Module 5 Options Theory for Professional Trading

Chapter 22

Re-introducing Call & Put Options

153

M5-Ch22-cartoon

22.1 – Why now?

I suppose this chapter’s title may confuse you. After rigorously going through the options concept over the last 21 chapters, why are we now going back to “Call & Put Options” again? In fact we started the module by discussing the Call & Put options, so why all over again?

Well, this is because I personally believe that there are two learning levels in options – before discovering option Greeks and after discovering the option Greeks. Now that we have spent time learning Option Greeks, perhaps it is time to take a fresh look at the basics of the call and put options, keeping the option Greeks in perspective.

Let’s have a quick high-level recap –

  1. You buy a Call option when you expect the underlying price to increase (you are out rightly bullish)
  2. You sell a Call option when you expect the underlying price not to increase (you expect the market to either stay flat or go down but certainly not up)
  3. You buy a Put option when you expect the underlying price to decrease (you are out rightly bearish)
  4. You sell a Put option when you expect the underlying price not to decrease (you expect the market to stay flat or go up but certainly not down)

Of course the initial few chapters gave us an understanding on the call and put option basics, but the agenda now is to understand the basics of call and put options keeping both volatility and time in perspective. So let’s get started.

22.2 – Effect of Volatility

We know that one needs to buy a Call Option when he/she expects the underlying asset to move higher. Fair enough, for a moment let us assume that Nifty is expected to go up by a certain percent, given this would you buy a Call option if –

  1. The volatility is expected to go down while Nifty is expected to go up?
  2. What would you do if the time to expiry is just 2 days away?
  3. What would you do if the time to expiry is more than 15 days away?
  4. Which strike would you choose to trade in the above two cases – OTM, ATM, or ITM and why would you choose the same?

These questions clearly demonstrate the fact that buying a call option (or put option) is not really a straightforward task. There is a certain degree of ground work required before you buy an option. The ground work mainly revolves around assessment of volatility, time to expiry, and of course the directional movement of the market itself.

I will not talk about the assessment of market direction here; this is something you will have to figure out yourself based on theories such as technical analysis, quantitative analysis, or any other technique that you deem suitable.

For instance you could use technical analysis to identify that Nifty is likely to move up by 2-3% over the next few days. Having established this, what would you do? Would you buy an ATM option or ITM option? Given the fact that Nifty will move up by 2-3% over the next 2 days, which strike gives you maximum bang for the buck? This is the angle I would like to discuss in this chapter.

Let’s start by looking at the following graph, if you recollect we discussed this in the chapter on Vega –

Image 1_CE

The graph above depicts how a call option premium behaves with respect to increase in volatility across different ‘time to expiry’ time frames. For example the blue line shows how the call option premium behaves when there are 30 days to expiry, green for 15 days to expiry, and red for 5 days to expiry.

With help of the graph above, we can arrive at a few practical conclusions which we can incorporate while buying/selling call options

  1. Regardless of time to expiry, the premium always increases with increase in volatility and the premium decreases with decrease in volatility
  2. For volatility to work in favor of a long call option one should time buying a call option when volatility is expected to increase and avoid buying call option when volatility is expected to decrease
  3. For volatility to work in favor of a short call option, one should time selling a call option when volatility is expected to fall and avoid selling a call option when the volatility is expected to increase

Here is the graph of the put option premium versus volatility –

Image 2_PE

This graph is very similar to the graph of call premium versus volatility – therefore the same set of conclusions hold true for put options as well.

These conclusions make one thing clear – buy options when you expect volatility to increase and short options when you expect the volatility to decrease. Now the next obvious question is – which strike to choose when you decide to buy or sell options? This is where the assessment of time to expiry comes into play.

22.3 – Effect of Time

Let us just assume that the volatility is expected to increase along with increase in the underlying prices. Clearly buying a call option makes sense. However the more important aspect is to identify the right strike to buy. Infact when you wish to buy an option it is important to analyze how far away we are with respect to market expiry. Selection of strike depends on the time to expiry.

Do note – understanding the chart below may seem a bit confusing in the beginning, but it is not. So don’t get disheartened if you don’t get it the first time you read, just give it another shot 

Before we proceed we need to get a grip on the timelines first. A typical F&O series has about 30 days before expiry (barring February series). To help you understand better, I have divided the series into 2 halves – the first half refers to the first 15 days of the series and the 2nd half refers to the last 15 days of the F&O series. Please do keep this in perspective while reading through below.

Have a look at the image below; it contains 4 bar charts representing the profitability of different strikes. The chart assumes –

  1. The stock is at 5000 in the spot market, hence strike 5000 is ATM
  2. The trade is executed at some point in the 1st half of the series i.e between the start of the F&O series and 15th of the month
  3. We expect the stock to move 4% i.e from 5000 to 5200

Given the above, the chart tries to investigate which strike would be the most profitable given the target of 4% is achieved within –

  1. 5 days of trade initiation
  2. 15 days of trade initiation
  3. 25 days of trade initiation
  4. On expiry day

Image 3_CE_Theta

So let us start from the first chart on the left top. This chart shows the profitability of different call option strikes given that the trade is executed in the first half of the F&O series. The target is expected to be achieved within 5 days of trade execution.

Here is a classic example – today is 7th Oct, Infosys results are on 12th Oct, and you are bullish on the results. You want to buy a call option with an intention of squaring it off 5 days from now, which strike would you choose?

From the chart it is clear – when there is ample time to expiry (remember we are at some point in the 1st half of the series), and the stock moves in the expected direction, then all strikes tend to make money. However, the strikes that make maximum money are (far) OTM options. As we can notice from the chart, maximum money is made by 5400 and 5500 strike.

Conclusion – When we are in the 1st half of the expiry series, and you expect the target to be achieved quickly (say over few days) buy OTM options. In fact I would suggest you buy 2 or 3 strikes away from ATM and not beyond that.

Look at the 2nd chart (top right) – here the assumption is that the trade is executed in the 1st half the series, the stock is expected to move by 4%, but the target is expected to be achieved in 15 days. Except for the time frame (target to be achieved) everything else remains the same. Notice how the profitability changes, clearly buying far OTM option does not makes sense. In fact you may even lose money when you buy these OTM options (look at the profitability of 5500 strike).

Conclusion – When we in the 1st half of the expiry series, and you expect the target to be achieved over 15 days, it makes sense to buy ATM or slightly OTM options. I would not recommend buying options that are more than 1 strike away from ATM. One should certainly avoid buying far OTM options.

In the 3rd chart (bottom left) the trade is executed in the 1st half the series and target expectation (4% move) remains the same but the target time frame is different. Here the target is expected to be achieved 25 days from the time of trade execution. Clearly as we can see OTM options are not worth buying. In most of the cases one ends up losing money with OTM options. Instead what makes sense is buying ITM options.

Also, at this stage I have to mention this – people end up buying OTM options simply because the premiums are lower. Do not fall for this, the low premium of OTM options creates an illusion that you won’t lose much, but in reality there is a very high probability for you to lose all the money, albeit small amounts. This is especially true in cases where the market moves but not at the right speed. For example the market may move 4% but if this move is spread across 15 days, then it does not make sense holding far OTM options. However, far OTM options make money when the movement in the market is swift – for example a 4% move within 1 or say 2 days. This is when far OTM options moves smartly.

Conclusion – When we are at the start of the expiry series, and you expect the target to be achieved over 25 days, it makes sense to buy ITM options. One should certainly avoid buying ATM or OTM options.

The last chart (bottom right) is quite similar to the 3rd chart, except that you expect the target to be achieved on the day of the expiry (over very close to expiry). The conclusion is simple – under such a scenario all option strikes, except ITM lose money. Traders should avoid buying ATM or OTM options.

Let us look at another set of charts – the idea here is to figure out which strikes to choose given that the trade is executed in the 2nd half of the series i.e at any point from 15th  of the month till the expiry. Do bear in mind the effect of time decay accelerates in this period; hence as we are moving closer to expiry the dynamic of options change.

The 4 charts below help us identify the right strike for different time frames during which the target is achieved. Of course we do this while keeping theta in perspective.

Image 4_CE_Theta

Chart 1 (top left) evaluates the profitability of different strikes wherein the trade is executed in the 2nd half of the series and the target is achieved the same day of trade initiation. News driven option trade such as buying an option owing to a corporate announcement is a classic example. Buying an index option based on the monetary policy decision by RBI is another example.  Clearly as we can see from the chart all strikes tend to make money when the target is achieved the same day, however the maximum impact would be on (far) OTM options.

Do recall the discussion we had earlier – when market moves swiftly (like 4% in 1 day), the best strikes to trade are always far OTM.

Conclusion – When you expect the target to be achieved the same day (irrespective of time to expiry) buy far OTM options. I would suggest you buy 2 or 3 strikes away from ATM options and not beyond that. There is no point buying ITM or ATM options.

Chart 2 (top right) evaluates the profitability of different strikes wherein the trade is executed in the 2nd half of the series and the target is achieved within 5 days of trade initiation. Notice how the profitability of far OTM options diminishes. In the above case (chart 1) the target is expected to be achieved in 1 day therefore buying (far) OTM options made sense, but here the target is achieved in 5 days, and because the trade is kept open for 5 days especially during the 2nd half of the series, the impact of theta is higher. Hence it just does not make sense risking with far OTM options. The safest bet under such a scenario is strikes which are slightly OTM.

Conclusion – When you are in the 2nd half of the series, and you expect the target to be achieved around 5 days from the time of trade execution buy strikes that are slightly OTM. I would suggest you buy 1 strike away from ATM options and not beyond that.

Chart 3 (bottom right) and Chart 4 (bottom left) – both these charts are similar expect in chart 3 the target is achieved 10 days from the trade initiation and in chart 4, the target is expected to be achieved on the day of the expiry. I suppose the difference in terms of number of days won’t be much, hence I would treat them to be quite similar. From both these charts we can reach 1 conclusion – far OTM options tend to lose money when the target is expected to be achieved close to expiry. In fact when the target is achieved closer to the expiry, the heavier the far OTM options bleed. The only strikes that make money are ATM or slightly ITM option.

While the discussions we have had so far are with respect to buying a call option, similar observations can be made for PUT options as well. Here are two charts that help us understand which strikes to buy under various situations –

These charts help us understand which strikes to trade when the trade is initiated in the first half of the series, and the target is achieved under different time frames.

Image 5_PE_Theta

While these charts help us understand which strikes to trade when is the trade is executed in the 2nd half of the series and the target is achieved under different time frames.

Image 6_PE_Theta

If you go through the charts carefully you will realize that the conclusions for the Call options holds true for the Put options as well. Given this we can generalize the best practices for buying options –

Position Initiation Target Expectation Best strike to trade
1st half of the series 5 days from initiation Far OTM (2 strikes away from ATM)
1st half of the series 15 days from initiation ATM or slightly OTM (1 strike away from ATM)
1st half of the series 25 days from initiation Slightly ITM options
1st half of the series On expiry day ITM
2nd half of the series Same day Far OTM (2 or 3 strikes away from ATM)
2nd half of the series 5 days from initiation Slightly OTM (1 strike away from ATM)
2nd half of the series 10 days from initiation Slightly ITM or ATM
2nd half of the series On expiry day ITM

So the next time you intend to buy a naked Call or Put option, make sure you map the period (either 1st half or 2nd half of the series) and the time frame during which the target is expected to be achieved. Once you do this, with the help of the table above you will know which strikes to trade and more importantly you will know which strikes to avoid buying.

With this, we are now at the verge of completion of this module. In the next chapter I would like to discuss some of the simple trades that I initiated over the last few days and also share my trade rationale behind each trade. Hopefully the case studies that I will present in the next chapter will give you a perspective on the general thought process behind simple option trades.


Key takeaways from this chapter

  1. Volatility plays a crucial role in your decision to buy options
  2. In general buy options when you expect the volatility to go higher
  3. Sell options when you expect the volatility to decrease
  4. Besides volatility the time to expiry and the time frame during which the target is expected to be achieved also matters

153 comments

  1. keshav says:

    Very good information sir.. thanks a lot and I am very curious to know ur trades..

  2. Ajay says:

    Awesome. Had a few queries regarding the suitable strikes for various trades, while going through the previous chapters. This chapter cleared almost all of my queries. Thanks. 😀

  3. Viren says:

    Hey Karthik! Awesome man. After research on different brokers, I joined Zerodha a month back. Either I wasn’t introduced to Varsity or I overlooked it. You guys are rocking. I was searching everywhere on internet about trading info and strategies and accidentally came across Varsity and that ended my search. Nowhere I could find all the information so compiled, thorough and simplified.
    Your hard work is very much appreciated. Keep the good work going.
    Waiting eagerly for next module.

  4. R P HANS says:

    Very important info or I will say it is extract of the full module in a very practical way. Thanks a lot for that. Actually about a year back I was trying to understand the same thing by looking at historical data on NSE site and copying them to excel and doing some calculation. But was very tedious and I left in between without any success. It is nice that you gave in a perfect form.
    * option shorting has been covered in earlier chapters but can it more explained the way log options are explained?
    * What is high or low for volatility based on which we can judge chances of volatility movement. I mean to say if volatility is already high then its chances of going up may not be high even some trigger in near future. Market must have already considered the volatility factor.
    * Is it possible that spot prices may go up but the the volatility will come down? Then what to do in options?
    I think you had promised to give one case starting from the TA and /or FA to option and showing option trade taking place. Will it come in the next chapter.

    Waiting eagerly for next chapter and next module.
    Thanks
    R P HANS

    • Karthik Rangappa says:

      1) Is there anything specify you are looking at when shorting options? I suppose most of it has been explained.

      2) For nifty Vix ard 17-18% is considered normal. You can keep this as reference value.

      3) The next chapter has few case studies.

  5. narsimha says:

    sir,from next month futures margins r dramatocally increased,will it lead to increased option trading (bcoz retail traders cant afford that much marginsin fut so they may shift)i may be one among,clarify

  6. Prashant Warrier says:

    Dear Karthik,

    Another Brilliant chapter….Thanks a ton!……Maybe at this point, it may also be worthwhile to revisit Open interest in context of options. i.e how to interpret the current trading range using open interest information? It is widely believed (although maybe not necessarily true) that option writers control the option markets and therefore their action can give some indication of the likely short term market direction. Therefore the ability to interpret OI and its changing dynamics in the context of options may be useful?

    • Karthik Rangappa says:

      In fact the whole theory of “options pain” stems from Options + OI concept. Will be discussing this in the next module.

  7. r v n sastry says:

    Dear Sir,
    I would earnestly request you to kindly clarify the following as per my understanding from Key takeaways of this chapter that :
    (1) Buy options when I expect that the volatality will increase which in otherwords market will go down due to selling pressure . For suppose , if I buy call and put options both at same strike, call will go down and put will increase. And also
    (2) Sell options when I expect volatality will decrease which in other words market will go up. If I sell call and put options both when I expect volatality will decrease, both call and put option values will increase after decrease of volatality. I will be very much thankful if you can kindly advise whether my is right or wrong and if my understanding is wrong, please enlighten about my observation. I sincerely hope you will guide me with suitable reply Sir. Awaiting eagerly for your advice in the matter.Thanking you very much. With Best Regards, God Bless you Sir, R.V.N.Sastry

    • Karthik Rangappa says:

      1) Increased volatility does not mean market will go down
      2)Likewise decrease in volatility does not really mean that the market will increase

  8. Ramu says:

    Hi Zerodha, This is very help full information, thanks for sharing. I wanted to know about approx. what % people (out of total traded people ) actually make money in F&O trading? as i check on web i see very scattered info but more or less retailers most of the times (>70%) lose money badly. As an institution which does business on FO trading you should be having appropriate info.
    Thanks in advance.

  9. Pratheesh says:

    Dear karthik,if my question is irrelevant plz avoid,otherwise kindly reply,look below this is a screen shot of nifty today 9.53am,i have a doubt nifty futures October contract opening rate 8400,high rate8723.85,how this trade is possible at opening itself?except that rates 99.9% trade is in betwn 8350-8250 levels,earlier also this kind of odd trades seen in nifty..kindly clear my doubt
    Quote As on Oct 26, 2015 09:53:04 IST
    CNX Nifty – NIFTY

    Open
    8,400.00
    High
    8,723.85
    Low
    8,302.55

  10. suresh kumar srivastava says:

    Again appreciation for your decent work , waiting for Currency and Commodity lessons.

  11. Ankit says:

    Next chapter please……….

  12. Sumeet Nagar says:

    Next Chapter please

  13. Sumeet Nagar says:

    What about squaring off the trade on the same day during the 1st half of the series? Which Strike should be selected?

  14. Sumeet Nagar says:

    Hi Karthik,
    I have a query..
    As per today’s data, Nifty 8400 CE is trading at 31.25 and 8400PE is trading at 353.15..
    My view is that Nifty spot will not cross 8400 till Nov expiry..
    So, what should i do.. Sell 8400 CE and collect the premiums or Buy 8400 PE and hold till expiry..
    I am confused.. Can u explain why and what i should do..

  15. kumar says:

    Hi Karthik,
    Thnks for lessons. I have read your module 4 & 5.
    I am new to trde.
    Want to know how can i identify the target and % target(here 4% up).

    thnks.

  16. Aravind says:

    Hi Karthik,

    Thanks for sharing this wonderful tips.

    However I have a question on settlement of options on expiry day. For example, assume I purchase Nifty 8000 [email protected] 15 – total qty 1000 on day before expiry. Nifty crashes on expiry day and ends at 7910. What will happen if I don’t sell the 8000 puts that I hold? Will it be auto squared off by zerodha? If not, what damages will I have to face as penality- excess chsrges/taxes?

    Thanks,
    Aravind

  17. Prashant says:

    Hi Karthik,
    Thanks for detailed chapters. I have read your module 4 & 5.
    Request you please make it available in pdf format module 5.

  18. sarath says:

    sir,

    what is naked option ? please explain

  19. Avinash Punjabi says:

    Loved the subject Re introduction to CALL – PUT options and the decision making process regarding which strikes to buy based on the time frame. I would want a similar perspective on selecting which options to write based on the above guidlines. If you feel it is too much to give the detailing as above then please give us a few guidelines n how to proceed on the same which will help us make the calculations. I am sure it wll be of great help to all members here. Thanks.

  20. Avinash Punjabi says:

    Loved the subject Re introduction to CALL – PUT options and the decision making process regarding which strikes to buy based on the time frame. I would want a similar perspective on selecting which options to write based on the above guidlines. If you feel it is too much to give the detailing as above then please give us a few guidelines n how to proceed on the same which will help us make the calculations. I am sure it wll be of great help to all members here. Thanks.

  21. R P HANS says:

    Sir, You must have explained but I want to know again that how to put target and stop loss on a naked call or put option. We know only spot price movement and its probable range. Shall the target and Sl be define on spot price or option’s premium?
    Thanks

  22. Hari says:

    Hi bro,
    I think I have started to get a “feel” about what options are all about. Feels good knowing these stuff. Thank god I found out about Zerodha & Varsity 🙂
    I have few queries about volatility and as I understand its like:
    1) I know if there are any events then volatility shoots up.
    2) I know if there is nothing special(no events) its going to stay at reference level (i.e. like you said VIX of 18).
    3) Question: when exactly does VIX go down? why does volatility go down? I have few guesses like dull market due to holidays etc but I need your expert answer 🙂

    Thanks Karthik bro!

    • Karthik Rangappa says:

      Hari,

      1) Before any important event, Volatility increases
      2) Events are not the only thing that drives volatility…increased trading activity can also drive the volatility.
      3) Typically VIX goes down when fear goes down i.e the market should go up.

  23. SARATH says:

    when volatility increase option premium also increase ..so in case of nifty volatility means implied volatility or India vix,…?
    when vix going down and iv of call option increase which means there is a chance of increasing option premium… Right?
    and last qusition in option greek calculator which iv we enter the volatility box call option or put option’s IV

  24. ANIL NEGI says:

    Hello karthik ji
    wonderful article, i have a question that is from todays data, arvind ltd highest OI at 330 today on call side, but as per chart it indicate that price has given a breakout and it can go back further, hows interpret it than

  25. Avneesh Yadav says:

    Hey Karthik,
    Thanks for the wonderful article.
    Since you have divided the time in 15 days interval but what about when we want to buy expiry which is two months away. Will the same charts/conclusions work ?

    • Karthik Rangappa says:

      Yeah, 2 months away is still as good as ‘start of the series’ so you could stick to those guidelines.

  26. Sai Sreedhar says:

    Could you hint, how Hedging can be done with the help of Options?
    Is it good enough to say BUY Put Options of NIFTY for hedging – but how to determine how many contracts and what should the strike price?

    • Karthik Rangappa says:

      Assume you have 2 lots of Future long, the delta equivalent for these two lots would be +2. To hedge this position you will need to buy puts which add up to -2. This would mean you buy 4 ATM puts.

  27. sabu says:

    Taking Theta into consideration, If I sell MIS option and would like to collect premium then would it be better to sell ATM or OTM?

  28. Vishwa says:

    Hi Karthik,
    please confirm,
    1.) Nifty Underlying is 8629.15. If i were to take CE call buy at strike 8500, at a premium of 139.50. So at close of expiry i.e. 25-Aug, The underlying should be above 8639.50 to consider a profit. Say on end of expiry the underlying was 8650, then is it 10.50 * no. of lot, considered the profit?
    2.) if i were to write a sell call option for 8800 strike at prem 5.30 and say at expiry the spot is at 8650, then i get to keep the premium of 5.30 or if multiple lots have been bought then it is 5.30*no. of lots. Is that right

    Thanks in advance.

    • Karthik Rangappa says:

      1) Nifty should be 8500 + 140 = 8640 for you to breakeven…and you make a profit over and above that. Yes, it would be 10.5*lot size.

      2) Yes you will retain the premium as long as Nifty is at or below 8800.

  29. Vishwa says:

    Thanks for the above clarification, Sir say if I want to opt for any one of the above option for current expiry, can I do that even on last day of expiry i.e. 25-aug. & is 3:30 pm the cut off.

    • Karthik Rangappa says:

      On expiry day the current month contract expires…and therefore you cannot transact in that contract. However, you can buy/sell other contracts.

      • Anish Chandrasekaran says:

        Hi Karthik,
        Pls tell what you mean by we cannot transact on the contract on expiry day. Can we not sell when premium goes up?

  30. Kamal says:

    Excellent site to gain knowledge .Kudos to Zerodha team.
    I’d like you to validate my observation which is on Day 1 of Sep month series the Nifty spot closed at 8572 ,sep futures at 8628 and sep 8500CE at 8702 (delta would be at 0.85).Was it a good idea to buy futures and short 8500CE ? this way we could pocket premium of 8702-8628=74 points as 8500CE and futures both will converge to end at same level?
    When will this strategy fail ?

  31. Ananth says:

    Hi Karthik
    Thanks a lot for the detailed explanation; If I want to judge whether Implied volatility is moving high or low for an individual stock (in order to take a decision whether to short or long an option), how can I get the data of historical Implied Volatility ; I understand we can easily calculate historical volatility, but how to know historical IV movement ? I tried the below link, but it does not capture Implied Volatility.
    https://www.nseindia.com/products/content/derivatives/equities/historical_fo.htm

  32. cquasar says:

    Hi Karthik, I am new here. I know of options spreads/vol trading, but I haven’t really taken the plunge and done any real trading on a personal account. What’s the best way to get started?

    • Karthik Rangappa says:

      The best way would be to run the strategy would be to actually deploy it in real markets and start taking small bets 🙂

  33. Rishikesh says:

    Hi Karthik,

    How to know beforehand that volatility of a particular option is going to increase ?
    Is there any particular mechanism to predict this
    or
    should we just keep watching the option chain of the underlying to see if its volatility is increasing?

    • Karthik Rangappa says:

      You can forecast volatility by employing volatility forecasting models like GARCH. This is a quant heavy topic and requires you to have some background in stats.

  34. Divy says:

    Is there a chapter what specifically explains at which strike price an option should be bought at ?

  35. Avinash Pawde says:

    Call option of Asian paints of strike price 960 is at 1.25₹, if tomorrow Asian paints again fall much so then will this call option turns to be zero value? And if day after tomorrow Asian paints goes up then will my call option continues to rise or my contract will be end as soon as the call option value turned zero?

  36. Taurus says:

    There’s a table in the end of this module, which highlights the “Best strike to trade” based on target expectation timeline and position initiation timeline. Is it applicable for all 4: Long call, short call, long put, short put.

  37. 9SR says:

    Dear Karthik,
    Greetings. In Chapter 22, monthly series is divided in to 2 halves and results of the trading is explained with the help of 8+8 bar charts. Is Volatility Cone is the basis for these bar charts ? or any other thing. Request your clarification on this.
    Regards

    • Karthik Rangappa says:

      No, these charts are developed using R, basically an algorithm which suggests which is the best strike to trade for a given timeframe.

  38. kaushik says:

    Thnks for reply

  39. 9SR says:

    Dear Karthik,
    When back calculating IV, taking nse option prices, using BS Model and Binomial Model, IV values are differing significantly. Binomial Model, resulting lesser IV. Any explanation? Which Model is correct wrt profitability ?
    Regards

    • Karthik Rangappa says:

      I know both binominal and B&S models lead to similar premium values. However, I’ve never tested for historical IV’s. So I guess I wont be able to comment to this.

  40. trader2017 says:

    While trading options is it important to look just at the volume figures for liquidity purpose or should we look into the Open interest figures as well? If yes for both, then could you tell how much is the ideal level for a contract to be liquid (volume and OI separately)? Also, I see that some call option contracts rise tremendously in value even if the underlying has fallen in value..for example on 24 march, TV18BRDCST CE of 27th apr 17 expiry, and strike of 52.5 rose by 3300% from the previous day close.. this has happened even if the underlying fell by 0.57% from previous close. Is there any way to spot such contracts and cash the gains by selling the contract soon ? 🙂

    • Karthik Rangappa says:

      While both are important, I particularly look at volumes. Always compare today’s volume with respect to average volumes for a particular timeframe. For example, I’d look at today’s volume with respect to last 10 day average.Ditto for OI. Its hard to spot such trades, but with good amount of skill and luck, you certainly can 🙂

  41. trader2017 says:

    When I see the open interest and volume data for equity options, most of the times the open interest is extremely high when compared to volume throughout the trading month. So since volume is the number of contracts traded and open interest is the number of positions that are still open, if say for example I see the NIFTY 8000 call of 25 jan 17 expiry, till the expiry date the volume was around 8403 and open interest was 95925.
    1) Does this mean that after market close 87522 contracts (95925-8403) were exercised?. This seems to be the same case where most of the options are exercised for other underlyings as well. Note that this is an ITM option.
    2) Doesn this indirectly mean that a lot of people are ending up losing money because there is a greater STT that is levied on exercising options? And why are people exercising instead of squaring off?
    3) what will happen if I try to square off an ITM option on the day of expiry but I don’t find any buyer for my option?

  42. Ankit says:

    Hello karthik sir,
    I have a question i am tracking May, 2017 currency option(USDINR) for sometime
    today(21 april) underlying in red but ATM and slightly Atm & OTM puts mean close to underlying price also declining not much but little bit why this happining as per my calculation volatility is normal not decreasing , and there is lot more time to expiry then no problem with theta
    Then why this happening
    I guess this is due to all options contains excess value to protect Seller s and as this option going to be current months the price reaching towards normal or fair range
    Am i right sir pls…..correct me if neccsesory….

    • Karthik Rangappa says:

      Maybe due to liquidity issues. Keep track of the traded prices, sometimes when liquidity is low, the option premiums misbehaves 🙂

  43. trader says:

    SInce STT on exercised options is quite high and eat up profits made in ITM options, then how can traders square off contracts whose daily volume are also low? for example if you look for SBI CE strike 275 with expiry 27 apr 2017, from 27 mar till 27 april in the following link https://nseindia.com/products/content/derivatives/equities/historical_fo.htm the daily contracts traded for this option of SBI till the day of expiry is quite low. In this case will you suggest that the trader buys only one or two contracts so that he can sell it easily before expiry and he can avoid the trap of any options not getting squared off due to insufficient buyers? Second question is, you can see in the data that the open interest figures are quite high even till the date of expiry. so does this mean that lacs of contracts got exercised on their own on expiry day and the option holders ended up paying the high stt?

    • Karthik Rangappa says:

      Yes, in fact ample liquidity is one of the key criteria for selecting stocks for intraday purpose. Its tough to find liquidity beyond 4-5 big names (ICIC, RIL, Infy TCS etc). Yes, many contracts gets exercised upon expiry. For people who dont know, they end up paying high STT.

  44. trader says:

    How can I find liquid stock option contracts (with specific strikes) and be sure that I will be able to find a buyer easily if I want to sell my contract before expiry? Also, if a contract for a specific strike has had over 1000 daily volume in past month then does it indicate that in the future months also it is more likely to have good volume? in general how do I know that a particular strike of a stock option is going to attract good volumes?

    • Karthik Rangappa says:

      You just need to scan the market to figure out where the liquidity lies. Usually, it is concentrated in few names such as – Nifty, Bank Nifty, ICICI, Infy, SBI, HDFC, RIL, TCS etc.

      No, today’s volume does not guarantee future volume.

  45. Ingit singh says:

    How do you arrive at the 8 graphs in section 22.3 of module 5-2. These are used in module 6 also. Are these based on historical data and remain unchanged or one has to plot them for every strategy. Plz ignore if the question is too dumb.

  46. Uday Sharma says:

    Can you please guide me how to trade in option from Zerodha pi/kite.

  47. Anantharajan Natarajan says:

    Dear Sir,

    Option chain contains current month, Mid month & Far month. For example My doubt is if current month not available volume, open interest or Bis ask spread is more so I wouldn’t take any option position. Then I drill it down find a mid month or far month options satisfied with Volume, Bid and ask spread. So if I want to select the option (ITM, ATM & OTM) how to consider or think 1st half of the series or the 2nd half of the series to initiate the trade.

    • Karthik Rangappa says:

      In the present Indian context, you will not find this situation. Liquidity is available in the current month as opposed to mid or far month.

  48. Shubham Choudhary says:

    Dear Sir,
    Do you have modules on option strategies??

  49. rahul says:

    Hello Karthik,

    The above charts really get to the core of why successfully trading options remains a challenge to many retail investors as myself. That said, a chart of Theta vs Strike Price will also help in understanding the core concept, IMO. I ended up searching for the chart when I realized that time value of ITM options is less than that of ATM options, which I found quite confusing.

    I’d read on the internet that Deep ITM naked options are a relatively safe bet but the above charts along with Theta-vs-Strike-price is really driving the point home for me.

    Thank you once again for this excellent material.

  50. yash says:

    Why is 5th module not available for download??

  51. Arijit B says:

    Guruji,
    Excellent stuff. If possible, please post table of Position Initiation Target Expectation Best Strike To Trade for banknifty weekly options.
    Is it a correct strategy to buying two strike price Call / Put when banknifty did not have trend of more than 200 points and forecasting it would rise / fall ? Please do let me your views. Is there any formulae to predict the premium based on predicted index if I know all the geeks and implied volatility. Thanks and Regards, Arijit

    • Karthik Rangappa says:

      Ah yes, that table has been pending for a while now 🙂

      Any strategy requires backtesting, Arijit. Cannot make a blind statement 🙂

  52. Arijit B says:

    Guruji,
    Thanks for your prompt reply and the suggestion for backtesting. Will confirm my theory with sample from 01/01/17 should suffice.
    Do you know or where can I find Black Scholes formular to predict the premium based on predicted index if I know all the geeks and implied volatility?
    Thanks and Regards,
    Arijit

    • Karthik Rangappa says:

      I’d suggest you take more data points, at least for the last 2 years. Check this – https://zerodha.com/tools/black-scholes/

      • Arijit B says:

        Guruji,

        Thanks for the sample size …works in progress…

        I require formula not calculator as I know how to calculate the geeks from options chains table but I want to calculate the future premium for a strike price for predicted future index and current geeks…

        Thanks and Regards,
        Arijit

        • Karthik Rangappa says:

          Ah, expected premium? This has to be again based on how the expected change in greeks, not sure if something of this sort is available online.

          • Arijit B says:

            Guruji,
            I want to write the calculator based on the formula calculating the premium for a strike price for a range of forecast index price, based on calculated geeks from option chain table.
            Please help, if possible.
            Thanks and Regards,
            Arijit

          • Karthik Rangappa says:

            I’m not sure about this, Arijit. Can you elaborate a bit more? Thanks.

  53. Ravi Kumar BA says:

    You are a True Teacher!.. Who Knows what the students expect …
    We wanted this kind of Summary and reinforcement of complex Options in one single chapter!

  54. Gaurav says:

    Hi Karthik,

    Great learning from you. I just wanted to know how will you choose strikes in case I want to short options. This is because I have a portfolio and would like to hedge it and collect premiums. Do we still select strikes in the same manner as we do while buying options? Also, is it a good idea to short both call and put options to hedge each other out?

    Regards,

    Gaurav.

  55. Ash says:

    What standard checklist, pattern and indicators do you strongly use on a daily basis for intra day or 2-3 days type of trades while trading the “Nifty 50 Index Option”?

  56. Hemant says:

    Dear sir,
    This chapter is highly confusing!
    If your target is achieved in 5 days do u square off at that point or continue till expiry? You target at the profit in premium or profit at the end in the strike price?

  57. Sachin Singh says:

    Hey! Since volatility increases when an important announcement is coming up, and increase in volatility is directly proportional to increase in premium, so irrespective of the result of the company, it would always make sense to buy a call option around 1-3 days before? If true, then what would be the appropriate strike price for this?

    • Karthik Rangappa says:

      Volatility tends to increase, does not always increase! However, if it does, I would be comfortable buying slightly OTM, assuming there is at least 5- 8 trading sessions before expiry.

  58. Ravi Kumar says:

    Dear Sir,
    If we know the target is expected on expiry day, it is suggested to buy ITM strike option during the first half of series.
    1. which ITM strike option to buy? Slightly ITM or ITM?
    2. If we buy ITM option and there is no price movement in the underlying, would the premium erode due to Theta value and lose money? what happens to premium in this case?

  59. Arijit B says:

    Guruji,

    Your pedagogy is excellent and reflects what you have gone through to arrive at level of excellence !
    ————————————————————————————————————————————————
    You get compute geeks from option table.
    There should be formula with which one calculate the premium (by Black Scholes) for forecast index.
    Hope the above is clear.

    Thanks and Regards,
    Arijit

    • Karthik Rangappa says:

      Ah, I get it. This may not very intuitive since both the premium and the index movement (delta) are co-dependent. So you will end up in some sort of a circular loop when trying to do this. Anyway, let me give it more thought. Thanks.

  60. Rajiv says:

    It’s very good. the contents are so elaborative, I am good to read this. I shall apply it to real trades.

  61. Darshan says:

    how it is affecte to P&L ;
    1) X share trading at 100(spot price). i know share will be up 20 points(i.e.120) within 25 days. i bought CE option with slightly ITM (first half of expiry). but market react early and target achieved within 5 days. how affected to p&L as well as any other point that should be keep in mind ?
    2) which Moneyness for call option i have to choose when i only know X share have upward moves from current level ? May be 1st or 2nd half of the series.
    3) what is the thought behind buying/selling of next months expiry ? or better to not jump at initial level.

    • Karthik Rangappa says:

      1) In this case, the options premium will go much higher than the value predicted by delta. This is because of ample time value.
      2) If you have sufficient time, then opt for slightly OTM option, else opt for ATM option.
      3) Liquidity could be an issue with next month options, I’d suggest you stick to the current month options.

      Good luck.

  62. RAJAN . A.T. says:

    Sirs,
    I am Rajan A.T.
    After going through this chapter on ” Reintroducing Call & Put option, Kindly clear my following doubts.
    a) How is a Call option is different from a Put option for a same strike rate? for example How the ATM of today ( 16-01-2018 ) 10700 CE is different from the 10700 PE ?
    b) How ITM shift from left to right after ATM ie the light yellow back ground
    If the answer is of long stretch kindly give me a link to this answer.
    I have read this module no 5 two times . I could not get the answer for my above question.

    Please allow me to give an example of some what same to compare.
    Take chart of a Railway Time Table (RTT. in short) . This is a common chart familiar to almost maximum number of people.
    Let us compare both charts. The Railway Time Table (RTT. in short) and the Nifty Option Chain (NOC. in short)
    1 The central Strike Price column in the Nifty Option Chain (NOC) can be compared to the Train No and train name column of the Railway Time Table (RTT).
    2. The left side of the strike price column in NOC is Call option and its details . same way
    left side of RTT is UP direction of the trains and details of stations on the route and arrival & departure time of those stations.
    3 The right side of the strike price column in NOC is Put option and its details . same way right
    side of RTT is DOWN direction of the trains and details of stations on the route and arrival & departure time of those station.
    Kindly compare like this and make it very simple to understand.
    Considering the effort & time the full team of people have invested to prepare such a beautiful and versatile book, these type of comparison charts will go a long way. SORRY for taking your valuable time.

    Regards

    Rajan A. T.

    • Karthik Rangappa says:

      1) The basic difference is in terms of the directional opinion – you make money on call when the stock price goes up and you make money on a PUT when the stock price goes down
      2) This depends on the option type (calls and Puts). I’d suggest you read the chapter on Moneyness of option to understand this better.

      The RTT example is nice, unfortunately, I’ve not traveled much, hence not too familiar with the railway chart. But appreciate your inputs. Thanks.

  63. Rahul Pandey says:

    margin money is like a loan or a debt. isn’t it? so am i liable to pay the extra money that i borrowed as margin money for intraday trade that enhanced my profit??

    • Karthik Rangappa says:

      Sort of yes, but this is a standard feature offered by most brokers and no one really charges for it.

      • Rahul Pandey says:

        i am actually new to trading and when i received a mail from NSE at the day’s end of stocks bought and sold and it showed that i actually traded in lakhs when i just had 5000 in my account, that really got me scared.

  64. Murtoza Shaikh says:

    The way you bifurcated one month option contract into 15 day i.e. the effect of time on premium .
    Can you tell me the effect of time in premium in case on Bank nifty as the option contract are for one week (as per my knowledge. I am new to all this stuff correct me if I am wrong).

  65. Ramadevi says:

    Dear Sir, Please refer the last sentence in 22.3 ” the best practice for buying options differs with last column of the table where as it mentioned for trade
    Is it same for buying and selling the options.
    I.e 1st half of the series and the result is expected in 5 days from the initiation, the best strike to trade is far OTM is it holds good for both buying and selling.
    Regards

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