Option Basics Trading Guide

Version 1.1

Authored By
Santosh Kumar Pasi
SantoshPasi@[Link]

Reviewed By
Pooja Verma

[Link]

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Contents
Welcome............................................................................................................................................................ 3
1. Market Segment .............................................................................................................................. 4
2. Option .................................................................................................................................................... 5
3. Why should we trade Option? ................................................................................................. 6
4. Options Terminologies ................................................................................................................. 7
5. Basic Options Positions ............................................................................................................. 15
6. Option Writer Advantages and Disadvantages ........................................................... 16
7. LONG position characteristics ............................................................................................... 17
8. SHORT position characteristics ............................................................................................ 18
9. Option Premium Pricing ............................................................................................................ 19
10. Volatility ............................................................................................................................................. 22
A. Historical Volatility .................................................................................................................. 22
B. Implied Volatility ...................................................................................................................... 23
C. Historical Volatility Vs Implied Volatility ................................................................... 23
11. Implied Volatility’s expected behavior ............................................................................ 24
12. Option Greeks ................................................................................................................................. 26
13. Jargons: Common Terminologies ........................................................................................ 31
14. Understanding Chart (Candlestick) ................................................................................... 36
15. Price patterns ................................................................................................................................. 38
16. Trend .................................................................................................................................................... 39
17. Tools: OpStrater ............................................................................................................................ 40
18. OpStrater: Strategy Decision Maker (VIX) .................................................................... 40
19. OpStrater: Strategy Decision Maker (HV-IV)............................................................... 41
20. Tools: OptionsOracle India Plugin ...................................................................................... 42
21. Configuring OptionsOracle ...................................................................................................... 43
22. Using OptionsOracle ................................................................................................................... 48
23. Understanding Strategy Summary ..................................................................................... 52
24. Adding Position in “Strategy Positions” ......................................................................... 55
25. To square-off position in OptionsOracle ......................................................................... 56
26. PUT CALL Ratio ............................................................................................................................... 57
27. Option Pain ....................................................................................................................................... 59
28. Best Practices ................................................................................................................................. 60
29. Assessment ...................................................................................................................................... 61
30. Additional resources ................................................................................................................... 63
31. Modules .............................................................................................................................................. 64

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Welcome

Thank you for enrolling in the workshop/purchasing our Options

Strategy Premium Tool.

Following are components of Options Strategy Premium Tools:

1. OpStrater
2. OptionsOracle India Plugin (supporting currency options)
3. Options Basics Guide (installer copies this file on
desktop)
4. One-year technical support

This tool is for personal and standard use only by its

authorized user and not be shared with anyone. If it is
shared or attempted for reverse engineering, we will
remove access without prior notice. Any amount paid for
this tool will not be returned on violation of terms and
conditions.

This guide explains the basic concept of Option trading, Option

terminologies and Option Greeks in a very simple language with
examples. This is an introduction to the Options Trading
Workshop.

We recommend to read this book multiple times, so that when

you attend our workshop, you will get most out of the workshop.

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1. Market Segment

There are different instruments available in the market namely:

• Equities (Cash)
• Derivative Products:
o Futures
o Options

CAPITAL MARKET

CASH FUTURES & OPTIONS

FUTURES OPTIONS

CALL PUT

Derivative securities are financial contracts that derive their value from
other securities.

Examples of derivative securities are:

• Futures contracts
• Options (Call, Put) contracts
• Forward contracts

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2. Option

An option is a contract between two parties giving the taker (buyer) the
right, but not the obligation, to buy or sell a security at a predetermined
price on or before a predetermined date. To acquire this right, the taker
pays a premium to the writer (seller) of the contract.

The party taking a long position i.e. buying the option is called
buyer/holder/owner of the option and the party taking a short position i.e.
selling the option is called the seller/writer of the option.

The option buyer has the right but no obligation with regards to buying or
selling the underlying asset, while the option writer has the obligation in
the contract. Therefore, the option buyer/holder/owner will exercise his
option only when the situation is favorable to him/her, but, when he/she
decides to exercise, option seller/writer would be legally bound to honor
the contract.

Option can be used as:

Leverage
Options help you profit from changes in share prices without putting down
the full price of the share. You get control over the shares without buying
them outright.

Hedging
They can also be used to protect yourself from fluctuations in the price of
a share and letting you buy or sell the shares at a pre-determined price for
a specified period of time.

Though they have their advantages, trading in options is more complex

than trading in regular shares. It calls for a good understanding of trading
and investment practices as well as constant monitoring of market
fluctuations to protect against losses.

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3. Why should we trade Option?

Equities
We generally trade if our bias is bullish. It requires huge money to make
a decent profit.

Futures
We trade if our bias is either bullish or bearing. Compare of equities, it
requires lesser capital to make an equivalent profit.

Options
We can trade if our bias is either bullish or bearish or neutral
(sideways). Compared to futures, it requires lesser capital to make an
equivalent profit. Options are a leveraged product.

CASH FUTURE OPTION

Can buy even 1 share. Very high exposure, because you cannot trade
in small amounts. You can trade by lot size.
You are a shareholder. You are not a shareholder.
You receive dividends, You do not receive dividends, bonus, rights and
bonus, rights and other benefits.
other benefits.
Suitable for long term Generally suitable for traders.
investors.
Not very risky for long Highly risky.
term investors.
Can keep the shares Have to sell or square-off your position.
for a lifetime.
Non-leveraged. Leveraged. Highly leveraged.
Traded generally for Can be traded for Can be traded for
bullish view. Bullish and Bearish Bullish, Bearish and
view. Sideway.

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4. Options Terminologies

Derivatives
Derivatives, such as futures or options, are financial contracts which derive
their value from a spot price, which is called the “underlying”.

Option
An Option is a contract that gives the right, but not an obligation, to buy or
sell the underlying asset on or before a stated date/day, at a stated price,
for a price.

Premium
When you buy an option, the purchase price is called the premium. If you
sell, the premium is the amount you receive. An option's premium has two
parts: an intrinsic value and a time value.

Option Types
There are two types of Options available:
• Call Option
• Put Option

Call Option
This type of contract gives the holder (buyer) the right to buy (“call away”)
the underlying stock from the seller (writer) at a specific price (strike), but
only for a specified amount of time (expiry).

Example:
NIFTY 28Jan16 CE 7200

Can you think of real life examples for Long CALL and Short CALL.

Put Option
This type of contract gives the holder (buyer) the right to sell (“put”) the
underlying stock to the seller (writer) at a specific price (strike), but only
for a specified amount of time (expiry).

Example:
NIFTY 28Jan16 PE 7000

Can you think of real life examples for Long PUT and Short PUT.

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Difference between CALL and PUT:

CALL PUT
The buyer of the option has the A put option is a financial contract
right, but not the obligation to buy between two parties, the seller
an agreed quantity of a particular (writer) and the buyer of the option.
underlying instrument from the
seller of the option at a certain time
(the expiration date) for a certain
price (the strike price).
The seller (or "writer") is obligated
The put allows its buyer the right
to sell the commodity or financial
but not the obligation to sell a
instrument should the buyer so commodity or financial instrument
decide. (the underlying instrument) to the
writer (seller) of the option at a
certain time for a certain price (the
strike price).
The buyer pays a fee (called a The writer (seller) has the
premium) for this right. obligation to purchase the
underlying asset at that strike price,
if the buyer exercises the option.

Underlying Asset/Security/Stock
Options are derivate products of underlying asset/security.

Examples:
If we are considering NIFTY Option, its underlying asset is NIFTY 50 Index.
If we are considering BANKNIFTY Option, its underlying asset is BAKNIFTY
Index.
If we are considering TCS Option, its underlying asset is TCS Equity.

Strike Price
The strike price is defined as the price at which the holder of an options can
buy (in the case of a call option) or sell (in the case of a put option) the
underlying security when the option is exercised. Hence, strike price is also
known as exercise price.

Examples of Strike Price:

For NIFTY are: ..., 7000, 7050, 7100, 7150, 7200, 7250, 7200, …

Avoid illiquid strike (any strike with 50s ... like 7150, 7250, 7350), as this
may have higher bid-ask spread.

Expiration date
It is the last day on which the contracts expire.

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Futures and Options contracts expire on the last Thursday of the expiry
month for most of Indexes and stock options. If the last Thursday is a
trading holiday, the contracts expire on the previous trading day.

For NIFTY, BANKNIFTY and Currency pairs, we have weekly expiry on every
Thursday.

Examples:
Jan 28, 2016; Feb 25, 2016; Mar 31, 2016, April 28, 2016

Duration of an Option
In India, options can be traded for 3 months:
1. NEAR Month: (Current month, Let’s consider Jan is current month)
2. NEXT Month: (Next month, that will be Feb)
3. FAR Month: (Next to next month, that will be Mar)

Contract Size (Lot)

Lot size is the number of units of underlying asset in a contract. Currently
lot size of Nifty option contracts is 75.

Examples:
One contract of NIFTY Options has 75 Nifty Index.
One contact of TCS Option has 200 TCS shares.

Contract size may change, please verify before placing order.

American option
The owner of such option can exercise his right at any time on or before
the expiry date/day of the contract.

European option:
The owner of such option can exercise his right only on the expiry date/day
of the contract. In India, the Options are European, hence we see CE, PE.

Note: In India, we follow European type option with cash settlement. So

instead of exercise, it is settled in cash by the exchange for most of scrips.
Now for few scrips, we are actually moving towards pure European type
option, where delivery will be compulsory.

Spot price:
It is the price at which the underlying asset trades in the spot market.

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Moneyness of an Option:
Comparing the spot price with the strike price, Options will be classified
under three categories:

Moneyness of an Option
CALL Option Moneyness PUT Option
Strike Price < Spot Price In-The-Money Strike Price > Spot Price
Strike Price = Spot Price At-The-Money Strike Price = Spot Price
Strike Price > Spot Price Out-of-The-Money Strike Price < Spot Price

On NSE Option Chain page, the ones in yellowish background color are ITM
and the ones with white background are OTM options.

We recommend to avoid trading Deep ITM option, as mostly those are

illiquid. In that case, bid-ask spread will be wide.

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ITM (In-the-money)
An in-the-money option is an option that would lead to positive cash flow
to the holder if it were exercised immediately.

A Call option is said to be in-the-money when the current price stands at a

level higher than the strike price. If the Spot price is much higher than the
strike price, a Call is said to be deep in-the-money option.

In the case of a Put, the put is in-the-money if the Spot price is below the
strike price.

ITM CALL: When the current underlying SPOT price is above the strike
price.
ITM PUT: When the current underlying SPOT price is below the strike price.

Examples:
IF NIFTY is at 7510

CALL:
Any CALL strike lower than current price (7510) is considered as ITM i.e.
7400 CE, 7300 CE, 7200 CE, and lower.

PUT:
Any Put strike higher than current price (7510) is considered as ITM i.e.
7600 PE, 7700 PE, 7800 PE or higher.

ATM (At-the-money)
An at-the-money option is an option that would lead to zero cash flow if it
were exercised immediately. An option on the index is said to be “at-the-
money” when the current price equals the strike price.

Examples:
IF NIFTY is at 7510

CALL:
Any CALL strike equal to or very close to current price (7510) is considered
as ATM i.e. 7500 CE.

PUT:
Any Put strike equal to or very close to current price (7510) is considered
as ATM i.e. 7500 PE.

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OTM (Out-of-the-money)
An out-of- the-money Option is an option that would lead to negative cash
flow if it were exercised immediately. A Call option is out-of-the-money
when the current price stands at a level which is less than the strike price.

If the current price is much lower than the strike price the call is said to be
deep out-of-the money. In case of a Put, the Put is said to be out-of-money
if current price is above the strike price.

OTM CALL: When the strike price is above the current underlying SPOT
price.
OTM PUT: When the strike price is below the current underlying SPOT
price.

Examples:
IF NIFTY is at 7510

CALL:
Any CALL strike higher than current price (7510) is considered as OTM i.e.
7600 CE, 7700 CE, 7800 CE, and higher.

PUT:
Any Put strike lower than current price (7510) is considered as OTM i.e.
7400 PE, 7300 PE, 7200 PE or lower.

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Options Writing/Shorting Margin
As Option writing carries unlimited risk, broker and exchange will ask for
security deposits (require certain capital requirement) before they will allow
you to short options.

For option buyer, they need to pay only premium and not the margin, as
buying option carries limited loss (limited to premium paid).

The option seller on the other hand has a potential for unlimited loss. Thus
the seller has to deposit margin with the exchange and broker as a security
in case of huge loss due to adverse price movement in the option price.

Total Margin = SPAN margin (Exchange) + Exposure margin (Broker)

SPAN margin
SPAN i.e. Standard Portfolio Analysis of Risk which is a method for
measuring portfolio risk. In Indian stock markets, SPAN margin is also
commonly referred to as VaR margin or initial margin which is the
minimum margin requirement for initiating a trade in the markets. This is
to safety of Exchange.

Exposure Margin
In addition to SPAN margin which is collected at the time of initiating trades,
an additional margin over and above the SPAN margin is collected which is
known as the Exposure margin and is also known as additional margin.
This margin is collected in order to protect a broker’s liability which may
arise due to wild swings/moves in the markets. This is to safety of Broker.

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Option Chain

[Link]
n_chain/[Link]?symbolCode=-
10006&symbol=NIFTY&symbol=NIFTY

or

[Link] -> Live Market -> Option Chain -> Equity Derivatives

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5. Basic Options Positions
We can go LONG or SHORT Options (CALL or PUT), here are four basic
Option positions.

CALL PUT
Long (Buyer) Right to Buy Right to Sell
Short (Seller) Obligation to Sell Obligation to Buy

CALL buyer has right, not obligation, to buy underlying

asset from CALL seller
CALL Buyer CALL SELLER
CALL Seller is obliged to sell underlying asset to CALL
buyer if exercised.

PUT buyer has right, not obligation, to sell underlying

asset from PUT seller PUT SELLER
PUT Buyer
PUT Seller is obliged to buy underlying asset from PUT
buyer if exercised.

Four Basic Option Positions

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6. Option Writer Advantages and Disadvantages

Options writing should be done if Option premium are higher.

Option Writing (Advantages)

Max gain = premium received (Receives premium for the obligation)
Time decay favors Option writer.
Should be done only in case if IV or VIX is high.

As we are shorting Options, we need additional margin instead of just

premium value.

Option Writing (Disadvantages)

Max risk = unlimited (if without strategies/insurance)
Margin required
Should not be done if IV or VIX is low.

CALL OPTION BUYER CALL OPTION WRITER

Pays premium Receives premium
Right to exercise and buy the Obligation to sell shares if
shares exercised
Benefits from rising volatility Benefits from time decay
Profits from price rising Profits from price falling or
remaining neutral
Limited losses Potentially unlimited losses
Potentially unlimited gain limited gain
Can SELL before expiry to close Can buy back before expiry or
out before assignment to close out

PUT OPTION BUYER PUT OPTION WRITER

Pays premium Receives premium
Right to exercise and sell the Obligation to buy shares if
shares exercised
Benefits from rising volatility Benefits from time decay
Profits from price falling Profits from price rising or
remaining neutral
Limited losses Potentially unlimited losses, but
technical losses only limited to the
share price falling to zero limited
gain
Potentially unlimited gain, but Limited gain
technically gain is only limited to
the share price falling to zero
Can SELL before expiry to close Can buy back before expiry or
out before assignment to close out

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7. LONG position characteristics

Long Option Positions

Pays Premium
RIGHT to exercise
Risk : Limited (limited to premium paid)
Reward : Unlimited
Margin : Not required, just premium

Here is Long CALL option P/L graph:

As we can see in the above chart, loss is limited and the profit is unlimited.
As a buyer of option, you will be losing value of theta every day. Remember
options are decaying assets.

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8. SHORT position characteristics
Whenever someone buys an option, there has to be a counterparty, who
has sold the same.

Short Option Position

Receives Premium
OBLIGATIONS to settle
Risk : Unlimited
Reward : Limited (limited to premium received)
Margin : Yes required

Here is Short CALL option P/L graph:

As we can see in the above chart, profit is limited and the loss is unlimited.
As a seller of option, you will be gaining value of theta every day, but
remember you have unlimited risk.

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9. Option Premium Pricing

Factors contributing value of an option premium are:

• Price of the underlying stock
• Time until expiration
• Volatility of underlying stock price
• Cash dividend
• Prevailing interest rate, etc.

An Option Premium can be viewed as compromised of two components:

• Intrinsic value
• Extrinsic value (time value)

When we are long on an option, time value is against us.

When we are short on an option, time value is favorable to us.

Intrinsic Value
The intrinsic value of an option is the value of exercising it now. If the
option has a positive monetary value, it is referred to as being in-the-
money (ITM), otherwise it is referred to as being out-of-the-money. If an
option is out-of-the-money at expiration, its holder will simply abandon the
option and it will expire worthless.

The difference between the underlying's price and the strike price. Only in-
the-money (ITM) options have intrinsic value whereas at-the-money (ATM)
and out-of-the-money (OTM) options have zero intrinsic value.

Intrinsic value can’t be negative (In case of OTM, Intrinsic value is

considered as zero)

Intrinsic Value (Call) = Underlying Price – Strike Price

Intrinsic Value (Put) = Strike Price – Underlying Price

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Time value
It is the difference between premium and intrinsic value, if any, of an
option. ATM and OTM options will have only time value because the intrinsic
value of such options is zero.

Time Value = Option Premium – Intrinsic Value

Example:
Let’s assume NIFTY is at 7710 and the Option chain table

Intrinsic Value, Intrinsic Value Time Value

Premium Calculation
Intrinsic Value (Call) = CE 7500: 231.05 (LTP)-210
Underlying Price – 7710-7500=210 =21.05
Strike Price
Intrinsic Value (Put) = PE 7500: 6.90 (LTP)-0.00
Strike Price – 7500-7710=-210 = 6.90
Underlying Price (taken as 0)

Now calculate:
Nifty at 7710 CE 7750: ________ _________
Nifty at 7710 PE 7750: ________ _________

Open interest
The number of outstanding contracts in a particular class or series existing
in the option market. Also called the “open position”.

Volume
Trading volume is the number of option contracts being exchanged between
buyers and sellers, and it measures the activity of options contracts on a
daily basis. At the start of a trading day, the volume will be zero and as
the day progresses, the volume will increase based on transactions.

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Here is volume at the start of the day. As day progresses, volume will
increase. Compare volume with OI values.

Series of options
NEAR: Current month series
NEXT: Next or second month series
FAR: Third month series

Days or Time to Expiration

The days or time remaining to the expiration period. It is an important
factor to determine option price. The value of option (time value) decreases
as the time to expiration gets closer. The more time remaining until
expiration, the more time value of the option contract has.

Reward to Risk Ratio

A reward/risk ratio is to compare the expected returns of an investment to
the amount of risk undertaken to capture these returns.

For example:
In strategy, if maximum profit potential is 90 points and maximum possible
risk is 30.
In that case, reward to risk ratio for strategy is 90/30 = 3:1.
So we are ready to take risk to loose Rs. 1 to earn potentially Rs. 3 as
reward.

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10. Volatility

The volatility of an option is a measure of the spread of the price

movements of the underlying instrument.

Volatility refers to the amount of uncertainty or risk about the size of

changes in a security's value. The more volatile the underlying instrument,
the greater the time value of the option will be. This will mean greater
uncertainty for the option seller who, will charge a high premium to
compensate. Option prices increase as volatility rises and decrease as
volatility falls.

Volatility values needs to be analyzed before deciding if we will be a seller

or a buyer of the option.

Volatility tries to capture the sentiments of the market—whether the

market is in a complacent or anxious mood.

Example:
INDIA VIX is volatility index for NIFTY 50, based on NIFTY 50 Index Option
price. INDIA VIX calculates volatility by computational methodology, that
relies on the best bid and offer price of the Nifty 50 index CALL and PUT
options.

There are two types of volatility:

• Historical volatility
• Implied volatility

A. Historical Volatility

Historical Volatility
A measure of the price fluctuation of an asset averaged out over a
period of time.
Historical volatility is the measure of a stock’s price movement
based on historical prices.
It measures how active a stock price typically is over a certain
period of time.
Historical volatility is measured by taking the daily (close-to-close)
percentage price changes in a stock and calculating the average
over a given time period.

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B. Implied Volatility

Implied Volatility
Implied volatility is the current volatility of a stock, as estimated
by its option price.

An option’s value consists of several components —

• The strike price
• Expiration date
• The current stock price
• Dividends paid by the stock (if any)
• The implied volatility of the stock
• Interest rates

C. Historical Volatility Vs Implied Volatility

Historical Volatility (HV) Implied Volatility (IV)

Looks back in time to show Trader’s view of expected
where volatility has been in the future volatility based on
past. current option prices.
Implied volatility is forward-
looking.

Shows expected trading range Indicator of the current

of market. sentiment of the market.

Historical volatility is a measure of the probability of a market holding a

given trading range over a period of time.

Historic volatility is based on the movement of the underlying market.

Implied volatility is what option traders expect historical volatility will be in
the future.

• Low implied volatility => Low option prices, so be buyer.

• High implied volatility => High option prices, so be seller.

Extreme bullish or bearish sentiment means higher implied option volatility,

which also means higher option prices.

Flat (Neutral) sentiment is found in range-bound market and quiet markets

will mean low implied option volatility and therefore lower option prices.

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11. Implied Volatility’s expected behavior

If Implied Volatility is Very high or high, it is expected to come to its

normal/neutral level.

If Implied Volatility is Very low or low, it is expected to come to its

normal/neutral level.

Most of time, implied volatility is expected to stay in neutral level.

Option writing strategies should be initiated when implied volatility is very

high or high and near the top end of its historical range.

When Volatility level is Very High and High, we are option seller.
When Volatility level is Very Low or Low, we are option buyer.
When Volatility level is Neutral, we could be either option buyer or seller.

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Volatility based Trading Approach

IVR (Implied Volatility Rank)

• Description of where the current IV lies in the comparison to its
yearly high and low IV.
• (Current IV – 52 week low / 52 week high – 52 week low) x 100%

IVP (Implied Volatility Percentile)

• The percentage of days over the past year, that were below the
current IV.
• (Number of trading days below current IV / 252 days) x 100%

HV/IV
• Historical Volatility Vs Implied Volatility.

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12. Option Greeks

The price of an Option depends on certain factors like SPOT price, volatility
of the underlying, time to expiry, interest rates, etc. The option Greeks are
the tools that measure the sensitivity of the option price to the above
mentioned factors.

They are often used by professional traders for trading and managing the
risk of large positions in options and stocks.

Following are major Options Greeks to be considered before deciding

Options trade/strategy.

Option Greek:
• Delta
• Theta
• Vega
• Gamma
• Rho

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Option Greeks
Delta It is the amount that an option changes with respect to a
small change in the underlying.
So it is rate of change in Option premium when underlying
prices changes by Rs. 1.
Its value is between 0 and 1.

Theta It is the amount that the option decays in one (1) day.
A writer receives income from time decay and therefore has
‘positive theta.’
A buyer incurs an expense from time decay and therefore
has ‘negative theta.’
Theta value increases we come close to expiry.

Vega It is the amount that an option changes if the ‘implied

volatility’ changes by one percentage (1%) point

Gamma Quantifies the rate of change of the delta with respect to a

change in the underlying

If Greek View (GRK button) is enabled in OptionsOracle, it does shows

Delta, Vega and Theta.

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Delta
It measures the change in the option price for a given change in the price
of the underlying and thus enables exposure to the underlying to be
determined. The delta is between 0 and +1 for calls and between 0 and -1
for puts (thus a call option with a delta of 0.5 will increase in price by Rs
0.50 for every Rs. 1 increase in the underlying).

Delta for ATM options are approximately 0.5. Delta for ITM options are
between 1 to 0.5 and delta for OTM options are between 0.5 to 0.

If you are purchasing options to open a position, you would like to have a
large delta. Then as the asset moves in the direction you predicted, you
would reap high gains for a low investment. For this, you have to buy ATM
option or slightly in-the-money option.

Delta can be used to measure

• Sensitivity/Impact (If underlying moves, possible impact)
• Probability (Based on delta value, probability of becoming ITM)

Example:
If a call has a delta of .50 and the stock goes up Rs. 1, in theory, the price
of the call will go up about Rs. 0.50. If the stock goes down Rs. 1, in theory,
the price of the call will go down about Rs 0.50.

If a put has a delta of -0.50 and the stock goes up Rs. 1, in theory, the
price of the put will go down Rs. 0.50. If the stock goes down Rs. 1, in
theory, the price of the put will go up Rs 0.50.

Vega
The amount of change in the price of an option in response to a 1% change
in volatility of the underlying asset. Both calls and puts will tend to increase
in value as volatility increases, as this raises the probability that the option
will move in-the-money. Both calls and puts will thus possess a positive
Vega.

Vega is useful because volatility is one of the most important parameters

determining the price of an option. Looking at historical volatility of the
underlying asset price, implied volatility of the option price, and Vega can
help you determine if overall options are expensive, neutral or cheaper.

Vega for ATM option are highest as it has highest level of uncertainty. It
can easily change from ATM to either ITM or OTM.

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Theta
It measures the effect of time decay on an option. As time passes, options
will lose time value and the theta indicates the extent of this decay. Both
call and put options are wasting assets and therefore have a negative theta.

Note that the decay of options is nonlinear in that the rate of decay will
accelerate as the option approaches expiry. The theta will reach its highest
value immediately before expiry. Remember Options are a decaying asset.

Option writer will have positive theta and Option buyer will have same
amount of negative theta.

Option sellers use theta to their advantage, collecting time decay every
day.

Theta is often called a "silent killer" of option buyers. Buyers, by definition,

have only limited risk in their strategies together with the potential for
unlimited gains. While this might look good on paper, in practice it often
leads to loss.

Gamma
It measures the change in delta for a given change in the underlying. (e.g.
if a call option has a delta of 0.5 and a gamma of 0.05, this indicates that
the new delta will be 0.55 if the underlying price moves up by one full point
and 0.45 if the underlying price moves down by one full point).

Mathematically, gamma is the second derivative of an options value with

respect to underlying price. It is used to gauge the price movement of an
option, relative to the amount it is in or out of the money. It is largest for
at-the-money options.

At-the-money options have the highest gammas. Gamma decreases as you

go in-the-money or out-of-the-money. Gamma is sometimes used as a risk
management tool to manage a large portfolio, because it tends to reflect
the speed of an option. Options with high gamma are the most responsive
to price movements, so they provide the most help in covering directional
exposure.

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Rho
Rho indicates the sensitivity of the fair value of the option to small changes
in the interest rate. For ease of use, it is often expressed as the amount
the option price would change with a one percentage point move in the
interest rate. This parameter generally does not have as large an impact as
the other parameters discussed above.

Greeks Summary
The Greeks helps us to examine our exposure to various option’s centric
risks.

Remember,
• Greeks helps us to assess our theoretical exposure.
• Greeks are dynamic and constantly changing.
• Greeks can help us to plan trades to take advantage of, or
avoid/minimize, the effects of these risks.
• Greeks can help us to manage trades by showing how the trade’s
various exposures have changed with respect to
• Time (Theta)
• Price (Delta/Gamma)
• Volatility (Vega)
• Interest Rates (Rho)

Difference Between Theta and Time Value

Theta Time Value
Theta increases as we move Time value reduces as we move close to
close to expiry expiry
Rate of change ₹ or $ value

Finally, here is a summary of the determinants of Option Value:

Summary of the determinants of Option Value
Factor CALL value PUT value
Increase in Stock Price Increases Decreases
Decrease in Stock Price Decreases Increases

Increase in variance of underlying asset Increases Increases

Decrease in variance of underlying asset Decreases Decreases

Increase in time to expiration Increases Increases

Increase in interest rates Increases Decreases
Increase in dividends paid Decreases Increases

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13. Jargons: Common Terminologies

Option Strategies
All option strategies are some combination of buying or selling of calls or
puts, and can even be combined with stock or future.

An option spread is established by buying or selling various combinations

of CALLs and PUTs, at different strike prices and/or different expiration
dates on the same underlying security. There are many possibilities of
spreads, but they can be classified based on a few parameters like price,
expires, Greeks.

Option Spreads

Bull Spread
Vertical Spread

Underlying Price
Strike Prices

Bear Spread

Calendar Spread

Expiration Dates

Option strategies are designed for different markets/trends (bullish,

bearish, or neutral) by using different methods. Option spread strategies
include vertical, horizontal, and diagonal spreads, and credit and debit
spreads.

CALL and PUT spreads

Any spread that is constructed using CALLs can be referred to as a CALL
spread, while a PUT spread is constructed using PUT options.

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BULL and BEAR spreads
If a spread is designed to profit from a rise in the price of the underlying
security, it is a BULL spread.

A bear spread is a spread where favorable outcome is obtained when the

price of the underlying security goes down.

Credit Spread
A credit spread is also known as a credit risk option. In credit spread, one
option is sold high and one option bought so that we receive a net credit
for the spread.

There are multiple types of credit spreads. Popular strategic credit spread
options involve short butterflies, short condors, iron condors and iron
butterflies.

Example:
Short Straddle, Short Strangle, Short Icon Condor, etc.

Debit Spread
A debit spread involves, buying expensive option and selling cheaper
option, so that we pay a net debit for the spread.

Example:
Long CALL, Long PUT, BULL CALL Spread, BEAR PUT Spread

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Vertical (or price) Spreads
The simultaneous purchase and sale of options identical in all respects
except for strike price. They can be created with either all CALLs or all PUTs.

Examples:
Bullish Vertical Spread
Using Calls : BULL CALL Spread
Using Puts : BULL PUT Spread

Bearish Vertical Spread

Using Calls : BEAR CALL Spread
Using Puts : BEAR PUT Spread

Horizontal (or time or calendar) Spreads

The simultaneous purchase and sale of options identical in all respects
except time to expiration. These spreads can also be referred to as
horizontal or time spreads. These spreads have the same type and strikes,
but different expirations, and are placed in low volatility environments.

Examples:
CALL Calendar Spread, PUT Calendar Spread

Diagonal Spreads
The simultaneous purchase and sale of options that differ in both strike
price and time to expiration. The diagonal spread is a combination of
vertical and calendar spread. This combination means different expirations
and different strikes are used.

Bull spread: benefiting from stock price increase

Bear spread: benefiting from stock price decrease
Time spread is based on volatility

Ratio Spread
The ratio spread involves buying a number of options and selling more
options of the same underlying stock and expiration date at a different
strike price. A ratio spread is generally a vertical spread where one leg has
more contracts than the other.

Example:
CALL ratio spread (1 Long ATM CALL, 2 Short OTM CALL)

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Delta Neutral Strategies
Delta neutral strategies are options strategies that are designed to create
positions that aren't likely to be affected by small movements in the price
of a security. This is achieved by ensuring that the overall delta value of a
position is as close to zero as possible.

A delta-neutral portfolio balances the response to market movements for a

certain range to bring the net change of the position to zero.

Remember “Delta” measures how much an option's price changes when the
underlying security's price changes.

It is high probability strategy but less rewarding, as you may end up

neutralizing delta multiple times.

Example:
As you can see here “Total Delta” is 0.

Once in the position, it is important to make adjustments in order to remain

delta neutral. As the price of the position moves, so does the delta. An
increase (decrease) in price of the underlying futures contract will increase
(decrease) the premium of the option, as well as the delta. Making
adjustments along the way will allow for the position to be as close as
possible to delta neutral.

Straddles
Simultaneous Purchase/Sale of the same number of CALLs and PUTs with
identical Strike Prices and Expiration Dates [Long or Short].

Example of Short Straddle:

SHORT NIFTY CALL 10000 and SHORT NIFTY PUT 10000

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Strangle
Simultaneous Purchase/Sale of CALLs and PUTs at different Strike Prices.

Example of Short Strangle:

SHORT NIFTY CALL 10200 and SHORT NIFTY PUT 9800

Bull Spread
Simultaneous Purchase and/or Sale of CALLs or PUTs that will produce
maximum profits when value of underlying asset rises.

Example:
LONG NIFTY CALL 10000, SHORT NIFTY CALL 10500

Bear Spreads
Purchase & sale of CALLs or PUTs for maximum profits when value of
underlying asset falls.

Example:
LONG NIFTY PUT 10000, SHORT NIFTY PUT 9500

Calendar Spreads [Time Spreads]

Purchase & sale of CALLs or PUTs with different expiration dates.

Example:
SHORT NIFTY CALL 10000 (JAN), LONG NIFTY CALL 10000 (FEB)

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14. Understanding Chart (Candlestick)

Candlestick chart is most widely used to analysis trend. It is better than

line or area chart. Other charts normally based on closing price, whereas
candlestick shows all four components (Open, High, Low and Close –
OHLC).

Here is candlestick.
Green candlestick means price closed in positive.
Red candlestick means price closed in negative.

Try NIFTY candlestick chart on following URLs:

[Link]/indices/s-p-cnx-nifty-advanced-chart

[Link]

What is High-Low known as?

If we take average of High-Low for last 14 days, what is it referred as?

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Candlestick Cheat Sheet:

Identifying Support and Resistance levels

• Using candlestick patterns
• Using indicators/oscillators
• Using Swing Highs and Swing Lows
• Using pivots
• Using price action
• Using Standard Deviation
• Using ATR
• Using OI

Can you identify what is daily ATR for NIFTY currently?

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15. Price patterns
Price patterns on chart are made of four basic patterns.

Price Patterns

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16. Trend

Trend shows us what direction to trade. Trend is assumed to continue until

it breaks.

Trend can be one of following three:

• Uptrend : Bullish
• Downtrend : Bearish
• Sideways : Non-directional

Identifying Trend

There are different methodologies to identify/confirm trend. We can

use one or combination of following:
• Moving Average (E20 (Exponential 20 days), E50, E100) and
retracement or trend line.
• Moving Average crossover (E10 and E20, E50 and E100)
• Higher High, Higher low, Lower Low, Lower High
• Breaking Support or resistance levels
• Comparing price of Future with Underlying
• Using PCR (PUT CALL Ratio)
• Direction of shift of Option Max Pain

Try practice trend on NIFTY candlestick chart on following URL:

[Link]
[Link]/indices/s-p-cnx-nifty-advanced-chart

Trend changes because of technical/cyclic reasons and economic

environmental changes. Trend may even change because of unexpected
change in environment. In case of trend change, trader/investor needs to
adapt change and move on. Those who could not adapt change is likely to
fail.

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17. Tools: OpStrater

OpStrater consists of following major components:

• Strategy Decision Maker VIX
• Strategy Decision Maker HV-IV
• Strategy Trader Manager
• Options Morphing
• Open Trades

18. OpStrater: Strategy Decision Maker (VIX)

Strategy Decision Maker (VIX) analysis INDIAVIX and recommends

strategies based on current volatility level.

Click on button “Update” to see recommendations.

Once it is updated, shows recommended strategies in second half of the

screen.

Steps:
1. Click on “Update” button.
2. Check “Last Updated” value
3. Check “VIX (Current)” value
4. Check “52 Week High” value
5. Check “52 Week Low” value
6. What is “Volatility Level”?
7. What is recommended Neutral Strategy?
8. What is recommended Bullish Strategy?
9. What is recommended Bearish Strategy?

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19. OpStrater: Strategy Decision Maker (HV-IV)

Strategy Decision Maker (HV-IV) analysis Implied Volatility verses

Historical Volatility and recommends strategies.

Steps:
1. Select Scrip NIFTY using HV-IV method.
2. Click on Auto IV or
3. URL link to open Option Chain table and Add ATM IV values
4. Click on “Download”
5. What is Last Update date?
6. What is current ATR?
7. What is “Volatility Level”?
8. What is recommended Neutral Strategy?
9. What is recommended Bullish Strategy?
10. What is recommended Bearish Strategy?

Remaining tool (“Strategy Trade Manager”, “Options Morphing” and “Open

Trades and Updates”) will be covered during workshop. These are not
supported for premium users.

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20. Tools: OptionsOracle India Plugin

OptionsOracle is strategy analysis tools that allows testing of different

options strategies using real-time options and stock-market information.
The tool provides an easy interface to build a stock/options position and
then test it using graphs and analytical tools. Its payoff chart helps to
analyze strategy status at different price, date and volatility.

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21. Configuring OptionsOracle

Once you install OptionsOracle, it is preconfigured automatically. We

recommend not to change those unless you have specific requirements.

In case if you wish to change, click on button “Config” as shown below.

1. Under “General” tab, make following settings as shown below:

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Click on Online Servers& Stock Exchange Selection drop down menu and
select servers. If you are trading Indian market, select “Plugin Server India
(NSE) …”.

Also recommended to use “Use Last Price” for Options Positions.

If you are behind proxy, then proxy settings need to be mentioned in

section “Proxy / Communication”. Your system administration or network
administration will be able to guide on this. This is only required if you are
behind proxy server and don’t have direction Internet connection.

2. Under “Commissions” tab, make following settings as shown below:

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Make sure all Commissions and even Federal rates are mentioned as
zero, unless you know significance and impact of same.

If you are very sensitive to commissions, then make sure to write correct
value including Unit/Contract.

3. Under “Margin” tab, you can set margin requirements based on your
broker. Generally, we recommend not to change default settings.

If you wish to have exact margin setup, please see blog post on

[Link]
[Link]

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4. Under “Volatility & Math” tab, make changes as shown below:

Some time, we use “Download Historical Volatility if Available

(increase download time), but generally we recommend to disable it
as it increases download time.

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5. Under “Summary” tab, following is recommendation settings.

This is important settings and we highly recommend to use as shown above,

in same order. If you are participating in workshop, will let you know
importance of this in workshop under module 2 section.

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22. Using OptionsOracle

Please follow following steps:

1. Start OptionsOracle India Plugin
2. Use “NIFTY” scrip in Symbol, and click Update
3. Click on Template and select Neutral Strategies (Neutral: Call
Calendar Spread)

Try selecting different strategies and see what happens in ”Strategy

Position” tables.

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Here is sample screenshot of “Strategy Positions”.
We have updated our traded (executed) price manually for each position.
See column “Price”.

4. Click on Graph and try to find out different parameters in Graph.

Current Price
of Underlying

Try moving mouse cursor over different price and watch changes in
profit/loss on status bar of graph.

Also you may wish to click on top right corner on T or E or selected date to
see possible status of pay-off on particular date.

Here T means today. E means on Expiration.

Let’s see status as of today by clicking on T.

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Payoff at Expiry and Payoff at select date (within expiry)
Here is another example for payoff on today (by clicking on “T”), try this
in “OptionsOracle Advance”. We clicked on “Invert Colors” to change
to bright theme.

Payoff for
Expiry Payoff for
selected date

Try changing mouse pointer over chart and see what it shows at
status bar of graph chart.

Show Positions:
If you would like to see the graphs of all the positions that construct the
strategy click the “Show Positions” button.

Show StdDev:
You can show the -2StdDev, -1StdDev, +1StdDev, and +2StdDev vertical
markers by clicking the “Show StdDev” button.

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Remember:
1 standard deviation = 68.2%
2 standard deviations = 95.4%

-2 SD -1 SD +1 SD +2 SD
34.1 34.1

68.2 %

95.4 %

Auto Scale:
The “Auto Scale” button located at status bar provides the ability to reset
the scale of the graph back to default at any point. Try changing graph size
using mouse drag (making square) or by scrolling mouse central roller.

Now click on “Auto Scale” to reset.

Try changing parameters at top (T or E) and see how it impact.

This is to see payoff chart on Expiry or for select date.

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23. Understanding Strategy Summary

Let us understand “Strategy Summary” as shown in OptionsOracle main

screen with example.

Maximum Profit Potential

Maximum profit potential in this strategy at the end-date (On expiry).

Maximum profit in this strategy is 165.04 points. If our scrip (NIFTY) closes
at 9300 on expiry, we will have maximum profit of 165.04 points.

Maximum Loss Risk

Maximum loss risk in this strategy at the end-date.

Maximum loss in this strategy is limited to 80 points. That would be around

5% loss based on investment in this strategy (including margin
consideration).

If “Maximum Loss Risk” is shown as ∞, it means in this strategy, risk is

infinite.

Upper Protection
Upper protection appears only if the strategy has positive profit with the
current underlying asset price. It shows the upper underlying asset price
in which the strategy breaks-even at the end-date.

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We are protected (in profit) until NIFTY (our scrip) is below 9535 i.e. 2.34%
away from current price. If NIFTY crosses upper protection (9535) and goes
above, loss will start in strategy.

Lower Protection

We are protected until NIFTY (our scrip) is above 9073 i.e. 2.63% away
from current price. If NIFTY crosses lower protection (9073) and goes
below, loss will start in our strategy.

Return if Unchanged
Profit/Loss status if expiry happens at current price level.

Currently NIFTY is at 9318 and if NIFTY closes on this price on expiry, our
profit will be 146.99 that is around 9.36% return on investment based on
margin consideration.

Current Return
Profit/Loss status as now.

As of now, our strategy is in 25 points profit i.e. 1.59% return on

investment.

Total Delta
Total Delta represents by how much the strategy return changes relative
to a movement of the stock price by 1.

In above example, Total delta for strategy is -0.01.

So if Underlying price goes up by Rs 1, we will be negative impacted by
0.01 points in our strategy.
Similarly, if Underlying price goes down by Rs 1, we will be positively
impacted by 0.01 points in our strategy.

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Total Vega
Total Vega represents by how much the strategy return changes relative
to movement of volatility by 1 %.

In above example, Total Vega for strategy is 10.27 points. So if Vega

changes by 1% (increases), it is going to impact by 10.25 (positive). In
case Vega decreases by 1%, we will be impacted positively by 10.25 points.

Total Theta
Total Theta represents by how the strategy return changes relative to
time change of one day.

Total theta in above example is 1.36. For credit strategy theta is positive
and for debit strategy, it is negative.
So if we stay one more day in strategy, theta earning will be 1.36 points.
Remember, theta increases day by day as we move close to the expiry.

Difference between Protection and Breakeven

Protection:
Scrip price needs to stay between Lower and Upper Protection to be in
profit. Mostly applicable for credit strategies.

Breakeven:
Scrip price needs to break either lower breakeven or upper breakeven to
go into profit. Mostly applicable for debit strategies.

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24. Adding Position in “Strategy Positions”

To add positions in “Strategy Positions”, you can use any of following

three methods:
1. Drag from “Option Chain” table to “Strategy Positions”
2. Use “Add row” button and manually change “Type”, “Strike”,
“Expiration”, etc.
3. Use “Template” and select predefined template. Later on you can
change “Strike”, “Expiration”, etc. if required.

Once you add position, you can change Type, Strike, Expiration, Quantity,
Price and other parameters. Notice color of price once you change it.

In Quantity column, if 1 is used, then the results in “Strategy Summary”

are in points.
In Quantity column, if actually lot size is used, then results in “Strategy
Summary” are in Rupee.
We prefer to use in points. While importing OptionsOracle details to
“Strategy Trade Manager” points format to be used i.e. Quantity should
in ‘1’ (or least possible value) instead of actual lot size/quantity.

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25. To square-off position in OptionsOracle

To square-off (close) position in OptionsOracle, you can add corresponding

closing (square-off) position.

Let’s say you have “Long CALL”, then add “Short CALL” with same strike
and expiry along with your square-off price. Your “executed” or “square-
off” price should be updated manually in “Price” column.

Here is example:

Position marked with 1 is “Short CALL 8200 9700” at Rs. 205.

Position marked with 2 is corresponding square-off position (Long CALL
9700” at Rs. 110. You can also change “Opn/Cls” status to “Close” to both
positions.

If you have “Short Position” you have to add corresponding “Long Position”
with square-off price.

Alternatively, you may right click on “Open”, it will show “Square-Off

Position”, it will automatically add square-off position. You should now
change corresponding position’s Price with your traded price and if required
change Quantity (in case portion of total position closed).

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26. PUT CALL Ratio

PUT CALL ratio is ratio of OI of PUT verses CALL. It is a popular tool to help
traders gauge the overall sentiment of the market.

Put Call Ratio Calculation = Open Interest of PUTs / Open Interest of CALLs

Click on PUT CALL Ratio and see title. Here is showing PCR is 0.86.

In “OptionsOracle Advance”, see second line in graph title. It shows

possible range expected for the series selected.
It shows “OI Analysis Range”.

PCR Value and our interpretation (consider writer’s perspective):

Value General Interpretation

0.0 to 0.4 Strongly Bearish
0.4 to 0.8 Bearish
0.8 to 1.2 Sideways
1.2 to 1.6 Bullish
1.6 and above Strongly Bullish

In screenshot above, PCR value is 0.86, so based on above table, it is

currently in sideways trend.

Generally Max OI Strike in CALL side is considered as nearest resistance

level and Max OI strike in PUT side is considered as nearest support level.

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Kindly note, OI Analysis range in PCR chart.
We will discuss in our workshop, how to effectively use PCR.

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27. Option Pain

This is a theory based on the fact that option buyers are retail traders who
typically buys option whereas option writers/sellers are
professionals/institutions who typically sells options and have a higher
chances of winning and making profits. It is believed that money-makers
(professionals/institutions) are making extra money by selling options
(both calls and puts), and they will manipulate the stock price approaching
expiration date to minimize their liability to exercise options, causing
"maximum option pain" to the option buyers.

According to this theory the underlying on the expiry day will gravitate
towards that point at which option buyers will feel the maximum pain,
basically a point where the maximum number of options, both calls and
puts value could become zero (worthless) on the expiry day. To calculate
this, we need the open interest of both calls and puts for various strike
prices.

Click on Option Pain and observer graph and graph title. Here it is showing
max pain is at 8350. So most likely based on current situation, expiry may
happen near 8350.

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28. Best Practices

Following are best practices we recommend while trading options:

1. Invest your money in assets like Liquid BeES or mutual fund or FD or

Bond and use that asset as collateral to trade options. This collateral
asset can be used for shorting options.
2. Make sure broker doesn’t charge over-night interest against collateral
asset usage, else switch broker.
3. Use discounted brokers to avoid higher brokerages. A penny save is
penny earned.
4. Use two or more brokers. In case if one broker is facing technical or
any other issue, you can alternatively use other broker for trading.
Some time, we may have conflicting trades, so you can take
conflicting trade in second account.
5. ITM Long Options should be squared-off before expiry; else exchange
will settle for you with penalty i.e. higher STT (STT on underlying asset
value instead of Option premium). ATM or OTM Long options will be
worthless, so no penalty. In case of Short positions (either ITM, ATM
or OTM), STT is already paid, so no penalty will be charged.
6. Stock Options having compulsory delivery should be squared-off
ideally on last Friday of expiry or before to avoid forced delivery.
7. Understand that there is no holy grail in the market. The early you
understand, it is better.
8. Avoid overtrading, overtrading is the single biggest malaise of most
trade.
9. Always have a trading plan. It means, you should have entry plan,
exit plan (including both profit booking and loss booking). You should
also have adjustment plan.
10. Avoid trading DEEP ITM options. Most of time, it will have higher bid-
ask spread and it is not easy to square-off Deep ITM option position.
11. If volatility is high or very high for some expected event (earning),
you may delay entry for credit strategies and enter just before an
event (possibly day of event or a day before that) when volatility is at
peak.

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29. Assessment

Before attempting online assessment and to get most out of our workshop,
we recommend following:
1. Make sure tools are activated.
2. You have read this PDF thoroughly; we recommend to read it multiple
times.
3. Make sure you have watched our recommended YouTube videos
4. You are practicing tools and are comfortable to use it.

URL for assessment:

[Link]

Once online assessment is submitted, we will try to verify your response as

early as possible. It generally takes 7-10 days and you will receive result
in your email.

Once we verify your response to online assessment, we will share second

study material. Also if you get more than 90% score and all other conditions
are met, we will add you in our Option Trading Telegram group
immediately.

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For OptionsOracle screenshot, please using following format while
posting in our Telegram or social media for any query.

This allows us to see all relevant details like strategy positions, strategy
summary and pay-off graph.

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30. Additional resources

Please watch following videos on YouTube:

Getting started with OptionsOracle:

• [Link]

OpStrater (The Options Strategy Trade Organizer):

• [Link]

Also, we recommend you to visit the following URL:

• [Link]
[Link]

• [Link]
ontrol-research/a-part-time-trader-who-uses-time-and-
risk-management-successfully-at-his-job-and-in-the-
[Link]

You can join the our FaceBook group or Tweet to get latest updates about
tools, workshop schedules and of course market outlook:

• [Link]

• [Link]

Other reading materials:

• [Link]
hures-literature/page-assets/options-strategies-quick-
[Link]
• [Link]
• [Link]
[Link]

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31. Modules

Below is the list of modules/topics we will cover during our Option

Trading Workshop.

1. Option Basics

2. Option Analysis and Trading Tools

Effectively using OptionsOracle
Effectively using OpStrater
• Strategy Decision Maker (VIX)
• Strategy Decision Maker (HV-IV)
• Strategy Trader Manager

3. Non-directional Strategies
Strategy guidelines
Mastering non-directional Option Strategies

4. Directional Strategies
Mastering bullish Option Strategies
Mastering bearish Option Strategies
Option Morphing

5. Adjusting Option Strategy Trades

Importance of adjustment
When to initiate adjustment
How to adjust Option strategies to minimize loss in case trade
is going against us?

6. Risk Management
Position sizing for strategies
Money management
Avoiding common mistakes

7. Practice
Identifying Option trades
Case studies

All seven modules will be covered in our “Options Trading

Workshop”.

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Thank you for reading Option Basics Trading Guide

You can read more updates on

[Link]

[Link]

Be Safe and Happy Trading 

Santosh Kumar Pasi, Options Trader and Trainer

+91.98202.00550

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