Nifty 17387.65 (-0.08%)
Sensex 58360.54 (-0.17%)
Nifty Bank 36630.2 (0.33%)
Nifty IT 36094.3 (-0.18%)
Nifty Financial Services 17935.85 (-0.26%)
Adani Ports 744.80 (0.77%)
Asian Paints 3156.00 (-0.77%)
Axis Bank 680.60 (0.67%)
B P C L 383.00 (1.10%)
Bajaj Auto 3331.05 (0.08%)
Bajaj Finance 7160.25 (-0.28%)
Bajaj Finserv 17750.10 (-0.05%)
Bharti Airtel 719.40 (-1.80%)
Britannia Inds. 3568.75 (-0.27%)
Cipla 912.80 (-0.92%)
Coal India 159.50 (0.13%)
Divis Lab. 4738.95 (-0.80%)
Dr Reddys Labs 4589.85 (-1.56%)
Eicher Motors 2481.40 (1.22%)
Grasim Inds 1734.80 (0.64%)
H D F C 2791.85 (-0.57%)
HCL Technologies 1177.85 (-0.58%)
HDFC Bank 1523.75 (-0.13%)
HDFC Life Insur. 703.10 (-0.31%)
Hero Motocorp 2484.40 (0.47%)
Hind. Unilever 2368.00 (-0.64%)
Hindalco Inds. 428.65 (-0.80%)
I O C L 122.30 (1.37%)
ICICI Bank 725.45 (0.42%)
IndusInd Bank 950.85 (0.56%)
Infosys 1762.80 (0.83%)
ITC 223.75 (-0.75%)
JSW Steel 650.45 (0.57%)
Kotak Mah. Bank 1972.60 (0.43%)
Larsen & Toubro 1821.00 (1.78%)
M & M 848.25 (-0.15%)
Maruti Suzuki 7280.55 (-0.61%)
Nestle India 19209.70 (-1.50%)
NTPC 128.15 (-0.43%)
O N G C 145.80 (1.25%)
Power Grid Corpn 215.90 (0.65%)
Reliance Industr 2459.00 (-0.96%)
SBI Life Insuran 1169.80 (-1.54%)
Shree Cement 26223.95 (-0.25%)
St Bk of India 478.20 (0.25%)
Sun Pharma.Inds. 759.05 (-0.94%)
Tata Consumer 771.80 (-0.19%)
Tata Motors 482.00 (0.61%)
Tata Steel 1110.90 (-0.13%)
TCS 3644.65 (0.05%)
Tech Mahindra 1622.30 (-0.45%)
Titan Company 2386.25 (-0.01%)
UltraTech Cem. 7426.55 (1.41%)
UPL 706.80 (1.23%)
Wipro 644.25 (-0.39%)

Understating Options and Its Types?

Understating Options and Its Types?
by Nilesh Jain 21/04/2017

What are Options?

An Option contract is a type of derivative instrument, which gives holder the right to buy an asset but not the obligation to purchase at a fixed price (strike price) for a specific timeframe. Option trading offers an opportunity to make profit in two ways- by being an option buyer or an option writer.

An Option trader can take four views on the market:

Bullish

Bearish

Expecting a movement, in either direction

Expecting a range bound movement of index/ stock, irrespective of direction.

Options are divided in to two parts:

Call Option

Put Option

Call Option: A ‘Call Option’ gives right to holder to buy a particular asset at a specific strike price against an upfront premium paid to the seller. The buyer of a call option has bullish stance on underlying assets.

A seller of a call option has an obligation to sell an underlying asset at the strike price if exercised by the buyer of a call option. Seller of a call option receives premium for taking risk associated with that obligation. Seller of an option has bearish or neutral view on the underlying assets.

Let’s try to understand with the help of an example of a house purchase on how call option fundamentally works:

Assume Deepak is the owner of a house. He agrees with Ritesh to sell his house to him after two months at the price of Rs 10,00,000. In their agreement Ritesh has the right but not the obligation to buy the house at a predefined price after two months, in order to access his right, Ritesh must pay some token money of Rs 50,000. Deepak takes this money and keeps it and now he is obliged to keep his agreement if asked by Ritesh.

Case 1: If the market value of that house increases to Rs 12,00,000. Ritesh will exercise his right to buy Deepak’s house at predefined price of Rs 10,00,000. Ritesh’s choice was profitable because he expected that the price of the house will go up and made net profit of Rs 2,00,000.

So, Ritesh bought this right because he believed that house price will go up and Deepak sold his right because he thought that house prices will go down after two months.

Case 2: If the market value of that house falls to Rs 8,00,000, Ritesh won’t be interested in buying that house from Deepak at Rs 10,00,000, because he can buy another house from market at Rs 8,00,000. So his right will expire worthless and will have to let go the token amount of Rs 50,000 as he is not exercising his right. The advantage for Deepak will be Rs 50,000 that Ritesh paid him as token for the house.

Let’s try to replace the same concepts with real scenario

Deepak is the writer of the option and Ritesh is the buyer

Rs 50,000 that Ritesh paid to Deepak in order to have the right is the Premium

The predefined price of Rs 10,00,000 is the strike price

Two months will be the expiration date of the option

The underlying assets is house

Realignment of the aforementioned scenario in terms of Nifty:

Nifty Current Market Price

9200

Buyer

Buy call

Seller

Sell call

Strike price

9200

Expiry

27 APRIL 2017

Underlying assets

Nifty

In real case scenario, buyer of a call option can square off his position and book profit anytime in the live market. Also, we have European options with pre-defined expiry date, where one can square off their position anytime before expiration. This strategy is called as Long call strategy.

Put Option: A put option is an option contract, where the holder of an option gets right but not an obligation to sell a security at specified price until its expiration. A buyer of put option has bearish view on underlying assets.

Writer/seller of a put option has an obligation to buy the underlying asset at a strike price, if exercised by buyer of a put option. Put seller receives premium for taking such risk associated with an obligation. Seller of a put option has a bullish to neutral view on underlying assets.

A simplified example

Suppose the stock of Reliance is trading at Rs 1400. A put option with a strike price of Rs 1400 with one month’s expiry is trading at Rs 15. You strongly believe that Reliance will drop sharply in coming weeks. So you bought one put option for Rs 15 covering 500 shares. When you buy put option your risk is limited to the premium paid, which comes around Rs 7,500 in this example. Put seller will receive Rs 7,500 because he is obliged to sell put option when you will exercise your right.

Case 1: As expected if Reliance falls to Rs 1350, then you will make a profit of Rs 50 per share, which comes around Rs 25,000 (50*500). Since you have paid Rs 7,500 as premium to purchase put option your net profit from entire trade will be Rs 17,500 (Rs 25000- Rs 7500).

Case 2: If stock price of Reliance surges against your expectation to Rs 1450, then your loss would be of Rs 50 per lot if you are holding futures, which comes around Rs 25,000 (50*500). Since you are the holder of the put option, you are not obligated to exercise the options, resulting in limited losses i.e. Rs 7500. This strategy is called as Long Put strategy.

To know more about How Options values are derived. Read more.

 

Open Demat Account

Enter First Name & Last Name
Enter Mobile Number
Enter correct otp
Please enter referal code
Start investing in just 5 mins
Free Demat account, No conditions apply
  • 0%* Brokerage
  • Flat ₹20 per order
Next Article

Option Buyer v/s Option Writer

Option Buyer v/s Option Writer
by Nilesh Jain 21/04/2017
New Page 1

An Option Buyer is someone who buys an option from sellers/ writer. The buyer of an option pays a premium and buys the right of that particular option but is not obliged to writer to exercise the option.

Buyer of an option has limited risk up to the premium paid, and theoretically it can earn unlimited reward if stock/index moves significantly higher (in case of call) and lower (in case of put). The biggest risk is of time decay and drop in volatility. If market remains range bound or near expiry, premium will erode faster due to time decay factor, which will result into negligible profit or may turn into losses.

Options should be bought only when you are confident that stock/index will move significantly either side because if stock/index remains range bound, the premium of both At-The-Money and Out-The-Money options will decrease and become zero till expiry. Advance traders can also buy options if they expect volatility to shoot up.

An Option Writer is someone who sells an option but without holding any long positions, it is like short selling the stock/index. The option writer receives premium and has the obligation to keep the agreement if buyer of an option exercises his rights. Writer of an option has a higher probability of making money compared to an option buyer. Option writers primarily trade on time decay and volatility, while market movement is secondary factor. Following are the two scenarios where option writers can initiate positions:

If he expects stock/index to trade sideways and volatility is expected to go down.

If he expects stock/index to move higher (if a put option) or lower (if a call option).

 

Option Buyer

Option Writer

Risk

Buyer of an option has limited risk (to the extent premium paid)

An Option writer has unlimited risk

Reward

Option buyer has unlimited profit potential

Option writer has limited profit potential (to the extent premium received)

Reward to risk ratio

Option buyer has high reward to risk ratio

Option writer has low reward to risk ratio

Probability

Probability for option buyer of making money will be 33%

Probability for option writer of making money will be 67%

Rights/obligation

Option buyer has right but not an obligation to exercise the option

Option writer has obligation but doesn’t have a right to exercise the option

Margin requirement

Option buyer pays premium to buy options

Option writer has to pay margin money, which will be same as futures (as risk is unlimited like futures).

Time Decay

Time decay works against an option buyer

Time decay works in favour of an option seller

Breakeven

Breakeven is the point where option buyer starts to make money.

It is the exact same point at which option writer starts to lose money.

Following is the payoff table of Option buyer (Long Put Strategy)

Current Nifty Price

Rs 8200

Strike price

Rs 8200

Buy Price

Rs 60

BEP (strike Price - Premium paid)

Rs 8140

Lot size (in units)

75

 

On Expiry Nifty Closes at

Net Payoff from Long put option

7800

340

7900

240

8000

140

8100

40

8140

0

8200

-60

8300

-60

8400

-60

Following is the payoff table of Option Writer (Short put strategy)

Current Nifty Price

Rs 8300

Strike price

Rs 8200

Selling Price

Rs 80

BEP (strike Price - Premium received)

Rs 8120

Lot size (in units)

75

 

On Expiry Nifty Closes at

Net Payoff from sell put option

7800

-320

7900

-220

8000

-120

8100

-20

8200

0

8300

80

8400

80

8500

80

Piece of Advice:

Investors, who have a low risk appetite, should stick to basic strategy like option buying, whereas option writing should only be used by sophisticated investors as risk involved in writing of an option is higher compare to reward.

Open Demat Account

Enter First Name & Last Name
Enter Mobile Number
Enter correct otp
Please enter referal code
Start investing in just 5 mins
Free Demat account, No conditions apply
  • 0%* Brokerage
  • Flat ₹20 per order
Next Article

What Are Mutual Funds And How Does Mutual Fund Work?

What Are Mutual Funds And How Does Mutual Fund Work?
by Prasanth Menon 21/04/2017
New Page 1

Mutual fund is a mechanism for pooling the resources by issuing units to the investors and investing funds in securities in accordance with objectives as disclosed in offer document. A professional Fund Manager manages the pool of money under a Mutual Fund.

A Fund Manager who manages a particular mutual fund invests in securities which are spread across a gamut of cross-section of industries and sectors. This diversification reduces overall risk for an individual investor who opts for a mutual fund. The risk reduces as all stocks might not move in the same direction at a particular time in same proportion.

Investors are allotted units in a Mutual fund with regards to the quantum of money invested by them. Mutual fund investors are also known as unit holders. In this scheme of dealings, investors in proportion to their investments share the profits or losses.

The mutual funds normally come out with a number of schemes with different investment objectives which are launched from time to time. A mutual fund is required to be registered with Securities and Exchange Board of India (SEBI), which regulates securities markets before it can collect funds from the public.

Understanding NAV

Net Asset Value (NAV) signifies the performance of a particular scheme of a mutual fund. In generic terms, NAV is the market value of the securities held by the scheme. One has to remember that, market value of securities changes every day, thus NAV of a scheme also varies on a day-to-day basis.

The NAV per unit is the market value of securities of a scheme divided by the total number of units of the scheme on any particular date. For example, if the market value of securities of a mutual fund scheme is Rs 200 lakh and the mutual fund has issued 10 lakh units of Rs 10 each to the investors, then the NAV per unit of the fund is Rs 20. NAV is required to be disclosed by the mutual funds on a regular basis - daily or weekly - depending on the type of scheme.

Mutual Fund schemes

Mutual Fund schemes can be categorised into open-ended scheme or close-ended scheme depending on its maturity period.

Different types of mutual funds

Open Demat Account

Enter First Name & Last Name
Enter Mobile Number
Enter correct otp
Please enter referal code
Start investing in just 5 mins
Free Demat account, No conditions apply
  • 0%* Brokerage
  • Flat ₹20 per order
Next Article

Beginner's Guide to 80C Tax Saving Instruments

Beginner's Guide to 80C Tax Saving Instruments
by Nutan Gupta 21/04/2017
New Page 1

Section 80C of the Income Tax Act deals with exemptions made on investments. It allows a tax deduction of up to Rs. 1,50,000 on investments made in instruments that qualify in this category. This is to encourage long-term savings among people. However, all the instruments that qualify for a tax deduction under Section 80C have a lock-in period of few years.

Instruments

Lock-in Period

Where it invests

National Savings Certificate (NSC)

5 years

Forms a part of Govt borrowings and deployed as per Govt. requirements

Equity Linked Savings Scheme (ELSS)

3 years

Stock markets

Bank Fixed Deposits

5 years

Deployed as bank sees fit

Public Provident Fund (PPF)

15 years

Forms a part of Govt borrowings and deployed as per Govt. requirements.

Life Insurance Policy

-

-

National Pension System (NPS)

Until the age of 60

Combination of stocks, corporate debt, and government debt, depending on individual choice.

Employee provident fund/ Voluntary provident fund

15 years (employer contribution), or for period of employment (employee share)

Government and PSU bonds

An individual can invest a maximum of Rs. 1.5 lakh in all the above instruments altogether and the entire amount of Rs. 1.5 lakh will be deducted from the individual’s taxable income. The returns generated by all these investments are not fixed.

Suppose an individual earns an annual income of Rs. 12 lakh. If he fails to invest Rs. 1.5 lakhs in 80C instruments, his taxable income would be Rs. 12 lakhs. However, if he manages to invest Rs. 1.5 lakh in tax saving instruments, his income will be taxed on Rs. 10.5 lakh as per the tax slab rates of that particular financial year.

How can one decide which investment is good for them?

Investment depends on one’s risk appetite. If an individual has a high risk-appetite, he can invest in ELSS. The returns of ELSS depend on market fluctuations. However, it gives higher return as compared to any other instrument under section 80C. If an individual has a low risk appetite, he can invest in PPF and Bank FD which gives fixed returns.

The original investment remains tax-free at the time of withdrawal. The taxability of gains differs based on the products one has invested in. The returns earned from PPF are tax-free even on maturity. However, the interest earned on a bank FD and NSC are taxable.

Open Demat Account

Enter First Name & Last Name
Enter Mobile Number
Enter correct otp
Please enter referal code
Start investing in just 5 mins
Free Demat account, No conditions apply
  • 0%* Brokerage
  • Flat ₹20 per order
Next Article

How to Pick the Best Equity Mutual Fund?

How to Pick the Best Equity Mutual Fund?
by Priyanka Sharma 21/04/2017
New Page 1

Choosing the right equity Mutual Fund from a large pool of available equity schemes is perhaps the most crucial aspect of your equity MF investment. To begin with, you need to be clear on factors such as past performance of the scheme, how it compares with peers and the benchmark, the volatility measures and risk adjusted performance of the scheme, scheme size, and expense ratio of the scheme and so on.

Here are some pointers to guide you to pick the right equity MF

Investment basics:

Before you start investing, you need to identify whether the need of the investment is short-term, which could be needed for say the down payment of a car, or long-term (retirement planning or for children’s education or wedding). Also, a lot depends on the extent of risk an investor is willing to undertake and the performance of a scheme over a period of time.

Picking the right fund house:

Do some research and identify fund houses that have a strong presence in the financial world, making them most probable candidates for providing funds that have a reasonably long and consistent track record. Experts argue that when it comes to fund houses, a strong parentage ensures efficient processes and the capability to build a strong business.

The idea is to get a fair assessment of the performance of fund over a period of time. An equity fund could give you over 100% returns at a time when the equity markets were witnessing a bull run, but the same fund might witness a drop in net asset value (NAV) when the markets were volatile. Instead of advising in such funds, it is advisable to look for funds that consistently outperform its benchmark over 3-5 years.

Weigh your options: Risk versus returns

An investment in securities inadvertently comes with certain risks, and for obvious reasons, if returns are not in proportion to the risks taken then the investment is not worth it. A good mutual fund is one which gives better returns than others for the same kind of risk taken. Some indicators of the performance of the MF should used to assess them. These are Sharpe Ratio, which is excess return given by the fund over return given by a risk-free instrument divided by a statistical term called Standard Deviation, which tells how volatile the returns of the fund have been over a period.

Know more about your fund manager:

Do not underestimate the importance of an efficient fund manager. Go through the performance of funds managed by him, especially during periods when markets went through difficult times. An investor should try to find out if a fund manager has expertise over different investment categories, and should gain from it.

Open Demat Account

Enter First Name & Last Name
Enter Mobile Number
Enter correct otp
Please enter referal code
Start investing in just 5 mins
Free Demat account, No conditions apply
  • 0%* Brokerage
  • Flat ₹20 per order
Next Article

All About House Rent Allowance (HRA)

All About House Rent Allowance (HRA)
by Divya Nair 01/06/2017

House Rent Allowance (HRA) is the amount which your employer pays you towards the rent of your accommodation. Every salaried individual living in a rented flat is entitled to claim HRA to save on taxes. HRA is regulated by the provisions of Section 10(13A) of the Income Tax Act.

How Is HRA Decided?

It is decided based on the criteria like salary of the employee and the city of residence of the employee. If the employee resides in a metro city, then he/she is entitled to HRA almost equal to 50% of the salary. For others, HRA entitlement is 40% of the salary.

How To Use HRA To Save Income Tax?

A salaried individual can claim HRA exemptions only if these conditions are met: HRA is received as part of the salary package If an employee stays in a rented house rent paid is more than 10% of the salary.

How Much Of HRA Is Exempt From Income Tax?

The entitled HRA to an employee is not always fully exempt from tax. Employers take into consider the least of the below three heads to exempt tax - HRA received from the employer Actual rent paid less 10% of salary 50% of basic salary for those living in metro cities 40% of basic salary for those living in non-metro cities

Taxable HRA For Mr. X Who Lives In Mumbai
Basic Salary Rs 30,000
HRA Received Rs 13,000
Rent On Accommodation 1,44,000

Hence, Mr.X would get an HRA exemption of Rs 13,000 (the least among the three conditions). You can also save tax by paying rent to your parents, grandparents even if they do not have taxable income. In this case, they will act as your landlord, but the owner of the house should be the one whose name is furnished in the rent receipt.

Documents Required To Claim HRA Benefit -

If the HRA claim is just upto Rs 3,000/month, employees need not furnish any documents. But for amount exceeding this limit, the following documents need to be submitted to the employer -

Rent Receipts:

For HRA tax exemption, employees need to affix a one rupee revenue stamp on rent receipt with details of rented house and landlord like address of rented house, landlord name, amount of rent etc. The rent receipt has to have the signature of the landlord.

Rental Agreement In Some Cases:

If the rent exceeds Rs 15000/month, then PAN details of the landlord is mandatory for claiming HRA exemption.

Open Demat Account

Enter First Name & Last Name
Enter Mobile Number
Enter correct otp
Please enter referal code
Start investing in just 5 mins
Free Demat account, No conditions apply
  • 0%* Brokerage
  • Flat ₹20 per order