Derivatives education site

thx ravi for ur help...as for swagat..can u please clarify...do u mean buying one fut say sept and selling same contract's oct fut? if that is so it is called spreading, not arbitrage...pls let me know...i can try to help u

C i dont have much idea about Derivatives. I was just goin thru a Derivatives manual and this idea stuck me. Can u pls elaborate how spreading done. What are the methods what are the Risks asscoiated and also the Obligations for payment.

sorry for the late reply. spreading is very common in case of commodities, spec. if u know that copper production will stop due to an impending strike and copper arrival will be less three months hence, or a new bumper crop is due to arrive in a month, or interest rates will be hiked in three months. Then u take one position this month (buy or sell future) and take the reverse position some month hence). What u r essentially trying to do is catch the premium. Say copper fut at sept is rs 100 and dec is rs 110. u know that a lot of copper will arrive in oct end or nov. so u buy sep at 100, sell dec at 110, and pocket rs10, hoping that sep will expire aroung 100 or above, and then when large stock arrives, price will fall and u make a profit on dec fut. THIS IS EXTREMELY risky in stocks to do with fut as stocks are just not affected by demand and supply. greenspan (or bernanke) sneeze can set the market down across all emerging market. not to mention accouniting fraud etc or plain vanilla FII slowdown in india (irrespextive of the fact that nothing is wrong with the stock held by u). So never indulge in this as ur risk is very very high. Of course u can spread with options, but thats a different story altogether.

Thanks for the reply

Ive made an attempt to give an idea on how Delta Nuetral Strategy works, i hope it will be helpful...........

The delta of an option is the rate of change in an option's price relative to a one unit change in the price of the underlying asset. So, for example, if a call option has a delta of 0.35 and the price increases by one rupee, the option's price should increase by 35 paise.

In the example above, the option has a delta of 0.35. Traders and brokers refer to that as "35 deltas." Simply multiply the delta by 100 to make it a percentage. Please be aware of that common convention. However, make sure you understand that "35 deltas" really means 0.35.

For the purpose of our discussion , whenever we mention the delta of an option, we are referring to the actual decimal value because that is what's actually used in all mathematical models.

What exactly is Delta Neutral?

The term "Delta Neutral" refers to any strategy where the sum of your deltas is equal to zero. So, for instance, if you buy 10 call options, each having a delta of 0.60 and you also buy 20 put options, each having a delta of -0.30 you have the following:

.....(10 x .0.60) + (20 x -0.30) = 6.00 + -6.00 = 0

Your position delta (total delta) is zero, which means you are delta neutral.

The technique you are about to learn, is just one application of delta neutral. It is a general trading approach that is used by some of the largest and most successful trading firms. It allows you to make money without having to forecast the direction of the market. You can use it on any market (stocks, futures, whatever), just as long as options are available and .... the market is moving. It doesn't matter whether or not the market is trending, but it won't work if the market is really flat.

The principle behind delta neutral is based upon the way an option's delta changes as the option moves further into or out of the money.

You will notice the following characteristics of an option's delta:

The absolute value of the delta increases as the option goes further in-the-money and decreases as the option goes out-of-the-money.
At-the-money call and put options have a delta that is right around 0.50 and -0.50 respectively.

Put options have a negative delta, which means if the price of an asset goes up, the price of a put option on that asset goes down.

Deep in-the-money call options have a delta that approaches +1.00.
Conversely, deep in-the-money put options have a delta that approaches -1.00.

Deep out-of-the-money calls and puts have deltas that approach zero.
The delta of the underlying asset itself always remains constant at 1.00.

If you short the underlying, the delta would be -1.0 instead of +1.0.

Keeping all of this in mind, we can construct the following delta neutral trade:

Nifty futures price 110
Statistical Volatility 8.00%
Option Strike Price 110
Days remaining 30

Price---------------------------------Option-----------------Option
of------------------------------------theoretical-------------delta
underlying----------------------------price

108______________________________2.14_____________ ___-0.73
109______________________________1.43_____________ ___-0.58
110______________________________0.91_____________ ___-0.42
111______________________________0.53_____________ ___-0.28
112______________________________0.28_____________ ___-0.1

Buy 2 Nifty futures at 110
Buy 5 Nifty futures put options (110 strike price) at 0.91 each

Delta of Tbond futures 2 x 1.00 = 2.00
Delta of put options 5 x -0.42 = -2.10
Total position delta 2.00 + -2.10 = -0.10 (Almost Zero)


How it works:
If Nifty futures increase from 110 up to 112: Profit on Nifty =2x2.00= 4.00
The put options will decrease from 0.91 down to 0.28 (each)
Loss on put options = 5 x (0.91 - 0.28) = 5 x 0.63 = 3.15
Net profit = 4.00 - 3.15 = 0.85

If Nifty futures decrease from 110 down to 108: Loss on Nifty =2x2.00 =4.00
The put options will increase from 0.91 up to 2.14 (each)
Profit on put options = 5 x (2.14 - 0.91) = 5 x 1.23 = 6.15
Net profit = 6.15 - 4.00 = 2.15

We can summarize this delta neutral approach as follows:

If you buy the underlying and buy put options so your position is delta neutral: When the market goes up, you have a profit on the underlying and you have a smaller loss on the options (because their delta decreased), so you wind up with a net profit.

When the market goes down, you have a loss on the underlying but you have a bigger profit on the options (because their delta increased), so again you have a net profit.

If you sell (short) the underlying and buy call options so your position is delta neutral: When the market goes up, you have a loss on the underlying but again you have a bigger profit on the options (their delta increased), so you have a net profit.

When the market goes down, you have a profit on the underlying but once again, you have a smaller loss on the options (their delta decreased), so you still have a net profit.

When you do this kind of delta neutral trading, you need to follow a few rules:
Always initiate the position with a total position delta of zero or as close to zero as possible. So, your starting position is "delta neutral."

When the market moves enough so your total position delta has increased or decreased by at least +1.00 or -1.00 delta (or more), you make an "adjustment" by buying or selling more of the underlying asset to get your position back to delta neutral. You can also sell off some of your options to get back to delta neutral. But the point is, you make profits consistently by making these adjustments.

If the price of the underlying asset doesn't move around much, close out the entire position. You need some price action for this approach to work. If the market just sits there, time decay will eat away at this position.

Keep an eye on the implied volatility of the options you're using. If it moves toward the high end of its 2 year range, stay away from this position for a while. Otherwise, you might have excessive time decay in your options when the implied volatility starts to drop.

The options you buy should have at least 30-60 days remaining before expiration. Remember that time decay accelerates as the option's expiration date approaches, so if you allow more time, you minimize the time decay.

As you have seen, these trade positions benefit by price movement in the underlying asset. It puts you in the enviable position of being able to take full advantage of big price moves, in any direction.

Hope ull enjoy this read,
Regards,
Rahul

hi thanks beginner_av

can i post my other doubt in derivative over here

regards

Satya

u can put any doubts here...i'll try to reply to them

ok thanks for u r reply . i will return with some doubts

Regards

Satya

1.Every body saying abnormal build up in OI , so what is this abnormal mean
Is it 30% above its previous days OI .

If we find a stockthat has just added up more than 30% OI then how can we get into it .wil it pull back , then enter or just enter in to the stock in its current trend on next day
Please tel us how to do trading with his type of stocks

2.Roll over : people saying good roll over to next month can sustain the current trend . people even say 90% is good . where can we get this data about roll over ???

3. Again I read somewhere that if the market heavy weights are reaching there limits in F&O then there will be little bit upside left and some profit booking may happen . so what is this limit and how can we get cues from it

These are may be silly questions but while reading i got this type of doubt . please reply

Regards

satya

Friend,

It is available on the ICICIdirect site.......http://content.icicidirect.com/ULFil...4111171013.asp


Take a look.