This Module is based on options trading . Thus we have tried to cover almost all the information about NCFM OTAM exam . I have also attached the workbook of Options trading advanced module by Nse at the end of this article .
Options - The Backgrounder
- Both Parties in the forward contract are committed.
- Both parties in the future contract are committed.
- In options , Only one partner is committed.
- American options are exercisable any time till the expiry of the contract.
- European options are exercisable only on expiry of the contract.
- Option contracts to buy an underlying are called Call Options.
- Option contracts to sell an underlying are called Put Options.
- Swaps are contract where two parties commit to exchange two different stream of payments , based on notional principal.
A = P * er *nHere ,
P = Prinicpal Amount
e = Exponential function and it value is 2.71828
r = Continuously compounded rate of interest
n = Number Of Periods
Example : Rs 10000 compounded continuously @ 7% per annum for 5 years would be calculated as
10000 * e0.07 * 5 = 14190.67
Options has two values - Intrinsic and Time Value
Note : Only In the money Options have intrinsic value and time value both , Out of the money and At the Money options do not have Intrinsic value , they only have time value.
- Call Options are said to be In the money , when its strike price is less than the spot price of the underlying asset. ie. Strike price < Spot price of underlying
- Call Options are said to be Out of the money , when its strike price is greater than the spot price of the underlying asset .ie. Strike Price > Spot price of the underlying
- Call options are said to be At the money , When its strike price is equal to the spot price of the underlying asset . ie . Strike price = spot price of the underlying.
- In the pic above , indiabulls real estate is trading at 80.35 on spot.
- All the call options with strike price < 80.35 are In the money options
- Call option with strike price = 80 is at the money option.
- Call options with strike price > 80.35 are out of the money options
- Intrinsic value of calls ( Only in ITM Calls) = Spot price of underlying - Strike price of call
- Time Value of calls = Actual price of call - Intrinsic Value
Example 1 : Lets Look at 77.50 strike call which is trading at 4.50 in the pic above. This call is In the money call as 77.50 < 80.35 ie. Strike price < Underlying price. Here Intrinsic value = 80.35 - 77.50 = 2.85 But the call option is trading at rs 4.50 , Then anything above 2.85 , is the Time value ie. Time value = 4.50 - 2.85 = 1.65
Example 2 : Lets look at the 85 strike call which is trading at 1.15 . This call option is Out of the money , as 85 > 80.35 ie Strike Price > Underlying Price . OTM options only have time value , No intrinsic value , Then here - Intrinsic value = 0 and time value = 1.15Put Options
- Put options are said to be In the money ,If strike price is greater than underlying price ie. Strike price > Underlying price
- Put Options are said to be At the money , If strike price is equal to the underlying price ie . Strike price = Underlying price
- Put options are said to be Out of the money , If strike price is less than the underlying price ie Strike price is < Underlying price
- In the pic above , Indiabulls real estate is trading at 80.35
- All the put options with strike price < 80.35 ie are out of the money puts.
- Put option with strike price = 80 are at the money puts
- Put options with strike price > 80.35 are in the money puts.
- Intrinsic value of Put (Only in ITM puts ) = Strike Price - Underlying price
- Time Value = Actual price of Put - Intrinsic Value
Example 1: Lets look at 85 strike put trading at 5.80 in the pic above. The underlying stock is trading at 80.35 . here Strike price > underlying price , Thus 85 strike put is In the money option thus it has both intrinsic and time value . Here , Intrinsic value = 85 - 80.35 = 4.65 ie strike price - underlying price .. Time value = 5.80 - 4.65 = 1.15 ie actual price of put - intrinsic value.
Example 2 : Lets look at 70 strike put which is trading at 0.25 . Since here Strike Price < Underlying Price . Thus it is a out of the money option . Thus it has only time value . Here intrinsic value = 0 and time value = 0.25.Normal distribution
- Normal distribution is denoted by Greek symbol Φ.
- Normal distribution is defined by mean and standard Deviation . Thus Φ(15,5) refers to normal deviation with mean 15 and standard deviation 5.
- It can even be depicted in the form of bell - shaped curve.
Mean = ln(spot price ) + ( r - σ2 /2) * T
ln =Natural log
r = Expected annual return on stock
After calculating mean , Calculate σ For the specified time period for using the following formula
After Calculating σ for the specified period , Calculate Range using the formula
σ = σ√t
Range = Mean +/- z* σ .. here σ = σ that we calculated for specific perdiodAfter calculating range , calculate the upper and lower end by using the following formula
Upper end = eMean + z* σ
Lower end = eMean - z* σ
Lower and upper end will give you the range within which stock may move within a certain period of time with a certain level of probability.
Lets understand it with an example...
Example : Indiabulls realestate is trading at 80.35 on spot with the expected rate of return of 7% and 11 days are left for expiry . The annual volatility of the share is 0.7418 . Calculate the upper and lower end for the current month with the accuracy level of 70%. .
Solution : Mean = ln(80.35) + [0.07- 0.74182/2] * 11/365 = 4.396793379 ... Now , we will calculate standard deviation for 11 days >> σ = 0.7418√11/365 = 0.1287765362 ...
Now , Range = Mean +/- z * s.d >>
Upper Range = 4.396793379 + 1.04 * 0.1287765362 = 4.530720977
lower range = 4.396793379 - 1.04 * 0.1287765362 = 4.262865781
now we know that ,
Upper End = eupper range = e 4.530720977 = 92.82
Lower End = eLower range = e 4.262865781 = 71In the above question , Upper end was 92.82 and lower end was 71 . This means that indiabull real estate would trade between 92.82 and 71 for the upcoming 11 days.
Important Market Indicators
- Put Call Ratio -- Put call ratio is one of the most trusted indicator to identify the future stock moment . It is the ratio between the volumes of call and puts of index or a stock .
- Higher volume of put options indicates a bearish trend in future
- Higher volume of call options indicates a bullish trend in future
- You can check the volume of options on the website of national stock exchange , here is the link. -- Contract wise price volume data
- Note : Rise in market along with rise in volume of put options / rise in put call ratio , indicates that market may fall
- Fall in market along with rise in volume of call options / fall in put call ratio , indicates that market will rise .
- Open Interest - Open interest means the that the total number of positions that have not been squared off . It means a position has been initiated but now covered .
- Higher open interest shows that the security has high liquidity .
- It shows that bid-ask spread would be less in the security.
- Rise in market along with rising open interest , shows that new long positions are being created in the market . This shows that upward trend may continue in the market.
- Rise in market along with falling open interest shows that short covering is taking place . It shows that market is weak The upward trend may not continue.
- Fall in market , along with rising open interest shows that new short positions are being created in the market . This shows that downward trend may continue.
- Fall in market along with falling open interest shows that long covering is taking place . It shows that downward trend may not continue,
- People often do it , when they expect the trend to continue further.
- Large number of roll over indicate that market is likely to continue its trend.
- Small amount of roll over indicate that trend may reverse .
For example : Open interest for nifty May future is 110,000 , OI for June future is 250,000 and OI for July future is 40,000 . Calculate roll over . Solution .
- Calculation of Roll Over = ( Open interest of Middle month ) / total open interest of 3 months
- here , Near month - may
- Middle Month - June
- Far month - Jule