest Every trade completed on the exchange has an impact upon the level of open interest for that day for example, if both parties to the trade are initiating a new position one new buyer and one new seller, open interest will increase by one contract; If both traders are closing an existing or old position (one old buyer and one old seller) open interest will decline by one contract. The third and final possibility is one old trader passing off his position to a new trader (one old buyer sells to one new buyer), in this case the open interest will not change.

Open interest = net number of open positions (unsettled trades).

Date MR. A
Dec 13 Buys 1 Option ( Add to O/I )

MR. B
Sells 1 option (completes sell buy transaction not added to open interest)

MR. C MR. D

Open Logic interest

1 Trading Volume 1 lot New position created by Mr. A & transaction completed by 1 buy & 1 sell 5 new contracts of Mr.C & transactions completed buy 5 buys & 5 sell

Dec 14

Buys 5 Sells 5 options options Add to O/I

Dec 13 = 1+5 new of Completes Mr. C = sell buy net open transaction int. = 6 Trading volume 5 Lots Dec 14 net O/I =61 completes settled sale buy so net transaction O/I = 5 Buys 1 option Trading volume 1 lot Dec 15 net O/I =5+5 Of Mr.A -5 of Mr. C net O/I = 5 Trading volume 5 Lots

Dec 15

Sells 1 option will be deducted from O/I

Mr. A settled position & Open interest down by 1 trade. 1buy = 1 sell

Dec 16

Buys 5 options

Sells 5 options

Mr. C reduced position of Dec 14 & Mr. A created 5 new positions.

Table to understand changes in open interest: LONG SHORT OPEN (BUYER) (SELLER) INTEREST
Initiating Initiating Squaring Squaring Initiating Squaring Initiating Squaring Rises No Change No Change Falls

Understanding implications of open interest:

http://sify.com/finance/equity/fullstory.php?id=14445905&cid=34002

Market wide Open interest limits & current open interest positions:
http://ventura1.com/Derivativesnew/DerivativesInner.aspx?id=9

Formulas for trading in Futures & Options:

Where to find the data on price, volume, Open Interest:
http://ventura1.com/Derivativesnew/iFrindex.aspx There are few formula tables mentioned below & to get the data of price/open interest/volumes, you will need to click the above link. Check open interest icon in above link & you will be able to find links to data on price, Volume & open interest like (stocks with High open interest, high Volumes & High price etc. You will need the data for following formula tables & find out future trend of the stocks. Study links: http://www.traderji.com/technical-analysis/1722-trendline-analysisopen-interest.html http://sify.com/finance/fullstory.php?id=14445905&cid=14289290

How to determine market trend:

Price Open Interest

Rising Rising Falling Falling Rising Falling Rising Falling

Interpretation
Market is Strong Market is Weakening Market is Weak Market is Strengthening

Price
Rising

volume
high

Open Interest
rising

Price reason expected to

continue to rise new bulls entering market

Rising

high

falling

fall

short covering

Rising

Low

steady

fall or stabilize

Falling

high

rising

continue to fall

Not enough buyers to sustain uptrend new bears entering market

Falling Falling

High Low

Falling Steady

Rise Rise or Stabilize

Long Liquidation Not enough sellers to sustain a downward trend

Price
Rising Rising Declining Declining

Volume
UP Down UP Down

Open Interest
UP Down UP Down

Market Trend
Strong Weak Weak Strong

Future price
UP Down UP ( All time high)

Open Interest
UP UP UP ( Record Highest)

Indication
Positive Negative Exit

Price
UP Down (Little )

Open Interest
Down Down ( Little )

Volume
Up (Little ) Down ( Little )

Indication
Short covering Profit Booking

Future Price
Up Down

Open Interest Volume

Up Up Up Up

Cost of Carry
Up Down

Indication
Bullish Bearish

Roll over:
Excellent if above 90% Good 70 % to 90 % Not good below 70%

Roll Over Data:

http://ventura1.com/Derivativesnew/DerivativesInner.aspx?id=22

Subscribe to Sharekhan.com for news letters, you will get Rollover Data.
http://www.business-standard.com/india/storypage.php?autono=311716

Important:
We cut all the stock/index futures from our selection process where roll over is less then 70 %.

Check market wide derivatives status & complete historical data on derivatives:
www.nseindia.com > Check 2nd icon from left F & O > Historical Data & also Market Today http://www.nseindia.com/content/fo/fii_stats.xls Check most active nifty calls & puts & some more info: http://www.optionsoutlook.com/

Futures & Options Glossary:

A leverage instrument where paying a small margin you can trade large volumes. Trading in future segment is very dangerous & a famous author says Futures & options are weapons for mass wealth destruction. F&O is useful for trading bearish; you can sell stock or index futures & get the benefit of the downward trend. 1) Spot Price: 2) Future Market price: 3) Lot size: 4) Contract Amount: Current market price Price prevailing in future market. Determined by exchange say Nifty you can buy Lot of 50, Reliance 150 etc. Lot size X Future price

For Example: Nifty lot size is 50 &Future price is 3000 then Contract amount is 1, 50,000/- (3000 X 50) 5) Index Future: When you trade in Index like Nifty/ Bank Nifty in futures market

6) Stock future: 7) Open Interest:

When you trade in stocks in futures market number of contracts which have not been Settled 8) Expiry/Settlement: Last Thursday of every Month 9) Rollover: Carry forward current position to next month 10) Cost of carry: Risk free rate of return, Cost of carry is in % Calculated annually 11) Premium: When future price is higher then cash 12) Discount: When future price is lower then cash 13) Basis: Future price 1010 Cash price 1000 = 10 Basis/Positive basis 14) Backwardation: Future price less then Spot price eg. Nifty 15) Contract life: 3 months current month, next month & Far Month 16) Roll over cost: On settlement if you sell RIL at 1800 & buy for next month at 1820 Difference of Rs.20 is a rollover cost. 17) Settlement: It is done on expiry. 18) Initial Margin: Margin you have to pay to a broker for trading in futures. 19) Mark-market Margin: Broker will ask you for this margin if your holding shows higher losses 20) Maintenance Margin: It is used to cover your mark to market margin. When you are bullish about market, you buy Nifty Future When you are bullish about any stock, you buy stock future When you are bearish about market/stock, you sell Nifty futures/ stock futures Future price = Spot price (Market price) +Cost of carry Dividend declared if any

Hedging:
Hedging is insuring your risk related to your investment in the market. How future hedging is done: Mr. X has news in RIL & wish to buy 1 lot of RIL @ 1500 in future segment. He must buy 1 lot from market of RIL @1500 & sell 1 lot of Nifty Future @3500 Suppose RIL future goes to Rs.1600 in few days then

Lot size of RIL X Profit 150 X 100 = 15000 at the same time due to RIL effect nifty goes to 3600 ( due to its weight in Nifty )then Lot Size of Nifty X Loss in Nifty 50 X100 = 5000 Net gain after hedging Rs.10, 000/- which should have been Rs.15, 000/- without hedging but his position was safeguarded against unfavorable market movements.

Hedging your portfolio:

You need to know the beta of your stocks to hedge your portfolio which can be found in SE monthly news letters & stock market magazines. For Example: Your portfolio is; Stock name RIL LNT HDFC Bank IDBI Parshvanath ________ Total % of portfolio 30 25 25 10 10 ______ 100 Beta 2 3 1 2 3 % weight X Beta 0.30 X 2 0.25X 3 0.25 X 1 0.10 X 2 0.10 X 3 = 0.60 = 0.75 = 0.25 = 0.20 = 0.30

Portfolio Beta = 2.10

Assuming your above portfolio value to be Rs.1 Cr, you need to insure your portfolio by selling nifty to the extent of Rs.2.10 Cr.(Portfolio Value X Portfolio Beta). The best way is to you can buy put options of Nifty & pay small premium, if market goes down then your put will gain in value & compensate for losses. Option price is impacted by DELTA. In simple terms, DELTA of 0.5 means that for 1 Rupee change in NIFTY, the option premium will

change by 0.5, to accommodate that you might like to buy 4 contracts of high value to cover risk attached to your portfolio. Beta values & volatility factor on yearly basis http://www.bseindia.com/about/abindices/betavalues.asp http://www.nseindia.com/content/indices/ind_betavalues.htm

Market hedging position in respect to PCR (Put call ratio):

PCR = Number of put traded / number of calls traded e.g. 1000/900 = 1.2 PCR in the range of 0.80 to 1.20, above this it is considered that market is adequately hedged which means that during any fall or correction market will find a support to gain from such lows. Open interest O/I put call ratio = No. of puts O/I / No. of calls O/I

Open interest PCR range is 1.1% to 1.4 or 1.6% it implies it is adequately hedged; above 1.75 % it is over hedged. Whenever market corrects, PCR comes down & lowest PCR points to market bottoms. Read some of the links: http://blog.monsterindia.com/my/uday415/what-is-hedging17623.html http://www.galatime.com/options/archives/2004/09/heres_part_2_of.h tml http://www.thehindubusinessline.com/iw/2008/01/06/stories/200801 0650340700.htm http://www.rediff.com/money/2007/jun/23hedge.htm www.ficci.com/media-room/speeches-presentations/2004/july/july17agri-vivek.pdf

Arbitrage
Arbitrage is a trading opportunity arising out of a difference in prices, with now computerized Terminals, opportunity usually vanishes before it could be grabbed. Nowadays arbitrage is done in following ways.

Arbitrage using index futures:

Buy Nifty component say RIL by same weightage & sell Nifty Futures. Nifty future is at 2 % Premium & when you square off on last day of settlement, you will earn risk free return of 2% Premium. Nifty if turns to discount you may earn more then 4% to 5 %. Similarly if RIL (Nifty Component) is trading in premium & Nifty future is in discount, buy nifty Future which is in discount & sell RIL (Nifty component), you will earn handsome returns on Square off.

Arbitrage using stock futures:

When you feel risk of downside, sell the stocks from your portfolios which are in future segment, your investment will be safeguarded against such short term losses. Arbitrage is possible between cash & future segments if there is difference in prices. RIL Cash 1800 RIL Future 1825 Sell RIL Future at 1825 & Buy in cash the same number of shares @1800 Difference is Rs.25, at the end of the contract i.e. last Thursday of month, Square off your position by selling in cash & buying future. Prices of cash & Future may go up or down, he may not have to worry, as in any case he will earn Rs.25 difference. Example,

RIL cash price & Future price goes to Rs.2000 then Profit in Cash Rs.200 per share Loss in future Rs.175 per share Net Rs.25 per share

These are called cash & carry arbitrages. Similarly if RIL future is in discount & you hold RIL in delivery, then sell RIL in cash & buy RIL Futures, square off at the end of contract, you will earn from imperfection in pricing. Links to learn about Arbitrage: http://arbitrage.blog.co.in/ http://www.karvy.com/articles/arbitrage.htm http://www.thehindubusinessline.com/iw/2008/10/05/stories/200810 0550481300.htm http://www.lazyshoe.com/companies-business/article5515.htm

Training in Arbitrage at Delhi, Mumbai & Kolkatta: http://www.indiastudychannel.com/forum/13871-Learn-Arbitrage-SafeWay-Trading-Indian-Stock-Market.aspx http://www.clickindia.com/detail.php?id=595350 http://kolkata.locanto.in/ID_101477838/LEARN-TECHNICALANALYSIS-ARBITRAGE-SHARE-TRADING-AND-PASS-NCFM.html http://mumbai.indialist.com/2414296/Business-Opportunities/OthersBusiness-Opportunities/A-Great-opportunity-to-learn-arbitrage-diploma-in-options-arbitrage-and-strategies.html http://bifm.edu.in/programs/EATD/index.html http://www.olx.in/q/arbitrage/c-278 http://www.clickindia.com/search.php?q=arbitrage&page=2

Note: we have no references or experience of dealing with above institutions.

Check readymade arbitrage opportunities at:

http://www.moneycontrol.com/stocks/marketinfo/marketinfo.php

Options:
We have just given a brief outline on Options. PCR = PUT Call Ratio = Number of Puts Traded / Number of Call traded Call Option: You buy a Land value of Rs.10 lac at New Bombay & pay token money of Rs.1 Lac. Case 1: Reliance buys the surrounding land & is declared as SEZ & it offers you 25 lacs Unlimited profit by paying a small premium Case 2: Dispute happens with a local don about the land you purchased & you decide to forget the amount paid. Call Option gives right to buy but no obligation to buy by giving a premium. When stock price goes up you can gain unlimited profits & loss is only limited to premium amount paid. Put Option: When you are taking a mediclaim of Rs. 2 lac by paying Rs.4000 as premium, if you are not falling ill then Rs.4000 is loss for the year & if you fall ill, your 2 lac hospital bill is being paid by insurance company.

When the stock price goes down, you gain profit & if the stock price goes up then your loss is only restricted to premium amount paid you, when you are paying the premium you become buyer of PUT OPTION. Profits are limited to premium amount & losses are unlimited, is called seller of PUT OPTION. Option buyers are Option holders & Option sellers are Option writers. Call Option:

Example:

Call Buyer
Have right to buy No obligation to buy Pays premium Losses limited to premium Profit unlimited Profit up when price up Margin is equal to premium IDBI CMP 100 Premium 9000

Call Seller

Obligation to sell No right to refuse Receives premium Losses unlimited Profit limited to premium Loss up when price up Has to pay margin to exchange Which is equal to future margin call premium 3 X Lot size 3000 = Total

At Expiry CMP 109 call premium 9 Call premium paid 3 = Rs.6 X 3000 = Rs.18000 profit

Stock Option: IDBI 100 CA 30/08/2007 IDBI 100 PA 30/08/2007 CA & PA are American in nature You can exercise any time or at the time of the expiry. Index Option: NIFTY 4300 CE 30/08/2007 NIFTY 4300 PE 30/8/2007 CE & PE European in nature Premium 3 Premium 3.50 CA PA Call Put

Put Option:

PUT Buyer Have right to sell No Obligation to sell Pays the premium Losses limited to premium paid Profit is Unlimited Profit up when price down Margin is equal to premium only

PUT Seller Obligation to buy No Right Receives the premium Losses unlimited Profit is limited to premium amount Losses up when prices go down Seller has to pay margin to exchange which is equal to future margin

Option premium:
Option premium is affected by following values. 1) CMP Current market price 2) Strike Value 3) Intrinsic value

4) Time value 5) Volatility ITM = Intrinsic time value ATM = Only Time value OTM = Only time vale but less then ATMM For example: 100 - CMP 110 PA 12 120 PA 21 This is example of ITM & always put will exercise from the strike price, here in example Strike price is 110 PA 120 PA Factors affecting Options premium:

Value
Spot price up Strike price up Time to expiry up Volatility up Interest rate up (will have an impact when RBI Changes interest rates)

Call Premium
up down up up up

Put Premium
up up up up up

There are three methods to calculate Option premium: 1) PCPM Put call parity method

2) BSOPM Black Scholes Option Premium 3) BOPM Greeks: Binary option premium

When spot price increases, call option premium increases. Increase in Option premium due to change in stock price is called DELTA Rate of change of DELTA is GAMA Measure of volatility is Measure of Time decay is VEGA Theta Q

Measure of Interest rate change Rho

Option strategies:
1) Plain Vanilla strategy 2) Spreads A) Bull call spreads B) Bear spread using call C) Bear spread using puts 3) 4) 5) 6) 7) 8) Straddle Strangle Strap Strip Butterfly Ratio call spread

Website for FUND NAVs, quotes & learning: http://sify.com/finance