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Other Knowledge

Market wide Position limit:

Market wide Position limit is a total number of shares which can be open at a time for that scrip. It includes Call, Put and Future quantity of all the months which are available for trading.

Span Margin Software:

SPAN - Standard Portfolio Analysis Software calculates the margin required on any position in Derivatives segment. It calculates the margin on 3 Sigma basis which gives the accuracy at 99% Value at Risk.

Currency Options:

Now we can trade in currency Options also. As of now we are allowed to trade in USD INR Options. Currency Options can become very good hedging tool for importers and exporters who carry exposure in Currency.

Why Options Strategy can generate good Returns:

There are many reasons why Options can generate good Returns
1. It carry Time value + Intrinsic Value. So People can manage the Greeks and can earn Time Value.
2. It carry Limited loss profile strategies which can give unlimited returns with less Risk.
3. We get 5 years Options in Nifty, so people who have long term view on market can also play easily. Though we are not getting huge liquidity in long term options as of now.
4. We have high fluctuation in Volatility Skew in two strikes of same underlying, which generates good opportunities for Volatility Spread Strategy.
5. Risk and return profile of Options strategies can be adjusted as per the suitability of Investor. People can choose lowest risk to highest risk strategies in Options.
6. It is a leveraged product, so it can make huge returns on low investment.

Benefits of Delta Neutral Spread:

Delta shows you your view on Portfolio. If you are DeltaLong, that means you will make money when market rises and will lose money when market falls down and vice versa. Now if we don’t have any view on market and we don’t want to play on bullish or bearish spread then Delta neutral strategies can generate very good returns for us. Delta neutral strategies don’t have any view in market.

As Options premium gets change with respect to change in many variables so it becomes very difficult to handle all the Greeks simultaneously. So if we keep Delta neutral then we can focus on other Greeks easily.

Pros and Cons of Delta Neutral Strategies

Delta provides the change in premium of Options with respect to change in Spot Price. It is the first line Greek of Spot Price. It shows the impact on your profit and loss with respect to change in Spot Price. So if your portfolio Delta in neutral that means neither you are bullish in market nor you are bearish. So you will not make money when market will go up and will not lose money when market will fall down and vice versa.

The main benefit of Delta neutral Strategy is that people can focus on their view on Volatility and Time. As profit and loss will not be hampered by change in Spot so they don’t have to focus on movement of Spot as their portfolio Delta is neutral.

Problem with DeltaNeutral strategies are it require continuous involvement of trader to manage Delta and also incurs more transaction cost. Secondly you cannot use DeltaNeutralStrategies if you have any view on Spot Price. So suppose you feel that market is looking bullish today then you cannot use this strategy as it will not provide you any profit on bullish movement.

Now if you are running GammaLong Portfolio then process of doing Delta neutral continuously will make profit in your account as Gamma long portfolio makes Delta in your favour on either side of movement of Spot Price. Which means that when Spot rises, you naturally would like to be Delta long so Gamma will change your Delta from 0 to positive figure and Gamma will change your Delta from 0 to negative when Spot price falls down.

As against above, Delta neutral process will incur losses when Portfolio Gamma is Negative. As Negative Gamma will make you Delta long when Spot falls down and will make you DeltaShort when Spot price rises.

Pros and Cons of Gamma Neutral Strategies

Gamma provides us the change in Delta with respect to one rupee change in Spot Price of Underlying. Gamma is the second line Greek of Spot Price. Gamma neutral Strategies will force Portfolio Delta to remain constant even if Spot price moves either side.

Positive Gamma and Negative Gamma normally changes the value of Delta, so if you are running any Delta neutral strategy and if your Gamma is very high then it will force you to control the Delta continuously. As against this, if your Gamma is neutral and then your Delta will not move.

It is very important to understand that you cannot make Gamma neutral strategies just by buying Options or just by writing Options. You always need to make a combination of bought and sold Options for making Gamma neutral strategies. Gamma neutral strategies normally have less risk compare to high GammaStrategies.

The main problem in Gamma neutral strategies is that it becomes very difficult to earn Time Value as when you start making Gamma Neutral Strategies it automatically becomes Theta neutral Strategies. Similarly you cannot take view on Volatility also.

Pros and Cons of Theta Long Strategies

Theta provides change in Option Premium with respect to change in Time. Theta is the first line Greek of Time. The value of Theta always comes in negative so when you buy Options, you will become negative portfolio Theta and similarly when you sell Options, your portfolio Theta will become positive or long.

The main focus of Theta long strategies is to earn time value. As we know that Options carry very high time value and it reduces as the time reaches near to maturity. So people normally sell Options so that they can earn that time value.

The main problem in Theta long Strategies is that it incurs losses when market moves one sided significantly as Theta long Strategies are having GammaShort profile. It also requires to keep DeltaNeutral continuously as if your Delta is out then it can incur losses when market moves against your view.

Theta long Strategy is a very rewarding strategy if we can control the Gamma and Delta continuously and also it requires to take a bet on Volatility as increase in volatility can also generate risk in Theta long strategies.

Pros and Cons of Vega Neutral Strategies

Vega shows change in Option Premium with respect to change in Volatility. Currently movement in Volatility is much higher compare to movement in Spot Price. Many times we buy a Call when we are having bullish view and then we find that Spot price increases while CallOptions decreases. This is just because of Volatility. As Volatility falls down, premium of Call and PutOptions falls down. So it is very important to handle the Volatility while trading OptionsStrategies.

VegaNeutralStrategies are having neutral effect of change in Volatility. So when our focus is either on Time or on Spot Price and we don’t want any involvement of Volatility on our strategies, we should try to make VegaNeutralStrategies.

The main benefit of VegaNeutralStrategies is that it doesn’t change the payoff profile of strategy with respect to change in Volatility. We can make VegaNeutralStrategies only by making the combination of bought and sold Options. So they automatically become Gamma neutral or very near to Gamma neutral trade which indirectly means that those combinations are having very low risk profile.

The main problem with VegaNeutralStrategies is that even after initiating Vega neutral Strategies, you may incur losses when Volatility moves. It may happen when complete Vol skew doesn’t move one sided rather Volatility of Options you have sold rises and Volatility of Options you have bought falls may incur heavy losses of Volatility movement.

Pros and Cons of Options Strategies

The main object of introduction of OptionsStrategies was to provide some hedging tools against the risk of uncertainty. So Options can be used as good hedging tools. As Options are having many strike prices and different maturities and different types like Call and Put, we can make n number of combinations by using different Options.

Normally, in Equities or in Futures, we are having only two view i.e. Bullish or Bearish. But here we can take many other views like slightly volatile, highly volatile, range bound, bullish up to X level and bearish up to Y level etc.

OptionsStrategies provide us the benefit of leverage. We can initiate good exposure with less margin. We can initiate lot of Strategies with limited loss and unlimited profit profile. So we can decide our maximum risk profile and can execute the suitable strategy.

Options also carry large Time Value. So we can trade some strategies which provide us good opportunities to earn that time value. But before executing these strategies, we should understand the risk factor of each strategy so that we can check the suitability of strategy as per our risk return profile.

The best point of Options strategy is that it can be done for any type of risk taker. That means if someone wants to take risk of Rs. 200 only, then also he can make some strategies and if you want to take risk in millions then also you can get some options strategies. Normally, return profile is directly related with the risk associated, but in Options, you can make good return profile with less risk association, just by finding out best combination of Options. As every Option is having some unique risk return profile so different combination of these options can create extraordinary risk return profile.

The main problem with OptionsStrategies is that it is slightly difficult to grasp behavior of Options and OptionsStrategies. So one need to devote some time to understand the complete concept of Options. But it can make real miracle after understanding the complete concept.

Open Interest:

Open Interest means total Open Position which has not been squared off. Open Interest shows us the interest of investors towards market. SEBI has restricted Brokers and Investors to take position in same stock after certain level to remove the probability of any unfair activities in market.

How Open Interest is useful for taking view in market:

What is open interest: Open interest is the number of contracts outstanding at any point in time on an exchange.

How to take directional view of scrip using Open Interest:

Rule: OI increase supports the trend, OI decrease indicates reversal of trend.

It is normally observed that a rise in price with a rise in open interest, increases the probability of rise in scrip and vice versa. Further, an increase in price and fall in open interest indicates a drying bull run and a decrease in price and fall in open interest indicates a drying bear run. Following table can be used for reference:


Logic: In financial market loss averaging is a killing strategy. When people average in losses, market is very probable to take them into more losses and it is highly probable that they are going to exit at the highest possible losses. Remember that financial market trend cycle normally seen everywhere. It looks like as follows:

Price Decision by average investor
5000 Best price to buy (looks very cheap)
4800 It has become cheaper, Lets average
4900 Saw what I said, Price will certainly come to 5500
4600 Market is acting stupid, I am not afraid, Average more
4200 Panic, not sure what to do
4000 Oh, I feel I was cheated by my advisor, price is likely to touch 3600. I will exit and reenter at 3600
3950 Yes, I am far more smarter than market
4100 This time I am going to stick to my view. I am sure it will go to 3600
4300 I think as soon as it comes to 4000 will reenter
  And so on…

If you look at this general phenomena, OI was increasing at 4800 and 4600 and the price was falling. Hence the trend was continuing. At 4000, price was reducing but OI was decreasing (Investors cutting position). This suggested end of bear run. Similar is the case with bull run as well.

How to take directional view of scrip using Open Interest in Calls and Put options:

Now, say you have a scrip which has reasonable liquidity in Options. Given that, OI in options can also help taking view in that scrip.

1. View for expiry

Rule:Strike at which there is highest open interest in puts, in say before 10 days to expiry, it is very less probable that scrip will go below that level. Similarly strike at which there is highest open interest in Calls, it is very less probable that scrip will rise above that level. For e.g. Expiry is on 31st January 2013, then let’s say you observe open interest on 21st January 2013 as follows:

Calls Strikes Puts
609550 5500 4659100
416850 5600 3364200
804500 5700 4706000
1143050 5800 5180850
2953000 5900 4140500
5468600 6000 2502050
4143850 6100 601900
4177650 6200 508250
2842500 6300 495650

Highest OI in calls is at 6000 (5468600) & Highest OI In puts is at 5800 (5180850). This OI distribution suggests that it is very less probable that market will rise above 6000 and it very less probable that market will go below 5800 in the given expiry i.e. by 31st January 2013.

Logic: OI in Options is normally looked at in terms of who has taken short position, as they are the one who are taking unlimited risk and are very high probable of taking sensible positions in the market. Given that, if short in calls is highest on 6000, that means conviction in market is that it is less probable that it will cross that level. Similar is the case in puts.

2. View for Intraday as well as next day beginning:

Rule: If net increase in put is more than net increase in Call with a reasonable amount, on any given day, then it is quiet probable that market will be positive intraday as well as next day beginning and vice versa. For e.g. Say, on any given day Change in Open interest is looking as follows:

Change in Calls Calls Strikes Puts Change in Puts
6400 609550 5500 4659100 61350
1100 416850 5600 3364200 81900
11700 804500 5700 4706000 279750
10800 1143050 5800 5180850 500500
229000 2953000 5900 4140500 405750
666400 5468600 6000 2502050 165800
651850 4143850 6100 601900 9200
553100 4177650 6200 508250 18150
74200 2842500 6300 495650 900
2204550       1523300

Now, total change in calls 2204550 and total change in puts is 1523300. So net change over Put to Call is -681250. Max OI in calls and puts is 5468600 (OI of 6000 Call). So, if this change in any direction is greater than 5.5Lac (10% of Max OI). In current scenario it is more than 5.5 lac and hence we can safely take a view that market is quiet probable to fall intraday as well as next day beginning.

Logic: Again the importance is of Options seller view. The option sellers have more conviction in selling calls then puts in intraday and hence the view that market is quiet probable to go down.

Implied Volatility Vs. Realised Volatility

Volatility: It is the measure of probable range of any scrip over a period of time. For e.g. If a scrip is trading at Rs. 100 with a volatility of 20% per annum, its expected range across one year is 120 to 80.

Historical/ Realised Volatility: It is the actual range of scrip over a period which has actually completed. Say for e.g. the price for one scrip is 115 and in the beginning of one year it was trading at 100 then its actual volatility is 15% per annum. Realised volatility is calculated on a daily basis and then is annualized for full year.

Implied Volatility: It is the volatility used by option trader to get the value of Options. It may vary from trader to trader and hence is generally calculated on the basis of Last traded price of Options and last traded price of corresponding future. For e.g. If price of 100 Call is trading at Rs. 2, when maturity is 15 days and Future is trading at Rs. 100, then the implied volatility of this option is 24.73%

Estimated Volatility: It is the traders’ fair estimate of volatility in a scrip over a period of time.

Why are these concepts so important in options trading?

Options trading is all about pricing the option. Now, for any given point in time, all other factors affecting option price viz strike price, spot, days to maturity and interest remains constant, and only factor that changes option price is volatility. So as far as option trading goes, it is very much important that the option trader could fairly estimate the Options volatility. If he can do so, he can always check the option price on the anvil of his volatility estimate and determine, whether to buy the option or sell the option.

This fight between a correct estimate and final outcome is in the core of understanding estimated volatility, implied volatility and realized volatility. As could be clearly understood, the only thing that can be worked upon by a trader is his estimate of volatility, because implied volatility is given by the market which he cannot change. He can trade on the basis of his estimate of volatility but by no means can change the implied volatility of market. On the other hand, Realised volatility is history and hence not tradable.

There are numerous studies on estimating volatility of which Garch model (and its variant) are one of the most prominent methods of estimate.