Chapter-1 Introduction

INTRODUCTION & SIGNIFICANCE OF THE STUDY

Options trading is selling or buying a specific asset set at predetermined prices

and dates. This type of trading requires a thorough understanding of opening an
options account, several advanced strategies, and a good knowledge of the
trading process. It is equally important to know how to trade options, which, if
you are not well aware of them, could make it more difficult for you to incur
significant losses. It’s generally more challenging to trade options compared with
stock trading. For that reason, you need to choose several shares to buy. But
when trading options, you have to take a lot of factors into account. You should
learn the difference between future and possible options as well.

Generally, options are classified into two types of contracts- put and call. A put
option gives the buyer the right to sell the underlying asset at a pre-negotiated
price in the future. By contrast, the contract purchaser can acquire the
underlying asset at a pre negotiated price in the long run through an option call.
The strike rate can be identified as such. For this reason, it is essential to
understand options trading thoroughly for the first time.

When the market conditions are unfavourable, options can still help generate
revenue. It can also serve as a buffer against adverse effects. Because of this,
learning how to trade options may bring you closer to making profits while being
aware.

Types of Options :

Call Option :

Call Option is a one of the type of option derivative. It refers to contract

parties entered into contracts may buy or may not buy at an underlying assets,
at an underlying price on future date. Here the contract will be long position.

Put Option :
 Put Option is one of the type of option derivative it refers to the contracts
made between the two parties an underlying assets may sell or may not sell and
underlying asset at an underlying price at an underlying quantity on future date
it is called put option.

American vs. European Options

American options can be exercised at any time between the date of purchase and the
expiration date. European options are different from American options in that they
can only be exercised at the end of their lives on their expiration date. The distinction
between American and European options has nothing to do with geography, only with early
exercise. Many options on stock indexes are of the European type. Because the right to
exercise early has some value, an American option typically carries a higher premium than an
otherwise identical European option. This is because the early exercise feature is desirable
and commands a premium.

Trading is one of the most profitable activities on the Internet. Every day, billions are
earned and lost at the click of a mouse by people who trade online. As a trader, you trade in
financial instruments such as stocks, currency pairs, and index funds. But why is trading so
advantageous now, how do you do it, and what are the characteristics of trading? In this
article you can read everything you need to know about trading.

What is trading :

Trading is a specific way of investing. You actively trade in, for example, a share. Trading
differs from ‘traditional investing’:

 Investing: Buying a share to achieve price gains in the long term.

 Trading: Buying and selling a stock quickly.

Types of Trading :

Intraday Trading :

Intraday trading, also known as day trading, involves buying and selling stocks within the
same trading day. Participants who engage in intraday trading aim to take advantage of short-
term price movements. They typically close all their positions before the market closes,
avoiding overnight market risks. Intraday trading requires quick decision-making skills,
technical analysis expertise, and a high level of discipline. Traders often use charts, patterns,
and indicators to identify potential opportunities for quick profits.

Technical Trading :

Technical trading, or technical analysis, involves studying past price and volume data to
predict future price movements. Traders using technical analysis use charts, patterns, and
indicators to make trading decisions.

Scalping :

Scalping is a trading strategy that involves buying and selling securities within a short period
of time, often just seconds or minutes, with the goal of making a profit from small price
movements. Scalpers aim to take advantage of short-term fluctuations in the market and
execute a large number of trades to capture small gains. Scalping can be done manually or
with the use of automated trading systems and requires a high level of discipline, focus, and
technical analysis skills. Because scalpers are exposed to higher commission and slippage
costs, they typically aim for a high win rate and small profit targets per trade.

Position Trading :

Position trading is a long-term trading strategy that involves buying and holding securities for
an extended period, typically from several months to years. Position traders focus on
analysing the long-term macroeconomic and fundamental trends, rather than short-term price
fluctuations. They use financial statements, economic data, news, and industry analysis to
identify undervalued assets with long-term growth potential. This strategy aims to benefit
from the general trend of the market or asset, and therefore, also requires patience, discipline,
and risk management skills. Successful position trading requires a full understanding of the
financial markets, including economic, political, and social factors that can impact the long-
term outlook for investments.

LITERATURE REVIEW

(Krishnan & G, January 2018) in this article named "Performance Analysis of Volatile
Strategy under Indian Options Market" explains, Option trading strategy are used to minimize
our risk and maximize profits option strategy are both combination of call and put. The trader
should thoroughly analyze the market to identify the appropriate strategy which can face the
high volatile market. Volatility is the reason for the generation of strategies. Option strategies
are used to reduce the risk during high fluctuations in the market. Extreme movements in
markets leads to high payoff on these strategies, due to which an effort is taken to generalize
the concepts of strangle and straddle in National Stock Exchange (NSE) in India. According
to option market experts straddle and strangle is the most suitable volatility strategy. Hence, a
question arises, which strategy generates higher returns. Therefore the analysis is undertaken
using Sharpe, Treynor and Jensen"s alpha ratios. The findings indicate that, when the
uncertainty in the market is more, it is better to adopt strangle strategy. Hence, trader should
analyse the market and then decide.

Meziani (2016) studied the variation in equity markets for the quarter ending September
2015. He found that exchange traded funds grown in popularity and several of them have
become optionable. thereby positioning themselves as another fast and cost efficient way of
controlling portfolio risk in the markets where volatility is very high.

Sonmezer (2016) questioned the way prominent option strategies are priced and
exoticoptions and applied and addressed behavioral approaches for the same. He also
discussed the speculative nature of exotic options and financial instability relationship
between them.

Malpani (2013) studied how options work in investments. His findings suggested that
Option trading is truly the favorite financial instrument of small retail investors over the past
few decades all over the world. Options trading allow investors with very small funds to gain
disproportionately big profits and to control stocks that would otherwise be too expensive to
own. Options trading are so powerful, it also extremely complex and dangerous if it is not
handled carefully. Options traders need a very firm knowledge of the basics of options
trading before even thinking of ways to make the money out of it.

Chirag Babulal Shah (July 2013) studied Bull Call Debit spread strategy on Nifty Index
Option. He back test the Bull Call debit spread strategy for a time period long enough to
cover the various practical scenarios of the capital market. A period of Syears is taken into
consideration and a algorithmic method of back testing is used. The study does not look at
any other factors such as market sentiments, the global scenarios, macro or micro economics,
etc. The Bull call debit spread strategy is a very basic and easy to understand This strategy
has proved to yield profits in and implement options strategy. the long run. The reason for the
profits is the extent of loss when one goes wrong compared to the profit when one goes right.

E.V.P.A.S.Pallavi1, Dr. K.S.S. Rama Raju and Dr. T. Kama Raju (2013) studied
Operational strategies and performance of options trading in India and found that Options can
be used to create portfolio with unique features, capable of achieving investment objectives.
Options are used world over to hedge not only the portfolio risk but also to maximize the
return on investments.

Dr. Ritu kothiwal; Mr. Ankur goel(2012), in review of trading/marketing strategies of

futures and options in India, lists top 9 trading strategies in derivatives as Buy call, Buy put,
Buy futures and sell call, Bull spread, calendar spread, strangle, straddle, stock insurance, sell
call & put.

Charles J. Higgins (2011) studied options in a different way. Options are bought to hedge
(insure) or to speculate on securities. He examined the sale of options in a conservative
approach (in lieu of limit orders) and in an aggressive approach (in lieu of margin interest
expense). He examined aspects. that are lesser known in terms of option level approvals,
option use in lieu of limit orders, and no interest expense versions of speculative leverage.

Wilkinson (2007) studied the effect of various option strategies using crude oil prices as
base. He applied each of the above strategy for a monthly predetermined period. His
strategies include Covered Call, Protective Put, Straddle, Strangle, Butterfly and Condor. His
findings revealed that the opportunity with option combinations is endless and depends on
trade scenario, nature of market: (bullish or bearish), selling premium and implied ranges that
the prevailing option prices suggest.

Pol Verschaeren (2006) Tested every single stock on the DOW JONES 30 with different
strategies related to derivatives options. The study concluded that returns on long calls; long
puts, Long Straddles and Long Strangles exceed the returns on the underlying stocks.
According to the model in the paper the conclusion was drawn that option strategies lead to
higher returns than investing on stocks.
Abid et al (2006) investigated the performance of option strategies, including writing OTM
covered- call and buying ITM Protective Put, with that of the pure stock investment, and
found that, in general, the buying ITM protective-put strategy has the best performance,
followed by the writing OTM covered-call strategy, both out performing the naked stock.

NEED FOR THE STUDY :

In a span of 10 years or so, Derivative markets has become one of the most traded market
and is attention because of it’s the role that it plays in any economy is important. Both
players from domestic as well from foreign market are investing their funds in the derivative
market. The derivative instruments is part of our curriculum which made me want to know
more about this topic which is the reason to do this project and having interest in the
derivative market. So investors who do not want to take risk but want to invest in the market
can invest in derivative market and can lock the price of the asset so that there is no effect of
any price changes that take place in the market to the investor and hence the profit of the
investor will not be affected. As there is astounding increase in the amount of trade that is
taking place in the market, this study can be used by the investors.

In recent times the Derivative markets have gained importance in terms of their vital role in
the economy. The increasing investments in derivatives (domestic as well as overseas) have
attracted my interest in this area. Through the use of derivative products, it is possible to
partially or fully transfer price risks by locking-in asset prices. As the volume of trading is
tremendously increasing in derivatives market, this analysis will be of immense help to the
investors.

Research Questions :

1.What are the current regulatory guidelines for options trading in India?

2. How do major economic events or policy changes affect options trading in India?

3. What are the most popular brokerage platforms for options trading in India?

4. Are there emerging technologies that are expected to impact the options market in the
near future?
Objectives of the Study :

1.To know the operations of options trading.

2.To study about the risk management in options trading.

3.To make proper suggestions to the investors for better investment choice.