A Report On Study of Option Trading Strategies and their application And Devising a model to advice best use of such

h strategies at Geojit BNP Paribas Ltd.

Submitted in partial fufillment of the requirement of M.B.A Degree course of Christ University Institute Of Management By APURVA GUPTA Reg No.1021055 Under the guidance of Company Guide Mr. Vijaya Kumar Branch Manager Geojit BNP Paribas Ltd. University St. Marks Road Bangalore Bangalore Faculty Guide Prof. Aravind CUIM Christ

DECLARATION

I hereby declare that the research report project titled Study of Option Trading Strategies and their application And Devising a model to advice best use of such strategies at Geojit BNP Paribas Ltd. is an original work carried out by me under the guidance of Mr. Vijaya Kumar , Branch Manager , Geojit BNP Paribas Ltd, St. Marks Road, Bangalore, submitted in partial fulfilment of the MBA (Master of Business Administration) Degree . This has not been submitted in part or full towards any other degree or diploma

Signature .. (APURVA GUPTA) Student MBA-J

CHRIST UNIVERSITY INSTITUTE OF MANAGEMENT BANGALORE -560 029 MBA 2010-2012 LETTER OF THE HEAD OF

ADMINISTRATION
This is to certify that Ms. Apurva Gupta (Registration no: 1021055) is a bona fide student of Christ University Institute of Management (MBA batch 2010-12) and has successfully completed his Summer Internship Project at Geojit BNP Paribas Study of Option Trading Strategies and their application And Devising a model to advice best use of such strategies at Geojit BNP Paribas Ltd

Place: Date:

-------------------------------Head of the Administration

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CUIM

CERTIFICATE FACULTY GUIDE This is to certify that this internship report on the title Study of Option Trading Strategies and their application And Devising a model to advice best use of such strategies at Geojit BNP Paribas Ltd at Geojit BNP Paribas is a bona fide work of Ms. Apurva Gupta under my guidance and support .This report is a part of MBA course with specialization in Finance stream and the content and the work done is genuine with respect to the information covered and thought expressed. Place: Date: Prof. Aravind --------------------------

ACKNOWLEDGEMENT

At this moment when all my efforts have borne fruit, I would like to place on record my sincere gratitude to all those who have made this project possible. My sincere thanks to Rev. Fr. Thomas T. V., Director Christ University Institute of Management for his support. I would like to express my heartfelt gratitude to Mr. CKT Chandrashekar, HOD of CUIM, for the guidance and opportunity given to learn through this experience of Summer Internship Project. I would like to acknowledge the support and guidance of Mr. Vijaya Kumar, Branch Manager, Geojit BNP Paribas Ltd. , Bangalore for his able guidance and precise supervision, which has been instrumental in making this study an interesting experience. I am pleased to do sincerely record my gratitude to my mentor Prof. Aravind for his constant support and motivation during the project. A special mention goes to my family and friends who have constantly extended their support and guidance towards completion of this project.
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At last I thank The Almighty God for his blessings and guidance

APURVA GUPTA

EXECUTIVE SUMMARY
In this study I have tried to study the various Option Trading Strategies and providing an advising model for a broking house. This study was done keeping in mind the Organization Geojit BNP Paribas. Geojit deals with the Capital Market. This study was undertaken in the month of April11 May 11, when both the sides of the market could be seen due to the announcement of recent monetary policy. This study was done in two stages which included: Quantitative analysis of various Option Trading Strategies, and advicing the clients so as to when to use which strategy.
A survey was conducted using the questionnaire to analyse the behaviour of the

investors and their awareness about Option strategies. The analysis of different strategy was done on the basis of the following

The amount of investment required Market timing for the strategy to be apt The survey was used to know the awareness of the service and its used by the clients in its truest sense. As a result of the study it was found still the awareness of option strategies is less and people find it difficult to understand these strategies and trade accordingly. Also advicing the clients so as when to use which strategy It was found that most of the investors invested in the equity and were reluctant to invest in options due a variety of reasons.

Contents

1. Company profile

2. Introduction to Options

Option Strategies
3. Design of the Study

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4. Interpretation and Analysis

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5. Recommendation

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6. Bibliography

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7. Annexures

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COMPANY PROFILE

Geojit is a retail financial services company in India with a strong presence in the Gulf that deals with savings and investment products ranging from equities and derivatives to mutual funds, Life and General Insurance and third party fixed deposits. The client needs are met via multichannel services- countrywide network of 539 offices, phone service, Customer care Centre and the Internet. It has Over 525,000 clients serviced through a network of over 500 offices Geojit BNP PARIBAS is a listed member of The National Stock Exchange (NSE) and The Bombay Stock Exchange (BSE). The Board of the company consists of professional directors including Kerela government nominee with 2/3rd of the Board Members being independent. Geojit is a charter member of the Financial Planning Standard Board Of India and is one of the largest DP brokers in the country.
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Nature Of Business Carried It is engaged in the following services: Equity and Derivatives Broking
Wealth Advisory Services: The Company offers these services to its customers

through a dedicated group for giving the most personal attention at every level

PMS- Portfolio Management Services PMS is a product wherein an equity investment portfolio is created to suit the investment objective of the client. Geojit invests the customer resources into stocks of different sectors, depending on their risk return profile. This service is particularly advisable for investors who cannot afford to give time or dont have the expertise for day to day management of equity.

VISION, MISSION AND QUALITY POLICY

VISION To be leading financial services intermediary for individual and Institutional clients from India and overseas. We will continuously strive to raise our service standards by intelligent application of technology processes. MISSION Corporate Governance is about commitment to values and about ethical business conduct. Timely and accurate disclosure of information regarding the financial situations, performance, ownership, and governance of the company. QUALITY POLICY, OBJECTIVES AND PRACTICES
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Corporate Governance is one of their major Quality Policy. It is about commitment to values and ethical business conduct. It is about how an organization is managed. This improves public understanding of the structure, activities and policies of the organization. The company believes that sound corporate governance is critical to enhance and retain client trust. Accordingly the company always seeks to attain performance rules within integrity. The Board extends its fiduciary responsibilities in the widest sense of term. The companies disclosure always seek to attain the best practices in international corporate governance. They are also responsible to enhance long term shareholder value and respect minority rights in all their business decisions. Its Current bank partners are Axis Bank, Federal Bank, City Union Bank, South Indian Bank Geojit hase been facilitated with the IBA runner-up award In 2007 and 2008, Axis Bank won the Indian Banks Associations runner-up award for the Best Online Trading Platform. In 2002 Geojit was the first to 1st in India to launch an integrated internet trading system for Cash & Derivatives segments .

COMPANYS PUBLICATIONS

Geodata Monthly Barjeel Market Digest Monthly Online Research Reports for the use of employees Research Reports to daily newspapers in Malayalam and English\

SUBSIDARY COMPANIES OF GEOJIT

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PRODUCTS AND SERVICES

There are wide range of products and services offered by the organization. Certified Financial advisors help clients to arrive at the right financial solution to meet their individual needs. The wide range of product and services includes: Equities

An equity share represents the form of ownership

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 These are High risk and high return investments Mainly traded in cash market or intraday Derivatives Derivative is a financial contract between two or more parties, which is derived from the future value of an underlying asset. At a point of tome there will always be a three month contract period. All settlements are done in cash Mutual Funds A mutual fund is a trust that pools the savings of a number of investors who share a common financial goal. The money thus collected is invested in market instruments. Here the investors are the unit holders.

Commodity Trade department Custody Accounts(Demat Accounts) Currency Futures IPOs Margin Funding Life Insurance( Metlife Insurance Company) Loans against commodities

INTRODUCTION TO OPTIONS
An option is a contract written by a seller that conveys to the buyer the right but not the obligation to buy (in the case of a call option) or to sell (in the case of a put option) a particular asset, at a particular price (Strike price/Exercise price) in future. In return for granting the option, the seller collects a payment (the premium) from the buyer.

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An important class of options are Exchange traded options form which have standardized contract features and trade on public exchanges, facilitating trading among large number of investors. They provide settlement guarantee by the Clearing Corporation .Thus the counterparty risk is reduced.Options can be used for hedging, taking a view on the future direction of the market, for arbitrage or for implementing strategies which can help in generating income for investors under various market conditions. OPTION TERMINOLOGY
Index options: These options have the index as the underlying. In India, we

follow a European style settlement. Eg. Nifty options, Mini Nifty options etc.
Stock options: Stock options are options on individual stocks. A stock option

contract gives the holder the right to buy or sell the underlying shares at the specified price. They have an American style settlement.
Buyer of an option: The buyer of an option is the one who by paying the option

premium buys the right but not the obligation to exercise his option on the seller/writer.
Writer / seller of an option: The writer / seller of a call/put option is the one who

receives the option premium and is obliged to sell/buy the asset if the buyer exercises on him.
Call option: A call option gives the holder the right but not the obligation to buy

an asset by a certain date for a certain price.

Put option: A put option gives the holder the right but not the obligation to sell an

asset by a certain date for a certain price.

Option price/premium: Option price is the price which the option buyer pays to

the option seller. It is also referred to as the option premium or simply premium.
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 Expiration date: The date specified in the options contract is known as the

expiration date, the exercise date, the strike date or the maturity.
Strike price: The price specified in the options contract is known as the strike

price or the exercise price.

American options: American options are options that can be exercised at any time

upto the expiration date.

European options: European options are options that can be exercised only on the

expiration date itself.

In-the-money option: An in-the-money (ITM) option is an option that would lead

to a positive cashflow to the holder if it were exercised immediately. A call option on the index is said to be in-the-money when the current index stands at a level higher than the strike price (i.e. spot price > strike price). If the index is much higher than the strike price, the call is said to be deep ITM. In the case of a put, the put is ITM if the index is below the strike price.
At-the-money option: An at-the-money (ATM) option is an option that would

lead to zero cashflow if it were exercised immediately. An option on the index is at-the-money when the current index equals the strike price (i.e. spot price = strike price).

Out-of-the-money option: An out-of-the-money (OTM) option is an option that

would lead to a negative cashflow if it were exercised immediately. A call option

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on the index is out-of-the-money when the current index stands at a level which is less than the strike price (i.e. spot price < strike price). If the index is much lower than the strike price, the call is said to be deep OTM. In the case of a put, the put is OTM if the ind.ex is above the strike price.
Intrinsic value of an option: The option premium can be broken down into two

components - intrinsic value and time value. The intrinsic value of a call is the amount the option is ITM, if it is ITM. If the call is OTM, its intrinsic value is zero. Putting it another way, the intrinsic value of a call is Max[0, (St K)] which means the intrinsic value of a call is the greater of 0 or (St K). Similarly, the intrinsic value of a put is Max[0, K St],i.e. the greater of 0 or (K St). K is the strike price and St is the spot price.
Time value of an option: The time value of an option is the difference between its

premium and its intrinsic value. Both calls and puts have time value. An option that is OTM or ATM has only time value. Usually, the maximum time value exists when the option is ATM. The longer the time to expiration, the greater is an option's time value, all else equal. At expiration, an option should have no time value.

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FOLLOWING ARE THE OPTION STRATEGIES

STRATEGY 1 : LONG CALL STRATEGY 2 : SHORT CALL STRATEGY 3 : SYNTHETIC LONG CALL STRATEGY 4 : LONG PUT STRATEGY 5 : SHORT PUT STRATEGY 6 : COVERED CALL STRATEGY 7 : LONG COMBO STRATEGY 8 : PROTECTIVE CALL STRATEGY 9 : COVERED PUT STRATEGY 10 : LONG STRADDLE STRATEGY 11 : SHORT STRADDLE STRATEGY 12 : LONG STRANGLE STRATEGY 13. SHORT STRANGLE STRATEGY 14. COLLAR STRATEGY 15. BULL CALL SPREAD STRATEGY STRATEGY 16. BULL PUT SPREAD STRATEGY STRATEGY 17 : BEAR CALL SPREAD STRATEGY STRATEGY 18 : BEAR PUT SPREAD STRATEGY STRATEGY 19: LONG CALL BUTTERFLY STRATEGY 20 : SHORT CALL BUTTERFLY STRATEGY 21: LONG CALL CONDOR STRATEGY 22 : SHORT CALL CONDOR

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STRATEGY 1 : LONG CALL

This strategy involves buying a call. It is meant for aggressive investors who are very bullish about the prospects for a stock / index, and expect the underlying stock / index to rise in future. Buying calls can be an excellent way to capture the upside potential with limited downside risk. Buying a call is the most basic of all options strategies. It constitutes the first options trade for someone already familiar with buying / selling stocks and would now want to trade options. Example Mr. XYZ is bullish on Nifty on 9th April, when the Nifty is at 5768.10. He buys a call option with a strike price of Rs. 5900 at a premium of Rs. 36.35, expiring on 28th April. On Expiry Nifty Closes At 5700 5800 5900 5936.35 5950 6100 6170 6250 Net Payoff From Call Option -36.35 -36.35 -36.35 0 13.65 163.65 233.65 313.65

ANALYSIS: This strategy limits the downside risk is limited to the extent of premium paid by Mr. XYZ (Rs. 36.35). But the potential return is unlimited in case of rise in Nifty. A long call option is the simplest way to benefit if one believes that the market will make an upward move and is the most common choice among first time investors in Options. Therefore with the investment of Rs 5936.35 unlimited profit can be earned and loss is only Rs 36.35 since the investor does not have any obligation to buy the underlying asset.

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STRATEGY 2 : SHORT CALL

A Call option means an Option to buy. Buying a Call option means an investor expects the underlying price of a stock / index to rise in future. Selling a Call option is just the opposite of buying a Call option. Here the seller of the option feels the underlying price of a stock / index is set to fall in the future. He is bearish in nature. Example: Mr. XYZ is bearish about Nifty and expects it to fall. He sells a Call option with a strike price of Rs. 5900 at a premium of Rs. 98, when the current Nifty is at 5962. If the Nifty stays at 5900 or below, the Call option will not be exercised by the buyer of the Call and Mr. XYZ can retain the entire premium of Rs. 98. On Expiry Nifty Closes At 5700 5800 5850 5950 5998 6100 6200 6300 Net Payoff From Call Option 98 98 98 48 0 -102 -202 -302

ANALYSIS: This strategy is used when an investor is very aggressive and has a strong expectation of a price fall (and certainly not a price rise). This is a risky strategy since as the stock price / index rises, the short call loses money more and more quickly and losses can be significant if the stock price / index falls below the strike price, hence are unlimited. Since the investor does not own the underlying stock that he is shorting this strategy is also called Short Naked Call. The reward is limited to the premium amount.
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STRATEGY 3 : SYNTHETIC LONG CALL: BUY STOCK, BUY PUT

In this strategy, we purchase a stock since we feel bullish about it. But what if the price of the stock went down. We wish we had some insurance against the price fall. So buy a Put on the stock. This gives you the right to sell the stock at a certain price which is the strike price. The strike price can be the price at which you bought the stock (ATM strike price) or slightly below (OTM strike price). In case the price of the stock rises you get the full benefit of the price rise. In case the price of the stock falls, exercise the Put Option (remember Put is a right to sell). You have capped your loss in this manner because the Put option stops your further losses. It is a strategy with a limited loss and (after subtracting the Put premium) unlimited profit (from the stock price rise). The result of this strategy looks like a Call Option Buy strategy and therefore is called a Synthetic Call. But the strategy is not Buy Call Option (Strategy 1). Here you have taken an exposure to an underlying stock with the aim of holding it and reaping the benefits of price rise, dividends, bonus rights etc. and at the same time insuring against an adverse price movement. Example Mr. XYZ is bullish about ABC Ltd stock. He buys ABC Ltd. at current market price of Rs. 5000 on 4th April. To protect against fall in the price of ABC Ltd. (his risk), he
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buys an ABC Ltd. Put option with a strike price Rs.4900 (OTM) at a premium of Rs. 143.80 expiring on 28th April. ABC Ltd. closes at (Rs.) on expiry 4400 4600 4800 5000 5143.8 5200 5400 5600 5800 Payoff from the Stock (Rs.) -600 -400 -200 0 143.8 200 400 600 800 Net Payoff from the Put Option (Rs.) 356.2 156.2 -43.8 -143.8 -143.8 -143.8 -143.8 -143.8 -143.8 Net Payoff (Rs) -243.8 -243.8 -243.8 -143.8 0 56.2 256.2 456.2 656.2

ANALYSIS: This is a low risk strategy. This is a strategy which limits the loss in case of fall in market (the right of selling given by the Put option helps in limiting the loss) .but the potential profit remains unlimited when the stock price rises(this very right of selling prevents from selling the stock at higher prices, thus the gains from the stock price can be retained).

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A good strategy when we buy a stock for medium or long term, with the aim of protecting any downside risk. The pay-off resembles a Call Option buy and is therefore called as Synthetic Long Call.

STRATEGY 4 : LONG PUT

Buying a Put is the opposite of buying a Call. When we buy a Call we are bullish about the stock / index. When an investor is bearish, he can buy a Put option. A Put Option gives the buyer of the Put a right to sell the stock (to the Put seller) at a pre-specified price and thereby limit his risk when the price of the stock/index falls significantly. It is used to take advantage of falling markets. EXAMPLE Mr. XYZ is bearish on Nifty on 24th March, when the Nifty is at 5820. He buys a Put option with a strike price Rs. 5800 at a premium of Rs. 52, expiring on 28th April. If the Nifty goes below 5748, Mr. XYZ will make a profit on exercising the option. In case the Nifty rises above 5800, he can forego the option (it will expire worthless) with a maximum loss of the premium. On Expiry Nifty Closes At 5600 5500 5600 5700 5748 5900
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Net Payoff (Rs) 348 248 148 48 0 -52

6100 6300

-52 -52

ANALYSIS: A bearish investor can profit from declining stock price by buying Puts. He limits his risk to the amount of premium paid but his profit potential remains unlimited. This is one of the widely used strategy when an investor is bearish.

STRATEGY 5 : SHORT PUT

Selling a Put is opposite of buying a Put. An investor buys Put when he is bearish on a stock. An investor Sells Put when he is Bullish about the stock expects the stock price to rise or stay sideways at the minimum. When we sell a Put, we earn a Premium (from the buyer of the Put). We have sold someone the right to sell you the stock at the strike price. Example Mr. XYZ is bullish on Nifty when it is at 5855.10. He sells a Put option with a strike price of Rs. 5800 at a premium of Rs. 170.50 expiring on 28th April. If the Nifty index stays above 5800, he will gain the amount of premium as the Put buyer wont exercise his option. In case the Nifty falls below 5800, Put buyer will exercise the option and the Mr. XYZ will start losing money. On Expiry Nifty Closes At 5300 5400 5500 5629.5 5700 5900 6000 6100
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Net Payoff (Rs) -329.5 -229.5 -129.5 0 70 170 170 170

ANALYSIS: Selling Puts can lead to regular income in a rising or range bound markets. But it should be done carefully since the potential losses can be significant in case the price of the stock / index falls. This strategy can be considered as an income generating strategy. If the stock price increases beyond the strike price, the short put position will make a limited profit for the amount of the premium(maximum profit) he earns , since the buyer will not exercise the Put option But, if the stock price decreases below the strike price, by more than the amount of the premium. The potential loss being unlimited (until the stock price fall to zero), since the buyer will exercise the option

STRATEGY 6 : COVERED CALL

An investor buys a stock or owns a stock which he feel is good for medium to long term but is neutral or bearish for the near term. At the same time, the investor does not mind exiting the stock at a certain price (target price). He uses the Covered Call strategy wherein the investor can sell a Call Option at the strike price at which he would be fine exiting the stock (OTM strike). By selling the Call Option the investor earns a Premium. Now the position of the investor is that of a Call Seller who owns the underlying stock. If the stock price stays at or below the strike price, the Call Buyer will not exercise the Call. The Premium is retained by the investor. In case the stock price goes above the strike price, the Call buyer who has the right to buy the stock at the strike price will exercise the Call option. The Call seller (the investor) who has to sell the stock to the Call buyer, will sell the stock at the strike price. This was the price which the Call seller (the investor) was anyway interested in exiting the stock and now exits at that price. So besides the strike price which was the target price for selling the stock, the Call seller (investor) also earns the Premium which becomes an additional gain for him. This strategy is called as a Covered Call strategy because the Call sold is

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backed by a stock owned by the Call Seller (investor). The income increases as the stock rises, but gets capped after the stock reaches the strike price. Example Mr A bought a stock of XYZ Ltd at Rs 4850 and simultaneously sells a Call Option at a strike Price of Rs 5000. This means Mr. A does not think that the price will go beyond Rs 5000. In case it rises above Rs 5000 Mr A does not mind getting exercised at that price and exiting the stock at Rs 5000. Mr A receives Rs 80 as premium for selling the Call Option XYZ Ltd. price closes at (Rs.) 4600 4700 4740 4770 4900 5100 5300 Following are the two cases:
1) The price of XYZ Ltd. stays at or below Rs. 4000. The Call buyer will not

Net Payoff (Rs.) -170 -70 -30 0 130 230 230

exercise the Call Option. Mr. A will keep the premium of Rs. 80. This is an income for him. So if the stock has moved from Rs. 3850 (purchase price) to Rs. 3950, Mr. A makes Rs. 180/- [Rs. 3950 Rs. 3850 + Rs. 80 (Premium)] = An additional Rs. 80, because of the Call sold.
2) Suppose the price of XYZ Ltd. moves to Rs. 4100, then the Call Buyer will

exercise the Call option and Mr. A will have to pay him Rs. 100 (loss on exercise of the Call Option). The payoff of Mr A would be: a) Sell the Stock in the market at : b) Pay Rs. 100 to the Call Options buyer : c) Pay Off (a b) received : d) Premium received on Selling Call Option : e) Net payment (c + d) received by Mr. A : f) Purchase price of XYZ Ltd. : g) Net profit :
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Rs. 4100 (-) Rs. 100 Rs. 4000 (This was Mr. As target price) Rs. 80 Rs. 4080 Rs. 3850 Rs. 4080 Rs. 3850

= Rs. 230 h) Return (%) : (Rs. 4080 Rs. 3850) x 100 Rs. 3850 = 5.97% (which is more than the target return of 3.90%).

ANALYSIS: This strategy is often used when the investor has a shorterm neutral to moderately bullish view on the stock he holds. Here the risk is that if the stock price falls to zero the investor loses the entire value of the stock but retains the premium since the Call is not exercised against him. The reward is limited to the (Call strike-Stock price paid) + premium.

STRATEGY 7 : LONG COMBO : SELL A PUT, BUY A CALL

A Long Combo is a Bullish strategy. If an investor is expecting the price of a stock to move up he can do a Long Combo strategy. It involves selling an OTM (lower strike) Put and buying an OTM (higher strike) Call. This strategy simulates the action of buying a stock (or a futures) but at a fraction of the stock price. As the stock price rises the strategy starts making profits. Example: A stock ABC Ltd. is trading at Rs. 450. Mr. XYZ is bullish on the stock. But does not want to invest Rs. 450. He does a Long Combo. He sells a Put option with a strike price Rs. 400 at a premium of Rs. 1.00 and buys a Call Option with a strike price of Rs. 500 at a premium of Rs. 2. The net cost of the strategy (net debit) is Rs. 1.

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ABC Ltd. closes at (Rs.) 250 300 350 400 450 501 550 600 650

Net Payoff from the Put Sold (Rs.) -149 -99 -49 1 1 1 1 1 1

Net Payoff from the Call purchased(Rs.) -2 -2 -2 -2 -1 48 98 148 198

Net Payoff (Rs.) 151 101 51 -1 -1 -0 43 99 149

ANALYSIS : In this strategy the risk is unlimited and reward is also unlimited. An investor should use this strategy only when he is strongly bullish about the market. Taking the above example in consideration, For a small investment of Re. 1 (net debit), the returns can be very high in a Long Combo, but only if the stock moves up. Otherwise the potential losses can also be high.

200 Payoff 100 0 -100 -200

STRATEGY 8 : PROTECTIVE CALL / SYNTHETIC LONG PUT

This is a strategy wherein an investor has gone short on a stock and buys a call to hedge. This is an opposite of Synthetic Call (Strategy 3). An investor sells a stock and buys an ATM or slightly OTM Call. In case the stock price falls the investor gains in the downward fall in the price. However, incase there is an unexpected rise in the price of the stock the loss is limited. The pay-off from the Long Call will increase thereby compensating for the loss in value of the short stock position. This strategy hedges the upside in the stock position while retaining downside profit potential.
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This strategy is used when an investor is of the view that the markets will go down (bearish) but wants to protect against any unexpected rise in the price of the stock. Example : Suppose ABC Ltd. is trading at Rs. 4457 in June. An investor Mr. A buys a Rs 4500 call for Rs. 100 while shorting the stock at Rs. 4457. The net credit to the investor is Rs. 4357 (Rs. 4457 Rs. 100) ABC Ltd. closes at (Rs.) 4100 4150 4200 4300 4350 4357 4400 4457 4600 4700 4800 4900 Payoff from the stock (Rs.) 357 307 257 157 107 100 57 0 -143 -243 -343 -443 Net Payoff from the Call Option (Rs.) -100 -100 -100 -100 -100 -100 -100 -100 0 100 200 300 Net Payoff (Rs.) 257 207 157 57 7 0 -43 -100 -143 -143 -143 -143

ANALYSIS : The net effect of this strategy is that the investor creates a pay-off like a Long Put, but instead of having a net debit (paying premium) for a Long Put, he creates a net credit (receives money on shorting the stock).Here the risk is limited ; since the investor expects the market to fall, in case it goes up he will exercise its call andmake a profit thus reducing the effect of the loss made by selling the stock. When the market falls he will make profit since he had sold the stock earlier at a higher price.

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STRATEGY 9 : COVERED PUT

Covered Put is a neutral to Bearish strategy. We do this strategy when we feel the price of a stock / index is going to remain range bound or move down. Covered Put writing involves a short in a stock / index along with a short Put on the options on the stock / index. The investor shorts a stock because he is bearish about it, but does not mind buying it back once the price reaches (falls to) a target price. This target price is the price at which the investor shorts the Put (Put strike price). Selling a Put means, buying the stock at the strike price if exercised.
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Example Suppose ABC Ltd. is trading at Rs 4500 in June. An investor, Mr. A, shorts Rs 4300 Put by selling a April Put for Rs. 24 while shorting an ABC Ltd. stock. The net credit received by Mr. A is Rs. 4500 + Rs. 24 = Rs. 4524. ABC Ltd. closes at (Rs.) Net Payoff Net Payoff from the Put (Rs.) Option (Rs.) 4100 400 -176 224 4200 300 -76 224 4300 200 24 224 4400 100 24 124 4450 50 24 74 4524 -24 24 0 4550 -50 24 -26 4600 -100 24 -76 4650 -150 24 -126 ANALYSIS : If the stock falls below the Put strike, the investor will be exercised and will have to buy the stock at the strike price (which is anyway his target price to repurchase the stock). The investor makes a profit(Stock price +premium-put strike price) because he has shorted the stock and purchasing it at the strike price simply closes the short stock position at a profit. And the investor keeps the Premium on the Put sold but still would have to face a reduced unlimited loss in case the market goes the other way( upward) Payoff from the stock (Rs.)

STRATEGY 10 : LONG STRADDLE

A Straddle is a volatility strategy and is used when the stock price / index is expected to show large movements. This strategy involves buying a call as well as put on the same stock / index for the same maturity and strike price, to take advantage of a movement in either direction, a rising or falling value of the stock / index. Example
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Suppose Nifty is at 5750 on 7th April. An investor, Mr. A, enters into a long straddle by buying a May Rs 5800 Nifty Put for Rs. 85 and a May Rs. 5800 Nifty Call for Rs. 122. The net credit received is Rs. 207, which is also his maximum possible profit. On expiry Nifty closes at 5300 5400 5500 5593 5600 5700 5800 5900 6000 6007 6100 6200 6300 Net Payoff from Put Net Payoff from Purchased (Rs.) Call purchased (Rs.) 415 -122 315 -122 215 -122 122 -122 115 -122 15 -122 -85 -122 -85 -22 -85 78 -85 85 -85 178 -85 278 -85 378 Net Payoff (Rs.) 293 193 93 0 -7 -107 -207 -107 -7 0 93 193 293

ANALYSIS : If the price of the stock / index increases, the call is exercised while the put expires worthless and if the price of the stock / index decreases, the put is exercised, the call expires worthless. Either way if the stock/index shows volatility to cover the cost of the trade, profits are to be made. The loss is limited to the initial premium paid if the market does not show any movement. Here the investor is direction neutral.

STRATEGY 11 : SHORT STRADDLE

A Short Straddle is the opposite of Long Straddle. It is a strategy to be adopted when the investor feels the market will not show much movement. He sells a Call and a Put on the same stock / index for the same maturity and strike price. It creates a net income for the investor. Investor believes that markets will be stagnant.

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Example Suppose Nifty is at 5750 on 27th April. An investor, Mr. A, enters into a short straddle by selling a May Rs 5800 Nifty Put for Rs. 85 and a May Rs. 5800 Nifty Call for Rs. 122. The net credit received is Rs. 207, which is also his maximum possible profit. On expiry Nifty Net Payoff from Put Net Payoff from Net Payoff closes at Sold (Rs.) Call Sold (Rs.) (Rs.) 5300 -415 122 -293 5400 -315 122 -193 5500 -215 122 -93 5593 -122 122 0 5600 -115 122 7 5700 -15 122 107 5800 85 122 207 5900 85 22 107 6000 85 -78 7 6007 85 -85 0 6100 85 -178 -93 6200 85 -278 -193 6300 85 -378 -293 ANALYSIS If the stock / index does not move much in either direction from the strike price, the investor retains the Premium(maximum gain) as neither the Call nor the Put will be exercised. However, incase the stock /index moves in either direction, up or down significantly, the investors losses can be significant. So this is a risky strategy and should be adopted and only when the expected volatility in the market is limited.

STRATEGY 12 : LONG STRANGLE

A Strangle is a slight modification to the Straddle to make it cheaper to execute. This strategy involves the simultaneous buying of a slightly out-of-the-money (OTM) put and a slightly out-of-the-money (OTM) call of the same underlying stock / index and expiration
31

date. Here again the investor is directional neutral but is looking for an increased volatility in the stock / index and the prices moving significantly in either direction. Example Suppose Nifty is at 5800 in April. An investor, Mr. A, executes a Long Strangle by buying a Rs. 5600 Nifty Put for a premium of Rs. 23 and a Rs 6000 Nifty Call for Rs 43. The net debit taken to enter the trade is Rs. 66, which is also his maxi mum possible loss. On expiry Net Payoff from Put Net Payoff from Net Payoff Nifty closes at Purchased (Rs.) Call purchased (Rs.) (Rs.) 5200 377 -43 334 5300 277 -43 234 5400 177 -43 134 5500 77 -43 34 5534 43 -43 0 5600 -23 -43 -66 5800 -23 -43 -66 5900 -23 -43 -66 6000 -23 -43 -66 6066 -23 23 0 6100 -23 57 34 6200 -23 157 134 6300 -23 257 234 6400 -23 357 334 ANALYSIS : Since OTM options are purchased for both Calls and Puts it makes the cost of executing a Strangle cheaper as compared to a Straddle, where generally ATM strikes are purchased. However, for a Strangle to make money, it would require greater movement on the upside or downside for the stock / index than it would for a Straddle. As with a Straddle, the strategy has a limited risk (i.e. the Call and the Put premium) and unlimited profitpotetial

300 200 100 0 -100 Payoff

STRATEGY 13. SHORT STRANGLE

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This strategy involves the simultaneous selling of a slightly out-of-the-money (OTM) put and a slightly out-of-the-money (OTM) call of the same underlying stock and expiration date. This typically means that since OTM call and put are sold, the net credit received by the seller is less as compared to a Short Straddle, but the break even points are also widened. Little volatility is expected when adopting this strategy. Example Suppose Nifty is at 5800 in May. An investor, Mr. A, executes a Short Strangle by selling a Rs. 5600 Nifty Put for a premium of Rs. 23 and a Rs. 6000 Nifty Call for Rs 43. The net credit is Rs. 66, which is also his maximum possible gain. On expiry Nifty closes at 5200 5300 5400 5500 5534 5600 5800 5900 6000 6066 6100 6200 6300 6400 Net Payoff from Put Sold (Rs.) -377 -277 -177 -77 -43 23 23 23 23 23 23 23 23 23 Net Payoff from Call Sold (Rs.) 43 43 43 43 43 43 43 43 43 -23 -57 -157 -257 -357 Net Payoff (Rs.) -334 -234 -134 -34 0 66 66 66 66 0 -34 -134 -234 -334

ANALYSIS : It tries to improve the profitability of the trade for the Seller of the options by widening the breakeven points so that there is a much greater movement required in the underlying stock / index, for the Call and Put option to be worth exercising. Here the risk is unlimited and profit is limited to the premium received.

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STRATEGY 14. COLLAR

Collar is a Covered Call with a limited risk. It involves buying a stock, insuring against the downside by buying a Put and then financing (partly) the Put by selling a Call. The put generally is ATM and the call is OTM having the same expiration month and must be equal in number of shares. The collar is a good strategy to use if the investor is writing covered calls to earn premiums but wishes to protect himself from an unexpected sharp drop in the price of the underlying security. Example Suppose an investor Mr. A buys or is holding ABC Ltd. currently trading at Rs. 4758. He decides to establish a collar by writing a Call of strike price Rs. 5000 for Rs. 39 while simultaneously purchasing a Rs. 4700 strike price Put for Rs. 27. Since he pays Rs. 4758 for the stock ABC Ltd., another Rs. 27 for the Put but receives Rs. 39 for selling the Call option, his total Investment is Rs. 4746. ABC Ltd. Closes at (Rs.) 4400 4450 4500 4600 4700 4750 4800 4850 4858 4900 4948 5000 5100 5150 5200 5250 5300 Payoff from Call Sold (Rs.) 39 39 39 39 39 39 39 39 39 39 39 39 -61 -111 -161 -211 -261 Payoff from Put Payoff Purchased (Rs.) from stock ABC Ltd. 273 -358 223 -308 173 -258 73 -158 -27 -58 -27 -8 -27 42 -27 92 -27 100 -27 142 -27 190 -27 242 -27 342 -27 392 -27 442 -27 492 -27 542 Net payoff (Rs.) -46 -46 -46 -46 -46 4 54 104 112 154 202 254 254 254 254 254 254

ANALYSIS : It is a low risk strategy since the Put prevents downside risk. However, do not expect unlimited rewards since the Call prevents that. It is a strategy to be adopted when the investor is conservatively bullish. Here the profit is also limited since the profit from stock is eaten up by the loss from call sold.

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1) If the price of ABC Ltd. rises to Rs. 5100 after a month, then, a. Mr. A will sell the stock at Rs. 5100 earning him a profit of Rs. 342 Rs. 4758) b. Mr. A will get exercised on the Call he sold and will have to pay Rs. c. The Put will expire worthless. d. Net premium received for the Collar is Rs. 12 e. Adding (a + b + d) = Rs. 342 -100 + 12 = Rs. 254 This is the maximum return on the Collar Strategy. However, unlike a Covered Call, the downside risk here is also limited : 2) If the price of ABC Ltd. falls to Rs. 4400 after a month, then, a. Mr. A loses Rs. 358 on the stock ABC Ltd. b. The Call expires worthless c. The Put can be exercised by Mr. A and he will earn Rs. 300 d. Net premium received for the Collar is Rs. 12 e. Adding (a + b + d) = Rs.- 358 + 300 +12 = - Rs. 46 This is the maximum the investor can loose on the Collar Strategy. The Upside in this case is much more than the downside risk. 100. (Rs. 5100

35

STRATEGY 15. BULL CALL SPREAD BUY CALL OPTION, SELL CALL OPTION
A bull call spread is constructed by buying an in-the-money (ITM) call option, and selling another out-of-the-money (OTM) call option. Often the call with the lower strike price will be in-the-money while the Call with the higher strike price is out-of-the-money. Both calls must have the same underlying security and expiration month. The net effect of the strategy is to bring down the cost and breakeven on a Buy Call (Long Call) Strategy. This strategy is exercised when investor is moderately bullish to bullish. Example: Mr. XYZ buys a Nifty Call with a Strike price Rs.5500 at a premium of Rs. 170.45 and he sells a Nifty Call option with a strike price Rs. 5800 at a premium of Rs. 35.40. The net debit here is Rs. 135.05 which is also his maximum loss. On expiry Nifty Closes at 5200 5300 5400 5500 5600 5635.05 5700 5800 5900 6000 6100 Net Payoff from Call Buy (Rs.) -170.45 -170.45 -170.45 -170.45 -70.45 -35.40 29.55 129.55 229.55 329.55 429.55
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Net Payoff from Call Sold (Rs.) 35.40 35.40 35.40 35.40 35.40 35.40 35.40 35.40 -64.60 -164.60 -264.60

Net Payoff (Rs.) -135.05 -135.05 -135.05 -135.05 -35.05 0 64.95 164.95 164.95 164.95 164.95

ANALYSIS: The Bull Call Spread Strategy has brought the breakeven point down (if only the Rs. 5500 strike price Call was purchased the breakeven point would have been Rs. 5670.45), reduced the cost of the trade (if only the Rs. 5500 strike price Call was purchased the cost of the trade would have been Rs. 170.45), reduced the loss on the trade (if only the Rs. 5500 strike price Call was purchased the loss would have been Rs. 170.45 i.e. the premium of the Call purchased). However, the strategy also has limited gains and is therefore ideal when markets are moderately bullish.

STRATEGY 16. BULL PUT SPREAD SELL PUT OPTION, BUY PUT OPTION
The concept is to protect the downside of a Put sold(ITM) by buying a lower strike Put(OTM), which acts as an insurance for the Put sold. the investor receives a net credit, because the Put purchased (further OTM) is cheaper than the Put sold. It is used when the investor is moderately bullish. Example: Mr. XYZ sells a Nifty Put option with a strike price of Rs. 5800 at a premium of Rs. 21.45 and buys a further OTM Nifty Put option with a strike price Rs. 5600 at a premium of Rs. 3.00 when the current Nifty is at 4191.10, with both options expiring on 28th April. On expiry Nifty Closes at 5300 5400 5500 5600 5700 5781.55 5800 5900 6000 6100 Net Payoff from Put Buy (Rs.) 297 197 97 -3 -3 -3 -3 -3 -3 -3 Net Payoff from Put Sold (Rs.) -478.55 -378.55 -278.55 -178.55 -78.55 3 21.45 21.45 21.45 21.45 Net Payoff (Rs.) -181.55 -181.55 -181.55 -181.55 -81.55 0 18.45 18.45 18.45 18.45

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ANALYSIS: If the stock / index rises, both Puts expire worthless and the investor can retain the Premium. If the stock / index falls, then the investors breakeven is the higher strike less the net credit received. Provided the stock remains above that level, the investor makes a profit. Otherwise he could make a loss. The maximum loss is the difference in strikes less the net credit received.

STRATEGY 17 : BEAR CALL SPREAD SELL ITM CALL, BUY OTM CALL
The strategy requires the investor to buy out-of-the-money (OTM) call options while simultaneously selling in-the-money (ITM) call options on the same underlying stock index. The investor receives a net credit because the Call he buys is of a higher strike price than the Call sold. The concept is to protect the downside of a Call Sold by buying a Call of a higher strike price to insure the Call sold. It is adopted when the investor is mildly bearish about the market. Example: Mr. XYZ is bearish on Nifty. He sells an ITM call option with strike price of Rs. 5600 at a premium of Rs. 154 and buys an OTM call option with strike price Rs. 5800 at a premium of Rs. 49. On expiry Nifty Closes at 5300 5400 5495 5500 5600 5700 5705 5800 Net Payoff from Call Sold (Rs.) 154 154 154 154 154 54 49 -46
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Net Payoff from Call bought(Rs.) -49 -49 -49 -49 -49 -49 -49 -49

Net Payoff (Rs.) 105 105 105 105 105 5 0 -95

5900 -146 51 -95 6000 -246 151 -95 6100 -346 251 -95 6200 -446 351 -95 ANALYSIS: If the stock / index falls both Calls will expire worthless and the investor can retain the net credit. If the stock / index rises then the breakeven is the lower strike plus the net credit. Provided the stock remains below that level, the investor makes a profit. Otherwise he could make a loss. The maximum loss is the difference in strikes less the net credit received. It earns a net income for the investor as well as limits the downside risk of a Call sold

STRATEGY 18 : BEAR PUT SPREAD BUY PUT, SELL PUT

This strategy requires the investor to buy an ITM (higher) put option and sell an OTM (lower) put option on the same stock with the same expiration date. This strategy creates a net debit for the investor. The net effect of the strategy is to bring down the cost and raise the breakeven on buying a Put (Long Put). The strategy needs a Bearish outlook since the investor will make money only when the stoc k price / index falls. The bought Puts will have the effect of capping the investors downside. While the Puts sold will reduce the investors costs, risk and raise breakeven point Example: Nifty is presently at 5694. Mr. XYZ expects Nifty to fall. He buys one Nifty ITM Put with a strike price Rs. 5800 at a premium of Rs. 132 and sells on Nifty OTM Put with strike price Rs. 5600 at a premium Rs. 52. On expiry Nifty closes at 5400 5500 5600 5700 5720 Net Payoff from Put Buy (Rs.) 268 168 68 -32 -52
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Net Payoff from Put Sold (Rs.) -148 -48 52 52 52

Net payoff (Rs.) 120 120 120 20 0

5800 -132 52 -80 5900 -132 52 -80 6000 -132 52 -80 ANALYSIS : If the stock price closes below the OTM (lower) put option strike price on the expiration date, then the investor reaches maximum profits. If the stock price increases above theITM(higher) put option strike price, then the investor has a maximum loss potential of the net debit. The Bear Put Spread Strategy has raised the breakeven point (if only the Rs. 5800 strike price Put was purchased the breakeven point would have been Rs. 5668), reduced the cost of the trade (if only the Rs. 5800 strike price Put was purchased the cost of the trade would have been Rs. 132 i.e. the premium of the Put purchased). However, the strategy also has limited gains and is therefore ideal when markets are moderately bearish.

150 100 50 0 -50 -100 Payoff

STRATEGY 19: LONG CALL BUTTERFLY: SELL 2 ATM CALL OPTIONS, BUY 1 ITM CALL OPTION AND BUY 1 OTM CALL OPTION.
A Long Call Butterfly is to be adopted the investor is looking to gain from low volatility at a low cost. A long butterfly is similar to a Short Straddle except your losses are limited. The strategy can be done by selling 2 ATM Calls, buying 1 ITM Call, and buying 1 OTM Call options (there should be equidistance between the strike prices). Example: Nifty is at 5800. Mr. XYZ expects very little movement in Nifty. He sells 2 ATM Nifty Call Options with a strike price of Rs. 5800 at a premium of Rs. 97.90 each, buys 1 ITM Nifty Call Option with a strike price of Rs. 5700 at a premium of Rs. 141.55 and buys 1 OTM Nifty Call Option with a strike price of Rs. 5900 at a premium of Rs. 64. The Net debit is Rs. 9.75. On expiry Nifty Net Payoff from Net Payoff 2 ATM Calls from 1 ITM
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Net Payoff from 1 OTM

Net Payoff (Rs.)

Closes at

Sold Callpurchased Callpurchased (Rs.) (Rs.) (Rs.) 5400 195.80 -141.55 -64 5500 195.80 -141.55 -64 5600 195.80 -141.55 -64 5700 195.80 -141.55 -64 5709.75 195.80 131.80 -64 5800 195.80 -41.55 -64 5890.25 15.30 48.70 -64 5900 -4.2 58.45 -64 6000 -204.2 158.45 36 6100 -404.20 258.45 136 6200 -604.20 358.45 236 ANALYSIS: The result is positive incase the stock / index remains range

-9.75 -9.75 -9.75 -9.75 0 90.25 0 -9.75 -9.75 -9.75 -9.75

bound. The maximum profit (Difference between adjacent strikes minus net debit) in this strategy is however restricted and takes place when the stock / index is at the middle strike at expiration. The maximum loss (Net debit paid) are also limited.

100 50 Payoff 0 -50

STRATEGY 20 : SHORT CALL BUTTERFLY: BUY 2 ATM CALL OPTIONS, SELL 1 ITM CALL OPTION AND SELL 1 OTM CALL OPTION.
A Short Call Butterfly is a strategy for volatile markets. It is the opposite of Long Call Butterfly, which is a range bound strategy. The Short Call Butterfly can be constructed by Selling one lower strike ITM Call, buying two ATM Calls and selling another higher strike OTM Call, giving the investor a net credit (therefore it is an income strategy). Example: Nifty is at 5800. Mr. XYZ expects large volatility in the Nifty irrespective of which direction the movement is, upwards or downwards. Mr. XYZ buys 2 ATM Nifty Call Options with a strike price of Rs. 5800 at a premium of Rs. 97.90 each, sells 1 ITM Nifty Call Option with a strike price of Rs. 5700 at a premium of Rs.

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141.55 and sells 1 OTM Nifty Call Option with a strike price of Rs. 5900 at a premium of Rs. 64. The Net Credit is Rs. 9.75. On expiry Nifty Closes at Net Payoff from 2 Net Payoff Net Payoff Net Payoff ATM from 1 ITM from 1 OTM (Rs.) CallsPurchased Call sold (Rs.) Call sold (Rs.) (Rs.) 5400 -195.80 141.55 64 9.75 5500 -195.80 141.55 64 9.75 5600 -195.80 141.55 64 9.75 5700 -195.80 141.55 64 9.75 5707.75 -195.80 131.80 64 0 5800 -195.80 41.55 64 -90.25 5900 -15.30 -48.70 64 0 6000 4.2 -58.45 64 9.75 6100 204.2 -158.45 -36 9.75 6200 404.20 -258.45 -136 9.75 ANALYSIS: The resulting position will be profitable in case there is a big move in the stock / index. The maximum risk occurs if the stock / index is at the middle strike at expiration. The maximum profit occurs if the stock finishes on either side of the upper and lower strike prices at expiration. However, this strategy offers very small returns when compared to straddles, strangles with only slightly less risk.
50 0 Payoff -50 -100

STRATEGY 21: LONG CALL CONDOR: BUY 1 ITM CALL OPTION (LOWER STRIKE), SELL 1 ITM CALL OPTION (LOWER MIDDLE), SELL 1 OTM CALL OPTION (HIGHER MIDDLE), BUY 1 OTM CALL OPTION (HIGHER STRIKE) A Long Call Condor is very similar to a long butterfly strategy. The difference is that the two middle sold options have different strikes. The profitable area of the pay off profile is wider than that of the Long Butterfly. The long options at the outside strikes ensure that the risk is capped on both the sides. The resulting position is profitable if the stock / index remains range bound and shows very little volatility. The maximum profits occur if the stock finishes between the middle strike prices at expiration.

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Example: Nifty is at 5800. Mr. XYZ expects little volatility in the Nifty and expects the market to remain rangebound. Mr. XYZ buys 1 ITM Nifty Call Options with a strike price of Rs. 5600 at a premium of Rs. 41.25, sells 1 ITM Nifty Call Option with a strike price of Rs.5700 at a premium of Rs. 26, sells 1 OTM Nifty Call Option with a strike price of Rs. 5900 at a premium of Rs. 9.80 and buys 1 OTM Nifty Call Option with a strike price of Rs.6000 at a premium of Rs. 6.00. The Net debit is Rs. 11.45 which is also the maximum possible loss. On expiry Nifty Closes at Net Payoff Net Payoff Net Payoff Net Payoff Net Payoff from 1ITM from 1 from 1 from 1 OTM (Rs.) Call ITM Call OTM Call Call purchased sold (Rs.) sold (Rs.) purchased (Rs.) (Rs.) 5300 -41.25 26 9.8 -6 -11.45 5400 -41.25 26 9.8 -6 -11.45 5500 -41.25 26 9.8 -6 -11.45 5600 -41.25 26 9.8 -6 -11.45 5611.45 -29.80 26 9.8 -6 0 5700 58.75 26 9.8 -6 88.55 5800 158.75 -74 9.8 -6 88.55 5900 258.75 -174 9.8 -6 88.55 5988.55 347.30 -263 -78.8 -6 0 6000 358.75 -274 -90.2 -6 -11.45 6100 458.75 -374 -190.2 94 -11.45 6200 558.75 -474 -290.2 194 -11.45 ANALYSIS : Risk is Limited to the minimum of the difference between the lower strike call spread less the higher call spread less the total premium paid for the condor. Profit is also Limited. The maximum profit of will be realized when the stock is trading between the two middle strike prices.

STRATEGY 22 : SHORT CALL CONDOR : SHORT 1 ITM CALL OPTION (LOWER STRIKE), LONG 1 ITM CALL OPTION (LOWER MIDDLE), LONG 1 OTM CALL OPTION (HIGHER MIDDLE), SHORT 1 OTM CALL OPTION (HIGHER STRIKE).
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A Short Call Condor is very similar to a short butterfly strategy. The difference is that the two middle bought options have different strikes. The strategy is suitable in a volatile market. The resulting position is profitable if the stock / index shows very high volatility and there is a big move in the stock / index. Example: Nifty is at 5800. Mr. XYZ expects high volatility in the Nifty and expects the market to break open significantly on any side. Mr. XYZ sells 1 ITM Nifty Call Options with a strike price of Rs. 5600 at a premium of Rs. 41.25, buys 1 ITM Nifty Call Option with a strike price of Rs. 5700 at a premium of Rs. 26, buys 1 OTM Nifty Call Option with a strike price of Rs. 5900 at a premium of Rs. 9.80 and sells 1 OTM Nifty Call Option with a strike price of Rs. 6000 at a premium of Rs. 6.00. The Net credit is of Rs. 11.45. On expiry Nifty Closes at 5300 5400 5500 5600 5611.45 5700 5800 5900 5988.55 6000 6100 6200 Net Payoff from 1ITM Call sold (Rs.) 41.25 41.25 41.25 41.25 29.80 -58.75 -158.75 -258.75 -347.30 -358.75 -458.75 -558.75 Net Payoff from1 ITM Callpurchased (Rs.) -26 -26 -26 -26 -26 -26 74 174 263 274 374 474 Net Payoff from 1 OTM Callpurchased (Rs.) -9.8 -9.8 -9.8 -9.8 -9.8 -9.8 -9.8 -9.8 78.8 90.2 190.2 290.2 Net Payoff from 1 OTM Call sold (Rs.) 6 6 6 6 6 6 6 6 6 6 -94 -194 Net Payoff (Rs.) 11.45 11.45 11.45 11.45 0 -88.55 -88.55 -88.55 0 11.45 11.45 11.45

ANALYSIS : Both the risk and the profit (The maximum profit of a occurs when the underlying stock / index is trading past the upper or lower strike prices.) are limited.

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OTHER STRATEGIES Call Back Spread : Short one ITM call option and long two OTM call options Similar to a Short Straddle except the loss on the downside is limited. Maximum Loss: Limited to the difference between the two strikes plus the net premium (which should be a credit).Maximum Gain: Unlimited on the upside and limited on the downside Put Back Spread : Long two OTM put options and short one ITM put option. Use when bullish on volatility. Maximum Loss: Limited to the difference between the two strikes less the premium received for the spread. Maximum Gain: Limited on the upside to the net premium received for the spread. Unlimited on the downside. Call Ratio Vertical Spread: Long one ITM call option and short two OTM call options. Use when bearish on volatility. Maximum Loss: Unlimited on the upside and limited on the downside. Maximum Gain: Limited to the difference between the two strikes less the net premium paid. Put Ratio Vertical Spread: Short two OTM put options and long one ITM put option. Use whem bearish on volatility. Maximum Loss: Unlimited on the downside and limited to the net premium paid on the upside. Maximum Gain: The difference between the two strike prices less the premium paid for the position.

DESIGN OF THE STUDY

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STATEMENT OF PROBLEM: A study of Option Trading Strategies and their application by the clients of Geojit BNP Paribas. Scope of the study : Compare the strategies used by the clients as against the specified strategies given by the NSE.
Advice the clients when to use what strategy depending upon their expectation of

the market , to fall or to rise. Also to find the the possible reasons inhibiting clients to invest in options. Objective of the study Primary objective Study the various Option Trading Strategies and their application at Geojit BNP Paribas. Generation of a model for investors advising them when to use which strategy, citing the risk and profits to be expected by applying a particular strategy. Secondary objective To understand the perception of investors about investing in Options for Long term or short term. SAMPLE DESIGN Sample Universe Sample Unit : Proffessionally or self employed men and women. Sampling Size : 70 Sampling Technique: Random Sampling either

DATA COLLECTION:
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Primary Data: Using Questionnaires Personal interview with the investors.

Secondary Data Transaction Details of the clients. Books and Articles.

STATISTICAL DESIGN : The collected data will be classified with the help of statistical tools such as percentages for the purpose of analysis. Data will be then analysed and inferences would be drawn from the analysis in the form of charts and graphs. CONTRIBUTION OF STUDY :
Help in finding a new opportunity for Geojit BNP Paribas in the field of Option

Trading. Helping in generating a model which colud advice them when to use which strategy based on their expectation about the market. LIMITATION OF THE STUDY Restricted only to investors that to a handful of them since access to large scale investors was not possible. Time factor was a chief limitation because to understand market no time is enough. Another major constraint would be the cost which was limited to my affordability.

47

EXPECTATION OF MARKET

STRATEGY TO BE USED
LONG CALL

BULLISH

SHORT PUT LONG COMBO ( Sell Put Buy Call) SHORT CALL

BEARISH

LONG PUT SYNTHETIC LONG PUT SYNTHETIC LONG CALL

MILDLY BULLISH
OTM)

COVERED CALL COLLAR BULL CALL SPREAD (Buy ITM Sell BULL PUT SPREAD (Buy OTM Sell ITM) COVERED PUT BEAR CALL SPREAD (Buy OTM Sell BEAR PUT SPREAD (Buy ITM Sell OTM)

MILDLY BEARISH
ITM)

LONG STRADDLE

HIGH VOLATILITY

LONG STRANGLE SHORT CALL BUTTERFLY SHORT CALL CONDOR SHORT STRADDLE

LESS VOLATILITY

SHORT STRANGLE
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LONG CALL BUTTERFLY LONG CALL CONDOR

From investment point of view

Options which are close to the spot price be it index/stock are generally traded, since they show greater movement as compared to the options with much lower or higher strike price. The major components of premium amount is Intrinsic Value Time Value

Thus by reducing the intrinsic value the premium amount can be reduced. As compared to the equity market here the investment is less, but the investor has to be cautious about his/her position.

Strategies involving buying and selling of stock alongwith the options can be little costly depending on the stock price. But trading in index options does not involve much of a cost. The premium amounts are falls in the bracket of Rs 100 to 300

Strategies such as Covered call, Synthetic Long Call Synthetic Long Put, Collar involve buying stock thus might get costly.

Strategies which belong to the high or low volatility market are used frequently by investors, following an impactful economic decision, taken by the government or a particular organization, since the investors are not sure whether the market will go up or fall down.

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Strategies involving more than two or three legs become more complex and are difficult for the investors to keep track of. For eg the condors and the butterfly are not commonly used.

As a rule not all investors decisions have a strong hold on the market, only a handful of them bring in the major changes which trade in large quantities. Options are not only difficult to trade by investors but also pose complexity in pricing them, and arriving at the strike price also. The famous Black Scholes Formula is used to arrive at the premium price of an option . The inputs required in this model are

The underlying assets current price The time to expiration of the option The risk-free interest rate The historical volatility of the underlying asset price

Given an assets historical volatility and using probability, the model is used to estimate how likely it is that an option will reach its strike price within the time left to expiration and thus its current theoretical premium value. There are also a number of more complex valuation models ranging from algebraic, to iterative to Monte Carlo simulation techniques.

Analysing the transaction details of the clients at Geojit BNP Paribas, referring to Annexure I (containing the transaction details of a particular client for the month of April till the expiry of the Nifty index option) , I came to the following conclusions.

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The term for trading used is intraday. Clients after taking a certain position do not wait till the expiry. On the other hand they square off their previous positions and take new positions many times before the expiration date.

The clients look for short term gains and do not make much use of strategies. The number of clients trading in Derivatives Market were very few as compared to the equity market.

Since I was interning during the months of April and May11, I got to see both the sides of the market. In April the market was bullish and in the month of May after announcing of the RBI monetary policy of increasing the repo rate by 50 basis points the market fell down drastically and I saw the other side of the market. A lot of volatility was expected in the market by speculators so therefore I would have advised to go for strategies such as LONG STRADDLE and LONG STRANGLE, which involves buying a put and a call together. Referring to example given while explaining the strategy with net debit(outflow) of Rs 66 the profit which could have been earned was unlimited when the market fell down drastically. The most common reasons why investors restrict themselves for trading in Options are Its complexity and thus difficult to understand Risky since the fluctuations are more than the underlying asset and Lack of awareness.

Since the trading in Option is settled in terms of cash a certain level of liquidity is required in the marketwhich at all times is not possible To understand the investor behaviour towards the opitions as a means of investment I designed a questionnaire and analysed it

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INTERPRETATION AND ANALYSIS

For introducing a new product in the market a through survey is done in order to deter mine the need for the product, but in this case the product is already there and a need is to be generated by creating awareness about the product. Thus a market survey was done by the way of questionnaire. There were 40 Graph Age distribution of the respondent

Graph Gender distribution of the respondent

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Graph Occupation of the respondent

The survey was focussed on the employed professionals and the businessmen Graph Bar graph showing since when the respondents have been investing in equity
45 40 35 30 25 20 15 10 5 0 0-3 yrs 3-6 yrs 6-9 yrs more than 9 yrs % age

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Clients which have been investing in equity for quite some time can start investing in derivatives since they know the basics of investing in stock markets. Prior to entering futures and options one should have some experience in equity since a long term investment in equity is generally rewarding. Therefore 41 % of the respondents can invest in Options. Graph Showing percentage of people in different domains of investment

The above graph shows that the investors are aware of the derivatives market and use it for the purpose of hedging it with the equity stocks( equity stocks and their futures ) But percentage of investors investing in options is very less. Graph Showing level of satisfaction with the returns from current postions

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Majority of the investors are happy or satisfied with the returns from the current portfolio

Graph showing modes of trading

38% of the investor trade on Intraday basis thus trading in options can be a field of investment Graph Showing reasons behind reluctance for investing in options

Most of the investors consider the complexity of options as a major hinderance

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for investment in options. A small section of the investors are unaware about the mechanism of options while others think that it is a risky mode of investment. Majority of the investors who are unaware of the option trading would want their specific brokerage houses to conduct presentations detailing the mechanism by which derivatives are traded and settled. A very small number of respondents which were questioned used options and only one or two of them used strategies and that to not in the truest sense.

RECOMMENDATIONS
On the basis of the interaction I had with the investors over the last two months and studying the option trading Strategies in detail , I have the following recommendations to make
Increasing Awareness : The analysis shows that most of the retail investors are

unaware of the Option Trading on their own with the use strategies involving taking more than one position. Generally derivatives are used for hedging purpose still most of the investors are unaware of the concept behind it and how association with derivatives can enhance the value of the portfolio of a particular customer.
Personal mail to Geojit clients : the current clients should be informed by mail

about this service and even offered to meet the Relationship Manager. Even awareness program can be arranged for the clients.
Conducting presentations: The clients should be invited to office regularly so as

their needs can be taken care of. The training staff or the business development officers( BDOs) should conduct presentations for clients who are interested and this could be followed by question and answer session to clear the doubts, and taking advice from so as to how they can be served better. These kind of activities make the client feel important since the brokerage that is deducted can have a negative affect on the clients.
Concessional Charges: The clients who have been with Geojit for quite long time

can be given which helps in customer retention.

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Those clients can provide references thus help in increasing the client base.
Differentiated Service: Geojit should strive to differentiate its offerings from the

comparable offerings of the competitors. Some of the possibilities are:

o

Geojit can offer Derivatives Research to some reputed firm. This will lend credibility to its offerings. Thus clients which are still reluctant to trade in options will consider it again since they will be guided by the experts.

It can make a mention of their services in a regular Newsletter and distributing it to their clients and other references for greater awareness

BIBLIOGRAPHY Websites:
www.nseindia.com www.investopedia.com www.optiontradingtips.com www.geojit.com

Books:
THE INVESTMENT GAME By Prasanna Chandra THE BIBLE OF OPTION STRATEGIES By GUY COHEN ROFIT WITH OPTIONS BY LAWRENCE G MACMILLAN HOW TO MAKE MONEY TRADING DERIVATIVES BY ASHWINI GUJRAL Optimal Long-Run Option Investment Strategies. By: Rendleman Jr., Richard J.. Financial Management (1972), Spring81, Vol. 10 Issue 1,

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A Study on Estimating Investment Timing of Real Options. By: Han, Hyun J.; Park, Chan S.. Engineering Economist, 2008, Vol. 53 Issue 3, Can We Capture the Value of Option Volatility? By: Lewis, Neal A.; Eschenbach, Ted G.; Hartman, Joseph C.. Engineering Economist, 2008, Vol. 53 Issue 3 Evaluating Product Plans Using Real Options. By: Shil, Prasenjit; Allada, Venkat. Engineering Economist, 2007, Vol. 52 Issue 3

The Varying Cost of Options and Implications for Choosing the Right Strategy. Source: Dubil, Robert Journal of Financial Planning; May2010, Vol. 23 Issue 5, p62-70, 8p ANNEXURE I Opt type CE PE PE CE CE PE CE CE CE PE PE PE PE PE PE CE CE CE CE PE PE PE PE PE PE PE Stk price 6000 5900 5900 6000 6000 5900 5800 5800 5800 5800 5800 5800 5800 5900 5900 5900 5900 5900 5800 5800 5800 5800 5800 5800 5800 5800 Tran date 18.04 18.04 18.04 18.04 18.04 18.04 18.04 19.04 19.04 20.04 20.04 21.04 25.04 25.04 26.04 26.04 26.04 26.04 26.04 27.04 27.04 27.04 27.04.\ 27.04 27.04 27.04
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Buy qty 0 250 0 100 400 0 800 50 500 500 250 1000 0 500 0 3350 0 0 0 400 300 200 500 100 0 0

Sell qty 100 0 250 0 0 750 0 0 0 0 0 0 1750 0 500 0 2000 2000 250 0 0 0 0 0 500 150

Rate 38.05 60.60 72.55 30.00 30.00 100 95 48.00 48.00 42.00 36.00 20.00 16.00 45.70 78.65 16.50 25.00 29.50 88 7.60 7.65 7.70 7.65 8.00 13.65 15

PE PE PE

5800 5800 5800

27.04 27.04 27.04

0 0 0

250 400 100

16 16 15

Symbol Date NIFTY NIFTY NIFTY NIFTY NIFTY NIFTY NIFTY NIFTY NIFTY NIFTY NIFTY NIFTY NIFTY NIFTY NIFTY NIFTY NIFTY 28-Apr-11 26-Apr-11 27-Apr-11 21-Apr-11 25-Apr-11 19-Apr-11 20-Apr-11 15-Apr-11 18-Apr-11 11-Apr-11 13-Apr-11 07-Apr-11 08-Apr-11 05-Apr-11 06-Apr-11 01-Apr-11 04-Apr-11 Expiry 28-Apr11 28-Apr11 28-Apr11 28-Apr11 28-Apr11 28-Apr11 28-Apr11 28-Apr11 28-Apr11 28-Apr11 28-Apr11 28-Apr11 28-Apr11 28-Apr11 28-Apr11 28-Apr11 28-Apr11

Strike Price 5800 5800 5800 5800 5800 5800 5800 5800 5800 5800 5800 5800 5800 5800 5800 5800 5800

Open 168.5 145.1 209.85 188.1 169.9 156 113 71.95 158 95 44.85 64.9 120 102.95 90 100 56

High 177.95 205.8 209.85 210.9 180 173.2 114.8 179.6 158 149.9 62.95 105.5 144.9 134.85 113.9 102.2 59

Low 138.25 139.15 145.65 148.05 148 111.15 81.1 60.15 89.6 43.05 36 46.9 104 90.3 34.2 38.4 0.05

Close 148.8 197.05 185.15 166.35 156.95 121.25 86.3 169.85 95.4 45.7 49.95 101.55 117.8 100.05 91.35 47.2 1.5

LTP 149.8 199 179 167.5 156.3 123.8 82.85 174.5 90 47.4 49.95 105 115.5 90.3 85.3 45.9 0.05

Settle Price 148.8 197.05 185.15 166.35 156.95 121.25 86.3 169.85 95.4 45.7 49.95 101.55 117.8 100.05 91.35 47.2 0

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