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Daily Derivatives Outlook 28 March 2013 Indices Positional Option Trades Nifty Short Strangles Highest Call OI at 5700 SELL Nifty April 5900 CALL and 5400 PUT Highest Put OI at 5600 Short Straddle at 5650 at combined premium of 42 SL 65 MARCH 5700 & 5600 Bullish Stock Option TradesAPRIL 6000 & 5300, 5900 & 5400 5800 & 5500 Buy Hind Unilever 480 CALL at 1.45 Buy Ranbaxy 440 CALL at 7.3MAY 6100 & 5200, 6000 & 5300 5900 & 5400, 5800 & 5500 Buy ITC 300 CALL at 6.3 Buy HDFC 820 CALL at 8.45Bank Nifty Short Strangles Highest Call OI at 11500 Buy Titan 250 CALL at 3.5 Highest Put OI at 11000 Short Straddle at 11200 MARCH Bearish Stock Option Trades 11400 & 10800 11300 & 10900 Buy Reliance 780 PUT at 3.8 USD/INR Highest Call OI at 54 Buy Tata Steel 300 PUT at 1.2 Highest Put OI at 55 Short Straddle at 54.75 Buy Reliance Power 60 PUT at 1.15 Buy DLF 230 PUT at 1.15 APRIL 56.5 & 53 Buy Hero Motors 1550 PUT at 7 56 & 53.5 55.5 & 54 Keynote Capitals Ltd. th The Ruby, 9 Floor, Senapati Bapat Marg, Dadar (W), Mumbai, India – 400028. Tel: 3026 6000 / 2269 4322
READY RECKONER ON OPTION AND TECHNICAL STRATEGIES : INTRODUCTION TO OPTIONS: Options are Wasting Assets with Option Pricing like Insurance Pricing. Strike Price is similar to Age of the Assets. OTM(Out of the Money) are Low Probability strikes (young assets), ATM (At the Money) are equal probability strikes (average age assets) and ITM (In the Money) are High Probability strikes ( old assets). Premium reduces from ITM to ATM to OTM as probability of event happening reduces. Mirror Image Concept : OTM for Calls is same as ITM for Puts and ITM for Calls is same as OTM for Puts. View for Strike Selection : OTM - Strong conviction. ATM - Moderate conviction . ITM – Low Conviction Advantages of Options – Profit from Trading range Markets, High Leverage, Built-in Stop Loss, Higher Probability of Profit using Spread Trades, Increase in trading opportunities due to multiple legs, Lower Margin requirements due to high gearing in options, Increase in Reward to Risk ratio. OPTION INTERNALS: Call-Put Parity : Futures Price = Strike Price + Call Premium – Put Premium Put Call Ratio ( Open Interest) is bullish at levels between 0.8 to 1.2 and bearish between 1.75 to 2. Equilibrium strike is with equal Call and Put Open interest with Highest Call Open interest strike as resistance and Highest Put Open interest as support. Greeks – Delta is the Probability. Gamma is the Change in Delta. Theta is the change in time remaining. Vega is the Change in Volatility (VIX) and Rho is the Change in Interest Rate. If VIX ( Volatility Index) is above average selling options is preferred and if VIX is below average buying options is preferred. The long-term average of the India VIX is around 24. Keynote Capitals Ltd. th The Ruby, 9 Floor, Senapati Bapat Marg, Dadar (W), Mumbai, India – 400028. Tel: 3026 6000 / 2269 4322
Historical Volatility (Realized Volatility) is based on the standard deviation of the underlying asset while Implied Volatility is derived from the option premium traders are willing to pay to hedge their positions. The Put Implied Volatility generally trades at a premium to Call Implied Volatility with panic or fear conditions in the market leading to expansion of the premium. RISK MANAGEMENT: Risk Management using options - Quantify the maximum risk and maximum reward and the breakeven points of a position before committing capital. A risk manager always focuses on how much can be lost in a position. Control the losses and the profits will take care of themselves. Determine an exit strategy in advance for every trade initiated. An exit strategy enables closure of loss-making positions unemotionally so that there is no freeze or panic when confronted with the loss. Stop Loss : Use 50% stop loss for premium paid or received for both one-leg and multiple-leg strategies. ONE-LEG STRATEGIES: Long Call and Long Put are Limited Risk and Unlimited Reward strategies. Short Call and Short Put are Unlimited Risk and Limited Reward strategies. TWO LEG STRATEGIES: Long Synthetic ( Buy ATM Call and Sell ATM Put) and Long Combo( Buy OTM Call and Sell OTM Put) are used to create synthetic long positions which have lower margins than comparable futures positions. Short Synthetic ( Buy ATM Put and Sell ATM Call) and Short Combo( Buy OTM Put and Sell OTM Call) are used to create synthetic short positions which have lower margins than comparable futures positions. Long Straddle, Long Strangle and Long Guts are Long volatility strategies ahead of events/results etc. Short Straddle, Short Strangle and Short Guts are Short volatility strategies when range- bound action is anticipated. Keynote Capitals Ltd. th The Ruby, 9 Floor, Senapati Bapat Marg, Dadar (W), Mumbai, India – 400028. Tel: 3026 6000 / 2269 4322
TWO-LEG FUTURE AND OPTION COMBINATION STRATEGIES: Protective Put and Protective Call protect futures positions by buying options. Covered Call/Ratio Call Write and Covered Put/Ratio Put Write cover futures positions by selling options. They involve unlimited risk and limited reward. Collar is a combination of the Covered Call and the Protective Put or the Covered Put and the Protective Call. TWO-LEG AND THREE- LEG SPREAD STRATEGIES: Bull Call Spread, Ratio Bull Call Spread and Bull Call Ladder are bullish debit spreads which involve buying a lower call option and selling upper call options. Bear Put Spread, Ratio Bear Spread and Bear Ladder are bearish debit spreads which involve buying a upper Put option and selling a lower Put option. Bull Put Spread is a bullish credit spread which involves selling a upper put option and buying a lower put option. Bear Call Spread is a bearish credit spread which involves selling a lower call option and buying a upper call option. Call Ratio Backspread is a credit spread which involves selling one or two lower strike calls (ITM or ATM) and buying two or three upper strike calls.(OTM). Put Ratio Backspread is a credit spread which involves selling one or two upper strike puts (ITM or ATM) and buying two or three lower strike puts.(OTM). FOUR-LEG BUTTERFLY AND CONDOR STRATEGIES: Long Iron Butterfly is a credit strategy using a combination of the Short Straddle and Long Strangle, while in a Long Iron Condor the middle strikes are separated. Short Iron Butterfly is a debit strategy using a combination of the Long Straddle and Short Strangle, while in a Short Iron Condor the middle strikes are separated. Long Call Butterfly involves buying a lower strike call (ITM), selling two middle strike calls (ATM) and buying a upper strike call(OTM). In Long Call Condor the middle strikes are separated. Long Put Butterfly involves buying a lower strike put (OTM), selling two middle strike puts(ATM) and buying a higher strike put (ITM). In Long Put Condor the middle strikes are Keynote Capitals Ltd. th The Ruby, 9 Floor, Senapati Bapat Marg, Dadar (W), Mumbai, India – 400028. Tel: 3026 6000 / 2269 4322
separated. LONG TERM OPTIONS and CALENDAR/DIAGONAL STRATEGIES Long Term Options can be used to create investment grade positions using spreads, synthetics and covered /protective positions. Calendar/Diagonal Calls is a debit spread involving buying a long-dated call option and selling a short-dated call option against it ( Diagonal Calls involve different strikes). Calendar/Diagonal Puts is a debit spread involves buying a long-dated put option and selling a short-dated put option against it ( Diagonal Puts involve different strikes). DELTA HEDGING METHODS The distance between the current market price and the short option breakeven point is divided into equal parts so that futures exposure is increased at consecutive delta adjustment points to ensure that the short option position is totally hedged by the time the breakeven point is reached. The size of the short option position is directly proportional to the distance of the short breakeven point to the current market price. Position size should be maximum at deep-out-of- the money strikes and reduce gradually as the distance to the market price reduces. Short gamma positions carry the maximum risk and using options instead of futures to hedge is advisable since futures does not cover the gap risk, while using ITM options covers the gap risk USING OPTIONS WITH SUPPORT/RESISTANCE AND MOVING AVERAGES: Buy call options at Support ( Bottom-fishing) and above resistance ( Breakout) . Buy Put options at Resistance ( Top-picking) and Below Support ( Breakdown). Moving Average Crossovers – Buy call options if price crosses the moving average from below and buy put options if price crosses moving average from above. The one month options can be linked to the 20dma with the three month options linked to the 50dma and the 1 year options linked to the 200dma. USING OPTIONS WITH OSCILLATORS: RSI – Buy call options when RSI is below 30 and Buy put options when RSI is above 70. The RSI 50 crossover can be used to buy calls on the upside crossover and to buy puts on the downside crossover. MACD and Parabolic SAR early warning buy signals indicate buying of calls ( bottom- Keynote Capitals Ltd. th The Ruby, 9 Floor, Senapati Bapat Marg, Dadar (W), Mumbai, India – 400028. Tel: 3026 6000 / 2269 4322
fishing) and sell signals indicate buying of puts ( top-picking). ADX indicates the strength of the trend and whether the market is in a trending or trading mode. When ADX is above 25 and +DI is above –DI then buy calls and if –DI is above +DI then buy puts. When ADX is below 25, then selling strangles and straddles will be profitable. Widening Bollinger Bands indicate increasing volatility and option buying is advised as a trending move is expected. Flat or Narrowing Bollinger Bands indicate reducing volatility and range-bound option selling strategies are advised. MARKET INTERNALS: Market Breadth Indicators – Volume and Delivery Volume Expansion, Open Interest Expansion and Contraction, Advance/Decline Ratio, 52 Week Highs/Lows. Open Interest Expansion and Contraction Rules – 1. Price Up and Open Interest Up – Long Buildup 2. Price Up and Open Interest Down – Profit Taking 3. Price Down and Open Interest Up – Short Buildup 4. Price Down and Open Interest Down – Short Covering. SECTOR AND STOCK SELECTION: Defensive stocks have low to moderate beta in sectors like FMCG, Healthcare, IT, Cement, Telecom. Cyclical stocks have high beta like Financials and Rate Sensitives like Auto, Infrastructure, Realty. Stock Selection – Invest in the constituents from broadbased indices like Nifty, Junior Nifty and Midcap as well as constituents of Sectoral Indices like Auto, Banking, Capital Goods, IT, FMCG, HC etc. Alpha Strategies - Long Stock and Short Index( Outperformance) or Short Stock and Long Index ( Underperformance). Pair Strategies - Long Stock and Short Stock within the same sector. Keynote Capitals Ltd. th The Ruby, 9 Floor, Senapati Bapat Marg, Dadar (W), Mumbai, India – 400028. Tel: 3026 6000 / 2269 4322
DisclaimerThis document is not for public distribution and has been furnished to you solely for your information and must not be reproduced orredistributed to any other person. Persons into whose possession this document may come are required to observe these restrictions.This material is for the personal information of the authorized recipient, and we are not soliciting any action based upon it. This reportis not to be construed as an offer to sell or the solicitation of an offer to buy any security in any jurisdiction where such an offer orsolicitation would be illegal. It is for the general information of clients of Keynote Capitals Ltd. It does not constitute a personalrecommendation or take into account the particular investment objectives, financial situations, or needs of individual clients.We have reviewed the report, and in so far as it includes current or historical information, it is believed to be reliable though itsaccuracy or completeness cannot be guaranteed. Neither Keynote Capitals Ltd., nor any person connected with it, accepts any liabilityarising from the use of this document. The recipients of this material should rely on their own investigations and take their ownprofessional advice. Price and value of the investments referred to in this material may go up or down. Past performance is not a guidefor future performance. Certain transactions -including those involving futures, options and other derivatives as well as non-investmentgrade securities - involve substantial risk and are not suitable for all investors. Reports based on technical analysis centers on studyingcharts of a stock’s price movement and trading volume, as opposed to focusing on a company’s fundamentals and as such, may notmatch with a report on a company’s fundamentals.Opinions expressed are our current opinions as of the date appearing on this material only. While we endeavor to update on areasonable basis the information discussed in this material, there may be regulatory, compliance, or other reasons that prevent usfrom doing so. Prospective investors and others are cautioned that any forward-looking statements are not predictions and may besubject to change without notice. Our proprietary trading and investment businesses may make investment decisions that areinconsistent with the recommendations expressed herein.We and our affiliates, officers, directors, and employees world wide may: (a) from time to time, have long or short positions in, and buyor sell the securities thereof, of company (ies) mentioned herein or (b) be engaged in any other transaction involving such securitiesand earn brokerage or other compensation or act as a market maker in the financial instruments of the company (ies) discussed hereinor act as advisor or lender / borrower to such company (ies) or have other potential conflict of interest with respect to anyrecommendation and related information and opinions.The analyst for this report certifies that all of the views expressed in this report accurately reflect his or her personal views about thesubject company or companies and its or their securities, and no part of his or her compensation was, is or will be, directly or indirectlyrelated to specific recommendations or views expressed in this report.No part of this material may be duplicated in any form and/or redistributed without Keynote Capitals Ltd’s., prior written consent. Keynote Capitals Ltd. th The Ruby, 9 Floor, Senapati Bapat Marg, Dadar (W), Mumbai, India – 400028. Tel: 3026 6000 / 2269 4322