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Option Basics


What is Options?

There are mainly two types of options in Derivatives Market. Call Option and Put Option. Call Options give us right to Purchase the underlying while Put Options give us right to sell.

What is Risk?

Risk means futuristic negative outcome of any action. Suppose I have bought one Nifty Future that means I am having the risk of loss if market falls down. We can use callPut Options to hedge this risk. But one should understand the fundamentals of Options Trading strategies before implementing those hedgingstrategies.

Futures:

Future means a Forward Contract + Standard Underlying + trading through exchange.

Derivatives:

Derivatives are the products which are not having their own value. Value of Derivatives can be derived from the value of Underlying. That means price of derivative changes when underlying price changes. Forward Contracts, Futures Contracts, Options and Swaps are few examples of Derivatives.

What is Risk Management?

Risk Management is a process where first we identify the different type of Risks and then we try to take some steps to hedge those risks by either adding or restricting more actions. For E.g. we have sold call and Put Options and are having one shortgamma position. Now we are having the risk of unlimited loss during either side movement. So either we can buy Out of the Moneyoptions or can restrict the trade to avoid these type of options selling trades. Both the actions are part of risk management.

Call Put:

Both call and Put Options are having perfect relationship with each other. PutCall Parity strategy shows the relationship between both the options.

Put Option:

Put Options means right to Sell. For e.g. Mr. X has bought USD 55 Dec 2013 Put Option at Rs.2. That means now Mr. X is having the Rights to sell USD any time before Dec 2013 at Rs.55 and he has paid Rs.2 Premium for this Right. We should note that here Mr. X has got Right to sell but not having any obligation that means if he wants he can sell but no one can force Mr. X to sell USD at Rs.55.

Call Option and Put Option Delta:

delta of Call Options always remain Positive while Put Optiondelta always remain negative.

Options Trading Strategies:

There are lot of strategies which can be made by using options. Bull Call Spread, Bull Put Spread, Bear Call Spread, Bear Put Spread, Straddle, Strangle, Strip, Strap, Butterfly, Condor, Box Spread etc. are few names of options Trading Strategies

Options and Futures:

The basic difference between options and Futures is that Future is having linear Pay off while options are having Nonlinear Payoff Profile.

Stock Options:

National Stock Exchange has launched two type of options. 1. Index Option & 2. Stock Option. options which are having underlying as any Index are called Index options. Nifty options are example of Index options while options which are having underlying as Equity are called Stock options. Reliance options are example of Stock options. Generally Stock options are having more Implied volatility compare to Index options.

Option Price:

options Price can be derived by considering following 5 factors. Spot Price, Strike Price, Time to Maturity, volatility & Risk Free Rate of Interest. Generally people use Black Scholes Formula for Option Pricing as it is easy to understand.

Derivatives in India:

SEBI has approved NSE and BSE to start Derivative exchange in May 2000 and trading on derivatives Contracts had started in June 2000. NSE has launched S&P CNX Nifty Futures and BSE has launched BSE 30 Sensex Future in June 2000. options Trading commenced in June 2001.

Why to understand Options?

Unlike Futures and Equities, options are having nonlinear Pay off Graphs. You can have limited losses and unlimited gains profile and vice versa with the help of puts. So we can make lot of Combinations with the help of options. We just need to understand the depth behavior of options. options are a great hedging tool. We can hedge the risk of our business by using them. We just need to pay premium when we buy options but those bought options give us the surety that if market moves in our favor, we will make unlimited profit and we will lose only premium if our view goes wrong. As we get lot of different strike prices in same underlying and same expiry, we can make many strategies like Bull Call Spread, Bear Call Spread, Bull Put Spread, Bear Put Spread, Straddle, Strangle, Ratio Spread, Butterfly, Condor, Calendar, Strip, Strap etc.





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