Future and options in indian stock market
As with any of the previous modules in Varsity, we will again make the same old assumption that you are new to options and therefore know nothing about options. For this reason we will start from scratch and slowly ramp up as we proceed. Let us start with running through some basic background information. The options market makes up for a significant part of the derivative market, particularly in India.
Internationally, the option market has been around for a while now, here is a quick background on the same —. Clearly the international markets have evolved a great deal since the OTC days.
However in India from the time of inception, the options market was facilitated by the exchanges. The badla system no longer exists, it has become obsolete. Here is a quick recap of the history of the Indian derivative markets —.
Though the options market has been around sincefuture and options in indian stock market real liquidity future and options in indian stock market the Indian index options was seen only in ! I remember trading options around that time, the spreads were high and getting fills was a big deal. However inthe Ambani brothers formally split up and their respective companies were listed as separate entities, thereby unlocking the value to the shareholders.
In my opinion this particular corporate event triggered vibrancy in the Indian markets, creating some serious liquidity. However if you were to compare the liquidity in Indian stock options with the international markets, we still have a long way to catch up.
There are two types of options — The Call option and the Put option. You can be a buyer or seller of these options. In fact the best way to understand the call option is to first deal with a tangible real world example, once we understand this example we will extrapolate the same to stock markets.
Consider this situation; there are two good friends, Ajay and Venu. Ajay is actively evaluating an opportunity to buy 1 acre of land that Venu owns.
The land is valued at Rs. Ajay has been informed that in the next 6 months, a new highway project is likely to be sanctioned near the land that Venu owns. If the highway indeed comes up, the valuation of the land is bound to increase and therefore Ajay would benefit from the investment he would make today.
So what should Ajay do? Clearly this situation has put Ajay in a dilemma as he is uncertain whether to buy the land from Venu or not. While Ajay is muddled in this thought, Venu is quite clear about selling the land if Ajay is willing to buy.
Ajay wants to play it safe, he thinks through the whole situation and finally future and options in indian stock market a special structured arrangement to Venu, which Ajay believes is a win-win for both of them, the details of the arrangement is as follows —. So what do you think about this special agreement?
Who do you think is smarter here — Is it Ajay for proposing such future and options in indian stock market tricky agreement or Venu for accepting such future and options in indian stock market agreement? Well, the answer to these questions is not easy to answer, unless you analyze the details of the agreement thoroughly.
I would suggest you read through the example carefully it also forms the basis to understand options — Ajay has plotted an extremely clever deal here! In fact this deal has many faces to it. Now, after initiating this agreement both Ajay and Venu have to wait for the next 6 months to figure out what would actually happen. However irrespective of what happens to the highway, there are only three possible outcomes —. Remember as per the agreement, Ajay has the right to call off the deal at the end of 6 months.
Now, with the increase in the land price, do you think Ajay will call off the deal? This means Ajay now future and options in indian stock market the right to buy a piece of land at Rs. Clearly Ajay is making a steal deal here. Venu is obligated to sell him the land at a lesser value, simply because he had accepted Rs. Another way to look at this is — For an initial cash commitment of Rs.
Venu even though very clearly knows that the future and options in indian stock market of the land is much higher in the open market, is forced to sell it at a much lower price to Ajay. The profit that Ajay makes Rs. It turns out that the highway project was just a rumor, and nothing really is expected to come out of the whole thing. People are disappointed and hence there is a sudden rush to sell out the land.
As a result, the price of the land future and options in indian stock market down to Rs. So what do you think Ajay will do now? Clearly it does not make sense to buy the land, hence he would walk away from the deal. Here is the math that explains why it does not make sense to buy the land —. Remember the sale price is fixed at Rs. Hence if Ajay has to buy the land he has to shell out Rs. Which means he is in effect paying Future and options in indian stock market.
Clearly this would not make sense to Ajay, since he has the right to call of the deal, he would simply walk away from it and would not buy the land. However do note, as per the agreement Ajay has to let go of Rs. For whatever reasons after 6 months the price stays at Rs. What do you think Ajay will do?
Well, he will obviously walk away from the deal and would not buy the land. Why you may ask, well here is the math —. Clearly it does not make sense to buy a piece of land at Rs. Do note, since Ajay has already committed 1lk, he could still buy the land, but ends up paying Rs 1lk extra in this process. For this reason Ajay will call off the deal and in the process let go of the agreement fee of Rs. I hope you have understood this transaction clearly, and if you have then it is good news as through the example you already know how the call options work!
But let us not hurry to extrapolate this to the stock markets; we will spend some future and options in indian stock market time with the Ajay-Venu transaction. I would suggest you be absolutely thorough with this example. If not, please go through it again to understand the dynamics involved. Also, please remember this example, as we will revisit the same on a few occasions in the subsequent chapters. Do note, I will deliberately skip the nitty-gritty of an option trade at this stage.
The idea is to understand the bare bone structure of the call option contract. Assume a stock is trading at Rs. You are given a right today to buy the same one month later, at say Rs. Obviously you would, as this means to say that after 1 month even if the share is trading at 85, you can still get to buy it at Rs. In order to get this right you are required to pay a small amount today, say Rs. If the share price moves above Rs. If the share price stays at or below Rs.
All you lose is Rs. After you get into this agreement, there are only three possibilities that can occur. Case 1 — If the stock price goes up, then it would make sense in exercising your right and buy the stock at Rs. Case 2 — If the stock price goes down to say Rs. Case 3 — Likewise if the stock stays flat at Rs.
Future and options in indian stock market is simple right? If you have understood this, you have essentially understood the core logic of a call option. What remains unexplained is the finer points, all of which we will learn soon. At this stage what you really need to understand is this — For reasons we have discussed so far whenever you expect the price of a stock or any asset for that matter to increase, it always makes sense to buy a call option!
Now that we are through with the various concepts, let us understand options and their associated terms. Hi Sir, Options is like greek and latin to me. Thanks for the analogies. No, all derivative contracts are routed via the exchanges. You cannot enter into an OTC arrangement, even if you do, it would not be regulated hence quite dangerous. What benefit would Ajay get by calling off the deal before the expiry of 6 months? He will instead wait for the whole 6 months for any chance of the highway future and options in indian stock market.
My first question Karthik is this: The dropdown value on the NSE website does not contain all months expiries — after 18th May we have 25th June followed by 24th Sept and then 31st Dec What happened to the other months? For to only June and Dec contracts are available. What happened to the remaining? Saurabh, glad you noticed it! For all stocks options the expiry is very similar to futures. Hence we have current month, mid month, and far month contracts. However for Nifty there are several different expiry options.
Leaps are good if you have a super long term view on markets. However the problem with leaps in India is that they are not liquid, there are hardly any trading activity here.
Are you aware of future and options tips in the market? Well future options are an excellent way to trade the future markets. Instead of straight futures contracts there are many new traders who start by trading futures options in the stock market. There is very less risk and volatility when you use options instead of futures.
But you will mainly see traders who are professional who use trade options. You need to buy options in the Indian stock market in order to bet on the price of the futures contract so that it goes higher or lower in trading purposes. So there are mainly two types of options — call option and put option. If you think that the underlying futures price will move higher then can buy call option.
In terms of put option, if you believe that the underlying future prices will move lower, then you can always opt for this option. You can also think of the pricing of options as a bet. There is also an expiration date of options. This means that they last for only a certain period of time.
You cannot hold an option for a long time. Suppose you buy an option in July, in that case, the option will expire in late June. So, you have to close the position before its expiration. So, you can go for future and options tips where you can manage your options in a systematic way.
Also go for share tips so that you can get the whole idea of the market. Click here for Indian stock market tips. For more details click here. What Are Futures Options? Call Option If you think that the underlying futures price will move higher then can buy call option. Put Option In terms of put option, if you believe that the underlying future prices will move lower, then you can always opt for this option.
How are Stock Futures different from Stock Options? In stock options, the option buyer has the right and not the obligation, to buy or sell the underlying share. Risk-return profile is symmetric in case of single stock futures whereas in case of stock options payoff is asymmetric. Also, the price of stock futures is affected mainly by the prices of the underlying stock whereas in future and options in indian stock market of stock options, volatility of the underlying stock affect the price along with the prices of the underlying stock.
What are Stock Futures? How are Stock Futures priced? What are the opportunities offered by Stock Futures? How are Stock Futures settled? Can I square up my position? When am I required to pay initial margin to my broker? Do I have to pay mark-to-market margin? What are the profits and losses in case of a Stock Futures position? What is the market lot for Stock Futures? Why are the market lots different for different stocks? What are the different contract months available for trading? What is spread trading on BSE?
As an investor, how do I start trading in Stock Futures? What securities can I submit to the broker as collateral? How does future and options in indian stock market investor, who has the underlying stock, use Stock Futures when he anticipates a short-term fall in stock price? How can an investor benefit from a predicted rise or predicted fall in the price of a stock?
What is pair trading?