Derivative Trading Techniques

FUTURE & OPTION

Futures Trading for Beginners – Get-Set-Go……….

They say a journey of a thousand miles begins with the first step. This is true of
futures trading for beginners as well. Even if you have investment experience you
might not know the difference between stock trading and futures. Don’t get worried
because that is the reason for this discussion. What is going to happen is that we will
look at futures trading for beginners and give you some of the basics to get you
started. If you have never been exposed to futures trading, this is fine; the journey
may be a thousand miles but we will take the first step together.

What is a Derivative? Understanding with conceptual approach.

Derivative is a product whose value is derived from the value of one or more basic
variables, called underlying. The underlying asset can be equity, index, foreign
exchange (forex), commodity or any other asset. 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.
The financial derivatives came into spotlight in 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.

FUTURE
Overview

Derivatives have made the international and financial headlines in the past for mostly
with their association with spectacular losses or institutional collapses. But market
players have traded derivatives successfully for centuries and the daily international
turnover in derivatives trading runs into billions of dollars.
Are derivative instruments that can only be traded by experienced, specialist traders?
Although it is true that complicated mathematical models are used for pricing some
derivatives, the basic concepts and principles underpinning derivatives and their
trading are quite easy to grasp and understand. Indeed, derivatives are used
increasingly by market players ranging from governments, corporate treasurers,
dealers and brokers and individual investors.

Indian scenario

While forward contracts and exchange traded in futures has grown by leaps and
bound, Indian stock markets have been largely slow to these global changes.
However, in the last few years, there has been substantial improvement in the
functioning of the securities market. Requirements of adequate capitalization for
market intermediaries, margining and establishment of clearing corporations have
reduced market and credit risks. However, there were inadequate advanced risk
management tools. And after the ICE (Information, Communication, Entertainment)
meltdown the market regulator felt that in order to deepen and strengthen the cash
market trading of derivatives like futures and options was imperative.

Trading strategies in future Market

Speculation

We have seen earlier that trading in index futures helps in taking a view of the market,
hedging, speculation and arbitrage. In this module we will see one can trade in index
futures and use forward contracts in each of these instances.

Taking a view of the market

Have you ever felt that the market would go down on a particular day and feared that
your portfolio value would erode?

There are two options available:

Option 1: Sell liquid stocks such as Tata Steel, Reliance, L&T, SBI etc.

Option 2: Sell the entire index portfolio as Nifty, Bank Nifty etc.
The problem in both the above cases is that it would be very cumbersome and costly
to sell all the stocks in the index. And in the process one could be vulnerable to
company specific risk. So what is the option? The best thing to do is to sell index
futures i.e. NIFTY.

Hedging

Stock index futures contracts offer investors, portfolio managers, mutual funds etc.
several ways to control risk. The total risk is measured by the variance or standard
deviation of its return distribution. A common measure of a stock market risk is the
stock’s Beta*. The Beta of stocks is available on the www.nseindia.com.

* Beta: The Beta factor measures how volatile a stock is when compared with an index. The higher the beta, the more volatile
the stock is. (A negative beta means that the stock moves inversely to the market so when the index rises the stock goes down
and vice versa).

While hedging the cash position one needs to determine the number of futures
contracts to be entered to reduce the risk to the minimum. Have you ever felt that a
stock was intrinsically undervalued? That the profits and the quality of the company
made it worth a lot more as compared with what the market thinks? Have you ever
been a ‘stock-picker’ and carefully purchased a stock based on a sense that it was
worth more than the market price?

A person who feels like this takes a long position on the cash market. When doing
this, he faces two kinds of risks:

1. His understanding can be wrong, and the company is really not worth more than the
market price or

2. The entire market moves against him and generates losses even though the
underlying idea was correct.

Everyone has to remember that every buy position on a stock is simultaneously a buy
position on Nifty. A long position is not a focused play on the valuation of a stock. It
carries a long Nifty position along with it, as incidental baggage i.e. a part long position
of Nifty.
Arbitrage

An arbitrageur is basically risk averse. He enters into those contracts were he can
earn risk less profits. When markets are imperfect, buying in one market and
simultaneously selling in other market gives risk less profit. Arbitrageurs are always in
the look out for such imperfections.

In the futures market one can take advantages of arbitrage opportunities by buying
from lower priced market and selling at the higher priced market. In index futures
arbitrage is possible between the spot market and the futures market (NSE has
provided special software for buying all 50 Nifty stocks in the spot market.

• Take the case of the NSE Nifty.

• Assume that Nifty is at 4600 and 3 month’s Nifty futures is at 4800.
• The futures price of Nifty futures can be worked out by taking the interest cost
of 3 months into account.
• If there is a difference then arbitrage opportunity exists.

Options
Stock markets by their nature are very fickle. While fortunes can be made in a
moment, why not invest in derivatives. Investing in stocks has two sides to it – a)
Unlimited profit potential from any upside (remember Infosys, Maruti, SBI, MMTC etc.)
or b) a downside which could make you a pauper (almost every buying on 21000
SENSEX level).

Derivative products are structured precisely for this reason -- to curtail the risk
exposure of an investor. Index futures and stock options are instruments that enable
you to hedge your portfolio or open positions in the market. Option contracts allow you
to run your profits while restricting your downside risk or loss.

Apart from risk containment, options can be used for speculation and hedging and
investors can create a wide range of potential profit scenes. Here we will try and
understand some basic concepts of options.
What are options?

Some people remain puzzled by options. The truth is that most people have been
using options for some time, because options are built into everything from mortgages
to insurance. An option is a contract, which gives the buyer the right, but not the
obligation to buy or sell shares of the underlying security at a specific price on or
before a specific date. ‘Option’, as the word suggests, is a choice given to the investor
to either honour the contract; or if he chooses not to walk away from the contract.

To begin, there are two kinds of options: Call Options and Put Options.

A Call Option is an option to buy a stock at a specific price on or before a certain date.
In this way, Call options are like security deposits. Call options usually increase in
value as the value of the underlying instrument rises. When you buy a Call option, the
price you pay for it, called the option premium, secures your right to buy that certain
stock at a specified price called the strike price. If you decide not to use the option to
buy the stock, and you are not obligated to, your only cost is the option premium.

Put Options are options to sell a stock at a specific price on or before a certain date. In
this way, Put options are like insurance policies. When you buy put option gains in
value as the value of the underlying instrument decreases. With a Put Option, you can
"insure" a stock by fixing a selling price. If something happens which causes the stock
price to fall, and thus, "damages" your asset, you can exercise your option and sell it
at its "insured" price level. If the price of your stock goes up, and there is no "damage,"
then you do not need to use the insurance, and, once again, your only cost is the
premium. This is the primary function of listed options, to allow investors ways to
manage risk.

Technically, an option is a contract between two parties. The buyer receives a

privilege for which he pays a premium. The seller accepts an obligation for which he
receives a fee.

We will discuss further into the mechanics of call/put options in subsequent lessons.

Pricing of options:
Options are used as risk management tools and the valuation or pricing of the
instruments is a careful balance of market factors.

There are four major factors affecting the Option premium:

• Price of Underlying
• Time to Expiry
• Exercise Price Time to Maturity (Strike Price)
• Volatility of the Underlying

And two less important factors:

• Short-Term Interest Rates

• Dividends

Review of Options Pricing Factors

The Intrinsic Value of an Option

The intrinsic value of an option is defined as the amount by which an option is in-the-
money or the immediate exercise value of the option when the underlying position is
marked-to-market.

For a call option: Intrinsic Value = Spot Price - Strike Price

For a put option: Intrinsic Value = Strike Price - Spot Price

The intrinsic value of an option must be positive or zero. It cannot be negative. For a
call option, the strike price must be less than the price of the underlying asset for the
call to have an intrinsic value greater than 0. For a put option, the strike price must be
greater than the underlying asset price for it to have intrinsic value.

Price of underlying

The premium is affected by the price movements in the underlying instrument.

For Call options – the right to buy the underlying at a fixed strike price – as the
underlying price rises so does its premium. As the underlying price falls so does the
cost of the option premium.

For Put options – the right to sell the underlying at a fixed strike price – as the
underlying price rises, the premium falls; as the underlying price falls the premium cost
rises.

The Time Value of an Option

Generally, the longer the time remaining until an option’s expiration, the higher its
premium will be. This is because the longer an option’s lifetime, greater is the
possibility that the underlying share price might move so as to make the option in-the-
money. All other factors affecting an option’s price remaining the same, the time value
portion of an option’s premium will decrease (or decay) with the passage of time.

Note: This time decay increases rapidly in the last several weeks of an option’s life.
When an option expires in-the-money, it is generally worth only its intrinsic value.

Volatility

Volatility is the tendency of the underlying security’s market price to fluctuate either up
or down. It reflects a price change’s magnitude; it does not imply a bias toward price
movement in one direction or the other. Thus, it is a major factor in determining an
option’s premium. The higher the volatility of the underlying stock, the higher the
premium because there is a greater possibility that the option will move in-the-money.
Generally, as the volatility of an under-lying stock increases, the premiums of both
calls and puts overlying that stock increase, and vice versa.

Higher volatility=Higher premium

Lower volatility = Lower premium

Interest rates

In general interest rates have the least influence on options and equate approximately
to the cost of carry of a futures contract. If the size of the options contract is very large,
then this factor may take on some importance. All other factors being equal as interest
rates rise, premium costs fall and vice versa. The relationship can be thought of as an
opportunity cost. In order to buy an option, the buyer must either borrow funds or use
funds on deposit. Either way the buyer incurs an interest rate cost. If interest rates are
rising, then the opportunity cost of buying options increases and to compensate the
buyer premium costs fall. Why should the buyer be compensated? Because the option
writer receiving the premium can place the funds on deposit and receive more interest
than was previously anticipated. The situation is reversed when interest rates fall –
premiums rise. This time it is the writer who needs to be compensated.

Key Regulations for Derivative markets

In India we have two premier exchanges The National Stock Exchange of India (NSE)
and The Bombay Stock Exchange (BSE) which offer options trading on stock indices
as well as individual securities. Options on stock indices are European in kind and
settled only on the last of expiration of the underlying. NSE offers index options trading
on the NSE Fifty index called the Nifty. While BSE offers index options on the
country’s widely used index Sensex, which consists of 30 stocks.

Options on individual securities are American. The number of stock options contracts
to be traded on the exchanges will be based on the list of securities as specified by
Securities and Exchange Board of India (SEBI). Additions/deletions in the list of
securities eligible on which options contracts is made available by NSE time to time.

Underlying: Underlying for the options on individual securities contracts shall be the
underlying security available for trading in the capital market segment of the
exchange.

Security descriptor: The security descriptor for the options on individual securities
shall be:

• Market type - N
• Instrument type - OPTSTK
• Instrument type - OPTINDEX
• Underlying - Underlying security
• Expiry date - Date of contract expiry
• Strike Price - Exercise Price
• Option type - CA/PA
• Exercise style - American Premium
 • Settlement method: Premium Settled
• CA - Call American
• PA - Put American.

Trading cycle: The contract cycle and availability of strike prices for options contracts
on individual securities shall be as follows:

Options on individual securities contracts will have a maximum of three-month trading

cycle. New contracts will be introduced on the trading day following the expiry of the
near month contract.

On expiry of the near month contract, new contract shall be introduced at new strike
prices for both call and put options, on the trading day following the expiry of the near
month contract.

Strike price intervals: The exchange shall provide a minimum of five strike prices for
every option type (i.e. call & put) during the trading month. There shall be two
contracts in-the-money (ITM), two contracts out-of-the-money (OTM) and one contract
at-the-money (ATM). The strike price interval for options on individual securities is
given in the accompanying table.

New contracts with new strike prices for existing expiration date will be introduced for
trading on the next working day based on the previous day's underlying close values
and as and when required. In order to fix on the at-the-money strike price for options
on individual securities contracts the closing underlying value shall be rounded off to
the nearest multiplier of the strike price interval. The in-the-money strike price and the
out-of-the-money strike price shall be based on the at-the-money strike price interval.

Expiry day: Options contracts on individual securities as well as index options shall
expire on the last Thursday of the expiry month. If the last Thursday is a trading
holiday, the contracts shall expire on the previous trading day.

Order type: Regular lot order, stop loss order, immediate or cancel, good till day,
good till cancelled good till date and spread order. Good till cancelled (GTC) orders
shall be cancelled at the end of the period of 7 calendar days from the date of entering
an order.

Permitted lot size: The value of the option contracts on individual securities shall not
be less than Rs 2 lakhs at the time of its introduction. The permitted lot size for the
options contracts on individual securities shall be in multiples of 100 and fractions if
any shall be rounded off to the next higher multiple of 100.

Price steps: The price steps in respect of all options contracts admitted to dealings on
the exchange shall be Re 0.05.
Quantity freeze: Orders which may come to the exchange as a quantity freeze shall
be the lesser of the following: 1 per cent of the market wide position limit stipulated of
options on individual securities or Notional value of the contract of around Rs. 5 crore.
In respect of such orders, which have come under quantity freeze, the member shall
be required to confirm to the exchange that there is no inadvertent error in the order
entry and that the order is genuine. On such confirmation, the exchange at its
discretion may approve such order subject to availability of turnover/exposure limits,
etc.

Base price: Base price of the options contracts on introduction of new contracts shall
be the theoretical value of the options contract arrived at based on Black-Scholes
model of calculation of options premiums. The base price of the contracts on
subsequent trading days will be the daily close price of the options contracts. However
in such of those contracts where orders could not be placed because of application of
price ranges, the bases prices may be modified at the discretion of the exchange and
intimated to the members.

Price ranges: There will be no day minimum/maximum price ranges applicable for the
options contract. The operating ranges and day minimum/maximum ranges for options
contract shall be kept at 99 per cent of the base price. In view of this the members will
not be able to place orders at prices which are beyond 99 per cent of the base price.
The base prices for option contracts may be modified, at the discretion of the
exchange, based on the request received from trading members as mentioned above.

Exposure limits: Gross open positions of a member at any point of time shall not
exceed the exposure limit as detailed hereunder:

• Index Options: Exposure Limit shall be 33.33 times the liquid net worth.
• Option contracts on individual Securities: Exposure Limit shall be 20 times the
liquid net worth.

Member wise position limit: When the open position of a Clearing Member, Trading
Member or Custodial Participant exceeds 15 per cent of the total open interest of the
market or Rs 100 crore, whichever is higher, in all the option contracts on the same
underlying, at any time, including during trading hours.

For option contracts on individual securities, open interest shall be equivalent to the
open positions multiplied by the notional value. Notional Value shall be the previous
day's closing price of the underlying security or such other price as may be specified
from time to time.

Market wide position limits: Market wide position limits for option contracts on
individual securities shall be lower of:

20 times the average number of shares traded daily, during the previous calendar
month, in the relevant underlying security in the underlying segment of the relevant
exchange or, 10 per cent of the number of shares held by non-promoters in the
relevant underlying security i.e. 10 per cent of the free float in terms of the number of
shares of a company.

The relevant authority shall specify the market wide position limits once every month,
on the expiration day of the near month contract, which shall be applicable till the
expiry of the subsequent month contract.

Exercise settlement: Exercise type shall be American and final settlement in respect
of options on individual securities contracts shall be cash settled for an initial period of
6 months and as per the provisions of National Securities Clearing Corporation Ltd
(NSCCL) as may be stipulated from time to time.

What Are Futures? Under standing a Non-Mathematical Approach

Future trading is different from investing in the stock market or bonds since you don’t
actually own anything. In futures trading, you are speculating on the future direction of
the price in the commodity you are trading. This is different for beginners in futures
trading; it is like a bet on the future price direction. The terms "buy" and "sell" merely
indicate the direction you expect future prices will take. He or she must only deposit
sufficient capital (Margin) with a brokerage firm to insure that he will be able to pay the
losses if his trades lose money.

Future trading is a sort of insurance plan for those who are trading and investing. A
farmer may sell futures on his wheat crop if he thinks the price will go down before the
harvest; conversely, a bread manufacturer may buy futures if they think the price of
wheat is going to rise before the harvest. Regardless of the price movement, both are
guaranteed their price. The final component of the equation is the investor in futures
trading who looks for changes in the futures markets and seeks to gain advantages by
buying or selling at a profit.

What Is The Potential of Futures Trading?

Trading futures has the potential to be an incredible profit maker. While the results are
truly extraordinary, not everyone can expect the level of successful trading be
achieved, there is good news for every investor; you can make money in futures
trading. You may only be a beginner trading futures, but you are savvy enough to
recognize the potential in futures trading.

What Are Futures Markets?

The beginner in futures trading needs to understand that futures are not trading on the
stock market only. Some of the better known futures markets are:

• Agriculture – This is a broad, commonly traded future which includes such

things as wheat, soybean and corn futures.
 • Currency Trading – Currency trading, also known as FOREX (foreign
exchange) trading, involves buying and selling currency from many different
countries such as the US dollar, the British pound and the Japanese yen.

• Interest Rate Futures – This market focuses on financial transactions, interest

rates and bonds.

• Energy Futures – This market centers its attention on gas and oil futures.

• Foods – This sector includes items such as coffee, sugar and orange juice.

• Metals – This is one of the more popular and better known sectors. The typical
commodities in metals are gold and silver.

What Do You Need To Do To Get Started?

There are several things you need to do as a beginner in futures trading:

• Start Learning – There is no substitute for education. Read books about futures
trading, talk with others that trade futures for information about futures trading.
Once you start investing your own money, you will be glad to understand
futures trading.

• Create a Trading Plan – This is crucial. You need to outline your goals and
objectives as well as your strategies in an unemotional manner. This way,
when greed and fear interferes with your decision making process, you will
have already decided your course of action.

• Select a Broker – This is a personal, but important part of the process. You can
implement your own trades but you need someone to actually place the orders.
Some full-service brokers offer more services and most Internet brokers offer
lower commissions. Even though you’re a beginner in futures trading, define
what you want from your broker and find someone who meets your needs.

• Use Japanese Candlesticks – This powerful commodity trading and charting

system will help not only the beginner in futures trading but is valuable to the
 “expert” as well. Candlesticks will help you to find the trends in the market that
most others miss.

A future trading for beginners is nothing more than learning, defining your processes
and sticking to your trading plan. This journey is no longer a thousand miles for you;
you’ve already taken the first step so keep moving toward you goal!

Paper Trading Futures - Getting Your Thoughts Down on Paper

Do you love just throwing away money? No, not one of your favorite things? Well,
most people feel the same way so jumping into something like futures trading is pretty
scary. The good news is that you can learn by throwing away some virtual money and
not the real stuff with something called paper trading futures. Paper trading futures is
an easy, free way to simulate futures trading without the financial risk.

What You Might Notice?

If you put the cart before the horse and try to implement positions before you
understand futures trading, you will be in for a surprise. The language of futures
trading is different; there is terminology you need to learn, strategies that you won’t
understand and even the trading software will probably be confusing. So, before you
try to begin commodities trading, go to an experienced broker and learn the terms,
learn the techniques and learn the software where you are trading futures.

Is Paper Trading Futures Important?

Paper trading futures is not important; it is merely a simulation of the things required to
trade futures in the real world. But you must practice before you really trade futures,
because this is a risky job without learning. This is a skill and the consequence is
losing your money so don’t take paper trading futures lightly.

Conclusion

It is difficult to find another business opportunity where you can practice and learn for
free. Take advantage of this unique opportunity and start paper trading futures today.
Don’t take this as game, learn terminology and trading strategy.
Futures Trading - Balancing Risk and Reward

There is a paradox in futures trading; “get-rich” trading usually leads to poverty. While
it is true there are many people that do get rich in futures trading, the norm is to lose.
Because most investors don’t do the things necessary to be successful, they find
failure is the only other alternative. This is a practice that requires training, experience
and plenty of technical analysis.

The Risks of Futures Trading

While futures trading can be very risky, the rewards can be very nice as well. Futures
trading have a bad reputation as being filled with risk and, while there is risk; there is
return too. The truth is that futures trading are only as risky as a trader makes it. This
is not the lottery or a trip to the casino; if you take a conservative approach, look for a
reasonable return and make this a business, then the probability of success in
commodity trading is very good.

Is Substantial Risk Inevitable in Futures Trading?

Minimizing risk in futures trading is easy; instead of taking delivery or making delivery,
the speculator merely offsets his position at some time before the date set for future
delivery. If price has moved in the right direction, he will profit. If not, he will lose.
Greed and fear are the enemies of futures trading and the cause of most big losses.

Futures trading are not for everyone; it possesses risks that are limitless to an un-
informed, undisciplined investor. With solid trading rules and an understanding of the
markets and techniques required, futures trading can be a very rewarding endeavor.

Futures Markets

When formulating a trading plan for futures, it is important to think about the futures
markets where you trade. There are a number of futures markets with adequate
liquidity for speculation, but when choosing a market it is important to choose based
on your account size, level of risk and investment philosophy. Above all it is important
to be diversified; each market has its big move every year. Being diversified, helps
increase your chances of catch those big moves that make for successful trading.

Other Factors in Choosing Markets

Another key to choosing your futures markets is history. Futures markets that have
more big trending moves are more likely to have them in the future as well. The
following represents some of the best trending futures markets: currency future, stock
future or commodity future.

Now you have a short list of commodities that have a history of trending well. The next
step is to solidify your trading rules or your trading plan.

These rules should include:

1. Reviewing – This is a critical part of the process. You wouldn't drive a car
without knowing the difference between accelerator and break pedal the same
principle is true with your trading plan.
2. Strict Guidelines – Your trading plan must be specific and precise. Having a
tested, reliable trading plan we give you something solid when you hit a losing
period.
3. Testing – Thanks to the computer age, you can successfully test your trading
plan. Without this ability, your trading plan is left to chance. Does it work or fail?
Testing will give you the confidence you need to be a successful trader.

The final step is to go live with your new wisdom. You've identified your target
markets, formulated, reviewed and tested your trading plan; now is the time to put
your hard work to use. The futures markets have something in common with the stock
market; a well informed, patient investor is more likely to succeed than someone just
stabbing in the dark.

Is there anything else you can do to increase your chances of success in the futures
markets? Yes, there is. Implementing a trading system like Japanese Candlesticks
adds a powerful charting system, especially in the futures markets. Candlesticks were
invented over 300 years ago as a method for trading in the rice markets of ancient
Japan. The success of the system has grown and developed and it is an amazing tool
for today's futures markets. With the candlestick charting abilities you will gain you
could literally have a view inside the directions of futures before they even move.
Added to your trading plan, Candlesticks can put you in the right company for
successful trading in the futures markets.

Learning to Trade Futures

It has been said that success in this life is made up of equal parts of learning and
yearning. For nearly everyone, it's possible to accomplish your goals if you have
sufficient desire and education. If your desire is to trade futures, you already have a
direction; next, you need to couple a relentless pursuit of education with a strong
desire to succeed at something very interesting and potentially rewarding. Commodity
trading can be complex and frustrating but it is also well worth the effort.

Necessary Traits to Trade Futures

What are the four things necessary to trade futures? They are:

1. You Need to Have the Desire to Succeed As a Trader – There is a certain art that
is needed to trade futures…part student, part bulldog, part daredevil. Desire to
succeed will push you to learn more and trade futures smarter.
2. Persistence and Motivation – This is a by-product of your desire. Once you have
the desire to succeed, you will be willing to put in the time to learn to trade
futures and the motivation to make your new business a success.
3. Discipline, Discipline, Discipline – Discipline to learn the nuances of how to
trade futures, discipline to do technical analysis, discipline to book profits and
the discipline to make smart futures trades. If you trade futures like it is a
business you will acquire the discipline to be successful.
4. Someone to Help You Get Started – Whether you learn from someone you know,
from going to seminars, or reading books, you will need some help when you
start to trade futures. It is important to learn the terminology, techniques and
practices that make a successful trader and that knowledge is best passed
down from person to person.
What is a Futures Trading Plan?

A futures trading plan is similar to a stock trading plan; both represent your set of
“terms and conditions” for making trades. By establishing your futures trading plan
before you enter the market, you can establish rules void of the emotions that will grab
you in the heat of the moment. Why is this important? Whether things are going well or
poorly, there is a tendency for people to react emotionally. Emotions are a great thing
normally, but a poor guide when you are making major money decisions with your
investments. Some things you might want to include in your futures trading plan are:

• A Beginning Amount to Start – This is important not only from an investment

prospective but from a personal one as well. It is important to understand that
there is a direct relationship between the amount of capital invested and the
probability of successful trading. Professional recommends starting your
investing with a minimum of Rs.50,000; starting with less may leave you
vulnerable to greater risk since you can’t apply proper risk management
principles. Starting with less than this will put you at a disadvantage but you can
overcome it with a conservative approach.

• Counting the Cost – Your initial investment shouldn’t only be considered the
amount you are willing to invest but the amount you are able to lose. This is the
reason it is called “risk capital”. Risk capital is defined as money you can afford
to lose without affecting your standard of living. It should also be money that
you feel comfortable risking. Think of your F&O account as an investment in a
business. Many businesses fail; that's life. If you aren’t afraid of losing your
money you are more likely to make correct trading decisions.

• Being in the Trenches – Every investor needs to map out a strategy in their
futures trading plan for the actual buying and selling decisions. Some people
are very disciplined and able to remember the general principles of defensive
investing while others need a plan for every scenario possible. Be honest with
 yourself and evaluate your tendencies. This is not some indictment on your
character; this is your only opportunity to protect you investment, so be
thorough and honest. So this is always better to start with NIFTY with a proper
and proportional hedging by options.

• Stop Loss Plans – No one wants to think about what they do if they lose;
everyone wants to win every time but in a futures trading plan. This becomes
part of a stop loss strategy. There are defensive techniques for not only
recognizing when to get out of a buy but also how you should do it. Without
solid charting and analysis, it is impossible to determine whether a downtrend is
temporary or devastating.

• Technical analysis – This is the backbone of any futures trading plan. Through
charting and research, an investor has the best view of which direction a
commodity is heading and why. Committing to a trading system like
Candlesticks is invaluable to accomplishing your technical analysis due to its
powerful charting principles.

Principles to Live By

There are four central precepts for every futures trading plan; these principles should
be written at the top of your futures trading plan and posted next to your table. These
principles are:

1. Trade with the trend

2. Cut losses short
3. Let profits run
4. Manage risk

These rules outline everything that is important in a futures trading plan and
everything else that you include must recognize these for principles. By establishing
your futures trading plan you are able to learn the ideas of successful and profitable
investing in the futures markets.

Defining Futures Orders

Futures orders have a simple definition but a wide variety of possibilities. Not unlike
options trading in the stock market, futures orders cover a number of different trading
scenarios.

1. Market Orders – This is the most basic of futures orders. It is the same for
either buying or selling; once the order reaches the trading port, it is executed
for the best price available.

2. Limit Orders – A limit order is a futures order used for buying or selling when a
certain price is reached. A limit order to buy is placed below the current market
price and a limit order to sell is placed above the current market price. When
the target price is reached, a market order is executed to buy or sell based on
the limit order.

3. Stop Orders – Stop orders are used in futures markets as protective

techniques for either buying or selling. Three purposes of stop orders are:

a. Reducing losses on long or short positions

b. Opening new long or short positions
c. Protecting a profit on an existing long or short position

A buy stop order is placed above the market and a sell stop order is implemented
below the market.

4. Market If Touched – This futures order is the direct opposite of a stop order.
Sell Market If Touched orders are only executed if the price is above the market
while but buy Market If Touched orders are only executed if the target price is
below the market when implemented. An MIT order is usually used to enter the
market or initiate a trade. In commodities trading, an MIT order is similar to a
limit order in that a specific price is placed on the order. However, an MIT order
becomes a market order once the limit price is touched or passed through. An
execution may be at, above, or below the originally specified price. An MIT
order will not be executed if the market fails to touch the MIT specified price.
 5. Stop Limit Order - A stop limit order is a futures order that lists two prices and
is an attempt to gain more control over the price at which your stop is filled. The
first part of the order is written like a regular stop order. The second part of the
order specifies a limit price. This indicates that once your stop is triggered, you
do not wish to be filled beyond the limit price. Stop limit orders should usually
not be used in commodity trading when trying to exit a position.

6. Market On Opening – This is a futures order that is to be executed within the

opening range of trading.

7. Market On Close – This is the opposite of a Market on Opening. This futures

order is given to execute a trade in the closing seconds at the best available
price.

8. Fill Or Kill - Fill Or Kills are futures orders used by customers wishing an
immediate fill, but at a specified price. A floor broker will likely bid the order two
or three times and immediately return either a fill or an unable.
9. Spread – An investor is likely to use a Spread to take advantage of the
differences in two prices. For this futures order, a long and short position will
both be taken hoping to exploit the difference in price. For example, buy 15
October Corn Futures, sell 15 November Corn Futures plus 2 to the November
sell side. This spread order means to sell the spread when the November corn
is 2 points higher than the October corn.

Conclusion
In addition to these futures orders, there are additional orders that some but not all
markets recognize. It is important to discuss your futures orders with your broker so
that you are aware of the available orders. If you are trading oil futures your broker
can tell you whether you can implement Spreads or if Fill or Kill is unavailable in your
particular market. Knowing the terms involved with futures orders will help you to be a
more successful trader in the futures market.

Futures Analysis - Reading the Future with technical analysis

The name is definitely appropriate; futures analysis rests on being able predict future
movements with a reasonable level of accuracy. For many people, bar charts are their
tool of choice; it is familiar for sure but it leaves its users without valuable futures
analysis information. When reading a commodity trading chart, the Japanese
Candlestick signals provide users with a big advantage because they offer more
information and predict trends that bar chart simply can’t.

The history of Japanese Candlesticks

Japanese Candlestick signals were invented around 1700 as a method of futures

analysis and developed over the past few hundred years while trading rice. The
Japanese Rice traders analyzed reoccurring signals on their commodity trading chart
when trying to pinpoint the exact times to get in and get out of rice trading. Futures
analysis with these signals made the Japanese traders immensely wealthy. The
signals they identified are as effective today in futures analysis as they were centuries
ago.

Why Candlesticks are so powerful

Candlestick signals are the only trading system for futures analysis that considers
human emotion. Emotions will always be the same; whether you are analyzing a stock
trading chart or a commodity trading chart the same factors that have moved prices for
centuries will still be in effect today. This is not any new; the human psyche is very
predictable when it comes to investment decisions. Candlestick charts give a visual
representation of the investor’s sentiment to futures analysis.

For futures analysis, a commodity trading chart will show a distinct advantage over a
stock trading chart. The trends in a commodity trading chart will be more consistent,
lasting for longer periods of time. The outside influences on a commodity are
dramatically less than those found in a stock price. That can be used to an investor's
advantage when using futures analysis for a commodity trading chart.

You will find through futures analysis that most commodities have fewer elements to
affect the supply and demand than do stocks. Grains and some of the soft
commodities might have weather affect supply; in the currency trading, different
currencies may be affected by each other. The British pound, the Eurodollar and the
Swiss franc will usually trade the opposite direction of the US dollar.

The ability to analyze a commodity trading chart very quickly with Candlestick signals
produces a huge advantage for being able to analyze what the equity markets would
do. Crude Oil prices, the US dollar, Gold or any other commodity that could be
affecting the direction of the equity markets can be seen and analyzed very efficiently
using Candlestick signals.

In futures analysis, it is important to avoid reacting on emotions. This is the reason for
having trading rules, a trading plan and following the signals you find with
Candlesticks. Futures analysis with Japanese Candlesticks is a highly developed
means of looking into the future.

Options
Options, the ultimate high risk investment vehicle. So it is thought by the vast
majority. Why options are considered high risk? Simple, most investors lose money in
options. Statistics show that over 80% of all option trades lose money.

Why is this so? Perhaps they expect money by luck, do not imply techniques. First, as
with all investments, but especially with options, the direction of price movement has
to be correctly analyzed and the Strike Price too. This procedure alone is a major
hurdle for the vast majority of investors. Next, the magnitude of the price move has to
be correctly calculated; another procedure that has not been perfected by the average
investor. On top of all that, add being correct rather tune to the time element, the
unaccounted aspect of most option analysis.

A premium is built into the option price. This premium reflects the speculative fervor of
the market participants who think prices will move in their direction. The highly
leveraged method of participating in the move creates a parasitic premium that is
added to the true value of the option.
How do candlesticks turn un-advantageous probabilities into advantageous option
trading profits? The essential factors of the signals can be applied to align the
elements of successful option trades; signals, stochastics, market direction, etc. A few
simple processes can be employed that will exploit the same factors that make other
option investors lose money to put money into your pocket.

Assure Direction: As you study candlestick signals, you will discover the
improvement in accuracy will be quite noticeable. Under certain circumstances, the
"accuracy" probability becomes extremely high. When all the essential indicators line
up for a successful option trade, the signal showing strong buying in a stock, the
stochastics below the 20 line, further confirmed by a bounce off a trend-line, and
overall market direction, etc., an option trade can be executed. As in all the equations
for producing a profit in an option trade, direction is the first consideration. Obviously,
a clear and decisive signal is the reason for considering the trade in the first place.
Knowledge of the reversal signals creates a huge advantage for exploiting short-term
market moves. Especially profitable is the ability to pinpoint absolute bottom signals.
Not only is there the benefit of purchasing an option at the ultimate lowest price. Along
with direction, the potential magnitude of the move has to be determined.

Calculate Magnitude - Analysis of a stock trade incorporates the potential magnitude

of the price move. This involves analyzing where the next resistance/support might
occur. Speed and magnitude of the previous move that is reversing is one factor. A
congestion level above the reversal area is another. Trend lines and Fibonnacci
retracement levels are more considerations. But most importantly, the signal itself will
dictate how strong the move could be. A major reversal signal, compounded with a
gap up, will substantiate a much stronger advance than a secondary signal. The
status of the stochastics should indicate how long the upside move can potentially be
maintained. The analysis of the upside is going to dictate the ultimate trade strategy.
And this has to incorporate the final element; time.

Time - The weakest area of analysis for most option traders is the evaluation of time
constraints. This is the area that human weakness is most likely to be involved. The
direction and the magnitude not only have to be correct, they have to be correct in the
proper time frame. For every day the option trade is in existence, time is working
against the profits. Time also becomes a major determinant in the type of option trade.
Three weeks remaining before expiration will have a different trade strategy than one
week remaining. A two-month option will have different strategies than a two-week
option. The length of time to expiration dictates how to position the option trade.

Emotion is the major culprit causing option investors to lose money in 80% of option
trades. Most "call" option buyers purchase the call due to some reason they think that
will make the stock go up big. For example, let’s say the time frame is two weeks
before expiration date. After the commitment of funds to the trade, the price does
move up. Unfortunately, it does not move in the magnitude or speed to offset the
diminishing premium built into the option price. Being correct in the direction of the
move feeds the ego. The trade was correct. But if the magnitude of the price move
was not great enough to offset the cost of the option premium, an emotional dilemma
is created. Should the trade be liquidated or will the price move further, significantly
more than its norm, between now and the remaining time to expiration? Gone is the
original trade expectation and in comes "hope" for a positive resolution to the option
trade.

Utilizing candlestick analysis emphasizes the discipline of placing as many

controllable probabilities in your favor before a trade is established. Utilizing the steps
for putting on a successful stock trade becomes all that much more critical when
putting on an option trade. Each step needs to be scrutinized. Especially the final step,
watching how a stock price will open. If the other steps have been followed, analyzing
market direction, evaluating the sector chart, identifying a strong candlestick reversal
signal, and seeing the stochastics in the proper area, then the final evaluation
becomes an important element of the whole process - how is the stock price opening?
The reason this step is vitally important is due to the time constraint on the option
trade.

Implementing candlestick analysis into option trading greatly enhances the ability to
make huge profits. Having the advantage of projecting direction makes option
strategies simple. Identifying a candlestick "buy" or "sell" signal at the end of a trend
allows the option trader to exploit option strategies that best extract consistent profits
from the market, profits that take advantage of the 80% loss statistic. When other
option traders are trading on less precise technical analysis, candlestick option traders
can be executing trades precisely when the signals reveal the change in sentiment.
Having the knowledge of spreads, straddles, and premium diminishing, expands the
probabilities of creating the right option strategy for the right time and magnitude
potential. The candlestick signals act as a guide for the active option trader. Learn the
candlestick signals and the ability to extract huge option trade profits becomes a
common practice.

Candlestick option trading programs have been developed to make "high" risk trading
into a very low risk procedure. You can learn how to maximize the potential of an
option move using different trading strategies. Having the foresight of direction the
candlestick signals provide, the analysis of time and magnitude becomes simplified.
The leverage of options produces inordinate profit potential.

Options trading strategies With Candlestick Signals

1.) Bullish Options Trading Strategies

• Buying Calls
• Selling Puts
• Bull Call Spread
• Bull Put Spread

2.) Bearish Options Trading Strategies

• Buying Puts
• Selling Calls
• Bear Call Spread
• Bear Put Spread
• Put Hedge

3.) Special Candlestick Breakout Options Trading Strategies

• Buy Strangle
 • Buy Straddle

4.) Neutral Options Trading Strategies

• Selling Covered Calls

• Sell Straddle
• Sell Strangle
• Calendar Spread

1.) Buying Calls - Bullish Options Trading Strategy

Buying a Call is a decidedly bullish position on an underlying stock value. The investor
has the opportunity to participate in the rise of the stock’s value for the term of the
contract with a predetermined risk. Most investors will look to sell their contract at a
profit, while others may intend to exercise their right and purchase the underlying
shares.

To exit a call you have three options. You may let the call expire worthless (lose the
premium paid for the option). You may exercise the call at the agreed upon strike
price, and turn around and sell the stock at the current market price and profit from the
difference. You may sell your call when it rises in premium in tandem in the rise in the
under lying stock value.

The main benefit of buying a call is the limited risk of capital. The investor has a much
smaller cash layout, with a limited downside loss, and unlimited upside gain. On the
flip-side, the option investor does not have the same rights of the individual
shareholder such as dividends and voting rights.

In theory, the potential profit on a long call is unlimited as long as the underlying value
continues to rise. The potential loss is limited to the premium paid for the contract.
Buying Calls is a long call strategy that is best used in a bullish market where a rise in
the price of the underlying stock is anticipated. By electing to purchase a long call
option instead of the under lying stock, you increase your leverage and reduce the
inherent risk of the trade. The most you can lose on your purchase is the cost of the
premium. Buying Calls can be a great way to increase your participation in certain
stocks without tying up a log of funds. Options allow you to control a larger number of
shares for less capital.

A very precise and concise definition for Buying Calls is. Buying an equity call gives
the owner the right, but not the obligation, to buy number of shares of underlying stock
at a specified price (the strike price) at any time before a specific time (the expiration
date). This is a bullish strategy because the value of the call tends to increase as the
price of the underlying stock rises, and this gain will increasingly reflect a rise in the
value of the underlying stock when the market price moves above the option's strike
price.

The profit potential for the long call is unlimited as the underlying stock continues to
rise. The financial risk is limited to the total premium paid for the option, no matter how
low the underlying stock declines in price. The break-even point is an underlying stock
price equal to the call's strike price plus the premium paid for the contract. As with any
long option, an increase in volatility has a positive financial effect on the long call
strategy while decreasing volatility has a negative effect. Time decay has a negative
effect.

Selling Puts - Bullish Options Trading Strategy

Selling a put is very similar to a covered call, only with a slightly different perspective.
When you write a covered call you are speculating that the stock will go up or stay the
same. With a covered call, you must own the stock, so your risk is losing money to a
falling stock. In order to make money with a covered call, you need for the stock to go
up, or even sideways. Learning the technique of selling puts is a valuable step in
becoming a successful trader.

Selling a put, however, does not require you to own the stock in advance. This is the
beauty of playing the stock market by selling puts. You can sell puts on margin;
although it is necessary to research the margin requirements carefully. For put selling,
margin requirements vary from broker to broker. When you sell puts, the "premium"
collected for the trade is deposited into your account on the day your trade is entered
into.
There are a number of different reasons why you might want to sell a put on a stock.
As mentioned earlier, with a covered call, it is necessary for the stock to go up or
sideways to realize a profit. When selling a put, it is possible to make money investing
in stock several different ways, including when the stock is going down.

These ways are:

1. If the stock goes up, your put expires and you earn the premium.

2. If the stock stays flat, your put would also expire, leaving you to earn the
premium.

3. If the stock drops less than the difference of the selling price and the put, you
would again earn the premium.

4. If the stock shows a weakness that you consider temporary, you can “buy back
with a roll out”. This means that you buy back your option, and then sell the put
for the next month. This essentially buys you extra time for your stock to move
positively. The entire process would move out one month and the same
parameters. This is a key benefit in being able to perform stock technical
analysis.

5. Finally, you can use margin able stocks in your portfolio to sell puts on
additional stock which you can purchase below the current market price.

Once again, while there are a number of ways to earn money selling puts, and two
primary ways to lose money. First, if you hold a weak stock past its strike price and
sell, you actually create a situation where you lose on your investment. Second, is that
someone will “put” the stock to you at the put price. If your stock drops below the put
price, minus premium, and someone puts the stock to you, you will lose money. This
can be avoided with a “buy back with a roll out” or a simple buy back on your
option. As you might expect, a sound investor takes care to close positions before
being put to minimize the risk.

Bull Call Spread - Bullish Options Trading Strategy

A “bull call spread” is the term for one of several stock option trading strategies. The
bull call spread occurs when a modest (small) increase in the price of the asset is
expected. It is achieved by purchasing call options at a specific strike price while also
selling the same number of calls of the same asset and expiration date but at a higher
strike. The maximum profit in this strategy is the difference between the strike prices
of the long and short options, less the net cost of options. Most of the time, a bull call
spread is a vertical spread. This is actually covering of support & resistance levels.

The bottom line of a bull call spread is that the investor is able to buy a stock at a
lower price and in turn, sell at a higher price, thereby making a profit. In such a case,
the stocks belong to the same company, but have different strike prices. This allows
the wise investor to realize a profit by leveraging the varied strike prices against actual
price of the stock.

For this example of a bull call spread, assume that a stock is trading at Rs. 30 and an
investor has purchased one call option with a strike price of Rs. 33 and sold one call
option with a strike price of Rs. 38. If the price of the stock jumps up to Rs. 45, the
investor must provide a number (as in lot) of shares to the buyer of the short call at
Rs. 38. This is where the purchased call option allows the trader to buy the shares at
Rs. 33 and sell them for Rs. 38, rather than buying the shares at the market price of
Rs. 45 and selling them for a loss. A bull call spread is used by successful traders to
create a profit when a loss seems inevitable.

There are several factors to consider when utilizing a bull call spread. It is imperative
to follow a well-designed stock trading plan and avoid the emotions of greed and
fear. While this is a profitable technique, the bull call spread involves strike and call
prices, as well as the typical monitoring of stock prices to be familiar with their
movements. The easiest way to create a bull spread is to use a call option at, or near,
the current market price. When buying the lower priced call and selling a higher priced
one, a bull call spread has been created.

A modest gain is always better than the most thrilling loss.

Bull Put Spread - Bullish Options Trading Strategy

A Bull Put Spread is one of the moderately complex stock option trading strategies
and its purpose is to profit from stock that is either stalled or rising. It was conceived to
find income generating options trades that are bullish and have limited downside risks.
Because of its limited risk, a Bull Put Spread is even safe. In order to identify a stock
for a Bull Put Spread, it is necessary to perform some solid stock market technical
analysis. Once you find a stock that is range-bound or able to rise, you need to make
a trade on the options that will expire in one month or less. At that point, you should
buy lower strike puts that are Rs. 5 below the higher strike price. Then sell the same
number of higher strike puts that expire on the same date. (Note – both puts should
have strike prices that are LOWER than the current stock price.) Your goal in such a
strategy should be to earn a 12% net credit from the trade. For example, if the
difference, or spread, between the two strike prices is Rs. 10/-, you want to realize a
net credit of at least Rs. 1.20 for the trade. If the stock remains steady or moves
higher, the profit you earn is the net credit amount. Your risk is the difference between
the strike prices minus the net credit for the complete trade. A Bull Put Spread, as
mentioned before, is relatively safe and has the potential for a nice return. Remember
that there will be a net credit that will modify the bottom line of the completed
trade. Because you have bought strikes above and below the current stock price, any
movement upward works to your benefit.

2.) Buying Puts - Bearish Options Trading Strategy

Buying puts is a bearish, somewhat speculative technique in which the investor

anticipates that a stock will decrease in price during a set period of time. The trader
realizes a profit when the stock and its underlying put option decrease in price during
a set amount of time. The profit potential in such a deal is limited because a stock
price can never go below zero. Also known by the term “buying in-the-money puts”,
this technique is speculative; if the price of the stock remains steady or rises during
the option period, it is possible for the trader to lose the initial investment. This
risk reward ratios, however, are limited to the amount paid for the premium on the put
option.

The technique of buying puts is dependent on timing and charting a stock’s movement
to catch a downward price movement. Accurate charting of a stock and technical
analysis of its performance and direction are critical when buying puts. There are a
variety of events that can move the price of a stock down as desired, such as poor
earnings reports, buyout or acquisition of the company, and new product introduction
are among the events that can shape the views of investors and impact the stock
market. This strategy of buying puts can also put more money in the pockets
of successful traders.

The downside of this technique tends to be the possibility of an error of judgment. If an

investor decides to buy puts on a stock without properly researching its position or
charting its movement, it is possible that stock will be bullish or changing from bearish
to bullish. In essence, if a stock reached its bottom or is rising, the trader has moved
at the wrong time and is in danger of losing the premium for the trade.

Buying puts is actually an alternative to selling short on a stock. While being similar to
buying calls, the advantage of buying puts over selling short lies in the ability to
leverage the transaction and make your trading more successful. Since the puts can
be purchased on the margin, it is possible to control a much larger number of shares,
thereby increasing the profit potential on the purchase. Downward movements in
stock prices and their underlying put options create much larger returns than by simply
selling short even on less investment.

The price of a premium for buying puts is affected by two variables. First, the time
period involved for the option is a determining factor in price. The longer the time
between purchase and expiration dates, the higher the price. Second, the movement
of the underlying stock affects the price of the premium, especially in relation to the
stock’s strike price. A stock that has been in a bearish trend will have a higher
premium than a stock in a bullish trend. This is a stock market basic that can be
successful even for a beginner investing in the stock market.

Selling Calls - Bearish Options Trading Strategy

When an investor is feeling bearish on the market, another good stock option trading
strategy to employ is Selling Calls or Selling Bear Calls. This method is also known by
the name Vertical Bear Calls. This is considered a bearish strategy because the trader
profits if the underlying stock decreases in value. Basically, the strategy is to buy out-
of-the-money call options and sell in-the-money call options on the same stock with
the same expiration date. The plan is that the in-the-money stock closes lower than its
strike price at its expiration date, and then the trader realizes maximum profits
from selling calls.