BASICS OF DERIVATIVE - FOR TRADER’S

IDBI Capital Markets & Securities Ltd

June 20, 2022 1

 What will the session cover

 Basic concepts of Derivatives (Futures & Options)

 Basic strategies in derivatives

 Understanding market direction / trend indicators

June 20, 2022 2

 What are options?

 All investors know that buying stock entitles them to partial ownership in the
corporate entity issuing those shares. In other words, you are purchasing an
“Equity” participation in the company.
 What is an option, then?
 In a word, an option is actually a contract. Unlike stock, however, an option
does not convey to the purchaser ownership in anything. Instead, an option
contract conveys a right to its owner to buy or sell the underlying financial
instrument on which it is based.

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 Basics Of Options

 An equity option is a contract. To the investor purchasing and holding an

option, this contract conveys a right to either purchase or sell shares of the
underlying stock.
 There are two types of standardized equity options, calls and puts.
 Buy Call = Right to Buy 100 Shares.
 Buy Put = Right to Sell 100 Shares.
 A standard equity call option conveys a right, not an obligation, to its holder
to purchase 100 shares of the underlying stock, at a specific price per share,
for a predetermined amount of time.

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 Basics Of Options

 An equity put option, on the other hand, conveys a right to its holder
to sell 100 shares of the underlying stock, at a specific price per share, for a
predetermined amount of time.
 The person who writes the option, however, has incurred an obligation to
fulfil its terms if called upon to do so.
 The writer of a call option contract is obligated to sell underlying shares to
a call holder, if assigned.
 The put writer is obligated to purchase underlying shares from a put
holder, if assigned.

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 Why Standardization is Important

 Options, like other financial contracts, have specific terms. Among these are:
 Option type
 Option style
 Underlying security
 Exercise (strike) price
 Expiration date
 Let's examine each of these terms in more detail.

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 Underlying Security

 An equity option's underlying security is the stock that will change hands
when the option is exercised.
 An option is classified as a derivative security because its value is derived (in
part) from the value and characteristics of this underlying stock.

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 Call and Put Specifics -Example

 Standardized European-style Buy XYZ 60 call option:

A contract giving the BUYER...

The RIGHT to BUY a specified amount....
(1 LOT For Example 100 shares)
Of the underlying stock...
Buyer (XYZ Corporation)
At 60 per share...
(strike or exercise price)
At last Thursday of every month expiration...
(the option's last trading day)
If the BUYER chooses to exercise this right.
The purchaser is LONG this CALL contract

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 Call and Put Specifics - Example

 Standardized European-style Buy XYZ September 75 put option:

A contract giving the BUYER

The RIGHT to SELL a specified amount....
(1 LOT For Example 100 shares)
Of the underlying stock...
Buyer (XYZ Corporation)
At 75 per share
(strike or exercise price)
At last Thursday of every month expiration...
(the option's last trading day)
If the BUYER chooses to exercise this right.
The purchaser is LONG this PUT contract

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 Call and Put Specifics - Example

 Standardized European-style XYZ September 60 call option:

A contract whereby the WRITER

Is OBLIGATED to Sell a specified amount....
(1 LOT For Example 100 shares)
Of the underlying stock...
Writer (XYZ Corporation)
At 60 per share
(strike or exercise price)
At last Thursday of every month expiration...
(the option's last trading day)
If the WRITER is assigned on the contract.
The writer is SHORT this CALL contract

June 20, 2022 10

 Call and Put Specifics - Example

 Standardized European-style XYZ September 75 put option:

A contract whereby the WRITER...
Is OBLIGATED to Buy a specified amount....
(usually 100 shares)
Of the underlying stock...
(XYZ Corporation)
At 75 per share....
(strike or exercise price)
Writer
At last Thursday of expiration...
(the option's last trading day)
If the Writer is assigned on the contract.
The writer is Short this PUT contract

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 Exercise (Strike) Price

 An equity option's exercise price (also commonly referred to as its strike

price ) is simply the price, on a per share basis, at which the option holder (or
writer) has the right (or obligation) to either purchase or sell shares of the
underlying stock.
 At any Point in time 3 Type of Strike prices are open
 In The Money
 At The Money
 Out Of The Money

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In-the-money, At-the-money, Out-of-the-money

 A call is considered:

 In-the-money when its exercise (or strike) price is less than the current underlying
stock price.
 At-the-money when its exercise (or strike) price is the same as the current underlying
stock price.
 Out-of-the-money when the strike price (or strike) is greater than the current
underlying stock price.

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In-the-money, At-the-money, Out-of-the-money

 A put is considered:

 In-the-money when its exercise (or strike) price is greater than the current underlying
stock price.
 At-the-money when its exercise (or strike) price is the same as the current underlying
stock price.
 Out-of-the-money when the strike price (or strike) is less than the current underlying
stock price

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 Intrinsic and Time Value

 Option Premium = Intrinsic Value + Time Value

 In-the-money Options: Premium = Intrinsic Value + Time Value
 At-the-money Options: Premium = All Time Value
 Out-of-the-money Options: Premium = All Time Value

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 Time Decay

 An important characteristic of an option premium's time value portion is that it

generally decreases over time.
 Time Decay (Theta) has a negative slope as seen below

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 Strategies - Hedging with Puts

 Some option strategies are slightly more sophisticated than buying calls or selling puts.
Typically, they involve more than one element, such as combining the purchase or sale
of an option with the purchase of the underlying stock.
 For example, you can hedge against the possibility that a stock will drop in value by
simultaneously purchasing put options on a stock when you buy shares of that stock.
 Because the puts give you the right to sell the underlying stock at the exercise price at
any time before expiration, you limit potential losses that could result from a falling
market price.

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 Strategies – Bull Call Spreads

 If you purchase call options at one strike price, you write calls at a higher price. This
is referred as Bull Call Spread.
 The Cost for the strategy will be the premium paid.
 For Example you buy Stock A - 14500 Call for Rs 50 and Sell Stock A - 14700 Call for
Rs 20. Net Cost for this spread will be Rs 30 the difference.
 Strategy will have a Breakeven point of 14530, and profit will be Rs 170 if expiration
is at or above 14700.
 As part of choosing a vertical spread strategy, you also need to take into account
not only the direction that a stock's price is likely to move but:
 How much will the change be?
 How quickly that change will take place?


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 Strategies - Spreads

 An strategies, sometimes described as vertical spreads, may provide a modest

profit in a bull market, with the added benefits of reduced risk and reduced
investment cost.
 To use these strategies, which are referred to as bull call spreads and bull put
spreads.
 You simultaneously purchase one or more options — either call or puts — and
write, or sell, an equal number of the same option on the same underlying stock
with the same expiration date — but at different strike prices.
 The key to these strategies is that the strike price on the options you purchase and
those you sell are different, even though the expiration date is the same.

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 Pay off graph for -Bull Call Spread

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 Strategies – Bear Put Spreads

 To use a bear put spread, you buy a put with one strike price, and sell a put on the
same underlying stock with a lower strike price. Since the put you buy costs more
than the one you write, you'll pay more premium than you receive.
 The bear put is a debit spread.
 For Example you buy Stock A - 14400 Put for Rs 50 and Sell Stock A - 14200 Put for
Rs 25. Net Cost for this spread will be Rs 25 the difference.
 Strategy will have a Breakeven point of 14175, and profit will be Rs 175 if expiration
is at or below 14400.

June 20, 2022 21

 Pay off graph for Bear Put Spread

June 20, 2022 22

 Choose your objective

 Calls and puts are flexible financial products, and can be put together into a variety
of strategies that reflect many financial objectives.
 Speculate that a stock will remain stuck in neutral and profit from this lack of
momentum.
 Decide that generating income from an existing, sluggish stock position.
 Have unrealized profits from a previous stock purchase and decide to position your
shares for an up or down move with one simple strategy.

June 20, 2022 23

 Trading Rules

 Keep 2 day’s low/ high as stop loss for respective Buy / Sell position

 If you have made a buy call and your call is making a day's low, you should immediately square off

your position. Similarly if you have made a sell call and it’s making a day’s high you have to square

off the position ASAP.

 Avoid positions before and after two days of result announcement / event

 Avoid taking aggressive trading positions in the morning session if you are a intraday trader as the

volatility is too high mainly due to squaring off of BTST Calls

 Trade with current market trend. Don’t go against the flow.

 Book regular profits in volatile trading market.

 Keep trailing stop for winning trades which means book profit of 50% of the holding position as it

reaches half of your target and for the remaining 50% keep Stop loss as Cost

 Use strict stop loss. Always keep your Profit & Stop loss in 2 : 1 ratio

 Buy strength; sell weakness

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 Trading Rules

 Never, ever, ever, add to a losing trade

 If a Security has already moved 4 to 5 percent and is still making day’s high post 1 PM then
the chances of the stock going further up increases and every retracement on this level
should be your opportunity to buy. In technical words if a stock is crossing R2 and is still
making days high post 1 PM the chances of the stock going up till R3 increases
 Avoid trading in stocks with high VaR. Before Entering any FNO position always check the
VAR (Value at Risk) or Historic volatility of the stock. Higher the VAR risker the trading
position.
 Never hold an option buy position for too long. It’s like holding an ice-cream which melts
down
 Markets evolve and to become successful trader you need to evolve right along with them.
 You should never trade in junk stocks. Always trade in the stocks which are fundamentally
good and take positions as per risk appetite

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 Regional Heads

National Head : Mr. Shiv Mishra – shiv.mishra@idbicapital.com

West : Mr. Nilesh Parab - 9322193361 – nilesh.parab@idbicapital.com

North : Mr. Mritunjay Kumar – 9711344643 – mritunjay.kumar@idbicapital.com

East : Mr. Sandeep Dubey – 9883141416 – sandeep.dubey@idbicapital.com

THANK YOU
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