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Derivatives Academy

Dear Customer,

Thank you for enrolling for the ICICIdirect Derivatives Education series.

Derivatives as a term, conjures up visions of complex numeric calculations and speculative dealings. It comes across as an instrument, which is the prerogative of a few ‘smart finance professionals’.

In reality it is not so.

To understand derivatives better and to trade in the same, we are coming up with series of Lessons on Derivatives. The same will be sent to you every Wednesday for the next 12 Weeks.

In our first lesson we will look at the following:

1) An overview on Derivatives

2) What is a Futures contract?

A simple example of derivative is curd. Curd is a derivative of milk. The price of the curd depends on the price of the milk, which in turn depends upon the demand and supply of milk.

Derivative in short does not have a value by itself but it derives its value from an underlying. In the above example the underlying is milk and the derivative is curd.

Lets take a simple example to understand what a forward contract means.

Shyam wants to buy a TV, which costs Rs 10,000 but he has no cash to buy it outright. He can only buy it 3 months hence. He, however, fears that prices of televisions will rise 3 months from now. So in order to protect himself from the rise in prices Shyam enters into a contract with the TV dealer that 3 months from now he will buy the TV for Rs 10,000. What Shyam is doing is that he is locking the current price of a TV for a forward contract. The forward contract is settled at maturity. The dealer will deliver the asset to Shyam at the end of three months and Shyam in turn will pay cash equivalent to the TV price on delivery.

The above is an example of a forward contract.

Forward contracts, which have the following features, are termed as Futures:

• Traded in an Exchange

• Standardized in terms of quality and quantity

In our next mail we will be discussing more about Futures: Contracts available, pricing, Settlements etc.

Regards

Customer Service

ICICIdirect.com

Dear Customer,

In our last lesson we have seen the basics of Derivatives. In this session we will be discussing:

1) What are the different contracts available?

2) Margins and settlements

In India we have stock futures on 55 stocks and index futures contracts based on S&P CNX Nifty, CNX IT and the BSE Sensex available for trading. The contracts for 3 months duration are available at all times (Near Month, Middle month and Far month). Each contract expires on the last Thursday of the expiry month and simultaneously a new contract is introduced for trading after expiry of a contract.

Example:

Futures contracts in Satyam Computers in December 2003

Contract Month	Expiry/ Settlement
December 2003	December 24, 2003
January 2004	January 29, 2004
February 2004	February 26, 2004

On December 25, 2003

Contract Month	Expiry/ Settlement
January 2004	January 29, 2004
February 2004	February 26, 2004
March 2004	March 25, 2004

The minimum lot size differs from scrip to scrip and is approximately marked to Rs. 2,00,000 contract value.

Let us take an example of a trade that you can place in Derivatives. Say the SATCOM FUTURES expiring on December 24, 2003 is trading at 350. Let us say that you wish to buy this futures contract at this price on December 19, 2003.

What would be the margin requirements for placing this derivatives order?

Depending on the volatility of the underlying share, the margin will vary. To check the stock wise current margins applicable, please visit the Stock List on the Derivatives trading pages on ICICIdirect.com

The different margins collected for trading are:

Initial Margin: The margin blocked for at the first stage while the futures order is placed

Minimum Margin: The minimum margin required to any point to continue the position after considering losses if any.

Suppose that the price at the end of the day for this futures contract is 370, and if you wish to profit from the price raise, what can you do?

You can close your open positions: To close your position you are required to take an opposite position in the same underlying in the same month.

E.g. To close a buy SATYAM contract of December 24, 2003 expiry, you have to sell SATYAM contract of December 24, 2003 expiry only.

You can close your open position on any date till the expiry date of the contract.

In case the contract is open till the last day, the contract is automatically closed and difference has to be paid/received.

How does the settlement for this trade happen at the exchange?

The settlement for any trade in derivatives is done through a process called Mark to Market (MTM).

MTM (Mark to Market)

The MTM (Mark to Market) for the Futures position will happen on everyday basis

E.g. You have bought SATYAM contract of DECEMBER 24, 2003 expiry at 350. The closing price of the contract today is say Rs 355.

The difference of Rs. 5 (355 - 350) will be credited to your account on T+1 days.

The next day the closing price goes down to 340. The difference of Rs. 10 (350 - 340) will be recovered from your account on T+1 days.

This process of daily MTM will continue till the day the position is open.

The settlement price on the expiry date would be the Closing market price of the underlying share.

Regards

ICICIdirect

Customer Service

Dear Customer,

How are futures prices determined?

Pricing of Futures:

Pricing of futures can be explained by the formula

F (Futures Price) = S (Spot/Cash market Price) + C (Cost to Carry)

Cost to Carry:

To understand "cost to carry" we will take a simple example:

Mr. A wants to buy shares of company Y. The shares are worth 200. However Mr. A does not have the required funds to purchase the shares and hence opts for loan. Assuming Mr. A pays 1% interest per month on the loan.

The actual cost of the share for Mr. A now becomes Rs. 200 + 1% (Rs. 2) = 202

This Rs. 2 per share can be termed as the Cost to Carry or the interest cost.

As we near the expiry date of the contract the interest cost would reduce and on the expiry date the interest cost would be zero.

Therefore the Futures price = S (Spot/Cash market Price) on the expiry date.

In an ideal scenario you will observe that the every successive month contract is priced slightly higher than the earlier month contract.

E.g.

CONTRACT	PRICE
SATCOM (Spot Price)	353.20
SATCOM (Dec-2003 Contract)	353.75
SATCOM (Jan-2004 Contract)	357.25

In our next lesson we will discuss how we can trade in futures through ICICIdirect.com

Regards,

ICICIdirect.com

----------------------------------------------------------- reco. from pawan dilani----------------------------------------
(2005-09-05 10:21:19) pawan_dialani: BUY "Narmada Chematur Petrochemicals Ltd target 56 in 4 weeks
(2005-09-05 10:24:24) pawan_dialani: buy obc and pnb now for 5 days keep a sl of 10 rs get atleast 10% return sure call
(2005-09-05 10:24:41) pawan_dialani: Buy India Cement Sl 107 Tgt 130 CMP 112
(2005-09-05 10:27:19) pawan_dialani: pnb and obc futures hv started
---------------------------------------------------------end of pawan dilani's reco --------------------------------------------

Dear Customer,

In this lesson we will see how trading in futures can be done through ICICIdirect.com

Step 1 - Allocate Funds for Trading

As in equity the first step to trade is to allocate funds for trading in Futures and Options segment separately. Based on the funds allocated you will then get the limits to transact in the derivatives segment.

Step 2 - Know your margins

Select the Option "Know your margins". Enter the details of the position that you want to take and submit. This will give you the exact amount of limits that you need to have in Derivatives segment to place your order.

Step 3- Contract Details

Select the option "Place Order". In this select the stock code for which you want to place order. Select the segment as Futures. This will display the list of contracts for 3 months. You can then select the contract of your choice and click on the desired action "Buy/Sell/Get quote"

Step 4- Place Order

After you select the action (Buy/Sell) you will be taken to the Place order option. The minimum lot size will be automatically selected. You can change the same in multiples of the lot size.

You will be displayed the Contract selected and the minimum lot size for that underlying. You can trade in that lot size or in multiples thereof. After selecting Limit or Market, we have a choice of selecting the type of Order as

a) Day: Day orders are all orders, which would be valid only for that particular trading day.

b) GTD (Good till date): GTD orders are orders which if not executed on the same day would still be valid at the exchange level till the date specified by you. We can specify 7 calendar days at the most or the expiry period whichever is nearer.

c) IOC: IOC orders are Immediate or Cancel orders, which can be placed only during Market hours. Immediate or Cancel orders would go to the exchange and if the required quantity at the desired rate if available would be Executed or it will come back as cancelled the same moment.

Step 5 - Check the status of the order

After selecting the type of Order, you just go to click on "Submit". Like equity market, we can know the status of the order through the Order Book.

Once the order is executed, you can now view the current status in the "Open Position" screen. Here, you can view the contract details, position, quantity and the quantity related to unexecuted derivative orders. It would also display the LTP (Last traded price of that contract) as on that date and time. The Action screen would display the actions as:

a) Add Margin: In case your position is incurring losses, you are required to add sufficient margins so as to cover your losses.

b) Square off: This link would assist you in squaring off your open position.

Step 6 - Portfolio details

Portfolio details would display the realized/unrealized profits/losses on your existing or closed positions.

In our next lesson we would start with Basics of Options.

Regards

Customer Service

ICICIdirect.com


Dear Customer,

In this session we will discuss:

1) The Basics of Options

2) Types of Options

Stock markets by their very nature are fickle. While fortunes can be made in a jiffy more often than not the scenario is the reverse.

Investing in stocks has two sides to it

a) Unlimited profit potential from any upside or

b) Unlimited downside risk

Option contracts allow you to run your profits while restricting your downside risk.

Apart from risk containment, options can be used for speculation. Investors can create a wide range of potential profit scenarios.

Here we will try and understand some basic concepts of options.

What are options?

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.

Call Option

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.

If, for example, you wanted to rent a certain property, and left a security deposit for it, the money would be used to insure that you could, in fact, rent that property at the price agreed upon when you returned. If you never returned, you would give up your security deposit, but you would have no other liability. 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 Option

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

If you buy a new car, and then buy auto insurance on the car, you pay a premium and are, hence, protected if the asset is damaged in an accident. If this happens, you can use your policy to regain the insured value of the car. In this way, the put option gains in value as the value of the underlying instrument decreases. If all goes well and the insurance is not needed, the insurance company keeps your premium in return for taking on the risk.

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 dwelve further into the mechanics of call/put options in subsequent lessons.

Regards

Customer Service

ICICIdirect.com

Dear Customer,

In our fifth lesson, we had discussed the basics of Options. In this lesson we will discuss different types of options available, in further detail.

An Option is a contract between two parties, giving the buyer the right, but not the obligation to buy or sell shares at a predetermined price possibly on, or before a predetermined date.

To acquire this right the buyer pays a premium to the writer (seller) of the contract.

There are two types of options:

• Call Option
• Put Option

CALL OPTIONS

Call options give the buyer the right, but not the obligation, to buy the underlying shares at a predetermined price, on or before a predetermined date.

Illustration 1:

Raj purchases 1 call option contract of 1200 Satcom shares of 370 Strike price (expiring on January 29, 2004) by paying Rs. 17.50 as the premium. The price of Satyam in the Cash Market currently is Rs. 360.

This contract implies that Raj has bought the right of buying 1200 shares of Satcom any time on or before the expiry of the contract at 370.

Raj has bought this right by paying Rs. 17.50 as premium (1200*17.50 = 21,000). Whereas, the seller (Writer) has sold his right to Raj, by accepting the premium.

In case the price is favourable (i.e when Satcom scrip price in stock market is greater than Rs 370) to Raj, he will fulfill the contract and receive the profits, however if the price is unfavourable to Raj, he can choose and forego the premium amount paid.

In case of Call Option, the buyer will benefit if the price of the underlying goes up.

PUT OPTIONS

Put options give the buyer the right, but not the obligation, to sell the underlying shares at a predetermined price, on or before a predetermined date.

Illustration 2:

Sam purchases 1 put option contract of 100 Inftec shares of 5400 Strike price (expiring on January 29, 2004) by paying Rs. 230 as the premium. The price of Inftec in the Cash Market currently is Rs. 5425.

This contract implies that Sam has bought the right of selling 100 shares of Inftec any time on or before the expiry of the contract at 5400.

Sam has bought this right by paying Rs.230 as premium (100*230 = 23,000). Whereas, the seller (Writer) has sold his right to Raj, by accepting the premium.

In case the price is favourable (i.e when Inftec scrip price in stock market is lesser than 5400) to Sam, he will fulfill the contract and receive the profits, however if the price is unfavourable to Raj, he can choose and forego the premium amount paid.

In case of Put Option, the buyer will benefit if the price of the underlying goes down.

In our next session we will discuss the settlement of Option contracts and exercising of Options

Regards

Customer Service

ICICIdirect.com

DERIVATIVES EDUCATION SERIES - PREVIOUS MAILERS

Derivatives Education Series - 1

Derivatives Education Series - 2

Derivatives Education Series - 3

Derivatives Education Series - 4

Derivatives Education Series - 5

Dear Customer,

In our sixth session, we had discussed Call and Put options. In this session we will discuss the settlement of options and exercising of options.

In the Money Option (ITM): A Call Option is termed as ITM if the Strike price is less than the Cash Market Price and vice versa in case of a put option. This implies that you are buying a right to buy the underlying stock at a price, which is less than the current market price.

E.g. A strike price of 350 for Satcom when the spot market price is 360. The option of 350 is in the money by Rs.10. Since the intrinsic value of the option is Rs.10, the minimum premium value would at least be the premium. No one would like to sell a stock at a discount on the current market price.

Out of the Money Option (OTM): A Call Option is termed as OTM if the Strike price is more than the Cash Market Price and vice versa in case of a put option. This implies that you are buying a right to buy the underlying stock at a price, which is more than the current market price.

E.g. A strike price of 370 for Satcom when the spot market price is 360. The option of 370 is out of money by Rs.10. Since the underlying has to move Rs.10 for the option to make money, the premium for this option will be comparatively lesser than what you would pay for an ITM option.

At the Money Option (ATM): An option is termed as ATM if the strike price is same as the Cash Market price.

E.g. A strike price of 360 for Satcom when the spot market price is also 360.

At any point in time, the exchange has specified that 5 Strike prices each for Call and put options will be available for trading.

2 ITM (In the Money)

2 OTM (Out of the Money)

1 ATM (At the Money)

Each stock will have a different frequency of Strike prices. The same is specified by the exchange.

Raj purchases 1 call option contract of 1200 Satyam computers shares of 370 strike price (expiring on January 29, 2004) by paying Rs.15 as the premium. The price of Satyam in the cash market currently is Rs.365. The price of the underlying, has now moved up to Rs. 378. Due to this the premium for Rs. 370 call option, which was earlier Rs.15, will move up by Rs.11 and start quoting at Rs.26.

How does Raj book his Profits?

To close his position and book profit, Raj would be required to:

a) Take an opposite position i.e sell Call Option (expiring on January 29, 2004) of Rs. 370 strike price. Since he is selling a Call Option, he would receive the premium now. The difference in the premiums paid (Rs.15) and received (Rs.26) would be the profit. In this case Raj has made a profit of Rs.11 (26-15).

b) Exercise his option. In case an option is exercised Raj would get a difference between the Strike price and the Closing Price of the underlying on that day. In this case the same would be 378 - 370 = 08

However since Raj has already spent Rs.15 in premium, the net effect of this transaction would be a loss of Rs. 7.

In case of exercising the option, Raj is losing out on the premium, whereas by squaring off the position (i.e by taking a opposite position) Raj is earning a profit.

So why should Raj choose to exercise his option?

While it is advisable to close position by squaring off, sometimes the option becomes illiquid. In such a case you would be unable to transact and take an opposite position. In such cases to close your position, you would be required to exercise your position.

All the buy option positions will be automatically exercised if the same is in the money on the day of the expiry. All the ITM and OTM will expire worthless.

In our next session we will discuss about American and European options.

Regards

Customer Service

ICICIdirect.com

Dear Customer,

In our seventh session we had discussed the settlement of options and exercising of options. In this session we will discuss about American and European Options.

American Options

Option contracts which can be exercised on or before the expiry date are called "American Options"

All stock options are American Options. This is indicated by the alphabet " A " at the end of the contract viz: OPT-INFTEC-29-Jan-2004-5800-CA

E.g.

Raj buys a call option OPT-INFTEC-29-Jan-2004-5800-CA paying a premium of Rs 205/- per share. This is a stock option expiring on January 29, 2004.

Say, on 25th January 2004, the premium in the market for the same option is Rs 250/- at 2.30 p.m. and the spot price of the same is Rs 5845/- at the same time i.e. at 2.30 p.m.

Let us also assume that the closing price of the scrip at the end of the day is Rs 5850/-

The customer has two options to close his position.

a) The customer can square off the position at 2.30 p.m. Here he will receive a premium of Rs 250/- thereby making a profit of Rs 45/- ( 250- 205 ) on his trade. The square off has to be done during the market hours

OR

b) He can put in a request to exercise his option at 2.30 p.m. Here he will receive the difference between the closing price and his strike price i.e. 5850-5800 = Rs 50/- . The closing price is considered at the time of exercise and not the price at the time, at which the request is placed.

European Options

Options on Nifty are European Options- meaning that the buyer of these options can exercise his option only on the expiry day. He cannot exercise them before the expiry of the contract as is the case with stock options.

The buyer of European option can only square off his position to close the contract.

Alphabet " E " is displayed at the end of the contract description in case of European options viz: OPT-NIFTY-29-Jan-2004-1970-PE

E.g

Raj buys a put option OPT-NIFTY-29-Jan-2004-1970-PE paying a premium of Rs 45/- per share. This is a stock option expiring on January 29, 2004.

Say, on 20th January 2004, the premium in the market for the same option is Rs 60/- at 2.00 p.m. and the spot price of the same is Rs 1985/- at the same time i.e. 2.30 p.m.

Let us also assume that the closing price of the scrip is Rs 2000/-.

The only way for the customer to close his contract is to square off his position i.e the customer can just take advantage of the rise in premium and not the closing rate of NIFTY on that particular day.

The customer can square off the position at 2.30 p.m. Here he will receive a premium of Rs 60/- thereby making a profit of Rs 15/- ( 60-45 ) on his trade. The square off has to be done during the market hours

The customer can exercise this option only on January 29, 2004, which is the expiry date of the contract.

In our next session we will give guidelines to place an order in options.

Regards

Customer Service

ICICIdirect.com

Dear Customer,

In the eighth lesson we spoke on American and European options. In this lesson we will see how trading in Options can be done through ICICIdirect.com

Step 1 - Allocate Funds for Trading

As in equity the first step to trade is to allocate funds for trading in Futures and Options segment separately. Based on the funds allocated you will then get the limits to transact in the derivatives segment.

Step 2 - Know your margins

Buy position is Options carries the risk to the extent of the premium amount only, no margins are levied. However a sell position in Options will attract margins.

Step 3- Place Order

Select the option "Place Order". In this select the stock code for which you want to place order. Select the segment as Options. This will display another selection for Call/Put.

Select the required option type and enter. This will display a list of all the Options available.

You can then select the contract of your choice and click on the desired action "Buy/Sell/Get quote"

Step 4- Place Order

After you select the action (Buy/Sell) you will be taken to the Place order option. The minimum lot size will be automatically selected. You can change the same in multiples of the lot size.

You will be displayed the Contract selected and the minimum lot size for that underlying. You can trade in that lot size or in multiples thereof. After selecting Limit or Market, we have a choice of selecting the type of Order as

a) Day: Day orders are all orders, which would be valid only for that particular trading day.

b) GTD (Good till date): GTD orders are orders which if not executed on the same day would still be valid at the exchange level till the date specified by you. We can specify 7 calendar days at the most or the expiry period whichever is nearer.

c) IOC: IOC orders are Immediate or Cancel orders, which can be placed only during Market hours. Immediate or Cancel orders would go to the exchange and if the required quantity at the desired rate if available would be Executed or it will come back as cancelled the same moment.

Step 5 - Check the status of the order

After selecting the type of Order, you just go to click on "Submit". Like equity market, we can know the status of the order through the Order Book.

Once the order is executed, you can now view the current status in the "Open Position" screen. Here, you can view the contract details, position, quantity and the quantity related to unexecuted derivative orders. It would also display the LTP (Last traded price of that contract) as on that date and time. The Action screen would display the actions as:

a) Square off: This link would assist you in squaring off your open position.

b) Exercise: The other option to close the open positions is to exercise your option.

The status of the exercise request can be checked through the Exercise Book. ( Exercise option in case of a Nifty option is not available since it an European option. Refer to our previous mail for explanation on the same)

Step 6 - Portfolio details

Portfolio details would display the realized/unrealized profits/losses on your existing or closed positions.

In our next lesson we will speak more on strategies..

Regards

Customer Service

ICICIdirect.com

Dear Customer,

In the ninth lesson we spoke on how to trade in Options through ICICIdirect.com. In this lesson we will talk on Option strategies

There are times when you think the market is going to fall. However in the event that the market does not fall, you would like to limit your downside. One way you could do this is by entering into a spread. A spread trading strategy involves taking a position in two or more options of the same type, that is, two or more calls or two or more puts. A spread this is designed to profit if the prices to go down is called a bear spread.

Lets now talk on BEARISH CALL SPREAD Strategies

A vertical call spread is the simultaneous purchase and sale of identical call options but with different exercise prices.

To "buy a call spread" is to purchase a call with a lower exercise price and to write a call with a higher exercise price. The trader pays a net premium for the position.

To "sell a call spread" is the opposite: the trader buys a call with a higher exercise price and writes a call with a lower exercise price, receiving a net premium for the position.

To put on a bear call spread you sell the lower strike call and buy the higher strike call. An investor sells the lower strike and buys the higher strike of either calls or puts to put on a bear spread.

An investor with a bearish market outlook should: sell a call spread. The "Bear Call Spread" allows the investor to participate to a limited extent in a bear market, while at the same time limiting risk exposure.

The investor's profit potential is limited. When the market price falls to the lower exercise price, both out-of-the-money options will expire worthless. The maximum profit that the trader can realize is the net premium: The premium he receives for the call at the higher exercise price.

Here the investor's potential loss is limited. If the market rises, the options will offset one another. At any price greater than the high exercise price, the maximum loss will equal high exercise price minus low exercise price minus net premium.

The investor breaks even when the market price equals the lower exercise price plus the net premium. The strategy becomes profitable as the market price declines. Since the trader is receiving a net premium, the market price does not have to fall as low as the lower exercise price to breakeven.

An example of a bearish call spread.

Let us assume that the cash price of the scrip is Rs 100. You now buy a April call option on a scrip with a strike price of Rs 110 at a premium of Rs 5 and sell a call option with a strike price of Rs 90 at a premium of Rs 15.

In this spread you have to buy a higher strike price call option and sell a lower strike price option. As the low strike price option is more expensive than the higher strike price option, it is a net credit strategy. The final position is left with limited risk and limited profit. The maximum profit, maximum loss and breakeven point of this spread would be as follows:

Maximum profit = Net premium received

= 15 - 5 = 10

Maximum loss = Higher strike price option - Lower strike price option - Net premium received

= 110 - 90 - 10 = 10

Breakeven Price = Lower strike price + Net premium paid

= 90 + 10 = 100

Regards

Customer Service

ICICIdirect.com

Dear Customer,

In the tenth lesson we spoke on Bearish Call Spread strategy to be adopted in a falling market. In this lesson we will talk on Option strategies in a Volatile market.

Straddles in a Volatile Market Outlook

Volatile market trading strategies are appropriate when the trader believes the market will move but does not have an opinion on the direction of movement of the market. As long as there is significant movement upwards or downwards, these strategies offer profit opportunities. A trader need not be bullish or bearish. He must simply be of the opinion that the market is volatile.

• A straddle is the simultaneous purchase (or sale) of two identical options, one a call and the other a put.

• To "buy a straddle" is to purchase a call and a put with the same exercise price and expiration date.

• To "sell a straddle" is the opposite: the trader sells a call and a put with the same exercise price and expiration date.

A trader, viewing a market as volatile, should buy option straddles. A "straddle purchase" allows the trader to profit from either a bull market or from a bear market.

Here the investor's profit potential is unlimited. If the market is volatile, the trader can profit from an up- or downward movement by exercising the appropriate option while letting the other option expire worthless. (Bull market, exercise the call; bear market, the put.)

While the investor's potential loss is limited. If the price of the underlying asset remains stable instead of either rising or falling as the trader anticipated, the most he will lose is the premium he paid for the options.

In this case the trader has long two positions and thus, two breakeven points. One is for the call, which is exercise price plus the premiums paid, and the other for the put, which is exercise price minus the premiums paid.

Strangles in a Volatile Market Outlook

A strangle is similar to a straddle, except that the call and the put have different exercise prices. Usually, both the call and the put are out-of-the-money.

To "buy a strangle" is to purchase a call and a put with the same expiration date, but different exercise prices.

To "sell a strangle" is to write a call and a put with the same expiration date, but different exercise prices.

A trader, viewing a market as volatile, should buy strangles. A "strangle purchase" allows the trader to profit from either a bull or bear market. Because the options are typically out-of-the-money, the market must move to a greater degree than a straddle purchase to be profitable.

The trader's profit potential is unlimited. If the market is volatile, the trader can profit from an up- or downward movement by exercising the appropriate option, and letting the other expire worthless. (In a bull market, exercise the call; in a bear market, the put).

The investor's potential loss is limited. Should the price of the underlying remain stable, the most the trader would lose is the premium he paid for the options. Here the loss potential is also very minimal because, the more the options are out-of-the-money, the lesser the premiums.

Here the trader has two long positions and thus, two breakeven points. One for the call, which breakevens when the market price equal the high exercise price plus the premium paid, and for the put, when the market price equals the low exercise price minus the premium paid

Regards

Customer Service

ICICIdirect.com

Dear Customer,

In the eleventh lesson we spoke on Strategies in a Bullish Market. This lesson we will talk on General Do's and Dont's in Derivatives, Advantages of Futures and Options and General terms involved in Options

Do’s and Dont’s in Derivatives

ü Key to profit from options is to form a correct view first.

ü Construct a strategy around the view.

ü Opt for liquid stocks.

ü Book profits by squaring off your position instead of waiting for the expiry.

ü Option value decays towards the expiration. Hence market timing is important

ü In The Money contracts are more responsive to underlying price changes than Out of The Money contracts.

ü Better liquidity in At The Money contracts.

ü Avoid deep In The Money and deep Out of The Money strike prices. Such strike prices are generally illiquid

ü Keep sufficient allocated funds in Derivatives to cover any losses if you have a open position in Futures or Sell position in Options.

ü Learn to interpret Open Interest, Put Call Ratio and Cost to Carry

Advantages of Futures:

• Offers leverage.

• Contracts for stock indices available.

• Only a certain percentage of the trade value is blocked as margin. Futures traders are not required to borrow money in order to obtain leverage.

• Futures can be traded in both rising and falling markets.

• A position can be taken for a max of 3 months

• Higher profit potential due to higher leverage

• No delivery involved.

• Commission rates are lesser than if a similar leverage position is taken on delivery basis.

• Spread position can be taken to reduce risk. Spread position also attracts lesser

Advantages of Options:

• Offers leverage.

• Contracts for stock indices available.

• Buyer of an option can take a leveraged position by paying a small premium amount..

• A position can be taken for a max of 3 months

• Higher profit potential due to higher leverage

• No delivery involved.

• Commission rates are lesser than if a similar leverage position is taken on delivery basis.

Glossary

Derivative: An instrument, which derives its value from the value of an underlying instrument (such as shares, share price indices, fixed interest securities, commodities, currencies, etc.). Warrants and options are types of derivative.

Call option: An option contract that entitles the taker (buyer) to buy a fixed number of the underlying shares at a stated price on or before a fixed Expiry Day.

Put option: An option contract that entitles the taker (buyer) to sell a fixed number of underlying securities at a stated price on or before a fixed Expiry Day.

Premium: The amount payable by the taker to the writer for entering the option. It is determined through the trading process and represents current market value.

Underlying securities: The shares or other securities subject to purchase or sale upon exercise of the option.

In-the-money: An option with intrinsic value.

Out-of-the-money: A call option is out-of-the-money if the market price of the underlying securities is below the exercise price of the option; a put option is out-of-the-money if the market price of the underlying securities is above the exercise price of the options.

At-the-money: When the price of the underlying security equals the exercise price of the option.

American style: Type of option contract which allows the holder to exercise at any time up to and including the Expiry Day.

European style: Type of option contract, which allows the holder to exercise only on the Expiry Day.

Assignment: The random allocation of an exercise obligation to a writer. This is carried out by the exchanges

Exercise price: The amount of money, which must be paid by the taker (in the case of a call option) or the writer (in the case of a put option) for the transfer of each of the underlying securities upon exercise of the option

Expiry day: The date on which all unexercised options in a particular series expire.

Open interest: The number of outstanding contracts in a particular class or series existing in the option market. Also called the "open position".

Implied volatility: A measure of volatility assigned to a series by the current market price.

Delta: The rate in change of option premium due to a change in price of the underlying securities.

Volatility: A measure of the expected amount of fluctuation in the price of the particular securities.

Annualized return: The return or profit, expressed on an annual basis, the writer of the option contract receives for buying the shares and writing that particular option.

Intrinsic value: The difference between the market value of the underlying securities and the exercise price of the option. Usually it is not less than zero. It represents the advantage the taker has over the current market price if the option is exercised.

This concludes our lessons on Derivatives. If you require any additional information please feel to write to us on helpesk@icicidirect.com or call us at the nearest Call Centre and we will be glad to assist you

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