EXECUTIVE SUMMARY Markets have always played a central role in the economic development and ensuring orderly conduct of markets had been a constant endeavor various theories have provided an essential back drop to analyze and understand market behavior. In the case of financial markets, the prominent ones are. Efficient market hypothesis agency theory and information theory. Whenever the assumptions of these theories are not met fully there begins a case for regulation. The key concerns of financial market regulators are market integrity systemic safety and customer protection. These three concerns are inter wined and inter related. s it is evident from the growth pattern of the international markets that develop countries have maintained their position, while the emerging markets are also coming forward with full strength. few prominent emerging trends are the investors are becoming more market savvy information and communication tec hno log y is revolutioniz ing the way trans actions are carrie d ou t wor ld is bec omi ng a fin ancial villa ge emergence of trans!national business demands better coordination among regulators etc. In the future Indian markets are e"pected to become more vibrant and attain a leading position in the global financial system. With increasing role of information and communication technology information asymmetry is e"pected to reduce at an increasing rate organized e"changes are likely to become one!stop financial shopping malls. The committee has noted recent introduction of new products based on its interim recommendations and it has further recommended widening the range of new products. It is e"pected that these new products, namely mini contracts on e#uity inde", options contract with longer life$tenure creation of volatility inde" and futures and options contracts on it, options on futures, creation of bond inde"es and futures and options contracts on them, e"change traded currency %foreign e"change& futures and options contracts, e"change 'traded products involving different strategies, e"ch ange traded credit deriv atives over the coun t or product and e"chang e traded third party products will be able to meet the needs of various classes of investors. Each class of these products needs to be carefully designed and risk management specified by the e"changed with due approval by (E)I. *inally the committee feels that while the small individual investors could best protect their investments by hedging their positions in options market, they should carefully consider taking positions on futures markets because mark!to!market los ses resulting in margin calls could wipe ou t small individual investors. +
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A Study on Risk Return Analysis in Futures and Options (1)
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8/13/2019 A Study on Risk Return Analysis in Futures and Options (1)
The merican epository 0eceipts 304 and 6lobal epository 0eceipts 3604 1f I2I2I, (atyam and
Infosys Traded on stock e"changes in 7(8 of 9(, draw their values from the prices of shares traded in
India. (imilarly in mutual funds the prices of mutual fund units depends upon the prices of portfolio of securities
under that scheme.
History of Deriaties
The erivatives market has e"isted from centuries as need for both users and producers of natural
resources to hedge against price fluctuations in underlying commodities. lthough trading in agriculture and other
commodities has been the driving force behind the development of erivatives market in India, the demand for
products based on financial instruments ' such as bond, currencies, stocks and stock indices had outstripped the
commodities markets.
India has been trading in derivatives market in (ilver, spices, gold, coffee, cotton and in oil markets for
decade/s gray market. Trading in derivatives market was legal before Morar:i esai/s 6overnment had bannedforward contracts. erivatives on stocks were traded in the form of Te:i and mandi in unorganized markets.
0ecently futures contracts various commodities were allowed to be on various e"changes. *or E"ample 2otton
and 1il futures were traded in Mumbai, (oya bean futures in )hopal, ;epper futures in <ochi, 2offee futures in
)angalore etc.
In =une 5>>>, 7ational stock e"change and )ombay stock e"change started trading in futures in (ense"
and 7ifty. 1ptions trading on (ense" and 7ifty commenced in =une 5>>+. ?ery soon thereafter trading began on
futures and options on @+ prominent stocks in the month of =uly and 7ovember respectively, currently there areA+ stocks trading in 7(E derivatives and the list keeps growing.
erivatives products initially emerged has hedging devices against fluctuations in commodity prices and
commodity linked derivatives remained the sole form of such products for almost three hundred years. The
financial derivatives came into spotlight in post +BC> period, due to the in stability in the financial markets.
*inancial derivatives are instruments that their value from financial assets. These assets can be stocks,
bonds, currency etc. These erivatives can be *orward rate agreements, *utures, 1ptions, and (waps. s statedearlier the most traded instruments are futures and options. Dowever these products became very popular and by
+BB>s, they accounted for about two!thirds of total transactions in derivatives products. In recent years, the market
for financial derivatives has grown tremendously.
@
8/13/2019 A Study on Risk Return Analysis in Futures and Options (1)
The only stock e"change operating in the +Bth century were those of )ombay set up in
+HCF and hmadabad set up in +HBA. These were organized as voluntary non profit!making
association of brokers to regulate and protect their interests. )efore the controls on securitiestrading became central sub:ect under the constitution in +BF>, it was a state sub:ect and the
)ombay securities contracts 3control4 ct of +B5F used to regulate trading in securities. 9nder
this act, the )ombay stock was recognized in +B5C and hmadabad in +B@C.
uring the war boom, a number of stock e"changes were organized in )ombay,
hmadabad and other centers, but they were not recognized. (oon after it became a central
sub:ect, central legislation was proposed and a committee headed by . 6orwala went into the
bill for securities regulation. 1n the basis of the committee/s recommendations and publicdiscussion, the securities contracts 3regulation4 ct became law in +BF.
DE)INATION O) STOC# EXCHAN0E:
J(tock e"change means anybody or individuals whether incorporated or not, constituted
for the purpose of assisting, regulating or controlling the business of buying, selling or dealing in
securities.L
It is an association of member brokers for the purpose of self!regulation and protecting theinterests of its members.
It can operate only. If that 6overnment under securities recognizes it contracts 3regulation4 ct
+BF.The recognition is granted under section @ of the act by the central government, ministry of
*inance.
NEED )OR STOC# EXCHAN0E:
+>
8/13/2019 A Study on Risk Return Analysis in Futures and Options (1)
The stock e"changes monitor the integrity of the members, brokers, listed companies and clients.
2ontinuous internal audit safeguards the investors against unfair trade practices. It settles the
disputes between member broker, investors and brokers.
The national stock E"change 37(E4 of India became operational in the capital market segment on
@rd 7ovember +BBA in Mumbai. The genesis of 7(E lies in the recommendations of the pertainscommittee +BB+. part from the 7(E, it had recommended for the establishment of national
stock market system also. The committee pointed out some ma:or defects in the Indian stock
market. The efects specified are
+. ack of infrastructure facilities and outdated trading system.
5. ack of transparency in the operations that effect investor/s confidence.
@. 1ut dated settlement systems that are inade#uate to cater to the growing volume, leading to
delays.A. ack of single market due to inability of various stock e"changes to function cohesively with
legal structure and regularity framework.
These factors led to the establishment of the 7(E.
O-/ECTIVES:
+. To establish a nationwide trading facility for e#uities, debt instruments and hybrids.
5. To ensure e#ual access investors all over the country through appropriate communication
network.@. To provide a fair, efficient and transparent securities market to investors using an electronic
communication network.
A. To enable shorter settlement cycle and book entry settlement system.
F. To meet current international standards of securities market.
!ROMOTERS:
Industrial evelopment )ank of India 3I)I4
Industrial 2redit and Investment 2orporation of India 3I2I2I4
Industrial *inancing 2orporation of India 3I*2I4ife Insurance 2orporation of India 3I24
(tate )ank of India 3()I4
6eneral Insurance 2orporation 36I24
)ank of )aroda
2anara )ank
+5
8/13/2019 A Study on Risk Return Analysis in Futures and Options (1)
minimum capital plus additional capital kept with the stock e"change or 0s + million, whichever
is lower. 9ntil the notional loss e"ceeds the threshold limit, the margin is not payable.
This margin is payable by a stockbroker to the stock e"change in cash or as a bank guarantee
from a scheduled commercial bank, on a net basis. It will be released ion the pay!in day for the
settlement period .The margin money is held by the e"change for !+5 days. This cost the broker about >.A!+.5 percent of the notional loss, assuming that the
broker/s funding cost is about 5A!@ percent. Thus (peculative trading without the delivery of
shares is no longer cost!free. Each broker/s trading volume during a day is not allowed to e"ceed
the intraday trading limit. This limit is @@.@ times the base minimum capital deposited with the
e"change on a gross basis.
i.e., purchase plus sale. In the event of brokers wishing to e"ceed this limit, they have to deposit
additional capital with the e"change and this cannot be withdrawn for si" months.
NEATSYSTEM:
7eat I( (TTE!1*!TDE! 0T 2IE7T (E0?E0 )(E ;;I2TI17. t the
server end, all trading information is stored in an in!memory database to achieve minimum
response time and ma"imum system availability for users. Each trading member trades on the
7(E with other members through a ;2 located in the trading member/s office, anywhere in India.
The trading members on the Wholesale ebt Market segment are linked to the central computer
at the 7(E through dedicated A<bps leased lines and ?(T terminals. These leased lines are
multiple"ed using dedicated 5 Mbps, optical!fiber links. The WM participants connect to thetrading system through dial!uplinks.
7(E is one the largest interactive ?(T based stocked e"change in the world. Today
it supports more than @>>> ?(Ts and is e"pected to grow to more than A>>> ?(Ts in the ne"t
year. The 7(E ' network in the world. 2urrently more than B>>> users are trading on the real
time!online 7(E application. There are over +F large computer systems.
INDICES
n Inde" is used to give information about the price movements of products in thefinancial, commodities or any other markets. *inancial inde"es are constructed to measure price
movements of stocks, bonds!bills and other forms of investments. (tock market inde"es are
meant to capture the overall behavior of e#uity markets. stock market inde" is created by
selecting a group of stock that are representative of the whole market or a specified sector or
+F
8/13/2019 A Study on Risk Return Analysis in Futures and Options (1)
segment of market. n Inde" is calculated with reference to a base period and base inde" value.
(tock market inde"es are useful for a ?arity of reasons. (ome of them are
They provide a historical comparison of returns on money invested in the stock
market against other forms of investments such as gold or debt.
They can be used as a standard against which to compare the performance of an
e#uity fund.
It is a lead indicator of the performance of the overall economy or a sector of the
economy
(tock inde"es reflect highly up to date information
Modern financial applications such as Inde" *unds, Inde" *utures, Inde" 1ptions
play an important role in financial investments and risk management
Ma8or I+&i$es Ot3er I+&i$es
S9! CNX NI)TY CNX IT Se$tor I+&ex
CNX Nifty /%+ior CNX -a+. I+&ex
S9! CNX ;; CNX )MC0 I+&ex
CNX Mi&$ap 5;; CNX !SE I+&ex
S9! CNX Defty CNX MNC I+&ex
NSE4NI)TY
The national (tock E"change on pril 55, +BB launched a new E#uity Inde". The
7(E!F>.The new Inde" which replaces the e"isting 7(E!+>> Inde" is e"pected to serve as an
appropriate Inde" for the new segment of futures and options.
J7ifty Jmeans 7ational Inde" for *ifty (tock.
The 7(E!F> comprises F> companies that represent 5> broad Industry groups with an aggregatemarket capitalization of around 0s.+C>>>>crores.ll companies included in the inde" have a
market capitalization in e"cess of 0s.F>> cores each and should have traded for HFO of trading
days at an impact cost of less than +.FO.
+
8/13/2019 A Study on Risk Return Analysis in Futures and Options (1)
impetus for its establishment came from policy makers in the country, it has been set up a public
limited company, owned by the leading institutional investors in the country. *rom day one, 7(E
has adopted the form of a demutualised e"change the ownership, management and trading is in
the hands of three different sets of people.7(E is owned by a set of leading financial institutions,
banks, insurance companies and other financial intermediaries and is managed by professionals,who do not directly or indirectly trade on the E"change. This has completely eliminated any
conflict of interest and helped 7(E in aggressively pursuing policies and practices within a public
interest framework. The 7(E model however, does not preclude, but in fact accommodates
involvement, support and contribution of trading members in a variety of ways. Its )oard
companies of senior e"ecutives from promoter institutions, eminent professionals in the fields of
law, economics, accountancy ,finance, ta"ation, etc, public representatives, nominees of (E)I
While the )oard deals with broad policy issues, decisions relating to market operations are
delegated by the )oard to various committees constituted by it. (uch committee includesrepresentatives from trading members, professionals, the public and management. The day!to!day
management of the E"change is delegated to the Managing irector who is supported by a team
of professional.
Committees:
The E"change has constituted various committees to advise it on areas such as good
market practices, settlement procedures, risk containment systems etc.Industry professionals
manage these committees, trading members, E"change staff as also representatives from themarket regulator.
• E"ecutive 2ommittee
• 2ommittee 1n Trade 0elated Issues321TI4
SECURITITIES AND EXCHAN0E -OARD O) INDIA
SE-I<S RO"E IN A STOC# EXCHAN0E
The (E)I was established on pril +5, +BBH through an administrative order, but it
became a statutory and really powerful organization only since +BB5.The (E)I is under the
overall control of the Ministry of *inance, and has its head office at Mumbai.
The philosophy underlying the certain of the (E)I is that multiple regulatory bodies for securities
industry mean that the regulatory system gets dividend, causing confusion among market
participants as to who is really in command. In a multiple regulatory structure, there is also an
+H
8/13/2019 A Study on Risk Return Analysis in Futures and Options (1)
Pen (ecurities imited 3P(4 is one of the leading financial services company
!providing *inancial and Investment related (ervices and ;roducts. The 2ompany commenced as
a proprietary concern of M$s <. 0avindra )abu in +BH was converted to a imited company in
*ebruary +BBF as Pen (ecurities td. Pen has the distinction of being the *irst 2orporate Memberfrom Dyderabad and also the first .;. based broking firm to start trading on the 7ational (tock
E"change 37(E4. PE7 is a registered Member on the 2apital Market (egment and *utures K
1ptions segment of both 7(E and )(E.
PE7 is also a epository ;articipant 3;4 with 7ational (ecurities epository td.
37(4 and also with 2entral epositories (ervices td. 32(4. PE7 is also a (E)I 0egistered
;ortfolio Manager offering ;ortfolio Management (ervices to clients.
In 5B!>H!5>>H Pen (ecurities lanches brand name as PE7 M17EQ T.
>e+ Comtra&e !t2 "imite&:
+>>O subsidiary of P( and is a member of 7ational 2ommodities K erivatives
E"change imited 372ER4 and Multi 2ommodity E"change 3M2R4. PE7 operates from
Dyderabad as it head office and has branches and associates in ndhra ;radesh, Tamil 7adu,
Maharashtra, <arnataka, West )engal and 1rissa. The 2ompany operates from over +A>
locations with over F>> trading terminals.
Seri$es Offere& (y >e+ Se$%rities "imite&:
• Investment advisory services• Trading in cash market of 7(E and )(E
• Trading in *utures and 1ptions on 7(E and )(E
• Internet Trading in (tocks, futures and 1ptions both 7(E and )(E
• Mutual *unds advisory service
• epository (ervices in )oth 7( and 2(
5>
8/13/2019 A Study on Risk Return Analysis in Futures and Options (1)
commanded by the future due to demand. E.g.- would buy in the cash market and sell the e#ual amount in
the future, Dence creating a risk free arbitrage, vice!versa for the discount.
When the future contract approaches e"piry date, the cost of carry reduces as the time to e"piry
reduces thus futures and cash prices start converging. 1n e"piry date, futures price should e#ual cashmarket price.
Settleme+t i+ )%t%res mar.ets:
;resently both stock and inde" futures are settled in cash. The closing price in the cash segment is
considered as the settlement price. The difference between the trade price and the settlement price is
ultimately your profit$loss.
In case of delivery based settlement (tock!based derivatives are e"pected to be settled in delivery.
1n e"piry of the futures contract, the buyer$seller of the future would receive a long$short position at the
closing price in the cash segment on the ne"t trading day. This position in the cash segment would merge
with any other position the buyer$seller has. In case the buyer$seller wants he can s#uare up this position
by selling$buying the shares. 1r else he would be re#uired to deliver$receive the underlying shares on thesettlement day 3e.g. T54 in the cash segment.
The aforesaid methodology is not final yet. (ebi guidelines in this regard are awaited. Qou can call
e"changes and me to know the e"act methodology once the regulator. Inde" based erivatives would
continue to be settled in cash
@A
8/13/2019 A Study on Risk Return Analysis in Futures and Options (1)
A&a+ta'es of tra&i+' i+ I+&ex f%t%res:fter listening to the news and other happenings in the economy, you take a view that the market
would go up. Qou substantiate your view after talking to your near and dear ones. When the market
opens, you e"press your view by buying )2 stock. The whole market goes up as you e"pected but the
price of )2 stock falls due to some bad news related to the company. This means that while your view
was correct, its e"pression was wrong.
9sing 7ifty$(ense" futures you can e"press your view on the market as a whole. In this case you
take only market risk without e"posing yourself to any company specific risk. Though trading on 7ifty or(ense" might not give you a very high return as trading in stock can, yet at the same time your risk is also
limited as inde" movements are smooth, less volatile with unwanted swings.
When trading futures in cash the biggest advantage of futures is that you can short sell without
having stock and you can carry your position for a long time, which is not possible in the cash segment
because of rolling settlement. 2onversely you can buy futures and carry the position for a long time
without taking delivery, unlike in the cash segment where you have to take delivery because of rolling
settlement.
*urther futures positions are leveraged positions, meaning you can take an 0s +>> position by paying 0s
5F margin and daily mark!to!market loss, if any. This can enhance the return on capital deployed. *or
e"ample, you e"pect an 0s +>> stock to go up by 0s +>. 1ne way is to buy the stock in the cash segment
by paying 0s +>>. Qou make 0s +> on investment of 0s +>>, giving about +>O returns. lternatively you
@
8/13/2019 A Study on Risk Return Analysis in Futures and Options (1)
take futures position in the stock by paying about 0s @> toward initial and mark!to!market margin. Qou
make 0s +> on investment of 0s @>, i.e. about @@O returns. ;lease note that taking leveraged position is
very risky, you can even lose your full capital in case the price moves against your position. Qou can
s#uare up your future at any time once you have initiated the position, you need not wait until its e"piry
you can book profits or cut losses.
1ne can use volume and open interest rates to predict the movement of the market this is done
like this, the total outstanding position in the market is called open interest. In case volumes are rising and
the open interest is also increasing, it suggests that more and more market participants are keeping their
positions outstanding. This implies that the market participants are e"pecting a big move in the price of
the underlying. Dowever to find in which direction this move would be, one needs to take help of charts.
In case the volumes are sluggish and the open interest is almost constant, it suggests that a lot ofday trading is taking place. This implies sideways price movement in the underlying.
,3e+ Corporate Dii&e+&s are a++o%+$e&:
In the event of such corporate announcements, the e"changes ad:ust the position such that
economical value of your position on cum!benefit and on e"!benefit day is the same. While calculating
the theoretical price of a futures contract, the interest rate should be taken as net of dividend yield. (o on
announcement of the dividend, the futures price should be discounted by the dividend amount. Dowever
as per the policy of (ebi and stock e"changes, if the dividend is more than +>O of the market price of thestock on the day of dividend announcement, the futures price is ad:usted. The e"changes roll over the
positions from last!cum!dividend day to the e"!dividend day by reducing the settlement price by
dividend. In such a case, the announcement of such e"ceptional dividends does affect the price of futures.
(uppose 0eliance is trading at 0s @>> and a two!month 0eliance future which has AF days to
maturity is trading at 0s @>A. 0eliance declares F>O dividend, i.e. 0s F. The dividend amount is less than
+>O of the market price of 0eliance, so the e"change would not ad:ust the position. s such the market
ad:usts this dividend in the market price and the futures price goes down by 0s F to 0s 5BB.In case of )onus the lot size of the stock that gives bonus gets ad:usted according to the ratio of
the bonus. The position is transferred from cum!bonus to e"!bonus day by ad:usting the settlement price
to neutralize the effect of bonus.
)or example:
@C
8/13/2019 A Study on Risk Return Analysis in Futures and Options (1)
sufficient and you will be under hedged. It is very difficult 3in fact impossible4 to get perfect hedge but
one can improve the perfection by ad:usting the position in 7ifty futures from time to time.
Demystifyi+' Sto$. )%t%res
Dere we try to solve some myths about futures
When some li#uid money is available to you and you are trying to buy future stocks for risk free interest.
9sing stock futures you can deploy this money to earn risk!free interest. (uppose (atyam is #uoting at 0s
@>> in the cash segment and one!month future is #uoting at @>F, you can earn risk!free interest by
following the steps mentioned below-
)uy (atyam in cash market at 0s @>> and simultaneously sell (atyam future at 0s @>F.
;ay 0s @>> to take delivery of (atyam stock in cash market.
1n e"piry of (atyam future contract, the short position would be transferred to your account
in the cash segment and a delivery order would be issued against you.
eliver the (atyam stock.
Whatever happens to the price of (atyam, you earn 0s @>F ! @>> F on 0s @>> for one
month.
7eed to have mark!to!mark margins in your account, incase (atyam moves up.
If re#uired the future position can be rolled over to the ne"t month position with a difference of 0s A!F.
This roll!over process can continue till you want to get your money back.
The above e"ample was about how earn risk free interest when li#uid cash is available with you, when
the futures stock is going down in futures market but going up in the cash segment then we can do the
following-
(uppose one!month ()I future is #uoting at 5>> while ()I is #uoting at 0s 5>F in the cash segment.
*ollow the steps mentioned below to make risk!free money.
(ell ()I in the cash market at 0s 5>F and simultaneously buy ()I future at 5>>.
0eceive 0s 5>F and make delivery of ()I stock in the cash market.
1n e"piry of the ()I future contract, the long position would be transferred to your account in thecash segment and a receive order would be issued to you.
6et your ()I stock back.
Whatever happens to the price of ()I, you earn 0s 5>F ' 5>> F on your stock.
@B
8/13/2019 A Study on Risk Return Analysis in Futures and Options (1)
There are five fundamental factors that affect the price of an option. These are-
+. ;rice of the underlying stock or inde"
5. (trike price$e"ercise price of the option
@. Time to e"piration of the option
A. 0isk!free rate of interest
F. ?olatility of the price of underlying stock or inde"
d:ust the price for dividend e"pected during the term of the option to arrive at fine prices.
2onsider this suppose a stock is trading at 0sC>. There is A>O probability that the stock price would
move to 0sH>. (imilarly the probabilities of the price being 0sB>, 0s+>>, 0s++> and 0s+5> are 5FO,
+FO, +>O and FO respectively. What would be your e"pected return if you were the buyer of a call
option with a strike price of 0s+>>Y If the stock price were to finish at 0sH>, 0sB> and 0s+>>, the calloption would e"pire worthless. If the stock price were to finish at 0s++> or 0s+5>, you would gain 0s+>
and 0s5> respectively. Qour e"pected return from the call would be-
3A>OV>4 35FOV>4 3+FOV>4 3+>OV+>4 3FOV5>4 ++.
This means that you would like to pay anything less than 0s++ for this option to make a profit and the
seller would always like to get anything more than 0s++ for giving you this option.
Settleme+t:
;resently stock options are settled in cash. This means that when the buyer of the option e"ercises
an option, he receives the difference between the spot price and the strike price in cash. The seller of the
option pays this difference. It is e"pected that stock options would be settled by delivery of the underlying
stock. This means that on e"ercise of a call option, a long position of the underlying stock effectively at
the strike price would be transferred in the cash segment in the account of the buyer of the call option
who has the right to buy. n opposite short position at effectively the strike price would be transferred in
the cash segment in the account of the seller of the call option who has obligation to sell. (imilarly on
e"ercise of a put option, a short position in the underlying stock effectively at the strike price would be
transferred in the cash segment in the account of the buyer of the put option who has the right to sell. n
opposite long position at effectively the strike price would be transferred in the cash segment in the
account of the seller of the put option who has the obligation to buy. Dowever guidelines in this regard
are awaited from (E)I. ;lease check the e"act method of delivery!based settlement once the regulator
and e"changes announce it.
AF
8/13/2019 A Study on Risk Return Analysis in Futures and Options (1)
increases. 2onversely as the option becomes out of the money, the value of delta decreases. In other
words, delta measures the sensitivity of options with respect to change in the price of the underlying.
eep out!of!the!money options are less sensitive in comparison to at!the!money and deep in!the!money
options.
elta is positive for a bullish position 3long call and short put4 as the value of the positionincreases with rise in the price of the underlying. elta is negative for a bearish position 3short call and
long put4 as the value of the position decreases with rise in the price of the underlying.
elta varies from > to + for call options and from '+ to > for put options. (ome people refer to
delta as > to +>> numbers.
The elta is an important piece of information for a option )uyer because it can tell him much of
an option K buyer he can e"pect for short!term moves by the underlying stock. This can help the )uyer of
an option which call $ ;ut option should be bought. The factors that can change the elta of an option are
(tock price, ?olatility and 7umber of days.
THETA of a+ optio+ a+& its Si'+ifi$a+$e:
The theta of an option is an e"tremely significant theoretical number for an option trader. ike the
other 6reek terms you can calculate theta using option calculator.
Theta tells you how much value the option would lose after one day, with all the other parameters
remaining the same.
(uppose the theta of Infosys @>!day call option with a strike price of 0s@, B>> is A.F when Infosys
is #uoting at 0s@,B>>, volatility is F>O and the risk!free interest rate is HO. This means that if the price of
Infosys and the other parameters like volatility remain the same and one day passes, the value of this
option would reduce by 0sA.F.
AH
8/13/2019 A Study on Risk Return Analysis in Futures and Options (1)
Theta is always negative for the buyer of an option, as the value of the option goes down each day if his
view is not realized. 2onversely theta is always positive for the seller of an option, as the value of the
position of the seller increases as the value of the option goes down with time. 2onsider options as
depreciating assets because of time decay and appreciating due to
*avorable price movements. If the rate of appreciation is more than that of depreciation hold the option,
else sell it off. *urther, time decay of option premium is very steep near e"piry of the option. The
following graph would make it clearer.
VE0A of a+ Optio+ a+& its Si'+ifi$a+$e-
?ega is also a theoretical number that can be calculated using an option calculator for a given setof values of underlying price, time to e"piry, strike price, volatility and interest rate etc. ?ega indicates
how much the option premium would change for a unit change in annual volatility of the underlying.
(uppose the ?ega of an option is >. and its premium is 0s+F when volatility of the underlying is
@FO. s the volatility increases to @O, the premium of the option would change upward to 0s+F.. ?ega
is positive for a long position 3long call and long put4 and negative for a short position 3short call and
short put4.
(imply put, for the buyer it is advantageous if the volatility increases after he has bought theoption. 1n the other hand, for the seller any increase in volatility is dangerous as the probability of his
option getting in the money increases with any rise in volatility.
(ometimes you might have observed that though seven to ten days have passed after you bought
an option, the underlying price is almost in the same range while the premium of the option has increased.
This clearly indicates that volatility of the underlying might have increased.
AB
8/13/2019 A Study on Risk Return Analysis in Futures and Options (1)
Qour profit is limited to the premium received. t e"piration the break!even is strike price plus premium. Ma"imum profit is realized if the underlying price is below the strike price.
Do*+si&e ris.:
The price of the option increases as the underlying rises. Qou can cut your losses by buying the
same option if you think that your view is going wrong. osses keep on increasing as the underlying rises
and are virtually unlimited. (uch a position must be monitored closely.
Time &e$ay $3ara$teristi$:
1ptions are growing assets in the hands of a seller. s time passes, the value of position increases
as the option loses its time value. Qou get ma"imum profit if the option is at the money.
,3e+ -earis3
When you are very bearish, buy a put option. When you are very bearish on the market as a
whole, buy put option on indices 37ifty$(ense"4. When you are very bearish on a particular stock, buy put
option on that stock. The more bearish you are, the more out of the money 3lower strike price4 should be
the option you buy. 7o other position gives you as much leveraged advantage in a falling market with
limited down side.
F5
8/13/2019 A Study on Risk Return Analysis in Futures and Options (1)
The price of the option increases as the price of the underlying falls. Qou can s#uare up your
position by selling the same option at a higher price whenever you think that the underlying price has
come to the level you e"pected. t e"piration the break!even underlying price is the strike price minus
premium paid for buying the option.
Do*+si&e ris.:
Qour loss is limited to the premium you have paid. The ma"imum you can lose is the premium, ifthe underlying price is above the strike price at e"piry of the option.
Time &e$ay $3ara$teristi$:
1ptions are wasting assets in the hands of a buyer. s time passes, the value of the position
erodes. If the volatility increases, erosion slows if the volatility decreases, erosion hastens.
,3e+ NO )all
When you firmly believe that the underlying is not going to fall, sell a put option. When you
firmly believe that inde" 37ifty$(ense"4 is not going to fall, sell a put option on the inde". When you
firmly believe that a particular stock is not going to fall, sell put option on that stock. (ell out!of!the!
money 3lower strike price4 options if you are only somewhat convinced sell at!the!money options if you
are very confident that the underlying would remain at the current level or rise.
F@
8/13/2019 A Study on Risk Return Analysis in Futures and Options (1)
The above table shows *utures 2ontract return K risk associated with the pricemovement of I0 E227 for a month of *ebruary K March 5>+5. It has an averagereturn of !+.+F that is !++F.>> and risk is B.>>+FB.
!%t Optio+
2alculation of 0eturnsDate Stri.e !ri$e Close !ri$e Ret%r+s
The above table shows *utures 2ontract return K risk associated with the pricemovement of WI;01 for a month of *ebruary K March 5>+5. It has an average return of>.>CBC@ that is C.BC@ and risk is +F.@A.
!%t Optio+s
2alculation of 0eturnsate (trike ;rice 2lose ;rice 0eturns
The above table shows put option contract return K risk associated with the pricemovement of I0 E227 for a month of *ebruary K March 5>+5. It has an averagereturn of 5FA.CB that is 5FACB.>> and risk is 5C.+BF.
-3arat3i Airtel )%t%resCo+tra$t
2alculations of 0eturnsDate Ope+ pri$e Close pri$e Ret%r+s
The above table shows *utures 2ontract return K risk associated with the pricemovement of )D0TDI I0TE for a month of *ebruary K March 5>+5. It has anaverage return of !+.B5 that is !+B5.>> and risk is 5C.+BF.
B
8/13/2019 A Study on Risk Return Analysis in Futures and Options (1)
The above table shows 2all option contract return K risk associated with the pricemovement of )D0TDI I0TE for a month of *ebruary K March 5>+5. It has anaverage return of @B>.CAthat is @B>CA.>> and risk is ++.C.
Compariso+ of )%t%res Co+tra$t
Compa+ies Ret%r+ Ris.
ir eccan !+.+F B.>Wipro >.>CB +F.@A)harathi irtel !+.B5 5C.+B
C5
8/13/2019 A Study on Risk Return Analysis in Futures and Options (1)
)y the above graph we can understand that in *uture contract 0isk is more thanthe return for three companies. (o we suggest to those three companies to discontinue thefuture contract to avoid risk.
)y the bove graph we can understand that the risk is so less in the ;ut option forthe three companies i.e. ir eccan, )harathi irtel, and Wipro so we recommend tothose companies to continue with their contract.
)INDIN0S
0isk and 0eturns are Wipro, ir eccan, and )harathi irtel in futures, but where as inoptions risk is limited to premium and the profits are Wipro, ir eccan, and )harathiirtel.
In this research it is found that Wipro futures are generated positive returns of >.>CB.
Where as in Wipro call option it is found that the returns are positive 5FA.CB.
In this research it is found that ir eccan futures are generated negative returns of ' +.+F.
Where as in ir eccan call option it is found that the returns are positive [email protected].
In this research it is found that )harathi irtel futures are generated negative returns of '+.B5.
CA
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