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‘IMPACT OF OPEN INTEREST ON EQUITY MARKET TRENDS’
FOR BMA WEALTH CREATORS
TRIPTASREE GHOSH 10BSPHH010843
PROF KAUSHIK BHATTACHARYA.1 A REPORT ON ‘IMPACT OF OPEN INTEREST ON EQUITY MARKET TRENDS’ BY TRIPTASREE GHOSH (10BSPHH010843) A report submitted in partial fulfillment of The requirements of MBA Program of IBS HYDERABAD SUBMITTED TO: 1.COMPANY GUIDE BMA WEALTH CREATORS DATE OF SUBMISSION: 15/04/2011 .FACULTY GUIDE 2. MR. INDRA NARAYAN BISWAS.
.................4 MAIN TEXT…………………………………………………………………………………………………………………………………….15 ......3 INTRODUCTION……………………………………………………………………………………………………………………………............................................14 ATTACHMENTS…………………………………………………………………………………………………………………………….....2 Table of Contents ABSTRACT…………………………………………………………………………………………………………………………………..9 PLAN FOR COMPLETION OF THE PROJECT......... 13 REFERENCES…………………………………………………………………………………………………………………………………...........
Then the data have been sorted out as most active calls and puts based on OI positions. I have also studied the relationship between price and OI and how exactly do the turnover. Open Interest (OI) is the total number of outstanding futures/options contracts that are not closed or delivered on a particular day. Along with these. whether the stock will be bullish or bearish). After that a strategy was formulated where in net profit or loss obtained through this strategy is calculated. The project is mainly divided int0 two phases and the first phase has been completed till date.3 ABSTRACT: This project has been initiated for the purpose of acquainting me with the basics of the financial terminologies used in the stock markets along with the in-depth knowledge on how derivatives work and the impact of open interest on options. There are many factors that affect the option pricing and this project is based on the study of open interest position and how it affects the investment decisions. This study was done on futures of the following companies/ indexes: TATA CONSULTANCY SERVICES (TCS) RELIANCE (RIL) STATE BANK OF INDIA (SBIN) NIFTY BANK NIFTY .e. As per the strategy. OI position and price indicate whether the stock price will go up or go down (i. The first phase involved collection of two years NIFTY options data from the NSE website. one lot of most active call and one lot of most active put options (based on OI) is shorted in the market.
Our study is mainly focused on FUTURES and OPTIONS. the derivatives market has exhibited exponential growth both in terms of volume and number of traded contracts. According to the latest volume of rankings for the first half of 2010 by the Futures Industry Association (FIA). In India the emergence and growth of Derivatives market is a recent phenomenon. Since its inception in June 2000. Price quotation. Date and Delivery place (in case of commodity) etc.4 INTRODUCTION: Financial markets are. There are different kinds of Derivatives. Futures contracts are traded on exchanges that work as a buyer or seller for the counterparty. extremely volatile and hence the risk factor is an important concern for financial agents. National Stock Exchange (NSE) of India‟s ranking has improved by two places and its now the fifth largest derivatives exchange in the world. share. Section 2(ac) of Securities Contract Regulation Act (SCRA) 1956 defines Derivative as: a) “a security derived from a debt instrument. or index of prices. Exchange sets the standardized terms in terms of Quality. . by nature. The emergence of the Derivatives market is an ingenious feat of financial engineering that provides an effective and less costly solution to the problem of risk that is embedded in the price unpredictability of the underlying asset. b) “a contract which derives its value from the prices. risk instrument or contract for differences or any other form of security”. quantity. FUTURES: Futures is a standardized forward contract which enables an investor to buy (long) or sell (short) the underlying asset at a specified price at a specified future date through a specified exchange. of underlying securities”. loan whether secured or unsecured.
Shares by selling 1000 shares at Rs 115 and locks into future price. contingent upon occurrence of certain conditions. This is an example of equity future in which Sangita takes short position on ABC Ltd. Sangita decides to enter into futures market to protect her position at Rs 115 per share for delivery in January 2011. an option is a contingent claim. The price at which the option can be exercised is called an exercise price or a strike price. Current (spot) price of ABC Ltd shares is Rs 115 at National Stock Exchange (NSE). To give an example of a futures contract. and the option to sell an asset is called a put option. OPTION BUYER/HOLDER OPTION SELLER/WRITER Obligation to sale the underlying asset at strike price if the option holder desires CALL OPTION Right to buy underlying asset at strike price PUT OPTION Right to sale the underlying asset at strike price Obligation to buy the underlying asset at strike price if the option holder desires . Thus. on or before a specified period of time. iii)Currency futures. T. without any obligation. The option to buy an asset is known as a call option. OPTIONS: In a broad sense. to buy or sell an asset. More specifically. an option is a contract that gives the holder a right. suppose on November 2010 sangita holds 1000 shares of ABC Ltd.5 Following are the important types of financial futures contract:i )Stock Future or equity futures. an option is a claim without liability. ii)Stock Index futures. at an agreed price. Sangita entertains the fear that the share price of ABC Ltd may fall in next two months resulting in a substantial loss to her.Bill Futures. It is a claim. Each contract in futures market is of 100 Shares. and iv)Interest Rate bearing securities like Bonds.
„X‟ is the option buyer/holder and „Y‟ is the option writer/seller. „X‟ buys Nifty near month 5300 call option @73. volatility. . There are various factors like strike price. time remaining until expiration.5= -51. As per theoretical concept. risk free Interest Rate. American option: when an option can be exercised any time before its maturity.5 only (if Nifty closes below 5300) d) „Y‟ has a chance to have unlimited loss (any point above 5373.5 from „Y‟ (current market price 5260). The expiry date is 27th. if Nifty is above 5300 on expiry say 5425: a) „X‟ has the right to buy Nifty at 5300 from „Y‟ and „Y‟ is obliged to sell it if „X‟ desires. Option type: European.5.5 and net loss of „Y‟ will be (53005425)+73. it is classified in one of the following two categories: European option: when an option is allowed to be exercised only on the maturity date. So here the strike price is 5300. Open Interest position that affect the investment decisions.5) but maximum loss will be limited to 73. b) Net gain of „X‟ will be (5425-5300)-73. Example: On 9th of this month. it is called an American option.5 only. Depending on when an option can be exercised. Premium is 73.5) but maximum gain will be limited to 73.5 c) „X‟ has a chance to have unlimited gain (above 5373. it is called a European option.5=51. This project is mainly focused on the study of open interest (OI) positions and how it can be used as an effective tool while formulating strategies so that investors can gain from the options irrespective of volatility in the market. During the expiry we can have the following possibilities.6 The asset on which the call or put option is created is referred to as the underlying asset.
confirms a downward trend. and it is shown as a positive or negative number. C and D create a trading volume of 5 and there are also 5 more options left open. these two market players combine to make one contract. On Jan 3. along with an increase in price. a buyer and a seller. An increase or decrease in price while the open interest remains flat or declines may indicate a possible trend reversal. open interest does not change and the trading volume increases by 5. The main objectives of the project are: To study the impact of open interest positions on NIFTY options(most active call and put option in the near month expiry) Based on the study frame multiple profitable NIFTY option strategies so that investors can gain from the options irrespective of volatility in the market. A consequent increase in open interest. an increase in open interest.7 OPEN INTEREST DEFINED: Open Interest is the total number of options and/or Stock Future contracts that are not closed or delivered on a particular day. A takes an offsetting position and therefore. is said to confirm an upward trend. Jan 1 Jan 2 A buys 1 option and B sells 1 option contract C buys 5 options and D sells 5 options contracts Trading Activity 1 6 Time Open Interest Jan 3 Jan 4 A sells 1 option and D buys 1 option contract E buys 5 options from C who sells 5 options contracts 5 5 What Does Open Interest Tell Us A contract has both. On Jan 2. As a result. . The open interest position that is reported each day represents the increase or decrease in the number of contracts for that day. A buys an option. E simply replaces C and therefore. Similarly. along with a decrease in price. On Jan 4. open interest is reduced by 1 and the trading volume is also 1. which leaves an open interest and also creates a trading volume of 1. Time Trading Activity Open Interest On Jan 1.
Review of Financial Studies. skewness. combined with a long or short position in an option. Using S&P 500 options. http://papers. Mihir Dash. Do Call Prices and the Underlying Stock Always Move in the Same Direction? This article empirically analyzes some properties shared by all one-dimensional diffusion option models. (i) call (put) prices often go down (up) even as the underlying price goes up. the most popular strategies being covered-call writing and protective-put buying. Charles. options are not redundant securities.com/sol3/papers.ssrn. and the other type of strategy that was optimal at the highest strike price and whose payoff increased with increase in strike price. The study considers a class of stock and options strategies. Sindhu S.com/sol3/papers. The study applies these strategies to a sample of one hundred and twenty-seven stocks listed in National Stock Exchange F&O segment. together. It also tries to relate the optimal strategies and the returns from the optimal strategies to the characteristics of the distribution of returns of the underlying stock. Zhiwu.cfm?abstract_id=1293203 2. involving a long or short position in a stock. and (ii) call and put prices often increase.cfm?abstract_id=183108 .8 LITERATURE REVIEW: 1. Kavitha V. nor ideal hedging instruments---puts and the underlying asset prices may go down together. http://papers. A Study of Optimal Stock & Options Strategies: It is widely believed that the performance of pure-stock portfolios can be enhanced by incorporating different options strategies. one-dimensional diffusion option models cannot be completely consistent with observed option-price dynamics. Chen.ssrn. Bakshi. and kurtosis of the returns distribution of the underlying stock affected the optimal strategy. Gurdip S. November 2008. using corresponding stock options and tries to find out which of these strategies yields maximum returns. Therefore. The findings of the study indicate the strategies that were optimal in two ways: one type of strategy that was optimal at the lowest strike price and whose payoff decreased with increase in strike price. Deepa K M. October 1999. The results are valid after controlling for time-decay and market microstructure effects. or decrease. and Cao. we find that when sampled intraday (or inter-day). It was found that only the standard deviation.
OI position and price indicate whether the stock price will go up or go down. and hence the modeling of the data has been extended to these high frequency data to better capture the volatility in precision and hence increase the efficiency. The part a of the first phase begins with the collection of Data ( Nifty call and put options for the previous two years i. The first phase of the project has been completed and will form the major part of this report. As per the strategy. After that a strategy is formulated where in net profit or loss obtained through this strategy will be calculated. b) Study of the relationship between price and OI and how exactly do the turnover. This study was done on futures of the following companies/ indexes: TATA CONSULTANCY SERVICES RELIANCE STATE BANK OF INDIA BANK NIFTY NIFTY 2. After the data has been obtained the following steps have been undertaken: . Then the data is sorted-out based on OI positions. one lot of most active call and one lot of most active put options (based on OI) is shorted in the market. April 2009 to February 2011 and also the recession period data i. quarterly or daily) is available there.e. FIRST PHASE: a) The first phase is mainly based on collection of two years options data from the NSE website.9 MAIN TEXT: The project is divided into two phases. 1.e. Yearly data as well as other high frequency data (monthly. whether the stock will be bullish or bearish on short term basis).e. SECOND PHASE: During the second phase based on the findings from the first phase I will try to design multiple NIFTY option strategies so that investors can gain from the options irrespective of volatility in the market.(i. September -November 2008) from NSE website.
example: .10 1) An excel sheet has been maintained where in the data collected is systematically divided into monthly data and from which most active call and put options(based on OI position) have been calculated.
one lot of such active option is shorted in the market and the previously shorted option (in this case 5300) is squared off. 5300 NIFTY call option continues to be most active for the next few days and so there is no activity in the market. 4) On the basis of the comparison done various observations are made which will help in formulating multiple NIFTY options strategies.g.5 NET INFLOW 2775 OUTFLOW NET PROFIT/LOSS 106 5300 557. The net inflow is Rs.15 2257. For e. The strategy involves hypothetical shorting (selling) of one lot of most active call and put into the market each day.5 PROFIT 3) After the calculation of net profit/loss the change in the nifty (the difference between the closing price of NIFTY in the beginning of the month and the closing price at the end of the month) is obtained and compared against the result obtained. . In this way on the expiry date we obtain either a profit or a loss.5 34. DATE ACTIVITY 27-Jan-11 sell 5800 CE 28-Jan-11 no activity 31-Jan-11 no activity 1-Feb-11 sell 5400 CE & 5800 CE sq off 2-Feb-11 no activity 3-Feb-11 no activity 4-Feb-11 no activity 7-Feb-11 no activity 8-Feb-11 no activity 9-Feb-11 sell 5100 CE & 5400 sq off 10-Feb-11 no activity 11-Feb-11 no activity 14-Feb-11 sell 5400 CE & 5100 CE sq off 15-Feb-11 no activity 16-Feb-11 no activity 17-Feb-11 no activity 18-Feb-11 no activity 21-Feb-11 no activity 22-Feb-11 no activity 23-Feb-11 no activity 24-Feb-11 option expired LTP 55.2500 (50x50).5 350 3057.11 2) The next step involved formulation of a strategy and calculation of net profit or loss obtained through the strategy. So according to the strategy adopted one lot (i.65 1732. The moment 5500 becomes most active.e. Again on 9th of May 5500 NIFTY call option becomes most active. suppose on 1st of May 2010(expiry 28th May) the most active call option is NIFTY 5300 @ 50.5 8100 45. 50 call options) is shorted in the market.
decays). price and open interest. The part b involves tracing the daily movements in the futures of INDEX/STOCKS.. A Call option's premium consists of both intrinsic value (if any) plus time value. and any purchase is generally aggressive in nature If the open-interest numbers flatten.e. At expiration. open interest position. RULES OF OPEN INTEREST: If prices are rising and the open interest is increasing at a rate faster than its average.12 From the strategy adopted the inferences drawn are: Market flat to range bound (up or down by 200 points) the strategy is a gainer. and turnover of the above mentioned stocks/index are recorded systematically in an excel sheet and on the basis of change in price. it should be taken as a warning sign of an impending top High open interest at market tops is a bearish signal if the price drop is sudden . When there is high volatility within the range bound in the market this strategy is a gainer After a long consolidation period when there is a break out writing call and when there in a break down writing put options should be avoided When there is a dip in market the loss from the put options is being compensated by the profit from the call options. This indicates that more participants are entering the market. when the market closes the last traded price. the time value portion of the Call erodes (i. Another observation is that writing put option is more profitable when there is less volatility in the market directions. After a long period of consolidation when the market breaks out the loss from the call options is so high that it is not being compensated by writing put options Whenever there is any economic downturn like recession this strategy doesn’t hold good. stay neutral or go down in the days to come (2-3 days). The more the volatility the less is the amount of profit earned on put. involving additional buying. observations are made as to whether the stock prices will go up. *All the excel sheets are included in the attachments. As time passes. SBIN and TCS and the indexes selected are BANKNIFTY AND NIFTY respectively. it is a bullish sign. following a rising trend in both. The stocks selected are the Reliance. With the help of the above study it is also tested whether the following theoretical rules of open interest actually work in the real life scenario. the Call's value will equal its intrinsic value. turnover and OI. Every day.
This scenario will prove out a continuation of a downtrend and a bearish condition. The findings from this study are that most of the times whenever there is rise in price with a rise in open interest it indicates bullishness (i. it can be said that new money is entering the market. Decrease in price but increase in open interest indicates bearishness. if the total open interest is falling off and prices are declining.13 An unusually high or record open interest in a bull market is a danger signal. displaying aggressive new short selling. Lastly. 10th May to 12th May: Final editing of the project and compilation of final report . If prices are in a downtrend and open interest is on the rise. the stock prices will go up). the price decline is being caused by disgruntled long position holders being forced to liquidate their positions. Thus the findings can be summarized as: Bullish An increasing open interest in a rising market Bearish A declining open interest in a rising market Bearish An increasing open interest in a falling market Bullish A declining open interest in a falling market PLAN FOR COMPLETION OF PROJECT: 16th April to 9th May: Based on the results obtained from the first phase frame multiple profitable NIFTY option strategies so that investors can gain from the options irrespective of volatility in the market.e. When a rising trend of open interest begins to reverse. a bearish trend can be expected.
Lawrence G.icharts.bmawc.google.com www.org/ www.indianderivatives.in www.scholar.Mc.14 REFERENCES: TEXT BOOKS: I.Risk Management & Derivatives Options As A Strategic Investment.com www.jstor.Indian Financial Systems R MAHAJAN.Futures and Options Rene M.Stulz.com/ .com www.com/finance www.Millan NEWSPAPERS: Economic Times Mint Business Line WEBSITES: CAPITALINE (software provided by the Research Dept) www.bloomberg.M PANDEY: Financial Management M Y KHAN.google.
February 2011) NET PROFIT/LOSS ON STRATEGY ADOPTED Microsoft Office Excel 97-2003 Worksheet Net profit/loss on shorting of most active call/put and analysis MOST ACTIVE CALL AND PUT RECESSION(SEPTEMBER-NOVEMBER 2008) Microsoft Office Excel 97-2003 Worksheet Most active call & observation Microsoft Office Excel 97-2003 Worksheet Most active put & observation NET PROFIT/LOSS ON STRATEGY ADOPTED Microsoft Office Excel 97-2003 Worksheet Net profit/loss on strategy adopted and analysis DAILY ANALYSIS OF INDEXES/STOCKS Microsoft Office Excel 97-2003 Worksheet .February 2011) Microsoft Office Excel 97-2003 Worksheet Most active put and observation (April 2009.15 ATTACHMENTS: MOST ACTIVE CALL AND PUT OPTIONS (APRIL 2009-FEBRUARY 2011): Microsoft Office Excel 97-2003 Worksheet Most active call and observation (April 2009.January 2010) Microsoft Office Excel 97-2003 Worksheet Most active put and observation (February2010.January 2010) Microsoft Office Excel 97-2003 Worksheet Most active call and observation (February2010.