THREE GOLDEN RULES OF INVESTING :
- INVEST EARLY
- INVEST REGULARLY
- INVEST FOR LONG TERM
2008-03-18
2008-03-16
Follow up on Options Trading
Call option : loss limited, profit unlimited.
Put option : profit limited, loss unlimited.
When to Buy a Call Option.
(The quotes are fictitious)
If you are Bullish on a particular Scrip/Index. For example, you are Bullish on Reliance (CMP- Rs.350/-) and expecting it to touch 450 in a month's time (or any particular period say 2/3 months). So you will Buy Reliance Call Option for 1 month (or any particular period) by paying a premium of Rs.10/share (Say). During the course of month you will get Right to excercise your Call Option to Buy Reliance at 350 from the seller of Call Option. Suppose it does not move up, you are free NOT to excercise your option to Buy and your loss is limited to the Premium you have paid.
When to Buy a Put Option.
(The quotes are fictitious)
If you are Bearish on a particular Scrip/Index. For example, you are Bearish on ACC (CMP -Rs.150/-) and expecting it to touch 100/- in a month's time. So you will Buy ACC Put Option for 1 month by paying a premium of Rs.5/share (Say). During the course of month (you are Free to Buy ACC from market any time at lower price) you will get Right to excercise your Put Option to Sell ACC at 150/- to the seller of Put Option. Suppose it does not decline, you are free NOT to excercise your option to Sell and your loss is limited to the Premium you have paid.
When to Sell a Call Option.
(The quotes are fictitious)
If you are Bearish on a particular Scrip/Index. For example, you are Bearish on Infosys (CMP- Rs.3800/-) and expect that it will not move up significantly(or rather decline) in a month's time. So you will Sell Infosys Call Option at a strike rate Rs.3900/- (say) for 1 month and Receive the Premium. (Say Rs.100/share). During the course of month Buyer of Call Option will have Right (Not the Obligation) to take Infosys at 3900/- from you and you are obliged to honour your commitment. Remember that you are Holding risk of umlimited loss if Price of Infosys moves up significantly just at the cost of Premium you have received.(you should sell Call Option Only if you are sure that Price of Share will Fall/or not move up or you are holding shares with you to part with, if required)
When to Sell a Put Option.
(The quotes are fictitious)
If you are Bullish on a particular Scrip/Index. For example, you are Bullish on Satyam (CMP - Rs.200/-) and expect that it will not Decline significantly (or rather move up) in a month's time. So you will Sell Satyam Put Option at a strike rate Rs.215/- (say) for 1 month and Receive the Premium. (Say Rs.12/share). During the course of month Buyer of Put Option will have Right (Not the Obligation) to Sell Satyam at 215/- to you and you are obliged to honour your commitment. Remember that you are Holding risk of umlimited loss if Price of Satyam goes down at the cost of Premium you have received. (you should Sell Put Option Only if you are sure that Price of Share will Move up or you will take Delivery of shares, if required)
Options in Options:
1. You can exercise your right to buy/sell at strike price.
2. You need not exercise your right, but you are going to lose the premium paid upfront.
3. Most people resell the right at a higher premium.
Ex : Lets take the first example of reliance.
Here you have bought rights buy paying Rs.10 as premium.
Now lets say reliance price goes to say Rs.400, then the premium amount would have
also gone up, to say Rs.30. Then you can resell the right at 30 and book your profits.
Options market is more riskier market to cash markets. On the bright side the percentage of return is very high compared to the investments you put in. Options should be used for speculation and hedging and a low percentage to your total investments should go into options. Finally Options isn't for newcomers.
2008-03-09
Trading in Options
An Option is a contract which gives the right, but not an obligation, to buy or sell the underlying at a stated date and at a stated price.
Parties involved :
While a buyer of an option pays the premium and buys the right to exercise his option, the writer of an option is the one who receives the option premium and therefore obliged to sell/buy the asset if the buyer exercises it on him.
Options are of two types - Calls and Puts options :
1. ‘Calls’ give the buyer the right but not the obligation to buy a given quantity of the underlying asset, at a given price on or before a given future date.
2. ‘Puts’ give the buyer the right but not the obligation to sell a given quantity of the underlying asset, at a given price on or before a given future date.
Option premium : The premium is the price for acquiring the right to buy or sell. It is price paid by the option buyer to the option seller for acquiring the right to buy or sell.
Who decides the premium amount ?
It is calculated using a complex formula called the Black-Scholes formula.
http://en.wikipedia.org/wiki/Black-Scholes
It considers both intrinsic value and time value of a stock.
Time period : The options calendar always ends on the last Thursday of a month and you can buy/sell options for 'x' no. of months.
Strike price : It is the price of the underlying asset at which the same can be bought or sold if the options buyer excercises his right to buy/sell on or before the time period expiration.
Explaining the options concept with a simple example:
Let's say you have an item 'X' of worth Rs.10, I now give you Re.1 to gain control of 'X' for 1 month. This Re.1 is for you to keep, you never have to return it. Within this 1 month, I can do whatever I want with 'X', including selling it. On the expiry day, I would have the OPTION to give you back 'X', or Rs.10, this is what we were agreed upon. Within this 1 month, if I have sold the cup for Rs.12, on the expiry day, I'd have to give you Rs.10 and I'd keep Rs.2, subtracting that Re.1 I've given to you earlier, I've made 100% in 1 month.
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