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.

**Continuous Compounding**

The concept of continuous compounding is used in the calculation of many derivatives

A = P * eHere ,^{r *n}

A= Amount

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 * e^{0.07 * 5 = 14190.67}

**Options Valuation**

Options has two values -

**Intrinsic**and

**Time Value**

Note :OnlyIn the money Optionshave intrinsic value and time value both ,Out of the moneyandAt the Money optionsdo not have Intrinsic value , they only have time value.

**Call Options**

- 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

**Calculation Of intrinsic and Time Value of Call 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 isIn the moneycall as77.50 < 80.35ie.Strike price < Underlying price.HereIntrinsic value = 80.35 - 77.50 = 2.85But the call option is trading atrs 4.50, Then anything above 2.85 , is theTime 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 isOut of the money, as85 > 80.35ieStrike Price > Underlying Price .OTM options only have time value ,No intrinsic value, Then here -Intrinsic value = 0andtime value = 1.15

**Put 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 S**trike 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**.

**Calculation of Intrinsic and Time Value of Put options**

- 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 moneyoption thus it has bothintrinsicandtime value. Here ,Intrinsic value = 85 - 80.35 = 4.65iestrike price - underlying price..Time value = 5.80 - 4.65 = 1.15ieactual price of put - intrinsic value.

Example 2 :Lets look at 70 strike put which is trading at 0.25 . Since hereStrike Price < Underlying Price. Thus it is aout of the moneyoption . Thus it has onlytime value. Hereintrinsic value = 0andtime 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**.

**Calculation of Upper end and lower end**

Upper and lower end specifies the range within which stock may move within a specific period of time

Mean = ln(spot price ) + ( r - σ^{2}/2) * T

ln =Natural log

r = Expected annual return on stock

σ = Annual Volatility of the stock or Standard Deviation

T = Time Period

After calculating mean , Calculate

**σ**

**For the specified time period**for using the following formula

After Calculating σ for the specified period , Calculate

σ = σ√t

**Range**using the formula

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 = e^{Mean + z* σ}

Lower end = e^{Mean - 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- 0.7418... Now , we will calculate standard deviation for 11 days >> σ = 0.7418√11/365 = 0.1287765362 ...^{2}/2] * 11/365 = 4.396793379

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= e^{upper range = }e^{4.530720977 = 92.82}

In the above question ,Lower End= e^{Lower range = }e^{4.262865781 = 71}

**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,**Roll over -**When a contract reaches maturity , trader either allow it to expire or continue the same position in the same underlying for the next maturity .- 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 .
**Calculation of Roll Over**= ( Open interest of Middle month ) / total open interest of 3 months

**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 .**

- here ,
**Near month**- may **Middle Month**- June**Far month**- Jule

**Roll over**= (250,000)

**/**(110,000 + 250,000 + 40,000 )

= 250,000 / 400000 = 0.625 or 62.5 %

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This was the 1st part , The next part of the series will be available soon

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