FIN - 309

Capital Market Operations

 Objectives
• Application of Options

• Basic strategies of hedging using options

• Basic strategies of Speculation using options

• Basic strategies of Arbitration using options

 Link for News
• https://indianexpress.com/article/explained
/explained-tussle-between-future-group-
amazonwhat-happens-next-
6913824/#:~:text=Last%20year%2C
%20Biyani's%20Future%20Retail,worth
%20nearly%20Rs%202%2C000%20crore.
• https://economictimes.indiatimes.com/mar
kets/stocks/news/reliance-industries-slips-
over-4-post-q2-
results/articleshow/78992368.cms
 Introduction
• In option, as the name indicates, gives one
party the option to take or make delivery.
But this option is given to only one party in
the transaction while the other party has
an obligation to take or make delivery
Payoffs
 Use of Options (Only Simple
Strategies of Hedging,
Speculation and Arbitrage)

• Speculation and Hedging with Futures

Options
Speculation
Speculation: Bearish security,
sell calls or buy puts
The basics of option premium
determination
• While supply and demand ultimately
determines the price of options, several
factors have a significant impact on option
premiums, which are
– Spot Price of the underlying assets
– The exercise price of the option
– The volatility in the underlying markets.
• Time remaining to expiration
• Risk free rate of interest
• Dividend (only for option on equity)
 Define breakeven point
• Breakeven point is the point at which there is no
net loss or gain, one has just broken even. The
maximum amount the option buyer can lose is
the premium that he originally paid.
• It is that point where the payoff of the buyer is
exactly equal to the amount of premium paid. To
calculate the breakeven point on options, one
uses the strike price and the premium.
• Breakeven point Calculation
• Call Option = Strike Price + Premium
amount.
• Put Option = Strike Price - Premium
amount.
What is put/call ratio and how
is it used
• The put-call ratio is simply the number of
puts traded divided by the number of calls
traded. It can be computed daily, weekly,
or over any time period.
• It can be computed for stock options,
index options, or options on futures. Some
market technicians believe that a high
volume of puts relative to calls indicates
investors are bearish, whereas a high ratio
of calls to puts shows bullishness.
 What does the term delta
mean
• Delta measures the rate of change of an
option premium with respect to a price
change in the underlying asset.
• Delta is a measure of price sensitivity at
any given moment. Not all options move
point for point with their underlying asset.
• If an underlying asset moves 0.50 points
and the option only moves 0.25 points, its
delta is 50%; that is, the option is only
50% as sensitive to the movement of the
underlying asset.
• The delta is between 0 and +1 for calls
and between 0 and -1 for puts (thus a call
option with a delta of 0.5 will increase in
price by 1 tick for every 2 tick increase in
the underlying).
Hedging using futures
conclusion
 MTM
• Margins clearly play a very crucial role in
futures trading as it enables one to
leverage. In fact, margins are the one that
gives a ‘Futures Agreement’ the required
financial twist (as compared to the spot
market transaction). 
 Basic concepts
• Before we proceed any further, let us list
down a list of things you should know by
now.
• Futures is an improvisation over the
Forwards
• The futures agreement inherits the
transactional structure of the forwards
market
• A futures agreement enables you to
financially benefit if you have an accurate
directional view on the asset price
• The futures agreement derives its value
from its corresponding underlying in the
spot market
• The futures contract is a standardized
contract wherein the variables of the
agreement is predetermined – lot size and
expiry date
 Margin and leverage
• To enter into a futures agreement one has
to deposit a margin amount, which is
calculated as a certain % of the contract
value
• Margins allow us to deposit a small
amount of money and take exposure to a
large value transaction, thereby leveraging
on the transaction
 Why are Margins charged
• In the example quoted, 3 months from now
ABC Jewelers agrees to buy 15Kgs of
Gold at Rs.2450/- per gram from XYZ
Gold Dealers.
 Important points of MTM
• At the time of initiating the futures position,
margins are blocked in your trading
account
• The margins that get blocked is also called
the “Initial Margin”
• The initial margin is made up of two
components i.e. SPAN margin and the
Exposure Margin
 i n +
M arg
PA N
= S
r g i n
Ma rg in tur es
iti al M a on th
e f u
• In osure dep e n ds

Exp
s it
d a ily a
ar ie s lue
in v t V a is
ar g tra c . T h
n iti al m o f C on e ry d ay
u e o fi = % o t Siz ies eve
h e val a r gin ice * L ce var
1. T ce n it ial M res Pr res pri
pr i b e r, I = Futu e futu yday
e m em
V al ue , but th y ever
2. R ntract fi x ed lso var
o a a
3. C t size is argins
o m
4. L ans the
me
 Mark to Market (M2M)
• (M2M) is a simple accounting procedure
which involves adjusting the profit or loss
you have made for the day and entitling
you the same. As long as you hold the
futures contract, M2M is applicable.
 Example
• Assume on 1st Dec 2014 at around 11:30
AM, you decide to buy Hindalco Futures at
Rs.165/-. The Lot size is 2000. 4 days
later on 4th Dec 2014 you decide to square
off the position at 2:15 PM at Rs.170.10/-.
Clearly as the calculation below shows,
this is a profitable trade –
• Buy Price = Rs.165
• Sell Price = Rs.170.1
• Profit per share = (170.1 – 165) = Rs.5.1/-
• Total Profit = 2000 * 5.1
• = Rs.10,200/-
• However, the trade was held for 4 working
days. Each day the futures contract is
held, the profits or loss is marked to
market. While marking to market, the
previous day closing price is taken as the
reference rate to calculate the profit or
losses.
Closing prices for 4 days
Day 1
Day 2
Day 3 and Day 4
Conclusion
End of lecture