FINANCIAL DERIVATIVES

The options can be used to obtain desired returns and risk profiles with various combinations. Using straddle, strangle and spreads.

FORE School Of Management-FD Project

Submitted To:-

Submitted By:Aditya Thareja-191004 Aseem Goyal-191018 Padia Archin -191039

Prof. Kanhaiya Singh FORE School of Management New Delhi

Prateek Jain-191044

Contents

Acknowledgement.......................................................................................................3 Methodology.............................................................................................................4 Derivative Market.......................................................................................................5 History of derivatives markets in India...........................................................................5 Growth of Derivatives Market in India...........................................................................5 Options....................................................................................................................7 Call option.............................................................................................................8 Put Options............................................................................................................9 Options strategies......................................................................................................10 Options Payoffs.....................................................................................................10 FD-Term Project, By Group No.-9, Section-D Page 2

FORE School Of Management-FD Project Bull Market Strategies.............................................................................................12 Bear Market Strategies............................................................................................19 Volatile Market Strategies........................................................................................25 Stable Market Strategies..........................................................................................30 Bibliography............................................................................................................34

Bibliography

Acknowledgement
This formal piece of acknowledgement may be sufficient to express the feelings of gratitude people who have helped me in successfully completing my Final Project Report. I feel,I shall always remain indebted to Prof. Kanhaiya Singh, Finance
professor at FORE School of Management without whom it is being

impossible to complete my project report.He gave his kind supervision,guidance,timely support and all other kind of help required in each and every moment of need.
FD-Term Project, By Group No.-9, Section-D Page 3

Section-D Page 4 .FORE School Of Management-FD Project Aditya Thareja Aseem Goyal Padia Archin Prateek Jain Methodology FD-Term Project.-9. By Group No.

Introduced in 2000. and their clearing house/corporation to commence trading and settlement in approved derivatives contracts. index or reference rate. It is also important to remember that derivatives are derived from an underlying asset. S&P CNX. History of derivatives markets in India Derivatives trading commenced in India in June 2000 after SEBI granted the final approval to this effect in May 2001 on the recommendation of L. NSE and BSE. Growth of Derivatives Market in India Equity derivatives market in India has registered an "explosive growth" and is expected to continue the same in the years to come. index-based trading was permitted in options as well as individual securities. Nifty and Sensex. if the settlement price of a derivative is based on the stock price of a stock for e. This means that derivative risks and positions must be monitored constantly. Derivatives are used to shift risk and act as a form of insurance.-9. Infosys. For example. The underlying asset can be equity. Forex. Subsequently. financial derivatives market in India has shown a remarkable growth both in terms of volumes and numbers of traded contracts.g. By Group No. then the derivative risks are also changing on a daily basis. commodity or any other asset. This means that risks in trading derivatives may change depending on what happens to the underlying asset. They are very important financial instruments for risk management as they allow risks to be separated and traded. C Gupta committee. Initially. The FD-Term Project. which frequently changes on a daily basis. A derivative is a product whose value is derived from the value of an underlying asset. This shift of risk means that each party involved in the contract should be able to identify all the risks involved before the contract is agreed.FORE School Of Management-FD Project Derivative Market Derivatives have become very important in the field of finance. Section-D Page 5 . Securities and Exchange Board of India (SEBI) permitted the derivative segments of two stock exchanges. SEBI approved trading in index futures contracts based on various stock market indices such as. NSE alone accounts for 99% of the derivatives trading in Indian markets.

) 25163 100131 217207 168836 410 1752 8388 10107 Page 6 Daily (Rs.) Turnover (Rs.75 Cr. whereas the value of the NSE cash markets was only Rs.-9. Turnover (Rs. the turnover of the NSE derivatives market exceeded the turnover of the NSE cash market. 130. Trading in derivatives gained popularity soon after its introduction.551.FORE School Of Management-FD Project introduction of derivatives has been well received by stock market players. 90. cr.cr.) Turnover (Rs. Turnover FD-Term Project.038 Cr. Section-D .cr. For example. In due course.) 2001-02 2002-03 2003-04 2004-05 21483 43952 554446 772147 51515 286533 1305939 1484056 3765 9246 52816 121943 Notional (Rs. 3. the value of the NSE derivatives markets was Rs.) Notional cr.477. By Group No. Source: Compiled from NSE NSE Derivative Segment Turnover Year Index Futures Stock Futures Index Options Stock Options Average Turnover cr. in 2008.

64 6295345. an option is a contract between two parties.4 3934388.89 19220 29543 52153.76 2791697 3830967 7548563.07 87659. This is the primary function of listed options. To begin. you can "insure" a stock by fixing a selling price. The above analysis clearly depict that the stock future is clearly the dominant product in the derivate market with market share of 44% whereas stock option is still in the developing stage with a meager share of 3%.81 506065. once again. there are two kinds of options: Call Options and Put Options. Options An option is a contract. your only cost is the premium.27 3570111. Section-D Page 7 . "damages" your asset. In this way. Technically.32 180253 193795 359136. we surely can say that there is an upward trend in all product of derivate market. By Group No. Put options are like insurance policies With a Put Option." then you do not need to use the insurance.-9. Put Options are options to sell a stock at a specific price on or before a certain date.12 5195246. If the price of your stock goes up.67 4034387. and.55 229226.63 72392. which gives the buyer the right.84 8027964.2 8872694. you can exercise your option and sell it at its "insured" price level. and thus. and there is no "damage. If something happens which causes the stock price to fall. but not the obligation to buy or sell shares of the underlying security at a specific price on or before a specific date.89 Source: NSE Trend: If we analyze the trend of derivative market as well as product wise.78 338469 791906 1362110. to allow investors ways to manage risk.FORE School Of Management-FD Project 2005-06 2006-07 2007-08 2008-09 2009-10 2010-11 1513755 2539574 3820667. The buyer receives a privilege FD-Term Project.23 3479642.18 566789.3 45310.88 3731501.

and left a security deposit for it. rent that property at the price agreed upon when you returned. we can observe that Index option turnover is much higher than the stock option. but you would have no other liability. in fact. Call option A Call Option is an option to buy a stock at a specific price on or before a certain date. If you never returned. By Group No. Option Market in India Index Options v/s Stock Options Source: NSE Analysis: Looking at the graph of both Index option and stock option turnover in each year. the money would be used to insure that you could. The seller accepts an obligation for which he receives a fee. The main reason for the same is that the availability of very less product in the stock option whereas the major product in the index option is Nifty which generate huge amount of turnover for the Index Options. for example. Call options usually increase in value as the value of the underlying instrument rises. FD-Term Project. you wanted to rent a certain property. Section-D Page 8 . If. In this way.FORE School Of Management-FD Project for which he pays a premium. Call options are like security deposits.-9. you would give up your security deposit.

If you decide not to use the option to buy the stock. the price you pay for it. When you expect prices to fall. secures your right to buy that certain stock at a specified price called the strike price. So. He pays a premium for buying calls (the right to buy the contract) for 10*700= Rs 7000/-. The following are Nifty options traded at following quotes. FD-Term Project. Section-D Option contract March Nifty April Nifty May NIfty Page 9 bullish. You are are bearish.-9. Total Profit = 805 *100 = 8050.95) * 100 (market lot) =805 per If the index falls below 4936. Therefore. Illustration 1: Let us take another example of a call option on the Nifty to understand the concept better. Nifty is at 4922 on 26th Feb 2010. then you take a long position by buying calls. but the profit potential is unlimited. He sells the options or exercises the option and contract. he buys 10 options of May contracts at In May 2010 the Nifty index goes up to 4045. Source: Economictimes. You . your only cost is the option premium. By Group No.FORE School Of Management-FD Project When you buy a Call option.com A trader is of the view that the index will go up to 4940 in May 2010 but does not want to 4936. take the risk of prices going down. called the option premium. Call Options-Long & Short Positions When you expect prices to rise.95 the trader will not exercise his right and will opt to forego his premium of Rs 700.95. takes the difference in spot index price which is (4045-4936. in the event the index falls further his loss is limited to the premium he paid up front. then you take a short position by selling calls. and you are not obligated to.

The owner of a put option has the right to sell. You are bullish. Example: Sam purchases 1 INFOSYSTECH (Infosys Technologies) April 2730 Put --Premium 200 This contract allows Sam to sell 100 shares INFOSYSTECH at Rs 2730 per share at any time between the current date and the end of August. with a loss equal to the call premium. As the price of the underlying asset rises beyond the strike price. To have this privilege.FORE School Of Management-FD Project Put Options A Put Option gives the holder of the right to sell a specific number of shares of an agreed security at a fixed price for a period of time. By Group No. then you take a short position by selling Puts. then you take a long position by buying Puts. and will lose the premium initially paid for it. This means that the payoff function is flat. The buyer of a put has purchased a right to sell. the loss from owning it cannot exceed the price paid for it. We will begin with the buying of a call option.000 (Rs 200 a share for 100 shares). When you expect prices to rise.-9. Options strategies Options Payoffs There are four ways to invest in options: buying and selling either a put or a call. So long as the price of the underlying asset is below the strike price of the call. the call comes into the money. Because the buyer need not exercise the option. and the payoff begins to raise one for one with the price of the underlying asset. Put Options-Long & Short Positions When you expect prices to fall. You are bearish. Section-D Page 10 . Remember that buying an option creates rights but not obligations. Sam pays a premium of Rs 20. the holder will not exercise the option. FD-Term Project. beginning at an underlying asset price of zero and continuing to the strike price.

Rajiv Srivastava What benefits the call buyer costs the call writer. Payoff from Writing a Call Option Payoff Profit→ FD-Term Project. the writer begins to suffer a loss. But when the underlying asset price rises above the strike price. By Group No. and the payoff is positive. the writer pockets the premium.-9. Section-D Page 11 .FORE School Of Management-FD Project Payoff from Buying a Call Option Source: Derivatives By. the more the call writer loses. The higher the price climbs. So long as the underlying asset price remains below the strike price of the call. as shown in fig.

Puts have value only when the price of the underlying asset is below the strike price.FORE School Of Management-FD Project Source: Derivatives By. though it cannot go below the premium paid for the put Payoff from Writing a Put Option Payoff Profit→ Page 12 FD-Term Project. Section-D . The buyer of a put purchases the right to sell a stock at the strike price. the payoff falls. we can use the same simple process to draw their payoff diagrams. As the asset price rises. By Group No.Rajiv Srivastava Payoff from Buying a Put Option Source: Derivatives By.-9. The payoff is highest when the price of the underlying asset is lowest.Rajiv Srivastava Turning to puts.

The best outcome for an option writer is to have the option expire worthless. If you expect the market price of the underlying asset to rise. So long as the asset price exceeds the strike price. so that it is never exercised.Rajiv Srivastava Writing a put is the reverse of buying one. we can see that the put writer’s losses are highest when the price of the underlying asset is lowest. Bull Market Strategies Payoff Profit→ Calls in a Bullish Strategy An investor with a bullish market outlook should buy call options. Again.FORE School Of Management-FD Project Source: Derivatives By. Section-D Page 13 . The greater the increase in price of the underlying. the greater the investor's profit. FD-Term Project. the put writer’s payoff equals the premium charged to write the put. the writer loses when the holder gains. then you would rather have the right to purchase at a specified price and sell later at a higher price than have the obligation to deliver later at a higher price. so the maximum payoff is the premium. Looking at Figure. The investor's profit is the market price less the exercise price less the premium. By Group No. it declines as the price rises.-9. Put Premium The investor's profit potential buying a call option is unlimited.

here the trader buys a call with a higher exercise price and writes a call with a lower exercise price. Bullish Call Spread Strategies A vertical call spread is the simultaneous purchase and sale of identical call options but with different exercise prices. the holder of a call is under no obligation to exercise the option. investors with long put positions will let their options expire worthless.FORE School Of Management-FD Project The investor's potential loss is limited. his option is profitable. By writing Puts.-9. The break-even point occurs when the market price equals the exercise price: minus the premium. The trader pays a net premium for the position. To "sell a call spread" is the opposite. receiving a net premium for the position. Even if the market takes a drastic decline in price levels. By Group No. Section-D Page 14 . If the market price increases and puts become out-of-the-money. Because a short put position holder has an obligation to purchase if exercised. The investor breaks even when the market price equals the exercise price plus the premium. The maximum profit is limited to the premium received. A Put writer profits when the price of the underlying asset increases and the option expires worthless. At higher prices. He will be exposed to potentially large losses if the market moves against his position and declines. FD-Term Project. At any price less than the exercise price minus the premium. profit potential is limited. He may let the option expire worthless. an investor anticipating a bull market could write Put options. the investor loses money on the transaction. the potential loss is unlimited. Basically. Puts in a Bullish Strategy An investor with a bullish market outlook can also go short on a Put option. To "buy a call spread" is to purchase a call with a lower exercise price and to write a call with a higher exercise price. However.

the market price must be as great as the lower exercise price plus the net premium. the trader needs to buy the lower strike call and sell the higher strike call. while at the same time limiting risk exposure.-9. He pays a higher premium for the lower exercise price call than he receives for writing the higher exercise price call. an investor can lose is the net premium paid. the investor can lose is the net premium. Section-D Page 15 . we took up various positions in the Reliance industries derivative product. The combination of these two options will result in a bought spread. The investor’s potential loss is limited. The investor delivers on his short call and receives a higher price than he is paid for receiving delivery on his long call. then buying a call spread will be the appropriate strategy. The investor's profit potential is limited. To recover the premium. As explained above that in case of you expect market will be bullish in the future. When both calls are in-the-money. To put on a bull spread. By Group No. FD-Term Project. At the most. The cost of Putting on this position will be the difference between the premium paid for the low strike call and the premium received for the high strike call.FORE School Of Management-FD Project An investor with a bullish market outlook should buy a call spread. At the most. both will be exercised and the maximum profit will be realized. An example of a Bullish call spread Taking example from the market is as follow:On 29th April 2010. The "Bull Call Spread" allows the investor to participate to a limited extent in a bull market. The investor breaks even when the market price equals the lower exercise price plus the net premium.

Reliance call option at strike price of Rs. So here Lower strike price is Rs. buy a call or take long position in call at lower strike price and sell call at higher strike price.33 and at a strike price of Rs 1250. Section-D Page 16 . the premium is Rs.-9.05.1000 and Higher Strike price is Rs.1000 attract a premium of Rs.1250. As per the strategy. By Group No. FD-Term Project.0.FORE School Of Management-FD Project This is the snapshot of Market in The Economic Times On 29th April 2010.

95 Bullish Put Spread Strategies FD-Term Project.-9.Lower strike price .05 Maximum Loss = Lower strike premium .95 Breakeven Price = Lower strike price + Net premium paid = 1000 + 32.95 = 1032. By Group No.FORE School Of Management-FD Project We explore various outcomes with respect to Reliance industries share in the market which is as follow:- The net position of profit or loss is explained by the following diagram:- Maximum profit = Higher strike price .Higher strike premium = 33 -0.Net premium paid = 1250 .1000 – 32. Section-D Page 17 800 850 900 .05 = 32.95 = 217.

sell a put or take short position in put at higher strike price and buy put at lower strike price. The puts will offset one another. An investor with a bullish market outlook should sell a Put spread. To put on a bull spread.e. Continuing with the above example of Reliance securities. To "sell a put spread" is the opposite: the trader buys a Put with a lower exercise price and writes a put with a higher exercise price. The investor's profit potential is limited.-9. We explore various outcomes with respect to Reliance industries share in the market which is as follow:FD-Term Project. By Group No. both options will be out-of-themoney and will expire worthless. but at different exercise prices. while at the same time limiting risk exposure. On 29th April 2010.64. The investor breaks-even when the market price equals the lower exercise price less the net premium. when the market price moves up beyond the higher exercise price (both puts are then worthless).0. The investor's potential loss is also limited. If the market falls.1000 attract a premium of Rs.1000 and Higher Strike price is Rs. The trader will realize his maximum profit. the premium is Rs. As per the strategy. So here Lower strike price is Rs.1100. When the market price reaches or exceeds the higher exercise price. The difference between the premiums paid and received makes up one leg of the spread. receiving a net premium for the position. The bull spread can be created by buying the lower strike and selling the higher strike of either calls or put. To "buy a put spread" is to purchase a Put with a higher exercise price and to write a Put with a lower exercise price.FORE School Of Management-FD Project A vertical Put spread is the simultaneous purchase and sale of identical Put options but with different exercise prices. Reliance call option at strike price of Rs. the net premium. The "vertical bull put spread" allows the investor to participate to a limited extent in a bull market.05 and at a strike price of Rs 1100. The trader pays a net premium for the position. the options will be in-the-money. Section-D Page 18 . a trader sells the higher strike put and buys the lower strike put. The investor achieves maximum profit i. the premium received.

05 = 63. By Group No.95 =36.05 Bear Market Strategies Puts in a Bearish Strategy FD-Term Project. Section-D Page 19 800 850 900 950 .Net premium income = 1100 -63.95 Maximum loss = Higher strike price .05 Breakeven Price = Higher Strike price .Lower strike price – Net premium received = 1100 -1000.95 = 1036.FORE School Of Management-FD Project The net position of profit or loss is explained by the following diagram:- Maximum profit = Net option premium income or net credit = 64 – 0.-9.63.

he may lose the premium for the option. An investor with a bearish market outlook shall buy put options. The investor's potential loss is limited. you have a net short position and needs to be bought back before expiration and cancel out your position. By Group No. To profit. If the price of the underlying asset rises instead of falling as the investor has anticipated. he may let the option expire worthless. It will increase in value if the market falls. the market price must be below the exercise price. An increase in volatility will make it more likely that the price of the underlying instrument will move. The investor breaks even when the market price equals the exercise price: plus the premium. FD-Term Project. because they could purchase the underlying asset at the lower market price. By purchasing put options. higher the profits. The trader's breakeven point is the exercise price minus the premium. he will be exposed to potentially large losses if the market rises against his position. A put option is a bearish position.FORE School Of Management-FD Project When you purchase a put you are long and want the market to fall. If the market price falls.-9. Calls in a Bearish Strategy Another option for a bearish investor is to go short on a call with the intent to purchase it back in the future. Here the loss potential is unlimited because a short call position holder has an obligation to sell if exercised. the trader is losing money. An increase in volatility will increase the value of your put and increase your return. Section-D Page 20 . Since the trader has paid a premium he must recover the premium he paid for the option. the trader has the right to choose whether to sell the underlying asset at the exercise price. This increases the value of the option. The investor's profit potential is limited because the trader's maximum profit is limited to the premium received for writing the option. The higher the fall in price of the underlying asset. the trader breaks even. this choice is preferable to being obligated to buy the underlying at a price higher. At any price greater than the exercise price plus the premium. At the most. An investor's profit potential is practically unlimited. For this an investor needs to write a call option. In a falling market. By selling a call. When the market price equals the exercise price plus the premium. long call holders will let their out-of-the-money options expire worthless.

FORE School Of Management-FD Project An increase in volatility will increase the value of your call and decrease your return. The "Bear Put Spread" allows the investor to participate to a limited extent in a bear market. the options will be out-of-the-money and expire worthless. The trader pays a net premium for the position. Section-D Page 21 . The trader buys a put with a lower exercise price and writes a put with a higher exercise price. When the market price falls to or below the lower exercise price. FD-Term Project. When the option writer has to buy back the option in order to cancel out his position.-9. To "buy a put spread" is to purchase a put with a higher exercise price and to write a put with a lower exercise price. both options will be in-the-money and the trader will realize his maximum profit when he recovers the net premium paid for the options. the trader profits. By Group No. You sell the lower strike and buy the higher strike of either calls or puts to set up a bear spread. When the market price falls to the high exercise price less the net premium. An investor with a bearish market outlook should: buy a put spread. When the market falls beyond this point. receiving a net premium for the position. the market price must fall. To "sell a put spread" is the opposite. The investor's potential loss is limited. If the market rises rather than falls. The investor's profit potential is limited. To put on a bear put spread you buy the higher strike put and sell the lower strike put. The trader has offsetting positions at different exercise prices. Bearish Put Spread Strategies A vertical put spread is the simultaneous purchase and sale of identical put options but with different exercise prices. the trader breaks even. For the strategy to be profitable. he will be forced to pay a higher price due to the increased value of the calls. while at the same time limiting risk exposure. Since the trader has paid a net premium The investor breaks even when the market price equals the higher exercise price less the net premium.

64. buy a put or take long position in put at higher strike price and sell put at lower strike price.Lower strike price option . Section-D Page 22 800 850 .63.1000.1000 attract a premium of Rs.1100. On 29th April 2010. Reliance put option at strike price of Rs. As per the strategy.05 and at a strike price of Rs 1100. the premium is Rs.05 FD-Term Project.Net premium = 1100 .1000 and Higher Strike price is Rs.-9.FORE School Of Management-FD Project Continuing with the above example of Reliance securities. So here Lower strike price is Rs.0. We explore various outcomes with respect to Reliance industries share in the market which is as follow:- The net position of profit or loss is explained by the following diagram:- Maximum profit paid = Higher strike price option .95 = 36. By Group No.

the options will offset one another. The trader pays a net premium for the position. while at the same time limiting risk exposure. The investor breaks even when the market price equals the lower exercise price plus the net premium.95 Breakeven Price = Higher strike price . An investor with a bearish market outlook should: sell a call spread. To "sell a call spread" is the opposite: the trader buys a call with a higher exercise price and writes a call with a lower exercise price. both out-of-the-money options will expire worthless.-9. Since the trader is FD-Term Project.FORE School Of Management-FD Project Maximum loss = Net premium paid = 64 -0.05 = 63. the maximum loss will equal high exercise price minus low exercise price minus net premium. When the market price falls to the lower exercise price.95 = 1036. Here the investor's potential loss is limited. The maximum profit that the trader can realize is the net premium: The premium he receives for the call at the higher exercise price. Section-D Page 23 . The strategy becomes profitable as the market price declines.Net premium paid = 1100 – 63. An investor sells the lower strike and buys the higher strike of either calls or puts to put on a bear spread. To "buy a call spread" is to purchase a call with a lower exercise price and to write a call with a higher exercise price. receiving a net premium for the position. The "Bear Call Spread" allows the investor to participate to a limited extent in a bear market.05 Bearish Call Spread Strategies A vertical call spread is the simultaneous purchase and sale of identical call options but with different exercise prices. If the market rises. The investor's profit potential is limited. By Group No. To put on a bear call spread you sell the lower strike call and buy the higher strike call. At any price greater than the high exercise price.

1250. By Group No. We explore various outcomes with respect to Reliance industries share in the market which is as follow:- The net position of profit or loss is explained by the following diagram FD-Term Project. the premium is Rs. So here Lower strike price is Rs.1000 attract a premium of Rs.1000 and Higher Strike price is Rs. On 29th April 2010.05 and at a strike price of Rs 1100. the market price does not have to fall as low as the lower exercise price to breakeven.FORE School Of Management-FD Project receiving a net premium. Reliance call option at strike price of Rs.0. As per the strategy. sell a call or take short position in call at lower strike price and buy call at higher strike price. Continuing with the above example of Reliance securities.-9.33. Section-D Page 24 800 .

Section-D -32.Net premium = 1250 -1000 – 32.95 = 1032.95 Page 25 .-9.FORE School Of Management-FD Project Maximum profit Maximum loss received Breakeven Price = Net premium received = 33 -0.95 -32.95 = 217.95 -32. the following table and diagram can sum up the situation.95 = Higher strike price option .95 So by exploring all the 4 combination in the two markets.Lower strike price option .05 = Lower strike price + Net premium paid = 1000 + 32.05 = 32. Bu Buy a Call spread Ways To Remember FD-Term Project. By Group No.

these strategies offer profit the market is volatile. To "sell a straddle" is the opposite: the trader sells a call and a put with the same exercise price and expiration date. opportunities.-9. A trader need not be bullish or bearish.com To "buy a straddle" is to purchase a call and a put with the same exercise price and expiration date. Section-D Sell a ca Buy at Bear Sell at l Page 26 . A straddle is the simultaneous purchase (or sale) of two identical options.FORE School Of Management-FD Project Volatile Market Strategies Straddles in a Volatile Market Outlook Volatile market trading strategies are appropriate when the trader believes the market will move but does not have an opinion on the direction of movement of the market. As long as there is significant movement upwards or downwards. He must simply be of the opinion that Bull Call Buy a S Buy at Sell at h Source: theopotionguide. By Group No. one a call and the other a put. FD-Term Project.

the most he will lose is the premium he paid for the options. both the call and the put are out-of-the-money. In this case the trader has long two positions and thus. bear market. viewing a market as volatile. FD-Term Project. By Group No. A "straddle purchase" allows the trader to profit from either a bull market or from a bear market.-9. which is exercise price minus the premiums paid. exercise the call. two breakeven points. Strangles in a Volatile Market Outlook A strangle is similar to a straddle. the strike price we have taken is Rs. and the other for the put.) While the investor's potential loss is limited. Eg: Continuing with the same Reliance industries. 44. Here the investor's profit potential is unlimited. To "buy a strangle" is to purchase a call and a put with the same expiration date. Section-D Page 27 . If the price of the underlying asset remains stable instead of either rising or falling as the trader anticipated. but different exercise prices. the trader can profit from an up. The premium for call option for the strike price for the month of April is Rs.10 and premium for the Put option is Rs. which is exercise price plus the premiums paid. except that the call and the put have different exercise prices. the put. 0. If the market is volatile. 1080.50. One is for the call. should buy option straddles. (Bull market. Usually.FORE School Of Management-FD Project A trader.or downward movement by exercising the appropriate option while letting the other option expire worthless.

A "strangle purchase" allows the trader to profit from either a bull or bear market. the more the options are out-of-the-money. Section-D Page 28 .or downward movement by exercising the appropriate option. A trader. Here the loss potential is also very minimal because. One for the call. the lesser the premiums. Because the options are typically out-of-themoney.com To "sell a strangle" is to write a call and a put with the same expiration date. Here the trader has two long positions and thus. should buy strangles. and letting the other expire worthless. 1000. 1080 and the long put strike price is at Rs. but different exercise prices. By Group No. E. two breakeven points. If the market is volatile. and for the put. (In a bull market. The investor's potential loss is limited. the most the trader would lose is the premium he paid for the options. viewing a market as volatile. The trader's profit potential is unlimited.-9.FORE School Of Management-FD Project Source: theopotionguide. exercise the call. the trader can profit from an up. the market must move to a greater degree than a straddle purchase to be profitable. Should the price of the underlying remain stable.: Continuing with the same example. the put).g. in a bear market. The Short Butterfly Call Spread FD-Term Project. which breakevens when the market price equal the high exercise price plus the premium paid. when the market price equals the low exercise price minus the premium paid. the Long Call strike price is at Rs.

-9. FD-Term Project.com Like the volatility positions we have looked at so far. By Group No. The position would yield a profit only if the market moves below 40 or above 50.consisting of two short options balanced out with two long ones. Section-D Page 29 . It also uses a combination of puts and calls to achieve its profit/loss profile . The maximum loss is also limited. You are short the September 40-45-50 butterfly with the underlying at 45. The Call Ratio Back-spread The call ratio back-spread is similar in construction to the short butterfly call spread you looked at in the previous section. Say you had built a short 40-45-50 butterfly. two long calls at a medium exercise price and 1 short call at a high exercise price. Your potential gains or losses are: limited on both the upside and the downside. You are neutral but want the market to move in either direction. the Short Butterfly position will realize a profit if the market makes a substantial move. The only difference is that you omit one of the components (or legs) used to build the short butterfly when constructing a call ratio back-spread.but combines them in such a manner that the maximum profit is limited. The spread shown above was constructed by using 1 short call at a low exercise price.FORE School Of Management-FD Project Source: theopotionguide. The position is a neutral one .

you receive an initial credit for this position. The maximum loss is then equal to the high strike price minus the low strike price minus the initial net premium received. An increase in implied volatility will make your spread more profitable.g. you are neutral but want the market to move in either direction. It is created by combining long and short puts in a ratio of 2:1 or 3:1. By Group No. The profit on the downside is limited to the initial net premium received when setting up the spread. Source: theopotionguide. it is important that you respect the (in this case) 3:1 ratio in order to maintain the put ratio back-spread profit/loss profile. ratio spreads). profit profiles. The greater number of long options will cause this spread to become more profitable when volatility increases. While you may. of course. To put on a call ratio back-spread.com The Put Ratio Back-spread In combination positions (e.FORE School Of Management-FD Project When putting on a call ratio back-spread.-9. When you put on a put ratio backFD-Term Project. Your potential gains are limited on the downside and unlimited on the upside. the put ratio back-spread combines options to create a spread which has limited loss potential and a mixed profit potential. bull spreads. In a 3:1 spread. extend this position out to six long and two short or nine long and three short. you would buy three puts at a low exercise price and write one put at a high exercise price. with greater probability that the market will rally. you sell one of the lower strikes and buy two or more of the higher strike. Like its call counterpart. The call ratio back-spread will lose money if the market sits. if not identical. one can use calls or puts to achieve similar. The upside profit is unlimited. The market outlook one would have in putting on this position would be for a volatile market. Increased volatility increases a long option position's value. By selling an expensive lower strike option and buying two less expensive high strike options. butterfly’s. Section-D Page 30 .

-9. Source: theopotionguide. You sell the more expensive put and buy two or more of the cheaper put.Low strike price . As long as there is significant movement upwards or downwards. One usually receives an initial net premium for putting on this spread.FORE School Of Management-FD Project spread: are neutral but want the market to move in either direction. resulting in a net premium received. By Group No. Section-D Page 31 . these strategies offer profit FD-Term Project. Your market expectations here would be for a volatile market with a greater probability that the market will fall than rally. The cost of the long puts is offset by the premium received for the (more expensive) short put. Stable Market Strategies Straddles in a Stable Market Outlook Volatile market trading strategies are appropriate when the trader believes the market will move but does not have an opinion on the direction of movement of the market.Initial net premium received. The Maximum loss is equal to: High strike price . To put on a put ratio back-spread. you: buy two or more of the lower strike and sell one of the higher strikes.com Unlimited profit would be realized on the downside: The two long puts offset the short put and result in practically unlimited profit on the bearish side of the market.

viewing a market as stable.com To "buy a straddle" is to purchase a call and a put with the same exercise price and expiration date." A straddle is the simultaneous purchase (or sale) of two identical options. should: write option straddles. The investor's profit potential is limited. FD-Term Project. The investor's potential loss is unlimited. Writers of these options will not have be called to deliver and will profit from the sum of the premiums received.-9. By Group No.FORE School Of Management-FD Project opportunities. trader’s long out-ofthe-money calls or puts will let their options expire worthless. If the market remains stable. Should the price of the underlying rise or fall. This market outlook is also referred to as "neutral volatility. exposing himself to unlimited loss if he has to deliver on the call and practically unlimited loss if on the put. A "straddle sale" allows the trader to profit from writing calls and puts in a stable market environment. one a call and the other a put. Section-D Page 32 . To "sell a straddle" is the opposite: the trader sells a call and a put with the same exercise price and expiration date. He must simply be of the opinion that the market is volatile. Source: theopotionguide. the writer of a call or put would have to deliver. A trader. A trader need not be bullish or bearish.

com A strangle is similar to a straddle. and one for the put (common exercise price minus the premiums paid). both the call and the put are out-of-the-money. FD-Term Project. viewing a market as stable. The investor's potential loss is: unlimited.-9. Strangles in a Stable Market Outlook Source: theopotionguide. Usually the call strike price is higher than the put strike price. By Group No. Usually. investors having out-of-the-money long put or long call positions will let their options expire worthless. Section-D Page 33 . One for the call (common exercise price plus the premiums paid). If the market remains stable. should: write strangles. A trader. To "buy a strangle" is to purchase a call and a put with the same expiration date. The trader is short two positions and thus. but different exercise prices. The investor's profit potential is: unlimited. To "sell a strangle" is to write a call and a put with the same expiration date. A "strangle sale" allows the trader to profit from a stable market. two breakeven points. he will have to deliver on the call or the put. but different exercise prices. If the price of the underlying interest rises or falls instead of remaining stable as the trader anticipated. except that the call and the put have different exercise prices.FORE School Of Management-FD Project The breakeven points occur when the market price at expiration equals the exercise price plus the premium and minus the premium.

This spread is put on by purchasing one each of the outside strikes and selling two of the inside strike. you: buy the 40 and 50 strike and sell two 45 strikes.-9. Why would a trader choose to sell a strangle rather than a straddle? The risk is lower with a strangle. Although the seller gives up a substantial amount of potential profit by selling a strangle rather than a straddle. you do just the opposite. The trader is short two positions and thus.. utilizing calls and three different exercise prices. A long butterfly call spread involves: • • • Buying a call with a low exercise price Writing two calls with a mid-range exercise price Buying a call with a high exercise price To put on the September 40-45-50 long butterfly. and one for the put (low exercise price minus the premiums paid). he also holds less risk..FORE School Of Management-FD Project The breakeven points occur when market price at expiration equals. Long Butterfly Call Spread Strategy The long butterfly call spread is a combination of a bull spread and a bear spread. two breakeven points.com FD-Term Project. To put on a short butterfly. Section-D Page 34 . One for the call (high exercise price plus the premiums paid). By Group No. Source: theopotionguide. Notice that the strangle requires more of a price move in both directions before it begins to lose money.the high exercise price plus the premium and the low exercise price minus the premium.

○ The Indian Commodity-Derivatives Market in Operations.nse. • • MAGAZINES Page 35 FD-Term Project. Section-D . The maximum loss is limited to the net premium paid and is realized when the market price of the underlying asset is higher than the high exercise price or lower than the low exercise price.com. Bibliography Primary data: The data has been collected through Min Max Investment Advisor Foundation.-9. Maximum profit is attained when the market price of the underlying interest equals the mid-range exercise price (if the exercise prices are symmetrical).india.project guide. Secondary data: The data of the secondary data has been collected from the • • TheEconomic Times the www. By Group No. The strategy is profitable when the market price is between the low exercise price plus the net premium and the high exercise price minus the net premium. The investor's potential loss is: limited. BOOKS AND ARTICLES ○ NCFM on derivatives core module by NSEIL. The breakeven points occur when the market price at expiration equals the high exercise price minus the premium and the low exercise price plus the premium.FORE School Of Management-FD Project The investor's profit potential is limited. and stock brokers.

-9.com www.com www.com www.FORE School Of Management-FD Project ○ The Dalal Street ○ LSE Bulletin • INTERNET SITES ○ ○ ○ ○ www.nseindia. Section-D Page 36 . By Group No.bseindia.sebi.derivativeindia.in FD-Term Project.gov.