INTERNATIONAL JOURNAL OF MARKETING, Online Available at indianresearchjournals.

com
FINANCIAL SERVICES & MANAGEMENT RESEARCH
Vol.1 No. 6, June, ISSN 2277 3622

DEVELOPING OPTION STRATEGIES BY USING TECHNICAL

ANALYSIS: A CASE STUDY OF AUTOMOBILE SECTOR
DR. N MARUTI RAO
Associate Professor, PG Dept. of Business Administration, Rani Channamma University, Belagavi

ABSTRACT

During last one decade there was a rapid growth of derivatives market in India in terms of trading volume,
number of stock options available for trading, participation of investors in derivatives market. It was also
observed that retail investors are showing lot of interest in the derivatives market. However, retail investors have
lost lot of money in the derivatives market due to lack of knowledge about the product and investment strategies
etc. The risk involved in stock option trading can be minimized / return on stock option trading can be
improvised through designing suitable investment strategies such as bull spread, bear spread, butterfly spread,
strips, strap, strangle, straddle, etc. But, the fact is that simply selecting best of the option strategies does not help
investors to minimize risk or maximize profit, due care should be taken while selecting strike price, expiration
date and premium rates. So, investors need to develop risk management as well as risk analysis tool which is the
key to limiting option risk/ maximizing profit. In the backdrop of this a study has been conducted to develop
investment strategies for retail investors by using technical analysis. Auto industry was selected for the purpose of
the study. Major auto companies which are part of option segment were selected i.e. Tata Motors, Maruti Suzuki
India and Mahindra and Mahindra. The data required for the study was collected from Bombay Stock Exchange
and National Stock Exchange. The data collected were analysised by using Exponential Moving Average
Method, charts, etc. The paper makes an attempt to enumerate how Exponential Moving Average Method can be
used in selection of stock option strategy in order to manage risk associated with investment in stock option
market. A few managerial implications of this study are as stated under: wise investment decision, Enhancing
return on investment, hedging, etc.

Keywords: Close Price, Exponential Moving Average Price, Option Price and Option strategies.

INTRODUCTION
During last one decade there was a rapid growth of derivatives market in India in terms of trading volume, number of
stock options available for trading, participation of investors in derivatives market. It was also observed that retail
investors are showing lot of interest in the derivatives market. However, retail investors have lost lot of money in the
derivatives market due to lack of knowledge about the product and investment strategies etc. The risk involved in stock
option trading can be minimized / return on stock option trading can be improvised through designing suitable
investment strategies such as bull spread, bear spread, butterfly spread, strips, strap, strangle, straddle, etc. But, the fact
is that simply selecting best of the option strategies does not help investors to minimize risk or maximize profit, due care
should be taken while selecting strike price, expiration date and premium rates. So, investors need to develop risk
management as well as risk analysis tool which is the key to limiting option risk/ maximizing profit. There are number of
risk management and analysis tools available, which help investors to take wise investment decisions. One of the
popular tools which is widely used by technical analyst is Exponential Moving Average Method (EMAM) which helps
to predict future movement in stock price. If the investor uses technical analysis as a means to select stock option strategy
and strike price then it possible to minimize risk / maximize profit on stock option trading. In the backdrop of this a
study has been conducted to develop investment strategies for retail investors by using technical analysis. The paper
makes an attempt to enumerate how Exponential Moving Average Method can be used in selection of stock option

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strategy in order to manage risk associated with investment in stock option market. A few managerial implications of
this study are as stated under: wise investment decision, Enhancing return on investment, hedging, etc. Auto industry
was selected for the purpose of the study. Major auto companies which are part of option segment were selected i.e. Tata
Motors, Maruti Suzuki India and Mahindra and Mahindra. The data required for the study was collected from Bombay
Stock Exchange and National Stock Exchange. The data collected were analysised by using Exponential Moving
Average Method, charts, etc.

ABBREVIATION
EMAP: Exponential Moving Average Price
BSE: Bombay Stock Exchange
NSE: National Stock Exchange

Objectives of Study
1) To develop stock option strategy for auto stock
2) To develop a model for selecting stock option strategy.
3) To offer suggestions to retail investors

Methodology Auto industry was selected for the purpose of the study. Major auto companies which are part of
option segment were selected i.e. Tata Motors, Maruti Suzuki India and Mahindra and Mahindra. The data required for
the study was collected from Bombay Stock Exchange and National Stock Exchange. The stock prices of auto stock
traded in Bombay Stock Exchange from 2nd January to 10th February 2012 were collected. The option price and strike
price were collected from National Stock Exchange. The data collected were analysised by using Exponential Moving
Average Method, charts, etc. Predicting future price of stock

Tata Motors Ltd.

Tata Motors Ltd is a market leader in auto industry. Tata Motors is available for option trading both in NSE with lot size
of 500 units. Exponential Moving average price of the Tata Motors has been calculated based on 10 days moving period.

Chart - 1

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 DEVELOPING OPTION STRATEGIES BY USING TECHNICAL ANALYSIS: A CASE STUDY OF AUTOMOBILE SECTOR

It is evident from the chart 1 that the EMAP of Tata Motors has not intersected with close price during the period under
reference. If we assume that prior to 2nd January 2012, both EMAP and close price have intersected and thereafter
EMAP of Tata Motors is started moving in upward direction as it is visible from the chart then it is possible to predict
about future movement of price. The EMPA curve is moving in upward direction therefore the price of Tata Motors is
expected to move in upward direction.

Selection of Option strategy

As price of Tata motors is expected to go up moderately in the near term, it is suggested for investor to design Bull Put
Spread strategy as it will helps them to book profit/hedge risk. On 10th February 2012, the stock option price and strike
price quoted for Tata Motors Ltd (lot size: 500) in NSE option segment are given:

Underlying asset: Tata Motors Ltd

Expiration Date: 23rd March 2012
Option Type: Put

Strike price Option Price

120 4.00
130 35.60
135 39.60
140 44.25
145 48.70
150 48.50

Bull Put Spread Strategy

Buy 120, 1 Put on Tata Motors at Rs. 4.00 Sell 150, 1 Put on Tata Motors at 48.50

Chart -2

The chart-2 exhibits that the bull put spread strategy will ensure a maximum profit of Rs. 89000 if the spot price of Tata
Motors moves in upward direction as per the forecast.

Maruti Udyog Ltd.

Maruti Udyog Ltd is one of the leading players in the auto industry. Maruti Udyog is available for option trading both in

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NSE with lot size of 250 units. Exponential Moving average price of the Maruti Udyog has been calculated based on 10
days moving period.
It is evident from the chart -3 that the EMAP of Maruti Udyog has not intersected with close price during the period
under reference. If we assume that prior to 2nd January 2012, both EMAP and close price have intersected and
thereafter EMAP of Maruti Udyog is started moving in upward direction as it is visible from the chart then it is possible
to predict about future movement of price. The EMPA curve is moving in upward direction therefore the price of stock
will move in upward direction.

Chart -3
Selection of Option strategy
Price of Maruti Suzuki India Ltd expected to go up moderately in the near term; therefore investors have an opportunity
to use any of the following option strategy to book profit / hedge risk: a) long call option b) naked put option, c) bull
put spread. On 10th February 2012, the stock option price and strike price quoted for Maruti Suzuki India ltd in NSE
option segment are given below:
Underlying asset: Maruti Suzuki India Ltd
Expiration Date: 23rd March 2012

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 DEVELOPING OPTION STRATEGIES BY USING TECHNICAL ANALYSIS: A CASE STUDY OF AUTOMOBILE SECTOR

Chart - 4 : Payoff from Bull Put Spread

It can be understood from chart -4 that the bull put spread strategy helps investor to book profit if the price of
Maruti Suzuki India Ltd reaches to Rs.1200 and above in the cash market. The total payoff from this strategy is Rs.750
if the spot price of underlying asset reaches to Rs.1200 and Rs.25750 if the spot price reaches to Rs.1300.

Chart -5: Payoff from Long Call

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It is evident from the chart -5. that the long call strategy helps investor to book profit if the price of Maruti Suzuki India
Ltd moves to Rs.1180 and above in the cash market. The total payoff from this strategy is Rs.2000 if the spot price of
underlying asset reaches to Rs.1200 and Rs.32000 if the spot price reaches to Rs.1300.

Chart -6: Payoff from Naked Put

It is clear from the chart -6. that the Naked put strategy can helps investor to book profit if the price of Maruti
Suzuki India Ltd moves to Rs.1260 and above in the spot market. The total payoff from this strategy is Rs 4000 if the
price of underlying asset moves to Rs.1200 and Rs.14000 if the spot price moves to Rs.1300.
The analysis of chart-4, 5 and 6, reveals that investors should design long call strategy as this strategy helps them to
maximise profit compared to other option strategy.

Mahindra and Mahindra

Mahindra and Mahindra is also one of the major players in the auto industry. Mahindra and Mahindra is available for
option trading both in NSE with lot size of 500 units. Exponential Moving average price of the Mahindra and
Mahindra has been calculated based on 10 days moving period.

Chart -7

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 DEVELOPING OPTION STRATEGIES BY USING TECHNICAL ANALYSIS: A CASE STUDY OF AUTOMOBILE SECTOR

It is evident from the chart -7 that the EMAP of Mahindra and Mahindra has intersected with close price on 10th
February 2012 and started moving downward direction signalling that price of stock will move in downward direction
in the near future.

Selection of Option strategy

Price of Mahindra and Mahindra expected to move in downward direction; therefore investor has an opportunity to use
any of the following option strategy to book profit / hedge risk: a) naked call option b) bear call spread, c) bear put
spread. On 10th February 2012 the stock option price and strike price quoted for Mahindra and Mahindra Ltd in NSE
option segment are given below:

Underlying asset: Mahindra and Mahindra

Expiration Date: 23rd March 2012

Payoff from Naked call option

Basket I
Strike Price: 640
Call Option Price: 47.50

Chart -8

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Basket II
Strike Price: 660
Call Option Price: 39

Chart- 9
Basket III
Strike Price: 680
Call Option Price: 25.65

Chart 10

The analysis of charts 8, 9 and 10 reveals that it is advantageous for investors to sell call option with strike price of 680 at
Rs. 25.65 rather than selling call option with strike price of 660 and 640. The short position on call option with strike
price of 660 will fetch the investors Rs.19500 if the spot price moves as per the technical analysis.

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 DEVELOPING OPTION STRATEGIES BY USING TECHNICAL ANALYSIS: A CASE STUDY OF AUTOMOBILE SECTOR

Payoff from Bear Call Spread

Buy call option 800 at Rs. 1.20
Sell call option 640 at Rs.47.50

It is evident from the chart -11 that the bull call spread strategy can helps investor to book a minimum profit of 4350 and
a maximum profit of 24350 if the spot price moves in downward direction as per forecast

Chart 11

Payoff from Bear Put Spread

Buy call option 720 at Rs. 23.60
Sell call option 680 at Rs.16.35

It is evident from the chart -12 that the bull put spread strategy can helps investor to book minimum profit of 1375
and a maximum profit of 16375 if the spot price moves in downward direction as per forecast.

Chart 12

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The analysis of above table reveals that it is very safe and profitable for investor to design the bull put spread strategy
as it will ensure maximum and constant profit if the spot price of Mahindra and Mahindra moves to Rs.660/670/680.

Conclusion Investors in option market can use Exponential Moving Average Method for selecting option strategies
and strike price and option premium which may be of immense help to them in hedging risk associated with investment
in option market but also helps in maximising profit if prices of underlying stock moves in a direction as per the
prediction made by using EMAM.

REFERENCES
1) John Hull, "Options, Futures, and Other Derivatives, Prentice Hall, 2011.
2) John Person, technical analyst, Daniels Trading, "Moving Average Formula & Strategy Guide".
3) Raman Kumar, Atulya Sarin and Kuldeep Shastri, "The Impact of Options Trading on the Market Quality of the
Underlying Security: An Empirical Analysis" The Journal of Finance, Volume III, No.2, April 1998
4) Sandeep Srivastava, Surendra S Yadav, and P K Jain, "Significance of Non-Price Variables in Price Discovery: an
Empirical Study of Stock Option Market in India", Vikalpa, volume.33, No 2, April-June 2008.
5) Zhang, Jin E. "A lattice algorithm for pricing moving average barrier options"
6) Journal of Economic Dynamics and Control, Volume, 34, 2010, Pp: 542-554.

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