Module 5 Options Theory for Professional Trading

Chapter 5

The Put Option Buying

152

5.1 – Getting the orientation right

I hope by now you are through with the practicalities of a Call option from both the buyers and sellers perspective. If you are indeed familiar with the call option then orienting yourself to understand ‘Put Options’ is fairly easy.  The only change in a put option (from the buyer’s perspective) is the view on markets should be bearish as opposed to the bullish view of a call option buyer.

The put option buyer is betting on the fact that the stock price will go down (by the time expiry approaches). Hence in order to profit from this view he enters into a Put Option agreement. In a put option agreement, the buyer of the put option can buy the right to sell a stock at a price (strike price) irrespective of where the underlying/stock is trading at.

Remember this generality – whatever the buyer of the option anticipates, the seller anticipates the exact opposite, therefore a market exists. After all, if everyone expects the same a market can never exist. So if the Put option buyer expects the market to go down by expiry, then the put option seller would expect the market (or the stock) to go up or stay flat.

A put option buyer buys the right to sell the underlying to the put option writer at a predetermined rate (Strike price. This means the put option seller, upon expiry will have to buy if the ‘put option buyer’ is selling him.  Pay attention here – at the time of the agreement the put option seller is selling a right to the put option buyer where in the buyer can ‘sell’ the underlying to the ‘put option seller’ at the time of expiry.

Confusing? well, just think of the ‘Put Option’ as a simple contract where two parties meet today and agree to enter into a transaction based on the price of an underlying –

  • The party agreeing to pay a premium is called the ‘contract buyer’ and the party receiving the premium is called the ‘contract seller’
  • The contract buyer pays a premium and buys himself a right
  • The contract seller receives the premium and obligates himself
  • The contract buyer will decide whether or not to exercise his right on the expiry day
  • If the contract buyer decides to exercise his right then he gets to sell the underlying (maybe a stock) at the agreed price (strike price) and the contract seller will be obligated to buy this underlying from the contract buyer
  • Obviously the contract buyer will exercise his right only if the underlying price is trading below the strike price – this means by virtue of the contract the buyer holds, he can sell the underlying at a much higher price to the contract seller when the same underlying is trading at a lower price in the open market.

Still confusing? Fear not, we will deal with an example to understand this more clearly.

Consider this situation, between the Contract buyer and the Contract seller

  • Assume Reliance Industries is trading at Rs.850/-
  • Contract buyer buys the right to sell Reliance to contract seller at Rs.850/- upon expiry
  • To obtain this right, contract buyer has to pay a premium to the contract seller
  • Against the receipt of the premium contract seller will agree to buy Reliance Industries shares at Rs.850/- upon expiry but only if contract buyer wants him to buy it from him
  • For example if upon expiry Reliance is at Rs.820/- then contract buyer can demand contract seller to buy Reliance at Rs.850/- from him
  • This means contract buyer can enjoy the benefit of selling Reliance at Rs.850/- when it is trading at a lower price in the open market (Rs.820/-)
  • If Reliance is trading at Rs.850/- or higher upon expiry (say Rs.870/-) it does not make sense for contract buyer to exercise his right and ask contract seller to buy the shares from him at Rs.850/-. This is quite obvious since he can sell it at a higher rate in the open market
  • A agreement of this sort where one obtains the right to sell the underlying asset upon expiry is called a ‘Put option’
  • Contract seller will be obligated to buy Reliance at Rs.850/- from contract buyer because he has sold Reliance 850 Put Option to contract buyer

M5-Ch5-title

I hope the above discussion has given you the required orientation to the Put Options. If you are still confused, it is alright as I’m certain you will develop more clarity as we proceed further. However there are 3 key points you need to be aware of at this stage –

  • The buyer of the put option is bearish about the underlying asset, while the seller of the put option is neutral or bullish on the same underlying
  • The buyer of the put option has the right to sell the underlying asset upon expiry at the strike price
  • The seller of the put option is obligated (since he receives an upfront premium) to buy the underlying asset at the strike price from the put option buyer if the buyer wishes to exercise his right.

5.2 – Building a case for a Put Option buyer

Like we did with the call option, let us build a practical case to understand the put option better. We will first deal with the Put Option from the buyer’s perspective and then proceed to understand the put option from the seller’s perspective.

Here is the end of day chart of Bank Nifty (as on 8th April 2015) –

Image 1_ Bank Nifty

Here are some of my thoughts with respect to Bank Nifty –

  1. Bank Nifty is trading at 18417
  2. 2 days ago Bank Nifty tested its resistance level of 18550 (resistance level highlighted by a green horizontal line)
  3. I consider 18550 as resistance since there is a price action zone at this level which is well spaced in time (for people who are not familiar with the concept of resistance I would suggest you read about it here
  4. I have highlighted the price action zone in a blue rectangular boxes
  5. On 7th of April (yesterday) RBI maintained a status quo on the monetary rates – they kept the key central bank rates unchanged (as you may know RBI monetary policy is the most important event for Bank Nifty)
  6. Hence in the backdrop of a technical resistance and lack of any key fundamental trigger, banks may not be the flavor of the season in the markets
  7. As result of which traders may want to sell banks and buy something else which is the flavor of the season
  8. For these reasons I have a bearish bias towards Bank Nifty
  9. However shorting futures maybe a bit risky as the overall market is bullish, it is only the banking sector which is lacking luster
  10. Under circumstances such as these employing an option is best, hence buying a Put Option on the bank Nifty may make sense
  11. Remember when you buy a put option you benefit when the underlying goes down

Backed by this reasoning, I would prefer to buy the 18400 Put Option which is trading at a premium of Rs.315/-. Remember to buy this 18400 Put option, I will have to pay the required premium (Rs.315/- in this case) and the same will be received by the 18400 Put option seller.

Image 2_Option Chain

Of course buying the Put option is quite simple – the easiest way is to call your broker and ask him to buy the Put option of a specific stock and strike and it will be done for you in matter of a few seconds. Alternatively you can buy it yourself through a trading terminal such as Zerodha Pi We will get into the technicalities of buying and selling options via a trading terminal at a later stage.

Now assuming I have bought Bank Nifty’s 18400 Put Option, it would be interesting to observe the P&L behavior of the Put Option upon its expiry.  In the process we can even make a few generalizations about the behavior of a Put option’s P&L.

5.3 – Intrinsic Value (IV) of a Put Option

Before we proceed to generalize the behavior of the Put Option P&L, we need to understand the calculation of the intrinsic value of a Put option. We discussed the concept of intrinsic value in the previous chapter; hence I will assume you know the concept behind IV. Intrinsic Value represents the value of money the buyer will receive if he were to exercise the option upon expiry.

The calculation for the intrinsic value of a Put option is slightly different from that of a call option. To help you appreciate the difference let me post here the intrinsic value formula for a Call option –

IV (Call option) = Spot Price – Strike Price

The intrinsic value of a Put option is –

IV (Put Option) = Strike Price – Spot Price

I want you to remember an important aspect here with respect to the intrinsic value of an option – consider the following timeline –

Image-3_timeline-new

The formula to calculate the intrinsic value of an option that we have just looked at, is applicable only on the day of the expiry.  However the calculation of intrinsic value of an option is different during the series. Of course we will understand how to calculate (and the need to calculate) the intrinsic value of an option during the expiry. But for now, we only need to know the calculation of the intrinsic value upon expiry.

5.4 – P&L behavior of the Put Option buyer

Keeping the concept of intrinsic value of a put option at the back of our mind, let us work towards building a table which would help us identify how much money, I as the buyer of  Bank Nifty’s 18400 put option would make under the various possible spot value changes of Bank Nifty (in spot market) on expiry. Do remember the premium paid for this option is Rs 315/–. Irrespective of how the spot value changes, the fact that I have paid Rs.315/- will remain unchanged. This is the cost that I have incurred in order to buy the Bank Nifty 18400 Put Option. Let us keep this in perspective and work out the P&L table –

Please note – the negative sign before the premium paid represents a cash outflow from my trading account.

Serial No. Possible values of spot Premium Paid Intrinsic Value (IV) P&L (IV + Premium)
01 16195 -315 18400 – 16195 = 2205 2205 + (-315) = + 1890
02 16510 -315 18400 – 16510 = 1890 1890 + (-315)= + 1575
03 16825 -315 18400 – 16825 = 1575 1575 + (-315) = + 1260
04 17140 -315 18400 – 17140 = 1260 1260 + (-315) = + 945
05 17455 -315 18400 – 17455 = 945 945 + (-315) = + 630
06 17770 -315 18400 – 17770 = 630 630 + (-315) = + 315
07 18085 -315 18400 – 18085 = 315 315 + (-315) = 0
08 18400 -315 18400 – 18400 = 0 0 + (-315)= – 315
09 18715 -315 18400 – 18715 = 0 0 + (-315) = -315
10 19030 -315 18400 – 19030 = 0 0 + (-315) = -315
11 19345 -315 18400 – 19345 = 0 0 + (-315) = -315
12 19660 -315 18400 – 19660 = 0 0 + (-315) = -315

Let us make some observations on the behavior of the P&L (and also make a few P&L generalizations). For the above discussion, set your eyes at row number 8 as your reference point –

  1. The objective behind buying a put option is to benefit from a falling price. As we can see, the profit increases as and when the price decreases in the spot market (with reference to the strike price of 18400).
    1. Generalization 1 – Buyers of Put Options are profitable as and when the spot price goes below the strike price. In other words buy a put option only when you are bearish about the underlying
  2. As the spot price goes above the strike price (18400) the position starts to make a loss. However the loss is restricted to the extent of the premium paid, which in this case is Rs.315/-
    1. Generalization 2 – A put option buyer experiences a loss when the spot price goes higher than the strike price. However the maximum loss is restricted to the extent of the premium the put option buyer has paid.

Here is a general formula using which you can calculate the P&L from a Put Option position. Do bear in mind this formula is applicable on positions held till expiry.

P&L = [Max (0, Strike Price – Spot Price)] – Premium Paid

Let us pick 2 random values and evaluate if the formula works –

  1. 16510
  2. 19660

@16510 (spot below strike, position has to be profitable)

= Max (0, 18400 -16510)] – 315

= 1890 – 315

= + 1575

@19660 (spot above strike, position has to be loss making, restricted to premium paid)

= Max (0, 18400 – 19660) – 315

= Max (0, -1260) – 315

= – 315

Clearly both the results match the expected outcome.

Further, we need to understand the breakeven point calculation for a Put Option buyer. Note, I will take the liberty of skipping the explanation of a breakeven point as we have already dealt with it in the previous chapter; hence I will give you the formula to calculate the same –

Breakeven point = Strike Price – Premium Paid

For the Bank Nifty breakeven point would be

= 18400 – 315

= 18085

So as per this definition of the breakeven point, at 18085 the put option should neither make any money nor lose any money. To validate this let us apply the P&L formula –

= Max (0, 18400 – 18085) – 315

= Max (0, 315) – 315

= 315 – 315

=0

The result obtained in clearly in line with the expectation of the breakeven point.

Important note – The calculation of the intrinsic value, P&L, and Breakeven point are all with respect to the expiry. So far in this module, we have assumed that you as an option buyer or seller would set up the option trade with an intention to hold the same till expiry.

But soon you will realize that that more often than not, you will initiate an options trade only to close it much earlier than expiry. Under such a situation the calculations of breakeven point may not matter much, however the calculation of the P&L and intrinsic value does matter and there is a different formula to do the same.

To put this more clearly let me assume two situations on the Bank Nifty Trade, we know the trade has been initiated on 7th April 2015 and the expiry is on 30th April 2015–

  1. What would be the P&L assuming spot is at 17000 on 30th April 2015?
  2. What would be the P&L assuming spot is at 17000 on 15th April 2015 (or for that matter any other date apart from the expiry date)

Answer to the first question is fairly simple, we can straight way apply the P&L formula –

= Max (0, 18400 – 17000) – 315

= Max (0, 1400) – 315

= 1400 – 315

= 1085

Going on to the 2nd question, if the spot is at 17000 on any other date apart from the expiry date, the P&L is not going to be 1085, it will be higher. We will discuss why this will be higher at an appropriate stage, but for now just keep this point in the back of your mind.

5.5 – Put option buyer’s P&L payoff

If we connect the P&L points of the Put Option and develop a line chart, we should be able to observe the generalizations we have made on the Put option buyers P&L. Please find below the same –

Image 4_P&L Payoff

Here are a few things that you should appreciate from the chart above, remember 18400 is the strike price –

  1. The Put option buyer experienced a loss only when the spot price goes above the strike price (18400 and above)
  2. However this loss is limited to the extent of the premium paid
  3. The Put Option buyer will experience an exponential gain as and when the spot price trades below the strike price
  4. The gains can be potentially unlimited
  5. At the breakeven point (18085) the put option buyer neither makes money nor losses money. You can observe that at the breakeven point, the P&L graph just recovers from a loss making situation to a neutral situation. It is only above this point the put option buyer would start to make money.

Key takeaways from this chapter

  1. Buy a Put Option when you are bearish about the prospects of the underlying. In other words a Put option buyer is profitable only when the underlying declines in value
  2. The intrinsic value calculation of a Put option is slightly different when compared to the intrinsic value calculation of a call option
  3. IV (Put Option) = Strike Price – Spot Price
  4. The P&L of a Put Option buyer can be calculated as P&L = [Max (0, Strike Price – Spot Price)] – Premium Paid
  5. The breakeven point for the put option buyer is calculated as Strike – Premium Paid

152 comments

  1. R P HANS says:

    Hello Kartik,
    I want to clearify on hoe to select weather to buy call or sell put, cause both will be benifited if the market goes up. Same thing for selling a call and byuing a put, both will be profitable if market goes down. Then how to make choice or right decesion? Is it depends on margin money needed more for selling and amount to be invested is less if byuing an option? Or some other technical points or there.
    My next question on hoe to make use of volatility of the underlying stock?
    Thanks

    • Karthik Rangappa says:

      Well this depends on how cheap or expensive the premiums are. We will discuss this topic shortly very soon in this module, request you to stay tuned. Thanks.

  2. Kartikey says:

    Hello,
    I want to know how to trade options in the last 10 days before expiry,as i read that an option loses 2/3rd of its value in the last 15 days.If i buy call or put and banking on increase in its premium but the time decay (theta) increases during the last 10-15 days and everyday the option loses some value due to time decay.So can you please clarify how to trade in this situation.Is it better to stick to intraday option trading in the last 10 days? Thanks in advance.

    • Karthik Rangappa says:

      The time decay is just one of the force that acts upon the option premium….which by virtue tends to lower the option premium. Simultaneous there could bbe another force (say Vega) which can increase the option premium. The net increase or decrease of option premium is a sum of all these individual forces, collectively called the ‘Option Greeks’. So make sure you understand the Option Greeks well.

  3. RK0987 says:

    karthik, i gone through abv blog, but could not get my answer ie how to protect loss created by shorting option? . and how to calculait stop loss while shorting any option call or put.

    • Karthik Rangappa says:

      The best way to protect your loss is to have a stoploss. You can set up the stoploss based on 2 factors – (1) Support & Resistance Levels (2) Volatility of the stock. We have discussed the S&R levels here – http://zerodha.com/varsity/chapter/support-resistance/ . Volatility based stoploss is something we have not discussed yet on Varsity, we will do it in the options module.

  4. RK0987 says:

    thanks, karthik, pls arrang descussion on volatility based stoploss. in the mean time , i am confused that whether stoploss sould be put on b premium value or on nifty spot price basis, for example- i short nifty put option of 8350 @ 22/- when spot nifty was 8600, now whether i should put SL on premium that if it goes rs. 44 or 50 trade should sq off. or on basis of nifty spot that if nifty goes down to 8500 or 8450 trade should be sq off, i want to know the base of stoploss it sud be price of undertaking or premium value. pls reply, very important to me.

    • Karthik Rangappa says:

      Yes, we will discuss volatility in great length very soon.

      The SL should always be based on the underlying spot.

  5. khyati verdhan says:

    hi kartik
    thanks for your previous reply!
    Q.- since NSE or BSE opening bell is at 9:30 am. if i want to place an order before market open at first market price i.e. i want to place an order to buy or sell at first market price can i place an order at 9:00 am because opening and closing periods are very volatile the order to get stock at screen displayed price is very difficult. is the above is possible with futures, options, currency and commodity

  6. tatipaka says:

    Dear Sir,
    your module on options are really very good, we are also learning patience in waiting for next chapters which takes longer time.
    Thanks/regards
    Regards

  7. khyati verdhan says:

    i have asked it earlier but you have not given reply. my question is
    Q.- since NSE or BSE opening bell is at 9:30 am. if i want to place an order before market open at first market price i.e. i want to place an order to buy or sell at first market price can i place an order at 9:00 am because opening and closing periods are very volatile the order to get stock at screen displayed price is very difficult. is the above is possible with futures, options, currency and COMMODITY

  8. hi very new to trading. at this age of 68, i am very much confused between call sell and put buy both are in the bearish, premium is more in call sell, when actually we have to plan call sell. let me know. I have gone thru many books, out of all u people are very good knowledge, easy to undertand, very thankful to u. somasekhar.

    • Karthik Rangappa says:

      Thank you for the kind words Sir.

      For selling a call you will need to deposit margins but for buying puts you dont need margin. I would suggest you just stick to buying puts till you get comfortable with options. You can try call option selling once you are comfortable with derivatives.

  9. sarath says:

    sir, can i do option trading in commodities

  10. Umang Kumar Santuka says:

    Hi Karthik,
    Thank you for this option module.It is really good.I am having one query.
    Call Option sell and put option buy both represents bearish situation.But why would any one sell call option,if he/she is bearish he can buy put option.As in call option sell we have to add margin amount , profit is limited to premium amount and loss is exponential where as in put option buy it is vice-versa.
    So if any one is bearish then why he would sell call option insteasd he can buy put option.
    Please explain.

    • Karthik Rangappa says:

      Umang you do have a point, however there could be circumstances where the volatility is high and therefore the option premiums would be high. In such circumstances it makes sense to write options and collect premium rather than buy options at an expensive rate.

  11. Ajit says:

    hi Karthik..you have really made it simple.i want to ask if i see the open interest of call is increasing and put option decreasing what should we perceive …its bullish or bearish..because as i have checked the past data of nifty i have found that trading in puts is significantly higher than trading in call option(as mentioned at the lower bottom of option chain ..right/right)..and i also observed that PCR increasing while its moving up and decreses while trend goes down..please help me with this..thank you

    • Karthik Rangappa says:

      Ajit – instead of reading the OI data directly, I would suggest you use the ‘Options Pain’ theory…we will discuss the same shortly. I think Options pain is a slightly better indicator than the plain vanilla OI data.

  12. k l agarwal says:

    Dear Karthik, very good and informative blog on option greeks, pls continue educating your client, God bless you. how to contact you personaly in any emergency.

    • Karthik Rangappa says:

      Thanks for the kind words :).

      I;m usually quite active here..so you could drop in a message here itself.

      • k l agarwal client id RK0987 says:

        THANKS, Dear Karthik, i was going through your option modul-5 chapter-17 heading VOLATILITY & NORMAL DISTRIBUTION. i was confused when i reached to para 17.4 normal distribution……..
        1. how you came to daily average as – 0.04% as well daily standard deviation as 1.046%. i have tried my best and by going through earlier chapter, but could not, hence request to mail me excel file of this
        2. in solution -1, while getting andannualized number , you * by 252, why not 365. and even when i calculat on 252 it comes – 10.08% and not 9.66%.

        3. while caculating upper range of 8337 ,what do you mean by word EXPONTIAL, how it effect calculation, as per my calculation it is 10559 instead of 10841. same way lower range comes 7758.instead of 7777.
        pls let me know where i am wrong ?

        • Karthik Rangappa says:

          You can download the excel sheet towards the end of the chapter, this should solve your 1st query.

          365 is the convention used by NSE, hence I’ve used the same.

          Guess I’ve used exponential in a contextual sense. Suggest you refer the excel for more clarity on numbers.

      • k l agarwal says:

        Karthik, further to my earlier mail of taday, just now as per yr theory for daily return and annual volatility, i calculated nifty spot daily and annual vol… for 23-09-2014 to 22-09-2015. the result is daily
        volatility is .. 1.033 and annual 19.73 (by1.033 * sqrt(365) ). where as nse website shows daily as 1.47 and annual as 28.13. pls advise why so much difference. which one is applicable.

        • Karthik Rangappa says:

          Extract from chapter 16 – So why is there a slight difference between our calculation and NSE’s? – One possible reason could be that we are using spot price while NSE is using Futures price.

          Having said so, I really dont think there should be so much difference. Let me do the calculations once again..thanks.

  13. Ajit says:

    i am very eagerly waiting for pain theory Karthik…thanks for help

  14. k l agarwal client id RK0987 says:

    Thanks, karthik for prompt reply, specialy, for your personal advise/suggestion in CHAPTER-18, i guess , i would have read it earlier than i could have saved
    my heavy loss incurred in august and september. any way few further queries– for doing option writting trade in each month and if we start it from 15 days from expiry as greatly suggested by you—
    1. to get average, how many days old data , we should take to calculate average number?
    2. to get annual figure which number , we should take ie 252 or 365 ?
    your suggestion and advise will be highly helpful to us.thanks

  15. himanshu says:

    zerodha rocks,you guys have done a very good job in helping us with zerodha varsity,thanks a lot 🙂 ,one more thing(probably not the right place to say it) if you can also start offering us the IPO facility we no longer will need to have our other brokerage accounts.

  16. Sam says:

    Why there are no difference in chart. Even though they are different strike price.
    Ex: Nifty 8100, 8200, 8300 PE(CE)
    Everything same in chart even though premium price is different.

    P.S: I know it derives from Underlying price. But still I want to have little bit clarity on this.

    Thank you

  17. Sumeet Nagar says:

    Hi Karthik, I have few queries..
    1. Does the variation of the premiums purely depends on the Options Greeks? Buyers and Sellers does not have anything to do with it?
    2. Suppose LTP of Premium = 100. Now I put a buy order at 80 and someone sells it at 80.. So, my order gets executed and now the latest LTP=80.. It will remain at 80 till the next order gets executed right..Now, where does the Option Greeks comes into picture for determining the Premium value??

  18. Devanand Hiremath says:

    sir,
    On friday I buy 2 qty of put option banknifty at 140.00. Then I kept stop loss order for the same. When the price was reached at148.00 I modified st loss order 1 qty for the price 148.00 and 1 qty sold . Now there was no open order. And then when I tried to put 1 stop loss order for the remaining 1 buy order qty at the price 140.00 the order executed at 140.00 and sold for 140.00 even though the price was running at148.00. It shouldn’t remained open for the price 140.00. Why it happened ? And how to put stop loss order after removing partial buy order qty.? please reply.

  19. PRASHANTH AV says:

    karthik i have a few doubs how is nifty spot traded how do i monitor the price of nifty spot in my trading platform . when u trade nifty options what is the underlying asset nifty spot or the current month future price

  20. PRASHANTH AV says:

    i thought indexes are traded only in futures. but what is the concept of trading nifty spot

  21. rohan says:

    Can anyone suggest suggest good candlestick pattern to predict bearish fall in stock? So that after analyzing that I can go for put option.
    Eg- Pole-flag candle stick pattern is very good for predicting that stock will go up or not?

  22. Balaji says:

    Hi,
    Is anyone aware of the following / attached excel sheet… if case if you are aware kindly provide me the link

  23. Kaushik says:

    I have question regarding buying put options when the companies declare dividend. Generally when the dividend is distributed, the stock price falls down by the same amount. can we buy put option for the stock & sell on Ex-dividend date? i know if the Div is very low against the stock price the movement may not be significant, but if the dividend is 4-5% like 5 Rs. on 100 Rs stock price, can we take a chance? or the drop in price will be adjusted in the put option pricing?

    • Karthik Rangappa says:

      Usually the drop in price is factored in and the premiums reflect the effect of dividend. So I suppose there is not much gravy left in this strategy.

  24. Ashish says:

    I have purchased 4 lots of icici bank put option at strike price 180 @rs 7.60 as premium. After few days price of icici bank come down to 178. Now premium price of 180 put of icici bank raises to 11. Now i want to sell my 4 lot of put option @rs 11 as premium before. My profit would be 3.40 per share. is it write. plz explain

  25. Indrani Banerjee says:

    I am a new trader & have never traded in Options, but am thinking of doing so, but before so doing, I have been going through the modules on Options. In the above module while explaining, you said the following, “If Reliance is trading at Rs.850/- or higher upon expiry (say Rs.870/-) it does not make sense for contract buyer to exercise his right and ask contract seller to buy the shares from him at Rs.850/-. This is quite obvious since he can sell it at a higher rate in the open market.” Does this mean, in such a situation, I can sell these shares in the open market? Kindly explain.

    • Karthik Rangappa says:

      This is just a comparison…it means that you can literally sell the stock at a higher price in open market, why bother to settle for a lesser price via options.

      • Indrani Banerjee says:

        Thanks Karthik. Today is the first day, I tried to trade in OPTIONS. What I actually did is I used the “Call & Trade” facility because I simply could not understand how to initiate the trade. From where to find the Charts which showed all the Strike prices of a particular Stock or Index, which strike price to choose from them, etc. Suppose I want to option trade on SBI, where from do I get the chart showing all the details…..etc? My question I know is silly, but I believe once I get accustomed to the mechanism, it won’t appear so difficult. Until then, I need your kind support. Thanks.

        • Karthik Rangappa says:

          Indrani – If you are a Zerodha client, I would suggest you login using Kite….Kite is quite user friendly and I’m sure you will find it lot easier to use. Also, I’d suggest you give a call to Zerodha, our support executives will hand hold you.

  26. Amit says:

    Why PUTs are cheaper ?
    Nifty Spot closed @ 7615, but 7600CE closed @78, where as 7600PE closed @ 22.
    7600CE is just 15 points ITM, but the difference b/w premiums is very high. Any specific reason for the same.
    Thanks in Advance

    • Karthik Rangappa says:

      Generally speaking puts are cheaper to calls (belonging to same strike). Lots of factors contribute to this, including something called as the ‘Put call Parity’.

  27. Vinod says:

    Hi ….. Good to see u are guiding so many people… Today is my first day in options… I bought put options nifty 7700 @124 …. So I paid 9300 as margin…. Now nifty closed at around 7602.. So can I square off now… If I square off now will I get both profit and the margin I paid… Or only the profit… I mean what happens to the margin I paid…?

    • Karthik Rangappa says:

      If you have bought options then there is no margin that gets blocked. So yes, you would be profitable here – you can choose to square off and book profit.You will get back premium + profits.

  28. pradeep says:

    Dear Sir,
    If I have bought 3lots of put buy of bhel in intraday. How to square of my position in intraday?

  29. sameer chandra jha says:

    sir , if i buy options on expiry day MIS basis and if i didn’t square it off will i will be charged extra stt or it will be automatically squatre off by the system ,please tell in which case i have to pay extra stt.

  30. Sooraj Jogendra Mishra says:

    Dear Karthik Sir,
    Whenever I try to buy options of the stocks not index following problems occur:
    1) I can’t buy them at market price
    2) while selling or buying I have to use limit orders…
    Why this is happening?? is there any other procedure to buy stock options ?? because I dont find such problem while buying index options..
    I can get any detailed process on how to buy and sell stock options?? and does trailing stoploss work on stock option premiums??

    • Karthik Rangappa says:

      This is mainly because stock options are not as liquid as index options. It is recommended you look at liquidity before placing orders.

  31. T Venkatesh says:

    Hi,
    How do we calculate the Support and Resistance Levels for Premium prices ie, for individual Stock Options like for example, SBI 180 Call option is trading at Rs.4.50. How do we calculate the Pivot Point, Support and Resistance for this premium price of Rs.4.50 for the stock SBI.
    Regards,
    T Venkatesh

  32. Akshay says:

    Sir isn’t futures better than options with a strict stop loss and discipline especially since you can follow technical analysis like stochastics (and others) and more simpler ?

    • Karthik Rangappa says:

      This is not true as we cannot really compare the two instruments. The characteristics, payoff, leverage etc are all different. You use them as per the situation.

  33. amit gupta says:

    please confirm which is the right way to calculate.spot is 550,strike is 540 and choose to put buy at premium rs 12, and after 3 hours spot moves down 545 ,premium get 14 rs ,then i want to square off my position then what calculation would be applicable.(1).IV=strike-spot,p&l=IV-12 in that case i will get loss ,but conversely in case of (2).difference between premium (14-12=2*lot size) in that case i get profit ,so can you confirm me which calculation will get executed ,please clear it .

  34. amit gupta says:

    Kindly cleat the doubt ,i am using zerodha PI for trading .If i have rs 5000/- in my trade account and i buy a put option at premium rs 4,lot size 1000 .and after few times or day as premiun increases to rs 10/- in that case i square off my position and want to get the profit difference ,then it is necessary to have (10-4=6*1000=6000/-) in my trade account for square off the position ,or no extra fund required and rs 5000/- is sufficient .because i am selling to square off my position .Because as we buy then sell must be compulsory for square off the position .

    • Karthik Rangappa says:

      No. It is very simple here – you bought something for Rs.4 which is not valued at Rs.10, hence you make Rs.6 as profits.

  35. shyam says:

    What happens if I own an out of the money put option on expiration day and I don’t square it off?

  36. Rajat says:

    Hi Karthik,

    Since Put and call options individually cover the both, bearish and bullish, movements, how do we decide when to use put and when to use call. For example, if I am bearish on the stock, I can buy put or sell the call option or vice-versa. The only difference I could see between these is the extent of profit, which is limited in selling the call option. Is there any other point to be considered in such case?

    Thanks,
    Rajat

    • Karthik Rangappa says:

      Well, it really depends on the premiums are playing out. If volatility is high and the premiums have gone up significantly, then writing a call and collecting the premium is a much better idea than buying an expensive put.

  37. Pradip Gupte says:

    It is observed that questions and replies by MR Karthik pertains to year 2015. Now it is year 2017, whether this question answer session is still active?

    • Karthik Rangappa says:

      Yes Sir, site is very active. Comments are updated everyday here and new chapters are added once in 10 – 12 days.

  38. Piyush says:

    hello sir,
    If i want to exercise the put option( in profit) what is the procedure to do it. will it be done automatically by zerodha or do i need to do something.

  39. ravi says:

    hello karthik,

    i have a doubt about futures margin. for suppose i bought ITC futures contract at 350rs with a margin of 90000rs and lot size is 2400. recently one day ITC had gap downed nearly 50 to 60 points and came to 280 rs . In that case my loss is 120000 rs. so i lost my entire margin and i want to square off my position in order to avoid further loss. so who is going to face that extra 30000 rs loss ? i can afford loss only upto 1 lakh rupees, beyond that i dont have money . please explain this scenario.

    • Karthik Rangappa says:

      Ravi, Margin is made up of two components. SPAN and exposure margin. The moment you lose your exposure margin and start losing from SPAN margin, your position is squared off. Think of it as two halves…moment you lose one-half, the entire position is closed. This is a part of the broker’s risk management policy.

  40. Vishvendra Singh says:

    Hi Kartik,

    A pretty basic question here…the Option seller has to hold the option till expiry…is that correct??

    • Karthik Rangappa says:

      Not necessary. Both the option buyer and seller can trade the premiums…meaning they can buy and sell for any time frame they deem suitable. Could be few seconds, few mins, few days…or even hold till expiry.

  41. Abhishek Singh says:

    Sir,i’m new to option trading .Today I bought 2 lot of nifty 9850 put option ,expiry 28th Sep and Index is trading at 9912. My P&L showing -1860 .Suppose i sell the contract now ,will I lose the whole premium or only 1860 .?

  42. Suresh Sharma says:

    Hi,Kartik, if I have bought a stock in future can I hedge it by buying the put option of the same stock?
    Thanks

  43. Vik says:

    Sir,
    I feel that put option profits are not unlimited, as mentioned in the article.. as spot price can theoretically be lowest to zero only, and not negative..

  44. Deep Dave says:

    Hi,

    I had 1 query with regards to what you mentioned above in case of Buying a Put option.

    How can “The gains can be potentially unlimited”??

    If the underlying falls to Zero, that is where your Profit will stop isn’t it? So how can it be unlimited?

    Can you clarify??

  45. Sachin Singh says:

    In simpler terms, can you explain the change which has happened to the STT trap (for which you shared the link somewhere in the comments above) since 31st Aug, 2017? I understood what used to happen before that date, that is, the STT which got applied if one didn’t square off his position before expiry used to be very high, and eat away a lot (or all) of the profit. But what exactly has changed w.r.t to that rule?
    Thanks!

  46. Maschendhar says:

    Dear Sir,

    I have doubt regarding premium movement and settlement of options.
    1) what will be, if there is no trade for option which I have already purchased on 1st Dec17 by the end of expiry date of it. In this case how the settlement will be done.
    Ex:1) If I purchased “Nifty Dec 10200 CE” @ Premium Rs.200/- on 1st Dec17.
    2) If I sold “Nifty Dec 10200 CE” @ Premium Rs.200/-on 1st Dec17.
    If there is no trade on expiry day what will be the settlement?

    • Karthik Rangappa says:

      1) The exchange will settle this for you on the expiry day
      2) The settlement value will be dependent on the intrinsic value of the stock. However, the settlement itself will be carried out by the exchange if there are no buyers/sellers for your contract

  47. CreaTorr says:

    Hi Karthik,

    For a option Call buyer the profit can be potentially unlimited as the stock can reach any highest point. However, for a option put buyer their profit reach saturation point as underlying stock cann’t fall below zero. Am I correct?

  48. Tushar says:

    Dear Sir,

    Thanks for good information on Put and Call options. I also read on investopedia that put option can be used for hedging.

    I hold shares. Out of my portfolio, I want to hedge the shares of very good comanies, like Maruti, RIL, Britannia etc. Although I have understood the concepts of Put and Call options, I do not know how to hedge my existing good shares. I would appreciate if you explain.

    best regards,

    Tushar.

  49. santosh patidar says:

    If OI increases more than 95%, then security will go in Ban. This Ban starts immediately when it reaches to 95% or it is applicable from next day?

  50. Sha Navas says:

    Please help me in knowing the margin money required for executing the following transactions.
    1. Buying a lot of Nifty option, strike price 10,500 @ Rs. 200
    2. Selling a lot of Nifty options, same strike price
    1 lot = 75.

  51. Santosh Sah says:

    Hi,
    Bank nifty PE 24,200 is available at the premium of 427 and Bank Nifty CE at the premium of 460. Strike date for both is 28 th march 2018. If we sell the both PE and CE then will get Rs.887 as premium. So ultimately we will be in profit upto the decline or increase in the actual price of bank nifty upto Rs.887 from the strike price of 24,200…. Am I correct??? Is it happen like this? Are we safe upto the change in price by Rs.887?

  52. Saksham says:

    Sir,

    Currentlly nifty is at 10790 near.
    I want to buy nifty put option at 10800.
    Premium is 12000approx that is 154.
    Wht will be the breakeven point for me?

  53. P V S N RAJU says:

    When i Place an order in optons Buy Call/Put it shows MIS/DAY Pleae describe the differencce

  54. shyam says:

    In the P&L behaviour How does the premium – 315/- remain the same when the spot prices keep changing?

  55. Divay says:

    Hi Karthik,

    You are doing a great job answering queries of traders and investors.

    For the first time, I bought Options and want to understand P&L associated with it. I bought 105 India Cements PE at a premium of 1.80. Currently, it is trading at 107.55 (LTP as of Jun 21).

    Assuming India Cem Spot price on expiry is 104, will I make a loss of 0.80 (Considering Max (0, 105-104) – 1.80?
    Assuming India Cem Spot price on expiry is 103, Will I make a profit of 0.20 (Considering Max (0, 105-103) – 1.80?

    This would happen If I alllow contracts to expire ITM on the expiry day or else I square off my positions in between the difference in premium paid will be my actual P/L.

    In case the spot price remains above 105 on expiry day, I will lose the entire premium of 1.80… Right?

    Please correct me if I am wrong on any of the above statements. Thank you in advance!

    • Karthik Rangappa says:

      1) Yes, at 104, you will lose 0.8.
      2) Yes, at 103, you will make a profit of 0.2
      3) Yes, if you sq off the position before expiry, then you will make the difference between the buy and sell price of the premium
      4) Yes, at 105, you lose the entire premium paid.

      Good luck!

  56. raju says:

    Is it possible to do intraday trading on options?
    if yes how will expiry date be managed? As options expiry only on last Thursday.
    kindly reply me, sir.

  57. PRAKASH UMARETIYA says:

    Hello

    I have buy put option of Nifty 10600 @ RS 3 on 28th June 1018.

    Nifty spot closed @ 10589 on expiry.

    What is value of this position on expiry ?

    How settlement price be calculated by NSE ?

    • Karthik Rangappa says:

      The option will be settled at 11/- i.e 10600 – 10589. Since you have paid 3 as premium, your profit will be 11-3 = 8. However, I’m assuming charges and STT would have eaten this up.

  58. Vinoth says:

    Hi Karthick,

    Where can I check the liquidity of options. Today I expected Bajajfinsrv prices to go up following the results. So I wanted to implement a long straddle. When I checked NSE page there were enough contracts for call options but there was nothing for put option. So I was hesistant to take the trade as I was worried whether I could sell back the put option. Please let me know if my understanding is correct.

    More over there is a decent number of contracts for call options in all stocks but for most of the stocks there is not enough contracts for put options. Can we use contracts to determine the liquidity of options. Please correct me if I am wrong.

    • Karthik Rangappa says:

      Vinoth, this a problem with the stock option. The contracts are not too liquid. To check the liquidity, you can check –
      1) The spread between the bid and ask. The larger the spread, the lower the liquidity. The lower the spread, higher the liquidity
      2) You can also track the number of contracts being traded to get a sense of liquidity.

      • Vinoth says:

        Hi Karthik,

        Thanks a lot for your reply. I have back tested (paper traded) some option strategies (intraday) on various stocks for some time now and it seems to be working. Initially I did not think that liquidity will come as a barrier. Is there any other way we could overcome this?

        The reason I have chosen stocks over index is that we could see more than 2% to 3% movement intraday and that really is essential for making profits. Please correct me if I am wrong.

        Once again thanks a lot for your help.

  59. Ela Selvaraj says:

    Hi,

    Good chapter. To test I bought 1 PUT option of Nifty at strike 11100 at 25 Rs (20×75 rs = 1500 Rs). Suppose, if NIFTY goes back to 11050 how do I exercise the option? In Zerodha Kite, I have 2 options: 1 – Exit and 2 – Convert. Exit gives the price of premium. I know the value will decay with expiry. For tomorrow expiry if the premium value is less than 50 points NFITY profit how does it work?

    Its confusing can’t I exercise the NIFTY at 11050 and get 50 points profit instead of premium? or will premium change to 70rs? How does it work.

    It useful to link the Kite platform to understand the chapters here.

    • Karthik Rangappa says:

      In Nifty expires at 11050, then the 11100 PE option will expire with a 50 point intrinsic value. I’d suggest you exit the position.

  60. Abhi says:

    is CE seller is analogy to PE buyer is some sense ? as both has bearsish view

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