2 Replies to “Explain in detail how options are trading in indian deravatives market?”

  1. Hi,
    One thing you need to understand is that futures and options is mainly for hedging/speculation. It is not for individual investors. It is designed for large institutional investors/mutual funds. It is good to have knowledge about everything but somethimes, i feel it is wise not to touch it. It is a contract to buy/sell and not the actual delivery.
    Let me list a few terms used in the options market;
    1. Strike price – Forget about the definition given by various sites. You understand nothing by it. You’ve to get into the market to understand what it is. Let me take RIL for all my examples.. Say, RIL is quoting at Rs. 2236. You cannot go and ask for a contract of 2236 straight away. This is decided by the NSE that an RIL option has to have a strike price of 2190, 2220, 2250, 2280, 2310 etc. You see the sequence here; its +30. This also changes from stock to stock. So, you’ve to buy options contract at these rates. This is known as the strike price.
    2. Lot size – This is easy. You cannot enter into a contract today to buy just 1 share of Reliance Industries Ltd. It has to be 100 (fixed by the NSE). This lot of 100 shares is the size for RIL. It varies from stock to stock. Usually, the NSE approximates the value close to 2 lakh (the lot size * Current market price of the stock). The lot size doesn’t change too often.
    3. Premium – Now, the difficult part. If you have a watchlist of the index options (both call and put) with 20% variation on either side from the previous day’s close, you can see the huge difference (day-to-day) variation in out-of-the-money options (both CALL and PUT). The whole game of making/losing money is based on these premiums. My screen shows RIL 2310 CALL option LTP @ 34.90. But, the next column which shows the % change from yesterday shows a whopping 51% fall! That means, you’d have lost half your money had you bought RIL 2310 CALL yesterday! The premium fluctuates heavily on an intra-day basis.
    4. Call option – If you’re bullish about a stock or the whole market (index), you buy a CALL option. It is as good as selling a PUT option.
    5. Put option – If you’re bearish, then you BUY a PUT (remember, you’re BUYING and not selling a PUT option). It is as good as selling a CALL option.
    Usually, those who sell CALL/PUT are called options writers.
    6. Margin – Premium amount * market lot. This is the amount that you’ve to pay your broker at the time of entering into a contract i.e. either buying/selling a CALL/PUT. In case of RIL, I’ll have to pay 34.90*100 i.e. 3490 to my broker to buy an RIL 2310 CALL option which would expire on 27th March, 2008. Theoritically, i would gain only if RIL closes above 2344.90 (i’ve not included the brokerage here) on or before the expiry date. But, that’s not the reality. Since i mentioned earlier that premiums fluctuate heavily on an intra-day basis, you could get out with a 10% profit even on a single day!
    7. Expiry date – It is the last thursday of every month. If you’ve not exercised your option (i.e. you’ve not closed your open position, the contract gets expired on the expiry day automatically).
    8. European style – You cannot exercise the option on any day of your choice. It has to be on the expiry day only. In the financial dailies, the contracts are denoted as CE (CALL european), PE (PUT european) etc. In India, only the indexes are european style traded contracts.
    9. American Style – You can close your position the day of your choice, before the expiry day. Such contracts are denoted as PA & CA (PUT american & CALL american)
    10. In-the-money – CALLS or PUTS which are close to the prevailing price in the cash market is called in-the-money options. For example, RIL is @ 2236, then, 2220 & 2250 become in the money. This is not a hard and fast rule..
    11. Out-of-the-money – The options which are way too far from the current market price are called out of the money.
    There are many strategies to hedge; Covered call, unconvered call, straddle, strangle, to name a few..
    In options there’s one more factor called “decay” factor. This is an interesting concept and needs further explanation. But, for now, i hope my exhaustive answer would be enough to get some insight into options. I’ve written what has come to my mind and it might not be in the right order. Thanks.

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