Basics

What is Cash Market?

What is Future & Options? Why we use word “Derivative”?

• Futures and cash market difference

• Concept of Lot & Lot size and difference between
Cash market and Future Market
Options
Asset Tradable Instruments

Cash Market (Nifty) Futures (Nifty) Options (Nifty)

Qty : 1 (Minimum) Qty : 1 Lot (Minimum) = 75 * 12200 = Rs/- 9,15,000 Lot Size same as Futures

Ownership: 1 Share No Ownership No Ownership

Full Amount:
Margin Money = Rs/- 1,03,000 Premium
1 *12200 = 12200

- MTM MTM

No Leverage:
Leverage : 8 Times approx Leverage : 20 Times
1 *12200 = 12200

Long : Buy ---- Long + Short Long = Buy A Call Option

Short Sell: Intra Day Short Sell : Overnight Short = Buy A Put Option

}
Holding : 1 Near Month : 25 th July : 1 Near Month : 25 th July : Liquidity
Holding: Non
: 2 Next Month : 29 th August Series : 2 Next Month : 29 th August
Restrictive
: 3 Far Month : 26 th September : 3 Far Month : 26 th September

Nifty & Bank Nifty have weekly expiry

}
Expiry : 1 Near Month : 25 th July : 1 Near Month : 25 th July
Settlement: T +2 : 2 Next Month : 29 th August
: 3 Far Month : 26 th September
Rollover : 2 Next Month : 29 th August
: 3 Far Month : 26 th September
}
Moneyness of Options Contract
Strike Price  The strike price is the specified price at which
an option contract can be exercised.

• Strike prices are fixed in the option contract.

• For call options, the option holder has the right to purchase the underlying stock at that
strike price up to the expiration date.

• For put options, the strike price is the price at which the underlying stock can be sold.

• Let’s take an example of options exercising, ITM, ATM & OTM

 Options: Moneyness

Call Put

Underlying 11450 Underlying 11450

Far Deep
OTM ITM
11400 OTM 11400 ITM

11350 11350

Price Strike Price Strike

11300 ATM 11300 ATM
11272 Price 11272 Price

11250 11250

11200 ITM 11200 OTM

Deep Far
ITM OTM
11150 11150
Options is Zero sum game

The gain of a holder

is a loss of a writer
and Vice Versa
Intrinsic Value
• The Moneyness of an option contract is a classification method wherein each option
(strike) gets classified as either – In the money (ITM), At the money (ATM), or Out of the
money (OTM) option.

• This classification helps the trader to decide which strike to trade, given a particular
circumstance in the market.

• The intrinsic value of an option is the money the option buyer makes from an options
contract provided he has the right to exercise that option on the given day. Intrinsic Value
is always a positive value and can never go below 0.

• Intrinsic value of an option is the amount of money you would make if you were to exercise
the option contract

• Intrinsic value of an options contract can never be negative. It can be either zero or a
positive number

• Call option Intrinsic value = Spot Price – Strike Price

• Put option Intrinsic value = Strike Price – Spot price

Greeks
• "Greeks" is a term used in the options market to describe the different dimensions of risk
involved in taking an options position.
• These variables are called Greeks because they are typically associated
with Greek symbols.
• Options Premiums, options Greeks, and the natural demand supply situation of the
markets influence each other.
• Though all these factors work independently, yet they are all intervened with one
another.
• The final outcome of this mixture can be assessed in the option’s premium.
• For an options trader, assessing the variation in premium is most important. He needs to
develop a sense for how these factors play out before setting up an option trade.
• Theta - Measures the impact on premium based on time left for expiry
• Delta - Measures the rate of change of options premium based on the
directional movement of the underlying
• Vega - Rate of change of premium based on change in volatility
• Gamma - Rate of change of delta itself
Greeks: Options are wasting assets
• A wasting asset declines in value over time.

• Vehicles and machines are examples of fixed assets that are wasting assets.

• In the financial markets, options are wasting asset because their time value continually
diminishes to zero at expiration
Greeks : Theta of an Option
• Theta is a measure of the rate of decline in the value of an option due to the passage of
time.
• It can also be referred to as an option's time decay.
• If everything is held constant, the option loses value as time moves closer to the maturity of
the option.
• the amount of decay indicated by Theta tends to be gradual at first and accelerates as
expiration approaches.
Greeks : Delta of an Option
• Delta is one of four major risk measures used by option traders.

• Delta measures the degree to which an option is exposed to shifts in the price of the
underlying asset

• Delta is a measure of the change in an option's price (that is, the premium of an option)
resulting from a change in the underlying security.

• the delta helps us evaluate the premium value based on the directional move in the
underlying

• The value of Delta ranges from -1 to 0 for puts and 0 to 1 for calls. Means Call option
has a positive Delta and Put option has negative Delta
Greeks : Delta of an Option

Example 1 = Call Option Example 1 = Call Option

CALL PUT

Parameters Values Parameters Values

Underlying Nifty Underlying Nifty

Strike 12000 Strike 12000

Spot Value 12034 Spot Value 12034

Premium 263 Premium 263

Delta 0.55 Delta -0.55

Nifty move 100 Nifty move 100

(up or down) by (up or down) by

Expected movement Nifty move X Delta Expected movement Nifty move X Delta
in options 100 x 0.55 = 55 in options 100 x - 0.55 = - 55
premium is premium is
Greeks : Delta of an Option
Value of Delta (Approximately)

Option Type Approx Delta Value (CE) Approx Delta Value (PE)

Deep ITM Between + 0.8 to + 1 Between - 0.8 to - 1

ITM Between + 0.6 to + 1 Between - 0.6 to - 1

ATM Between + 0.45 to + 0.55 Between - 0.45 to - 0.55

OTM Between + 0.45 to + 0.3 Between - 0.45 to - 0.3

Far OTM Between + 0.3 to + 0 Between - 0.3 to - 0

Delta & Moneyness

Moneyness Strike Delta Nifty Old Change in New Premium %

move Premium Premium Change
points

Far OTM 12200 0.05 100 ` 80.00 100 x 0.05 = 5 80 + 5 = 85 6%

Slightly
12200 0.3 100 ` 80.00 100 x 0.3 = 30 80 + 30 = 110 38%
OTM

ATM 12200 0.5 100 ` 80.00 100 x 0.5 = 50 80 + 50 = 130 63%

Slightly
12200 0.7 100 ` 80.00 100 x 0.7 = 70 80 + 70 = 150 88%
ITM

Deep
12200 1 100 ` 80.00 100 x 1 = 100 80 + 100 = 180 125%
ITM
Greeks : Vega of an option
• With increase in Volatility, the premiums increase, but the question is ‘by how much?’.
This is exactly what the Vega tells us.

• The Vega of an option measures the rate of change of option’s value (i.e. premium) with
every percentage change in volatility.

• Since options gain value with increase in volatility, the Vega is a positive number, for
both calls and puts.

• For example – if the option has a Vega of 0.15, then for each % change in volatility, the
option will gain or lose 0.15 in its theoretical value.
Volatility
• The effect of Increase in volatility is maximum when there are more days to expiry – this
means if you are at the start of series, and the volatility is high then you know premiums
are on higher side.

• Maybe a good idea to write these options and collect the premiums – invariably when
volatility cools off, the premiums also cool off and you could pocket the differential in
premium

• When there are few days to expiry and the volatility shoots up the premiums also goes
up, but not as much as it would when there are more days left for expiry.

• So if you are a wondering why your long options are not working favorably in a highly
volatile environment, make sure you look at the time to expiry
• Historical Volatility is measured by the closing prices of the stock/index

• Forecasted Volatility is forecasted by volatility forecasting models

• Implied Volatility represents the market participants expectation of volatility

• India VIX represents the implied volatility over the next 30 days period

• Vega measures the rate of change of premium with respect to change in volatility

• All options increase in premium when volatility increases

• The effect of volatility is highest when there are more days left for expiry
India VIX
• India VIX indicates the investor’s perception of the market’s volatility in the near term
(next 30 calendar days)

• Higher the India VIX values, higher the expected volatility and vice-versa

• When the markets are highly volatile, market tends to move steeply and during such time
the volatility index tends to rise

• Volatility index declines when the markets become less volatile.

• Volatility indices such as India VIX are sometimes also referred to as the ‘Fear Index’,
because as the volatility index rises, one should become careful, as the markets can
move steeply into any direction.

• Investors use volatility indices to gauge the market volatility and make their investment
decisions

• What is the difference between NIFTY Index and India VIX?

Nifty India VIX

NIFTY measures the direction of the India VIX measures the expected
market and is computed using the volatility and is computed using the
price movement of the underlying order book of the underlying NIFTY
stocks options.

Nifty is a number India VIX is denoted as an annualized

percentage
Gamma
• The delta is a variable, whose value changes based on the changes in the underlying
and the premium

• The Gamma of an option measures this change in delta for the given change in the
underlying

• For a given change in the underlying, what will be the corresponding change in the delta
of the option?

• Change in premium with respect to change in underlying is captured by delta, and hence
delta is called the 1st order derivative of the premium

• Change in delta is with respect to change in the underlying value is captured by Gamma,
hence Gamma is called the 2nd order derivative of the premium

• As an analogy to physics, the delta of an option is its "speed," while the gamma of an
option is its “acceleration”.

• When the option being measured is deep in or out of the money, gamma is small.

• When the option is near or at the money, gamma is at its largest

• All options that are a long position have a positive gamma, while all short options have a
negative gamma.

• Gamma decreases, approaching zero, as an option gets deeper in the money and delta
approaches one.

• Gamma also approaches zero the deeper an option gets out of the money. Gamma is at
its highest when the price is at the money.

• Gamma is the rate of change for an option’s delta based on a single-point move in the
delta’s price.

Assumptions

Nifty Spot 11970

Strike 12100
Option Type CE
Moneyness Slightly OTM
Old Premium 68.00
Old Delta 0.35
 Gamma 0.001

Scenario 1

Points P/L 50

Nifty Spot New 12020 Gain / Loss in Premium (Delta) = 17.50

New Premium 1 = Old Premium + (Points P/L* Old Delta) = 85.50

New Delta 1 = Old Delta + (Points P/L* Old Gamma) = 0.40

Scenario 2

Points P/L -80

Nifty Spot New 11940 Gain / Loss in Premium (Delta) = -32.00

New Premium 2 = New Premium 1 + (Points P/L* New Delta 1) = 40.00

New Delta 2 = New Delta 1 + (Points P/L* Gamma) = 0.27

Greek Calculator Or Black Scholes
Calculator
• How to calculate these Greeks using the Black & Scholes (BS) Options pricing
calculator?

• The BS options pricing calculator is based on the Black and Scholes options pricing
model, which was first published by Fisher Black and Myron Scholes (hence the name
Black & Scholes) in 1973, however Robert C Merton developed the model and brought in
a full mathematical understanding to the pricing formula.

Overview of the model

The framework for the pricing model works like this:

• We input the model with Spot price, Strike price, Interest rate, Implied volatility, Dividend,
and Number of days to expiry

• The pricing model churns out the required mathematical calculation and gives out a
bunch of outputs

• The output includes all the Option Greeks and the theoretical price of the call and put
option for the strike selected

• Spot price – This is the spot price at which the underlying is trading

• Interest Rate – This is risk free rate prevailing in the economy. Use the RBI 91 day
Treasury bill rate for this purpose. You can get the rate from the RBI website, RBI has
made it available on their landing page

• Dividend – This is the dividend per share expected in the stock, provided the stock goes
ex dividend within the expiry period. For example, assume today is 11th September and
you wish to calculate the Option Greeks for the ICICI Bank option contract. Assume
ICICI Bank is going ex dividend on 18th Sept with a dividend of Rs.4. The expiry for the
September series is 24th September 2015, hence the dividend would be Rs.4. in this
case
• Number of days to expiry – This the number of calendar days left to expiry

• Volatility – This is where you need to enter the option’s implied volatility

Open Interest interpretation

• Definition: Open interest is the total number of outstanding contracts that are held by
market participants at the end of each day. Open interest measures the total level of
activity into the futures market.

• Description: If both parties to the trade are initiating a new position (one new buyer and
one new seller), open interest will increase by one contract. If both traders are closing an
existing or old position (one old buyer and one old seller), open interest will decline by
one contract. If one old trader passes off his position to a new trader (one old buyer sells
to one new buyer), open interest will not change.

• Increasing open interest means that new money is flowing into the marketplace. The
result will be that the present trend (up, down or sideways) will continue. Declining open
interest means that the market is liquidating and implies that the prevailing price trend is
coming to an end. Therefore, open interest provides a lead indication of an impending
change of trend.

• To determine the total open interest for any given market, we only need to know the
totals from one side or the other, buyers or sellers, and not the sum of both.

Open Interest Volume

Open interest information tells us Volume on the other hand tells us how many
how many contracts are open and live in the trades were executed on the given day
market.

OI is not discrete like volumes, OI stacks up or The volume counter starts from zero at the start of
reduces based on the entry and exit of traders the day and increments as and when new trades
occur.
Volume

Price Volume Trader’s Perception

Increase Increase Bullish

Decrease Decrease Bearish trend could probably end, expect reversal

Decrease Increase Bearish

Increase Decrease Bullish trend could probably end, expect reversal

Open Interest

Price OI Trader’s Perception

Increase Increase More trades on the long side

Decrease Decrease Longs are covering their position, also called long unwinding

Decrease Increase More trades on the short side

Increase Decrease Shorts are covering their position, also called short covering
Description Meaning Description Meaning

Call Buying Up Put Buying Up

Call Writing Down Put Writing Down

Call Writing Exiting Up Put Writing Exiting Up

Thank You