Part 3: Futures and Options – How do Options work?

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Futures and options are contracts and similar to any other contract it is a contract between a buyer and a seller. Buyer is bullish expecting the market to go up and seller is bearish expecting it to go down. Only when there is trade between a buyer and seller, a contract opens and all such open contracts are together called as open interest.

So if I have bought 1 lot of Nifty expecting it to go up and you have sold 1 lot expecting it to go down, that makes it 1 open contract and hence the open interest of 1.

Typically every derivative contract will have its nifty 8200 call option price OI, Nifty August futures will have its own OI and September nifty 8200 call option price will have its own.

Similarly, OI will be different for calls and puts of various strikes. OI will go up when more people start participating or existing people start adding positions.

According to the OI theory, typically when a market is going in a particular direction and there is a huge addition in OI, this means there is more conviction in nifty 8200 call option price move.

So if the market is falling and there is a huge nifty 8200 call option price in OI, this would mean that the existing short positions which are making profits are adding more and hence the fall could be bigger. But understand that this is only theory and may or may not work like this in reality. While trading options, the money required to buy options is much lesser than what is required to write sell first. So typically the people who write options are people having access to higher capital and hence the logic is that they are more proficient traders.

I guess it is important to also understand why retail traders typically buy options and institutions sell them? Retail traders are always looking at buying options because technically you have chances of making unlimited profits with investments of small premiums, very similar to how lottery tickets work. What a retail trader forgets to look at is the fact that the odds of winning are much lower than when you are writing options.

Assume that Nifty is at and A buys the call at Rs. Since A is buying Rs. A can make unlimited profits from his Rsbut B can make a maximum of Rs from the Rs invested. But check out the odds and see which side you want to be on. For B to win at Expiry: Nifty stays where it is, Nifty 8200 call option price goes below and Nifty goes up but stays belowhe can make profits in 3 different scenarios compared to an option buyer who can in only 1 scenario.

As you will see the odds of a writer winning are higher. But also understand that as a writer of options you take unlimited risks and being lax on risk management would mean a severe dent to your trading account.

Coming back to the query, when OI nifty 8200 call option price calls is going up, there are new buyers and sellers writers coming in and since the writer is a more proficient trader as explained above, the belief is that he is probably right and better nifty 8200 call option price on his side of the trade which is basically expecting Nifty to not cross So if someone says OI on Nifty calls has gone up significantly, according to the OI logic it means that if Nifty is above it might come below and if it is already belowit might find it tough to go above If I sell 2 lots and there are 2 people X and Y who have bought 1 lot each, assuming we are the only people trading the contract, the OI is 2.

What happens if X who has bought 1 lot sells it to another person Z, what is the OI now? When X nifty 8200 call option price the lot he had bought from you to Z, a new contract was not created; the existing contract just changed hands so the OI will remain two.

But nifty 8200 call option price Z bought say 1 lot from anyone other than X and Y, then that would be a new lot and hence the OI will now go to 3. Since in the query above a new lot was not created, the OI remains at 2.

If the market is going down and OI is increasing market could go even lower because of the OI logic. Assume the OI is presently 10 on Nifty futures and Nifty is at This means there are 10 lots long and 10 lots short.

AtOI went up to 20, basically doubled. When OI went up, either the people who were holding positions from before added or new people came in and bought and sold lots. If you were looking at all of this, which side would you want to be on, long or short?

Understand that atlongs are sitting at 50, loss and are weak and shorts are sitting on 50, profits and are stronger. That is why we infer that if OI went up significantly when market goes in a particular direction, the direction might continue for much longer.

Logic behind assuming that if the OI for calls went up significantly, markets might not cross ? Let me give you an example, assume you are sitting in an exam on financial markets and there are 2 people sitting next to you. One is Nithin who has almost 15 years of experience in the domain and on the other side is this boy called Siva who is just 2 years into the business and still confused about what the business is all about.

If you had to copy, from whom will you copy, Nithin or Siva? So if you had to bet, be on the same side as the proficient one because the odds of winning go up. So when the OI for calls is going up, there are new buyers and sellers coming in and since sellers are more proficient traders we assume that they are right and hence the market may not go above This is all a theory and may or may not work in real life, but we at Zerodha proprietary trading desk believe it works and are also planning on a tool to help all our traders to track the OI to know what direction the professional traders are in.

According to this theory the underlying Nifty in the above example on the expiry day will gravitate towards that point at which option buyers will feel the maximum pain, basically a point where the maximum number of options, both calls and puts value could become zero worthless on the expiry day. To calculate this we need the open interest of both calls and puts for various strike prices Nifty in this example and use a correct formula to calculate the MaxPain point. Once you have a formula to calculate MaxPain there are 3 ways in which you can use it for trading, assume Nifty is presently and MaxPain is showing You can setup strategies assuming that Nifty will go towards You can use this for position management, which means that if Nifty is below the MaxPain, take larger buy positions than short positions, because we are generally expecting Nifty to go up.

Similarly if Nifty is above the MaxPain, take bigger short positions than long ones as you expect the market to come lower towards the MaxPain. Keep tracking MaxPain and anytime there is a big move, either up or down, use it as a buy or sell signal respectively.

We at Zerodha are looking forward to providing you a tool to nifty 8200 call option price a proprietary strategy of MaxPain for Nifty on our new website. This tool can then be used in any of the 3 ways mentioned above. If the ratio is more than 1, it means that more puts nifty 8200 call option price traded during the day and nifty 8200 call option price it is less than 1 it means more calls traded during the day.

NSE shares this information on this link daily. Assume that this average range for PCR over the last 1 year is in between 0. Like MaxPain, PCR is also a contrarian strategy which believes that option buyers will typically lose money.

So a typical way to analyse PCR would be:. If PCR is below 1, it would mean nifty 8200 call option price more calls are being traded and since more calls are being traded by the retail traders option buyers this could mean that the markets might do the opposite which is go down. Lower than 1 the PCR is, higher the chances of the market coming down. Since you know that historically PCR has been in the range of 0.

If PCR is above 1, it would mean that more puts are being traded and since more puts are being traded by the retail traders option buyers this could mean that markets might do the opposite which is go up. Higher than 1 the PCR is, higher the chances of the market going up. Since historically PCR is in the range of 0. Love playing poker, basketball, and guitar.

Lastly thanks for this write up and hope you will provide many more such articles for mutual benefit we gain and trade more and you get more brokerage. It is tricky to put a formulae to calculate maxpain as there is none. We have to calculate it based on our own logic.

We will share the tool that we internally use at Zerodha and should be up with our new website in the next couple of months. You can use Kite, has over indicators http: Hello Sir, is the tool to identify Max pain available in Zerodha website. If yes where this can be find. Hi, Sir is the formula that you use internally at Zerodha to calculate Maxpainpoint available yet?

I have one doubt Sir. What nifty 8200 call option price be the OI change. What you can track is whether the net OI for an individual contract is going up or down. I have checked on the column options available. If this feature is already available but I am unaware, please advise me.

Yes, OI change is currently not available. On our list of things to do. Do read about why it might not be smart to track OI intraday. You can add Open Interest from here. PCR is not available nifty 8200 call option price Nifty Options alone. It is available for Index Options. You can get it by clicking here. On Expiry day all contract come to end with cash settlement, but end of the day still open interest show it,how? What it mean by? If nifty 8200 call option price are checking for the Aug futures open interest after market closing, it will basically be showing the last OI before closing of the contract.

But if you are looking at general Nifty Future OI, there will be Sep futures and Oct futures which will be open at the end of Aug futures. Max Pain is a theory and may or may not work the way it is nifty 8200 call option price. Market moves according to itself, but more often than not tends to go towards the point where it can hurt the options buyers the most.

Currently nifty is at It has appreciated by pints in last 3 days. Today data shows nifty index future OI increased by 1. So what I should infer by OI theory? But if a lot of calls are being written, then ideally according to Max pain theory, market will not go up much.

Hi, I just noted that for the option contracts data, zerodha does not have greek variables delta, theta etc. Will we get that data in zerodha?

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Most retail traders usually buy options, i. Selling options is used when exiting options that were already bought. What this means is that by buying an option calls or puts the odds of losing are significantly more. Now the question is if options buyers are inherently taking a higher risk, who is on the other side of the trade with better odds of winning? Let me explain with a basic introduction to what comprises option premium, different types of options, open interest and an example showing how most options expire worthless.

Option premium, the value of calls or puts that you see on your trading screen has two components, Intrinsic value, and time value. Intrinsic value is how much the option is in the money, or simply how much you would get if the options were to expire right now. Time value is the portion of premium which is over and above the intrinsic value of an option, i. The total number of open contracts for any option is called its Open Interest. In the example above if Nifty were to expire today at , the total options that would expire worthless would be: Yes, an option buyer can take quick intraday trades for a profit, or be on the right side of the market and have the potential of making unlimited profits, but the odds of winning are always in favor of an option writer who benefits with majority of options expiring worthless.

An option buyer has limited risk and unlimited profit potential, so if 1 lot of Nifty call was bought at Rs , the maximum loss on this trade is the Rs Rs x 50 , and if Nifty went to the call would make a profit of Rs 45, When you write an option, say 1 lot of calls at Rs , Rs Rs x 50 which is the premium paid by the buyer is credited to your trading account and this Rs on the premium is your maximum profit potential. After taking this trade if. Since the potential losses are unlimited, it is best as a beginner option writer to be conservative, and allocate only a small portion of your trading capital when starting off.

Since the risk is unlimited for an option writer, the exchange blocks margin and similar to futures is marked to market at the end of every day. So to buy an option at Rs , you need to have only Rs Rs x 50 , but to write an option you will need around Rs 25, which is marked to market daily, which means that if there is a loss you are asked to bring in those funds to your trading account by end of the day.

Option writing margin requirement varies for every contract, and as on today Zerodha is the only brokerage in India to offer a web based SPAN tool that lets you calculate this.

You have a bearish view of the market and Nifty is presently at Check the SPAN calculator for the margin required as shown below:. Love playing poker, basketball, and guitar. Around Rs required to short option. You can check it out yourself here: If i am exiting the call written mid way , is the process in Zerodha same as in case of buying a option..

I mean just by a single click on exit option i can the call option written. Can I hold the options over night [or till expiry] after shorting or is this settled at EOD automatically everyday? Will you charge interest for margin provided?

Should I buy back my option before expiry or should I leave it to expire, especially if it is in the money ITM. I have written November call , now today is expiry day, if market closes above what should I do? How we calculate vix for a stock like Infosys, Last time 11 October Result Day I observed that Option prices increased from 6 October to 10 October, this time prices decreased from 6 Jan o 10 Jan.

Calculation of Vix for a stock is pretty complex, let me see if I can find tool for you, nothing in the back of mind. Dr Sir I a little confused on This point Nifty is on expiry, value of calls on expiry is 0, and you get to keep the entire Rs Nifty is on expiry, value of calls is still 0, and you get to keep the entire Rs Did You mean no profit no loss?

In mis at I totally agree with you. Very important and required information for all of us. I understand that margin is required when one writes the naked option and has to arrange MTM funds. A question in my mind for a long time is, when one takes a debit spread, say long call and short call, the maximum the person looses is the difference in premium which was already paid. In such a case why should a margin be collected, though the margin is less than naked option writing?

Is it not sufficient to block selling the long option alone before covering the short option? The margins blocked are as per the exchange requirements, and yes the Indian exchanges are extra stringent about this. Coming to your example, Long call and Short call, and assume only Rs 10, is blocked for this the buy premium.

Yes the scenario is unlikely, but possible. I guess the only way such spreads will become popular is if NSE starts letting people trade the spreads directly itself, similar to calendar spreads. I want to write call and put nifty options Positionally. In this case we can get profit from premium melting. Other wise the lose also will be minimum and limited.

Can you give exposure? For above trading method, what is the margin for 4 lots qty? Ranganathan, you can check all margin requirements on our SPAN calculator: Krishna, it depends on what spread you are taking, check this blog on SPAN calculator , which shows how you can see the margin requirements of such spread using our SPAN calculator.

Just tried out your suggestion, but the math does not add up. Suppose I get into a bear call spread on Nifty, as follows:. SPAN margin — Rs: The total margin required is still Rs. The maximum loss on this spread is only Rs. The risk is limited, and so should the margin. The difference between the return on capital is almost 5x.

Why is the margin benefit so little? Is it possible to enable SPAN minimum requirements on individual trading accounts?

Guc, what you need to realize is that the risk for such contract is never limited, there is always a big execution risk which is open and one of the reasons why margins are higher. What if while exiting you got out of your buy CE position and market suddenly bounced up in this little time? The risk on your short CE would then be unlimited. Unless the spread itself starts trading on the market similar to calendar spreads , it will never be possible to block margins based on what you have suggested.

Also, this is an exchange regulation and the SPAN calculator gives what exchange asks us to block. DC, advisory is tricky because: People will never follow advise properly, but the adviser is liable for it.. If it starts working, traders will become puppets to the adviser.

What is missing is the liquidity, basically we need a lot more traders coming to the market, when they do, new products will automatically come about. The bigger problem for everyone to solve is bringing in liquidity to the markets. I wish you include two parts like buying and writing in brokerage calculator. Which helps writers to include STT. STT changes for option buy positions, if it is in the money and you let it expire.

You can read this blog for that.. If you look at the default example on http: If it is possible to set a trigger in the trading terminal for executing option strategy, it makes life easier. I mean when nifty futures trades at a set price, then the option strategy gets executed at market prices. Something like SL-M order. Setting trigger like what you said, take an option strategy if Nifty trades at a price, it is little tricky, mainly because of the regulations.

Exchange would consider that as an algo, which is not allowed for retail. For In the money options, Do we have facility to exercise the options at Spot price at end of Day? How it will be carried out. Mukesh, all Indian options are Europen options. If you exercise them, they will be cash settled. For more, check out the options trading module on Varsity. Nitin, On the last line algo for retail , there were a couple of SEBI circulars which wanted brokers to demonstrate appropriate risk management processes before offering algo access to their customers.

Is there some SEBI circular that prohibits retail from using algos? Is there also a SEBI circular under which exchanges derive power to validate algos? What SEBI has recently mandated is that for brokers providing algo, to compulsorily take part in mock trading sessions and a stricter audit. Let me try getting you the circular numbers on these. Hi This is very wonderful article. Really I appreciate you.

Recently I have opened trading account with OpetionsXpress. It is really wonderful system for trading in Options and Futures. I recommend to you to visit that site and create a Virtual trading account and evaluate the platform which they are providing to their clients. Still we are far behind in technologies. Sir, I appreciate you. It is a very good article.