FOME

CONCEPTS Part 2
OPTIONS BECOME A PRO
MONEY WILL FLOW

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SUCCESS!
 FOME Concepts Part 2 – OPTIONS
INDEX
What are Options?..........……………………………………….…………….......................3
Why Options?..........…………………………..……………………………………………………..4
Futures v/s Options…………………………………………………………………...................5
Option Terminologies………….….………………………………………….........................6
Call (CE) Option..……….………..………………………...............................................11
Put (PE) Option……..…..…………………………………………………..…........................14
CE & PE Overview.…………………………………………………………………………………….17
Break-even Point………………..…………………………..…………………………………..…..18
Open Interest……………………………………………………………………………………........19
Delta…………………………………………………………………………………………………….....20

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What are Options?
➢ Options are contracts which provide the holder the right to sell or buy a
specified quantity of an underlying asset at a fixed price on or before the
expiration of the option date.

➢ Options provide a right and not the obligation to buy or sell.

➢ Developed for Hedging and Speculating!

➢ There are two basic types of Options:

• CALL Option: It is an option contract which provides the holder a right
to buy specified assets at specified price on or before a specified date.

• PUT Option: It is an option contract which provides the holder a right

to sell specified assets at specified price on or before a specified date.

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Why Options?
➢ Flexibility: It provides multiple execution strategies to implement
one view. E.g. If view is Bullish then one can either Buy Calls or Sell
Puts.

➢ Leverage: It offers the highest leverage where one can invest very
minimal amount in the form of PREMIUM and take much greater
exposure of the underlying asset.

➢ Incomparable Risk/Reward: It provides very large profit potential

with pre-known maximum risk for an option buyer.

➢ Seller Profits: Selling options is like selling insurance so anyone who

feels like earning revenues by selling insurance can set himself up to
do so in the Options market.

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Futures v/s Options
PARAMETERS FUTURES OPTIONS
Option Buying - Need to pay complete
Need to pay Margin Cost (15-
Premium Cost
INVESTMENT 20%) for both Buying and
Option Selling - Need to pay Margin Cost (15-
Selling Futures
20%) but Receives Premium
VIEW Bullish – Buy / Long Bullish – Buy Call / Sell Put
EXECUTION Bearish – Sell / Short Bearish – Buy Put / Sell Call
Significant as Option value constitutes of Time
TIME IMPACT No Impact
Value which becomes Zero at Expiry
PLEDGING Allowed to use for both buying
Allowed to use only for selling Options
CAPITAL and selling Futures

PRICE Futures Price

Options Price (Premium)
DENOMINATION (Premium or Discount)

BREAK-EVEN Immediate similar to cash

Close or Far according to Option Price
POINT market
Option Buying - Limited risk and potentially
Both buying and selling have higher reward than risk involved
RISK REWARD
unlimited Risk and Reward Option Selling - Limited reward and potentially
higher risk than premium received
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Options Terminologies
➢ American Options:
• Currently not used in Indian Market
• Can be exercised any time before expiration or on the expiration date.
• CA: Call American, PA: Put American

➢ European Options:
• Used for Index and Stocks in Indian Market
• Can be exercised only on the expiry date and not before.
• CE: Call European, PE: Put European

➢ Option Buyer / Holder: The buyer of an option is the one who, by paying
the option premium, buys the right but not the obligation to exercise his
option on the seller/writer.
➢ Option Seller / Writer: The seller of an option is the one who receives the
option premium and is, thereby, obliged to sell/buy the asset if the buyer
exercises on him.

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Options Terminologies
➢ Option Price/Premium:
• The upfront payment made by the buyer to the seller to enjoy the privileges of
an option contract.
• Intrinsic Value + Time Value

➢ Intrinsic Value:
• The amount by which an Option is “In the Money”.
• For a call option : Intrinsic value = Spot price – Strike price
• For a put option : Intrinsic value = Strike price – Spot price
• E.g. If RIL spot is 920 & RIL 900 call is at a premium of Rs. 25 then Intrinsic Value
is 20.

➢ Time Value:
• The amount by which the Option is “Out of the Money”.
• The longer the time remaining until an option’s expiration, the higher its
premium will be.
• Time Value becomes Zero at Expiry.
• E.g. If RIL spot is 920 & RIL 900 call is at a premium of Rs. 25 then Time Value is
5.

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Options Terminologies
➢ Strike Price / Exercise Price:
• The pre-determined price at which the underlying asset can be
bought or sold.
• E.g. Nifty strikes prices of 9500, 9550, 9600, 9650, etc.
• Strikes which are closer to the spot price are more liquid and
expensive.

➢ ATM - At the Money (Break-Even Point):

• An option with strike price equivalent to the current spot price
➢ ITM - In the Money (Profit Zone):
• A Call option with strike price below the spot price
• A Put option with strike price above the spot price
➢ OTM - Out of the Money (Loss Zone):
• A Call option with strike price above the spot price
• A Put option with strike price below the spot price

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Options Terminologies
➢ Open Interest (OI): It refers to the total number of outstanding positions on a
particular options contract across all participants in the market at any given
point of time. It becomes Zero past the expiration date for a particular contract.

➢ Implied volatility (IV):

• It is the estimated volatility of underlying asset price.
• In general, implied volatility increases when the market is bearish and
decreases when the market is bullish. This is due to the common belief that
bearish markets are riskier than bullish markets.

➢ Expiration Date: A day on which the option is no longer valid and ceases to
exist.
• Last Thursday of every month for Monthly Expiry. E.g. Nifty, Bank Nifty, etc.
• Every Thursday for Weekly Expiry. E.g. Nifty, Bank Nifty, etc.

➢ Exercise Day: The date when the buyer/holder of an option exercises the
Option.

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Option Chain

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Call (CE) Option
➢ It is an option contract which provides the holder a right to buy specified
assets at specified price on or before a specified date.

➢ ITM: A CALL Option with strike price below the spot price.

➢ OTM: A CALL Option with strike price above the spot price.

➢ CE Premium = Intrinsic Value + Time Value

➢ Intrinsic value of CE = Spot price – Strike price

➢ Bullish View = Buy CE

➢ Bearish View = Sell CE

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CE – Bullish Scenario

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CE – Bearish Scenario

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Put (PE) Option
➢ It is an option contract which provides the holder a right to sell specified
assets at specified price on or before a specified date.

➢ ITM: A Put option with strike price above the spot price.

➢ OTM: A Put option with strike price below the spot price.

➢ PE Premium = Intrinsic Value + Time Value

➢ Intrinsic value of PE = Strike price – Spot price

➢ Bearish View = Buy PE

➢ Bullish View = Sell PE

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PE – Bullish Scenario

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PE – Bearish Scenario

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 CE and PE Overview
CALL OPTION BUYER : LONG CALL CALL OPTION WRITER (Seller) : SHORT CALL

• Receives premium
• Pays premium
• Obligation to sell shares if exercised
• Right to exercise and buy the shares
• Profits from falling prices or remaining
• Profits from rising prices
neutral
• Limited risk and potentially higher
• Limited reward and potentially higher risk
reward than risk involved
than premium received

PUT OPTION BUYER : LONG PUT PUT OPTION WRITER (Seller) : SHORT PUT

• Receives premium
• Pays premium
• Obligation to buy shares if exercised
• Right to exercise and sell shares
• Profits from rising prices or remaining
• Profits from falling prices
neutral
• Limited risk and potentially higher
• Limited reward and potentially higher risk
reward than risk involved
than premium received

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Break-even Point (BEP)
➢ Break-even point is the point where you are at “no profit, no loss”. In other
words, BEP is where you start making profit or loss.

➢ BEP calculation:
• Equity – BEP is the same price as you enter in your trade/investment.
Example: You buy or short (short on intra-day only) Reliance equity shares at
Rs. 1750, BEP will be 1750.
• Futures – BEP is the same price as you enter in your trade.
Example: You went long or short in Nifty Futures at Rs. 10,500, BEP will be
10,500.
• Call (CE) Option – BEP formula for CE is “Strike Price + Premium”.
Example: You went long or short in SBI 190 CE at Rs.5, BEP will be 190+5 =
195.
• Put (PE) Option - BEP formula for PE is “Strike Price - Premium”.
Example: You went long or short in SBI 190 PE at Rs.5, BEP will be 190-5 =
185.

NOTE: For options, the BEP point is considering the settlement on the day of
expiry.

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Open Interest (OI)
➢ Open Interest (OI) is the total number of outstanding positions in
options at a given point of time. This is inclusive of buyers and
sellers. In other words, Open Interest shows the total number of
buyers and sellers who are still in the trade.

➢ Build-up – When the OI goes up, we say that there is “build-up” in

Open Interest. Basically, it means that traders are entering into fresh
contracts resulting in OI going up.

➢ Covering – When the OI goes down, we say that there is “covering”

in Open Interest. In other words, it means that traders are squaring-
off their existing positions resulting in OI going down.

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Delta
➢ Generally, when the price of an asset moves by some amount its
corresponding derivative, options in this case, does not move with the
same value; there is always a difference. This difference in the ratio of
change in the spot price of an asset v/s option premium is shown by Delta.

➢ Delta is the rate of change in option premium as compared to the change

in spot price.

➢ Formula for calculating Delta:

Delta = Change in premium / Change in Spot

➢ Delta can be used to identify Stop Loss, Target, etc. when trading options.

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Delta Example

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Delta Example
➢ Delta = Change in premium / Change in Spot

➢ In the example of Reliance:

• Spot price on June 01, 2020 = 1480
• Spot price on June 05, 2020 = 1600
• Change in spot = 120 (i.e. 1600 – 1480)

• 1480 CE premium on June 01, 2020 = 48

• 1480 CE premium on June 05, 2020 = 134
• Change in premium = 86 (134 – 48)

• DELTA = 86 / 120
• DELTA = 0.71

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IMPORTANT TIPS FOR OPTIONS TRADING

➢ Don’t trade in options without proper understanding

and practice of Technical Analysis and Options Analysis.

➢ Avoid Illiquid stock options.

➢ Avoid deep OTM options.

➢ Be aware of Time decay in options.

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