DERIVATIVES

Derivative security or derivative is a contract which specifies the right or

obligation between two parties to receive or deliver future cash flows (or
exchange of other securities or assets) based on some future event.
Another way of defining a derivative is that it is a security whose value is
determined (derived) from one or more other securities, commodities, or events.
The value is influenced by the features of the derivative contract, which may
include the timing of the contract fulfillment, the value of the underlying security
or commodity, and other factors such as volatility.
The payments between the parties may be determined by the future changes of:
The price of some other, independently traded asset in the future (e.g., a
common stock)
The level of some index (e.g., a stock index or heating-degree-days)
The occurrence of some well-specified event (e.g., a company defaulting)
Some derivatives are the right to buy or sell the underlying security or commodity
at some point in the future for a predetermined price. If the price of the underlying
security or commodity moves into the right direction, the owner of the derivative
makes money; otherwise, they lose money. Depending on the definition of the
contract, the potential loss or gain may be much higher than if they had traded
the underlying security or commodity directly.

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CLASSIFICATION OF DERIVATIVES:
Derivatives are basically classified based upon the mechanism that is used to
trade on them.
They are:
Over the Counter derivatives
Exchange traded derivatives
The OTC derivatives are between two private parties and are designed to suit the
requirements of the parties concerned.
The Exchange traded ones are standardized ones where the exchange sets the
standards for trading by providing the contract specifications and the clearing
corporation provides the trade guarantee and the settlement activities
Common examples of derivatives are:
Forward contracts
Futures contracts
Options such as stock options
Swaps
Some less common, but economically intriguing, examples are:
Economic derivatives which pay off according to the state of the economy
as measured by national statistical agencies
Weather derivatives .

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Three types of investors trade in derivatives markets.
1) Hedgers: Hedgers enter the derivatives market to lock-in their prices to avoid
exposure to adverse movements in the price of an asset. While such locking may
not be extremely profitable the extent of loss is known and can be minimized.
2) Speculators: Speculators take positions in the market. They actually bet on
the direction of price movements. While profits could be extremely high, potential
for losses are also large.
3) Arbitrageurs: Arbitrageurs enter simultaneously into contracts in two or more
markets to lock in risk less profit. In India such gains are minimal as price
differences on NSE and the BSE are extremely small.
FORWARD CONTRACTS
A forward contract is a particularly simple derivative. It is an agreement to
buy or to sell an asset at a certain future time for a certain price. The contract is
usually between two financial institutions and one of its corporate clients. It is not
normally traded on exchange.
One of the parties to a forward contract assumes a long position and
agrees to buy the underlying asset on a certain specified future date for a certain
specified price. The other party assumes a short position and agrees to sell the
asset on the same date for the same price. The specified price in a forward
contract will be referred to as the delivery price. At the time the contract is
entered into the price is chosen so that the value of the forward contract to both
parties is zero. This means that it costs nothing to take either a long or short
position.
A forward contract is settled at maturity. The holder of short position
delivers the asset to the holder of long position in return for a cash amount equal

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to delivery price. A key variable determining the value of a forward contract at
any given time is the market price of the asset. As already mentioned, a forward
contract is worth zero when it is first entered into. Later it can have a positive or
negative value, depending on movements in the price of the asset. For example,
if the price of the asset rises sharply soon after the initiation of contract, the value
of a long position in the forward contract becomes positive and value of a short
position of a forward contract becomes negative.
The main features of forward contracts are
They are bilateral contracts and hence exposed to counter-party risk.
Each contract is custom designed, and hence is unique in terms of
contract size, expiration date and the asset type and quality.
The contract price is generally not available in public domain.
The contract has to be settled by delivery of the asset on expiration date.
In case, the party wishes to reverse the contract, it has to compulsorily go
to the same counter party, which being in a monopoly situation can
command the price it wants.
FUTURES CONTRACT
A futures contract is a form of forward contract, a contract to buy or sell an asset
of any kind at a pre-agreed future point in time that has been standardized for a
wide range of uses. It is traded on a futures exchange. Futures may also differ
from forwards in terms of margin and delivery requirements. To make trading
possible, the exchange specifies certain standardized features of the contract. As
the two parties to the contract do not necessarily know each other, the exchange
also provides the mechanism which gives the two parties guarantee that the
contract will be honored.
For example, Coffee grower may enter into a contract with a wholesale buyer to
sell Coffee at a particular price on a future date. The coffee buyer could have a

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mutually agreed contract with the seller (Forward Contract) or he / she could buy
a contract through a regulated market like the Coffee Futures Exchange India
Limited (COFEI). The National Stock Exchange and the Bombay Stock
Exchange offer such facilities for trading Futures and Options contracts an
underlying financial instrument like stocks/shares.
The types of futures that are traded fall into four fundamentally different
categories. The underlying asset traded may be a physical commodity, foreign
currency, an interest-earning asset or an index, usually a stock index.
A commodity futures contract is an agreement between two parties to buy or
sell a specified quantity and quality of commodity at a certain time in future at a
certain price agreed at the time of entering into the contract on the commodity
futures exchange.
A currency future is a transferable futures contract that fixes the price at which
a foreign currency can be bought or sold at a specified future date. Investors use
these financial future contracts to hedge against foreign exchange risk. These
financial derivatives can also be used to speculate and, by incurring a risk,
attempt to profit from rising or falling exchange rates. Investors can close out the
contract at any time prior to the contract's delivery date.
The futures can be on the interbank cash rate or on the forward exchange rate of
the currency. Currency futures are quoted in US-dollars per unit of foreign
currency.
An interest rate future is a futures contract with an interest bearing instrument
as the underlying asset. Examples include Treasury-bill futures, Treasury-bond
futures, LIBOR futures, Eurodollar futures.

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The attributes in which the futures contracts differ from forwards are:
Attributes Forwards Futures
Contract type Privately traded Exchange traded
Contract term Customized Standard
Price
transparency
Poor Good
Price
discovery
Poor Good
Liquidity Poor Good
Credit Risk High Low
Futures contracts are traded on an exchange. Forward contracts are mutually
agreed between two parties. As expected, the only benefit of entering into a
Forwards contract comes from the flexibility of having tailor-made contracts. Yet,
Forwards are important as prices in Forward markets serve as indicator of
Futures prices. Contracts on Futures markets are fixed in terms of contract size,
product type, product quality, expiry, and mode of settlement. Futures markets,
however, provide liquidity as contracts are traded on a broader client base.
Counter party risk (of non-delivery / non payment) is also eliminated in the
Futures market as the designated clearing house becomes counter party to each
trade that is, it acts as buyer to seller and as a seller to the buyer and guarantees
the trades.

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OPTIONS
An option is a contract whereby the contract buyer has a right to exercise
a feature of the contract (the option) at future date (the exercise date), and the
seller has the obligation to deliver the specified feature of the contract. Since the
option gives the buyer a right and the seller (also known as a writer) an
obligation, the buyer has received something of value. The amount the buyer
pays the seller for the option is called the option premium.
The buyer will exercise his right only if it is favorable to him. If it is not, he will not
exercise his right because he has no obligation. Thus, the underlying asset
moves from to another only when the option is exercised. When it moves from
one counterpart to another, its price (in cash) must move in the opposite
direction. The amount of price in cash is fixed at the time of contract and is called
the strike price or exercise price.
OPTION TYPES
Option type defines the nature of buyers right, which can be
Right to buy the underlying asset, which is called the call option; or
Right to sell the underlying asset, which is called the put option.
A call option is a financial contract between two parties, the buyer and the
seller of the option. The buyer of the option has the right but not the obligation to
buy an agreed quantity of a particular commodity or financial instrument (the
underlying instrument) from the seller of the option at a certain time for a certain
price (the strike price). The seller assumes the corresponding obligations.

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Example of a call option on a stock
If you buy a call option on M&M strike price Rs500, exercise June 1 2005.
If the share price is actually Rs520 on that day (the spot price) then you would
exercise your option (i.e. buy the share from the counter-party). You could then
sell it in the open market for Rs520, i.e. the option would be worth Rs20; your
profit would be Rs20 minus the fee you paid for the option.
If however the share price is only Rs480 then you would not exercise the option
(if you really wanted to own such a share, you could buy it in the open market for
Rs480, why waste Rs500 on it). The option would expire worthless.
Thus, in any future state of the world, you would be certain not to lose money on
the underlying by owning the option; your loss is limited to the fee you have paid.
From the above, it is clear that a call option has positive monetary value when
the underlying instrument has a spot price above the strike price. The option will
not be exercised unless it is "in-the-money".
A put option is a financial contract between two parties, the buyer and the
seller of the option. The put allows the buyer the right but not the obligation to sell
a commodity or financial instrument (the underlying instrument) to the seller of
the option at a certain time for a certain price (the strike price). The seller
assumes the corresponding obligations.
Example of a put option on a stock
You enter a contract to have the option to sell a share in M&M on June 1, 2005,
for Rs500.
If the M&M share price is actually only Rs480 on that day, then you would
exercise the option (i.e. sell the share from the counter-party). You could then
buy another share in the open market for Rs480, i.e. the option would be worth
Rs20; your profit would be Rs20 minus the fee you paid for the option.

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If, however, the share price is more than the option price, say, Rs520, then you
would not exercise the option. If you really wanted to sell such a share, you could
do so in the open market for Rs520, and make more profit than you would by
selling through the option. Your option would be worthless and you would have
lost your whole investment, the fee for the option.
Thus, in any future state of the world, you would be certain not to lose money by
owning the option; your loss is limited to the fee you have paid.
This example illustrates that the put option has positive monetary value when the
underlying instrument has a spot price below the strike price. The option will not
be exercised unless it is "in-the-money".
Option Feature
In other contracts, the focus is on underlying asset and each counterpart has
right and obligation (r&o) to perform. For example, in futures contract, the buyer
has the right and obligation to buy; and seller, the right and obligation to sell.
Option contract differs from others in two respects. The primary focus is on r&o,
not on underlying asset. Second, the r&o are separated, with buyer taking the
right without obligation (r w/o o) and seller taking the obligation without right.
Thus, the distinguishing feature of option is the right-without-obligation for the
buyer.
In option contract, what the buyer buys is the right, not the underlying asset; and
what the seller sells is the right, not the underlying asset.

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Exhibit 1: Option v Other Contracts
The option contract
For the option purchaser (also called the holder or taker), the option:
Offers the right (but imposes no obligation),
To buy (call option) or sell (put option)
A specific quantity,
Of a given financial underlying.
At an agreed price (exercise or strike price), or calculable value (based on
a reference rate)
Either before maturity date (American option) or at a fixed maturity date
(European option)
For a premium (option price).
The counterparty (option writer / seller) has an obligation to fulfill if the
option holder exercises the option. In return, the option seller receives the
option price or premium.

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Exhibit 2. Flows between Option Buyer and Seller
PAY-OFFS FOR OPTION CONTRACTS
CALL OPTION

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PUT OPTION
OPTION FRAMEWORKS
The buyer assumes a long position, and the seller a corresponding short
position. (Thus the seller of a call is "short a call" and has the obligation to sell to
the holder, who is "long of a call option" and who has the right to buy. The writer
of a put is "on the short side of the position", and has the obligation to buy from
the taker of the put option, who is "long a put".)
The option style will affect the terms and valuation. Generally the contract
will either be American style - which allows exercise before the maturity date - or
European style - where exercise is on a fixed maturity date. European contracts
are easier to value and therefore to price. The contract can also be on an exotic
option.

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Buyers and sellers of options do not (usually) interact directly; the options
exchange acts as intermediary and quotes the market price of the option. The
seller guarantees the exchange that he can fulfill his obligation if the buyer
chooses to execute.
The risk for the option holder is limited: he cannot lose more than the
premium paid as he can "abandon the option". His potential gain is theoretically
unlimited; see strike price.
The maximum loss for the writer of a put option is equal to the strike price.
In general, the risk for the writer of a call option is unlimited. However, an option
writer who owns the underlying instrument has created a covered position; he
can always meet his obligations by using the actual underlying. Where the seller
does not own the underlying on which he has written the option, he is called a
"naked writer", and has created a "naked position".
Options can be in-the-money, at-the-money or out-of-the-money. The "in-
the-money" option has a positive intrinsic value, options in "at-the-money" or
"out-of-the-money" has an intrinsic value of zero. Additional to the intrinsic value
an option has a time value, which decreases, the closer the option is to its expiry
date (also see Option time value).
OPTION USES
One can combine options and other derivatives in a process known as
financial engineering to control the risk in a given transaction. The risk taken on
can be anywhere from zero to infinite, depending on the combination of
derivative features used.

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By using options, one party transfers (buys or sells) risk to or from
another. When using options for insurance, the option holder reduces the risk he
bears by paying the option seller a premium to assume it.
Because one can use options to assume risk, one can purchase options to
create leverage. The payoff to purchasing an option can be much greater than by
purchasing the underlying instrument directly. For example buying an at-the-
money call option for $2 per share for a total of $200 on a security priced at $20,
will lead to a 100% return on premium if the option is exercised when the
underlying security's price has risen by $2, whereas buying the security directly
for $20 per share, would have lead to a 10% return. The greater leverage comes
at the cost of greater risk of losing 100% of the option premium if the underlying
security does not rise in price.

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RISK MANAGEMENT USING OPTIONS
HEDGING STRATEGY:
Options are an effective tool for hedging the risk in a stock or portfolio of
stock. Options basically have characteristics of an insurance policy. When we
buy an option contract we buy an assurance that any fall below a specified price
(in case of put option), or any rise above the specific price (in case of call option)
would be compensated by the option writer. We have to pay a premium, which is
the cost of hedging against a potential loss for such an assurance.
1. HAVE PORTFOLIO, BUY PUTS
This is a risk management strategy to protect your portfolio from falling below a
particular level. This is done by buying the right number of put options with the
right strike price. When the index falls your portfolio will lose value and the put
options bought by you will gain, effectively ensuring that the value of your
portfolio does not fall below a particular level. This level depends on the strike
price chosen by you.
E.g.: Assume we have a portfolio with beta 1.2 which we would like to insure
against a fall in the market.
How do we do this?
First chose the strike at which we should buy puts. This is largely a function of
how safe we want to play. Assume that the spot Nifty is 1200 and we decide to
buy puts with a strike of Rs.1140. This will insure our portfolio against an index
fall lower than Rs.1140.
No. of puts to buy = (portfolio value x portfolio beta)/ Index. Assume our portfolio
is worth Rs. 1 million with a beta of 1.2. Hence we have to buy (10, 00,000 x

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1.2)/1200 which works out to be 1000. As each market lot is 200 units, we have
to buy (1000/200) = 5 market lots with a strike of 1140.
What is the outcome?
By buying Nifty puts at a strike of 1140 (which is 5% lesser than 1200, the Nifty
spot) we ensure that the value of our portfolio does not decline below Rs. 0.94
million. (I.e. 6% fall from Rs. 1 million). This is because for a portfolio of beta 1.2,
an index fall of 5% translates into a 6% fall in the portfolio value.
Suppose the Nifty drops to 1080. The portfolio value will decline to Rs.0.88
million. (Again, since beta is 1.2, a 10% fall in the index translates to a 12% fall in
the portfolio value).
However the option provides a payoff of (1140 1080)* 5 *200 which is
equal to Rs. 60,000. This is the amount needed to bring back the value of the
portfolio back to Rs.0.94 million from 0.88 million (i.e. 8, 80,000 + 60,000 = 9,
40,000).
Note that although the upside is unlimited, the downside is limited only to the
premium paid. For instance if the Nifty rose to 1280, the investor would simply let
the puts expire. He would of course lose the put premium paid upfront but this is
the cost of buying insurance.
2. HAVE FUNDS, BUY CALLS
If you have funds, you can invest in some risk free investment
products like bank deposits and govt. bonds, and at the same time buy call
options on stocks by paying some premium. The premium cost will be
compensated by the return obtained from the money invested, and you are
assured to get all the gains from the upside move in the price of the stock
For example

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You have Rs. 2, 00,000 to invest. You put 1, 92,800 as fixed deposit with a bank
at 8% for one year. You buy one-year call option for 600 shares of Reliance with
a strike of Rs.330 by paying a premium of Rs. 12 per share. You thus pay Rs.
7200 (i.e. 12 x 600).
After one year you get Rs. 2, 08,224 from the bank. If the price of Reliance at
that time is more than Rs.330, you will exercise your option and buy the shares
at Rs. 330 each and sell them in the market thus gaining the difference. In case
the price of Reliance is less than Rs.330, you will allow the option to expire.
STRATEGIES FOR SPECULATION
Two most popular methods of doing speculation using options are Spread
trading and Combination trading.
SPREAD TRADING
Spread trading involves taking a position in two or more options of the
same type (call or put) at the same time. The most popular spread trading
strategies are:
Bull spread
Bear spread
Butterfly spread and
Calendar spread.
BULL SPREAD:
A bull spread is created when the trader is expecting the prices to rise. This is
done by:
BUYING A CALL WITH LOWER STRIKE PRICE.SELLING A CALL AT
HIGHER STRIKE PRICE.

How is it done?

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Suppose the spot price of ITC is Rs.750 and a trader expects that the
price will rise. He buys 100 calls with strike price of Rs. 775 at Rs. 5 per share
and sells 100 calls with a strike price of Rs.790 at Rs. 2 per share.
He pays a premium of Rs. 500 (i.e. 5 x 100) on the calls bought and receives Rs.
200 (i.e. 2 x 100) premium on calls sold. Thus he incurs an initial cost of Rs.300
as premium differential.
If the price of ITC moves to Rs.800
He would gain (800 775)*100 = Rs. 2500 on the calls bought, and lose (800-
790)*100 = Rs.1000 on calls sold. Thus his gain would be 2500 1000 = Rs.
1500. After deducting the initial premium cost of Rs. 300, his net profit would
sum up to 1500 300 = Rs. 1200.
If the price remains below Rs. 775 he loses Rs.300.(only premium paid). In this
strategy his maximum gains would be Rs. 1200 i.e. when price is Rs. 790 or
more and maximum loss would be Rs.300 when the price is Rs. 775 or less.
BEAR SPREAD:
A bear spread is created when the trader is expecting the prices to fall. This is
done by:
BUYING A CALL WITH HIGHER STRIKE PRICE. SELLING A CALL AT
LOWER STRIKE PRICE.
How is it done?
Suppose the spot price of ITC is Rs.850 and a trader expects that the
price will fall. He buys100 calls with strike price of Rs. 790 at Rs. 2 per share and
sells 100 calls with a strike price of Rs.775 at Rs. 5 per share.
He pays a premium of Rs. 200 (i.e. 2 x 100) on the calls bought and receives Rs.
500 (i.e. 5 x 100) premium on calls sold. Thus he initially gains Rs.300 as
premium differential.

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If the price of ITC falls to Rs.800
He would gain (800 790)*100 = Rs. 1000 on the calls bought, and lose (800-
775)*100 = Rs.2500 on calls sold. Thus he loses 2500 1000 = Rs. 1500. After
deducting the initial premium gain of Rs. 300, his net loss would sum up to 1500
300 = Rs. 1200.
If the price remains below Rs. 775 he gains Rs.300.(only premium paid). In this
strategy his maximum gains would be Rs. 300 i.e. when price is Rs. 775 or less
and maximum loss would be Rs.1200 when the price is Rs. 790 or more.
BUTTERFLY SPREAD
This spread is created when the market is not likely to move in either direction.
This is done by:
BUYING ONE CALL WITH RELATIVELY LOWER STRIKE PRICE (L).
BUYING ONE CALL WITH RELATIVELY HIGHER STRIKE PRICE (H).
SELLING TWO CALLS AT PRICE (M) WHICH IS BETWEEN PRICE (L) AND
PRICE (H).
How is it done?
Suppose the spot price of ITC is Rs.750. A Trader buys100 calls with
strike price of Rs. 775 at Rs.2 per share and sells 100 calls with a strike price of
Rs.725 at Rs. 13 per share and sells two calls with a strike price of Rs. 750 at a
premium of Rs.5.
He pays a premium of Rs. 1500 (i.e. 2 x 100 + 13 x 100) on the calls bought and
receives Rs. 1000 (i.e. 5 x 200) premium on calls sold. Thus he incurs an initial
cost of Rs.500 as premium differential.
If the price of ITC stays at Rs.750
He would lose (775 - 750)*100 = Rs. 2500 on the first call bought, and gain (750-
725)*100 = Rs.2500 on the second call bought and gain 25000 on 2 calls sold

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Thus his gain would be Rs.2000. After deducting the initial premium cost of Rs.
500, his net profit would sum up to 2500 500 = Rs. 2000
If the price remains below Rs. 725 or above Rs. 775 he would lose
Rs.500.(only premium paid). In this strategy his maximum gain would be Rs.
2000 i.e. when price is Rs. 750 and maximum loss would be Rs.500 when the
price is above Rs. 775 or below Rs. 725.
CALENDAR SPREAD:
A calendar spread is created by
SELLING A NEAR MONTH CALL OPTION WITH A CERTAIN STRIKE PRICE
BUYING A FAR MONTH CALL OPTION WITH SAME STRIKE PRICE.
The far month option with same strike would be expensive than the near month
option, thus involving an initial investment of premium differential. Both the
options are exercised at the maturity of the near month option.
In this case a trader will make maximum profits if market price is equal to the
strike price at maturity of the near month option. The option sold will have no
value, whereas the longer maturity option will be quite valuable.
In case the current price is far away from the strike price on maturity of near
month option, the trader will incur loss, which may be equal or less than the
premium differential.
A trader may also create a reverse calendar spread, i.e. buying the near month
option and selling the far month option. In this case his gains would be maximum
if the price on the maturity of near month option is far away from the strike price.
A calendar spread may be a bullish spread (strike price > current price), bear
spread (strike price < current price) or a neutral spread (where strike price is
equal or near to current price).

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COMBINATION TRADING
A combination is an option trading strategy that involves taking a position
in both calls and puts on the same stock. The most popular combinations are:
STRADDLE:
Straddle is an appropriate strategy for an investor who expects a large move in
the index but does not know in which direction the move will be. Straddle
involves:
BUYING A PUT AND CALL WITH THE SAME STRIKE PRICE AND SAME
EXPIRATION DATES.
How does this work?
Suppose the spot price of TISCO is Rs. 1100. A trader is expecting a big
move in the price. To take advantage of the expected volatility, he buys 100 puts
and 100 calls with a strike of Rs. 1100 by paying a premium of Rs 25 each for
both the options. He incurs an initial cost of Rs.5000 towards premium. Any
move of prices above Rs. 1150 and below Rs. 1050 will give a profit to the trader.
If there is no change in price he will incur a loss equal to the premium paid (i.e.
Rs. 5000).
STRIPS:
A strip consists of:
A LONG POSITION IN ONE CALL AND TWO PUTS WITH SAME STRIKE
AND EXPIRATION DATES.

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This is a variation of straddle, and is used when the chances of price
going down are more than the chances of it going up. In case of no move in
prices he loses most. In case of down move his profits are double as compared
to what he would gain if the price moves up.
STRAPS:
A strap consists of:
A LONG POSITION IN TWO CALLS AND ONE PUT WITH SAME STRIKE
AND EXPIRATION DATES.
This is a reverse position of a strip, and is used when the chances of price
going up are more than the chances of it going down. In case of no move in
prices he loses most. In case of an up move his profits are double as compared
to what he would gain if the price goes down.
STRANGLES:
BUYING A PUT AND A CALL WITH SAME EXPIRATION DATES AND
DIFFERENT STRIKE PRICES.
Call strike is higher than the put strike. Higher call strikes mean lower premium
and lower put also means lower premium. Thus the initial outflow and the
maximum potential loss is much lower in strangle as compared to a straddle.
Accordingly, for realising similar gains as in a straddle, the prices should move
much farther as compared to a straddle.

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RESEARCH DESIGN
STATEMENT OF PROBLEM
Derivatives were considered risky for retail investors because of their poor
knowledge about their operation. In spite of these encouraging developments,
industry analysts felt that the derivatives market had not yet realized its full
potential. Analysts pointed out that the equity derivative markets on the BSE and
NSE had been limited to only four products - index futures, index options and
individual stock futures and options which were limited to certain select stocks.
This project studies about option derivatives. This project shows how
options are useful especially for speculators, who actually bet on the direction of
price movements. While profits could be extremely high, potential for losses are
also large. A model is to be developed which helps in trading in option derivative
market. It should give the pay-off for not only individual options but also for
combination of options. And to know which option combination strategy would be
suitable when market moves up or down.
OBJECTIVES OF THE STUDY
To know which scrips are been most actively traded in options.
To find the optimum portfolio of those scrips.
To calculate the pay-off for all the options on the scrips.

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Find appropriate combination of options which are more profitable.
Compare investment and returns of the portfolio with that of the
combination of options.
SCOPE OF THE STUDY
The study tries to find the best option combination for the selected scrips,
which have maximum profits. It also compares the returns and investment
between portfolio of scrips and option combination. This study can also be
extended to other scrips and hence forth find the option combination which is
most profitable. The study is limited to ten companies, which are most actively
traded in National Stock Exchange.
RESEARCH METHODOLOGY
Type of research
This study requires more formalized and typically structured with clearly
stated hypothesis. And hence descriptive study is more suitable which helps in
descriptions of characteristics associated with the subject population. Also helps
in associations among different variables.
SOURCES OF DATA:
Secondary data
The data was collected through secondary sources. As this project was a
descriptive study conducted, there was no questionnaire used to collect primary
data or any other additional data. The secondary data source is through internet,
from website of National Stock Exchange.

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SAMPLING PLAN
The stock prices of the last 104 weeks. (10-May-2003 to 9-may-2005)
The nifty index from 10-May-2003 to 9-may-2005
Put and call options of the companies, options for each company having
same strike price and same expiry date.
All the stocks and options have been selected from National Stock
Exchange.
SAMPLE SELECTION
Non-probabilistic convenient sampling.
PLAN OF ANALYSIS:
The collected information was tabulated and analyzed in detail. Various
tabulations have been used to explain the findings clearly. Hypothesis testing has
been done to provide adequate support for the findings of the study. Some of the
statistical techniques used were as follows:
Single index model
T-test for equality of means
ANOVA.
Theoretical background is one of the important parts of the dissertation.
The very basic purpose of this is to gain an insight and provide an overview of
the study carried on. It helps the researcher to gain strong theoretical basis of the
problem study.
LIMITATIONS OF THE STUDY:
The study gives the model for construction of portfolio and combination of
options comprising of only equities.
The study limits to only ten companies from the ocean of the stock market.

25
The study limits to options with same expiry date, same strike price and
confined to only NSE.
GLOSSARY
AMERICAN STYLE OPTION
An option that can be exercised at any time from inception as opposed to a
European Style option which can only be exercised at expiry. Early exercise of
American options may be warranted by arbitrage. European Style option
contracts can be closed out early, mimicking the early exercise property of
American style options in most cases.
BETA
A measure of a security's or portfolio's volatility, or systematic risk, in comparison
to the market as a whole. It is also known as "beta coefficient."
EUROPEAN STYLE OPTION
An option that can be exercised only at expiry as opposed to an American Style
option that can be exercised at any time from inception of the contract. European
Style option contracts can be closed out early, mimicking the early exercise
property of American style options in most cases.
EXERCISE PRICE

26
The exercise price is the price at which a call's (put's) buyer can buy (or sell) the
underlying instrument.
MARGIN
A credit-enhancement provision to master agreements and individual
transactions in which one counterparty agrees to post a deposit of cash or other
liquid financial instruments with the entity selling it a financial instrument that
places some obligation on the entity posting the margin.
PREMIUM
The cost associated with a derivative contract, referring to the combination of
intrinsic value and time value. It usually applies to options contracts. However, it
also applies to off-market forward contracts.
STRIKE PRICE
The price at which the holder of a derivative contract exercises his right if it is
economic to do so at the appropriate point in time as delineated in the financial
product's contract.

27
CHAPTER SCHEME
Chapter: 1 THEORETICAL BACKGROUND OF THE STUDY
This chapter mainly deals with secondary data collected to support the
study and the reasons to problem of study. It explains option derivatives in detail
along with brief description of other derivatives.
Chapter: 2 RESEARCH DESIGN
A research design serves as a bridge between what has been done in the
conduct of study to realize the specified objectives. It is an outline of the projects
working.
Chapter: 3 PROFILES
This chapter includes the profile of the industry in which the study is
conducted. It gives a brief idea of the capital market, emergence of derivatives
market and derivatives market in India.
Chapter: 4 ANALYSIS AND INTERPRETATION
In this chapter a detailed analysis is done to know the pay-offs of the
option combination strategies. Model is prepared to know which option strategy is

28
most profitable. Hypothesis testing has been done using the T-test, and also
ANOVA.
Chapter: 5 SUMMARY OF FINDINGS, CONCLUSIONS AND SUGGESTIONS
In this chapter we will actually include all that we have analyzed and what
has been found. Finally conclude checking whether the objective of developing
the option strategy model has been achieved or not.
INDUSTRY PROFILE
INDIAN CAPITAL MARKET
The function of the financial market is to facilitate the transfer of funds
from surplus sectors (lenders) to deficit sector (borrowers). Normally, household
has excess of funds or savings, which they lend to borrowers in the corporate
and public sector whose requirement of funds far exceeds their savings. A
financial market consists of investors or buyers, sellers, dealers and does not
refer to a physical location. As elsewhere in the world, the Indian financial system
consists of the money market and capital market.
The capital market consists of primary market and secondary market
segments. The primary market deals with the issue of new instruments by the
corporate sector such as equity shares, preference shares and debentures. The
public sector consisting of central and state governments, various public sector
industrial units (PSUs), statutory and other authorities such as state electricity
boards and port trust also issue bonds. The primary market in which public issue
of securities is made through a prospectus is a retail market and there is no
physical location. Direct mailing, advertisements and brokers reach the investors.
Screen based trading eliminates the need of trading floor.

29
The secondary market or stock exchange where existing securities are
traded is an auction arena. Since 1995, trading in securities is screen based.
Screen based trading has also made an appearance in India. The secondary
markets consist of 23 stock exchanges including the NSE and OTCEI and Inter
Connected Stock Exchanges of India ltd. The secondary market provides a
trading place for the securities already issued to be bought and sold. It also
provides liquidity to the initial buyers in the primary market to re-offer the
securities to any interested buyer at a price, if mutually accepted. An active
secondary market actually promotes the growth of the primary market and capital
formation because investors in the primary market are assured of a continuous
market and they can liquidate their investments in the stock exchange.
DERIVATIVES MARKET
EMERGENCE OF DERIVATIVES MARKET
With globalization of the financial sector, it's time to recast the architecture
of the financial market. The liberalized policy being followed by the Government
of India and the gradual withdrawal of the procurement and distribution channel
necessitated setting in place a market mechanism to perform the economic
functions of price discovery and risk management. Till the mid 1980's, the
Indian financial system did not see much innovation. In the last 18 years,
financial innovation in India has picked up and it is expected to grow in the years
to come, as a more liberalized environment affords greater scope for financial
innovation at the same time financial markets are, by nature, extremely volatile
and hence the risk factor is an important concern for financial agents. To reduce
this risk, the concept of derivatives comes into the picture. Derivatives are
products whose values are derived from one or more basic variables called
bases. India is traditionally an agriculture country with strong government
intervention. Government arbitrates to maintain buffer stocks, fix prices, impose
import-export restrictions, etc.

30
Derivatives are financial contracts whose values are derived from the
value of an underlying primary financial instrument, commodity or index, such as:
interest rates, exchange rates, commodities, and equities. Derivatives include a
wide assortment of financial contracts, including forwards, futures, swaps, and
options. The International Monetary Fund defines derivatives as "financial
instruments that are linked to a specific financial instrument or indicator or
commodity and through which specific financial risks can be traded in financial
markets in their own right. The value of financial derivatives derives from the
price of an underlying item, such as asset or index. Unlike debt securities, no
principal is advanced to be repaid and no investment income accrues." While
some derivatives instruments may have very complex structures, all of them can
be divided into basic building blocks of options, forward contracts or some
combination thereof. Derivatives allow financial institutions and other participants
to identify, isolate and manage separately the market risks in financial
instruments and commodities for the purpose of hedging, speculating, arbitraging
price differences and adjusting portfolio risks.
The emergence of the market for derivatives products, most notable
forwards, futures, options and swaps can be traced back to the willingness of
risk-averse economic agents to guard themselves against uncertainties arising
out of fluctuations in asset prices. By their very nature, the financial markets can
be subject to a very high degree of volatility. Through the use of derivative
products, it is possible to partially or fully transfer price risks by locking-in asset
prices. As instruments of risk management, derivatives products generally do not
influence the fluctuations in the underlying asset prices. However, by locking-in
asset prices, derivatives products minimize the impact of fluctuations in asset
prices on the profitability and cash flow situation of risk-averse investors
Factors generally attributed as the major driving force behind growth of
financial derivatives are:
(a) Increased Volatility in asset prices in financial markets,

31
(b) Increased integration of national financial markets with the international
markets,
(c) Marked improvement in communication facilities and sharp decline in their
costs,
(d) Development of more sophisticated risk management tools, providing
economic agents a wider choice of risk management strategies, and
(e) Innovations in the derivatives markets, which optimally combine the risks and
returns over a large number of financial assets, leading to higher returns,
reduced risk as well as transaction costs as compared to individual financial
assets.
Development of exchange-traded derivatives
Derivatives have probably been around for as long as people have been
trading with one another. Forward contracting dates back at least to the 12th
century, and May well have been around before then. Merchants entered into
contracts with one another for future delivery of specified amount of commodities
at specified price. A primary motivation for pre-arranging a buyer or seller for a
stock of commodities in early forward contracts was to lessen the possibility that
large swings would inhibit marketing the commodity after a harvest.
The need for a derivatives market
The derivatives market performs a number of economic functions:
1. They help in transferring risks from risk adverse people to risk oriented
people
2. They help in the discovery of future as well as current prices
3. They catalyze entrepreneurial activity
4. They increase the volume traded in markets because of participation
of risk adverse people in greater numbers
5. They increase savings and investment in the long run

32
Types of Derivatives
Derivative contracts have several variants. The most common variants are
forwards, futures, options and swap.
DERIVATIVES MARKET IN INDIA
Derivatives markets have had a slow start in India. The first step towards
introduction of derivatives trading in India was the promulgation of the Securities
Laws (Amendments) Ordinance, 1995, which withdrew the prohibition on options
in securities. The market for derivatives, however, did not take off, as there was
no regulatory framework to govern trading of derivatives. SEBI set up a 24-
member committee under the Chairmanship of Dr. L.C. Gupta on 18th November
1996 to develop appropriate regulatory framework for derivatives trading in India.
The committee recommended that derivatives should be declared as 'securities'
so that regulatory framework applicable to trading of 'securities' could also
govern trading of securities. SEBI was given more powers and it starts regulating
the stock exchanges in a professional manner by gradually introducing reforms in
trading. Derivatives trading commenced in India in June 2000 after SEBI granted
the final approval in May 2000. SEBI permitted the derivative segments of two
stock exchanges, viz NSE and BSE, and their clearing house/corporation to
commence trading and settlement in approved derivative contracts.
Following the committee's recommendations, the Securities Contract
Regulation Act (SCRA) was amended in 1999 to include derivatives within the

33
scope of securities, and a regulatory framework for administering derivatives
trading was laid out. The act granted legality to exchange-traded derivatives, but
not OTC (over the counter) derivatives. It allowed derivatives trading either on a
separate and independent derivatives exchange or on a separate segment of an
existing stock exchange. The derivatives exchange had to function as a self-
regulatory organization (SRO) and SEBI acted as its regulator. The responsibility
of clearing and settlement of all trades on the exchange was given to the clearing
house which was to be governed independently.
Introduction of derivatives was made in a phase manner allowing investors
and traders sufficient time to get used to the new financial instruments. On June
9, 2000, the Bombay Stock Exchange (BSE) introduced India's first derivative
instrument - the BSE-30(Sensex) index futures. It was introduced with three
month trading cycle - the near month (one), the next month (two) and the far
month (three). The National Stock Exchange (NSE) followed a few days later, by
launching the S&P CNX Nifty index futures on June 12, 2000.The trading in index
options commenced in June 2001 and trading in options on individual securities
commenced in July 2001. Futures contracts on individual stock were launched in
November 2001. In June 2003, SEBI/RBI approved the trading in interest rate
derivatives instruments and NSE introduced trading in futures contract on June
24, 2003 on 91 day Notional T-bills. Derivatives contracts are traded and settled
in accordance with the rules, bylaws, and regulations of the respective
exchanges and their clearing house/corporation duly approved by SEBI and
notified in the official gazette. The plan to introduce derivatives in India was
initially mooted by the National Stock Exchange (NSE) in 1995. The main
purpose of this plan was to encourage greater participation of foreign institutional
investors (FIIs) in the Indian stock exchanges.
Their involvement had been very low due to the absence of derivatives for
hedging risk. However, there was no consensus of opinion on the issue among
industry analysts and the media. The pros and cons of introducing derivatives

34
trading were debated intensely. The lack of transparency and inadequate
infrastructure of the Indian stock markets were cited as reasons to avoid
derivatives trading. Derivatives were also considered risky for retail investors
because of their poor knowledge about their operation. In spite of the opposition,
the path for derivatives trading was cleared with the introduction of Securities
Laws (Amendment) Bill in Parliament in 1998.
The introduction of derivatives was delayed for some more time as the
infrastructure for it had to be set up. Derivatives trading required a computer-
based trading system, a depository and a clearing house facility. In addition,
problems such as low market capitalization of the Indian stock markets, the small
number of institutional players and the absence of a regulatory framework
caused further delays. Derivatives trading eventually started in June 2000. The
introduction of derivatives was well received by stock market players. Trading in
derivatives gained substantial popularity, and soon the turnover of the NSE and
BSE derivatives markets exceeded the turnover of the NSE and BSE cash
markets. For instance, in the month of January 2004, the value of the NSE and
BSE derivatives markets was Rs.3278.5 billion (bn) whereas the value of the
NSE and BSE cash markets was only Rs.1998.89 bn.
In spite of these encouraging developments, industry analysts felt that the
derivatives market had not yet realized its full potential. Analysts pointed out that
the equity derivative markets on the BSE and NSE had been limited to only four
products - index futures, index options and individual stock futures and options
which were limited to certain select stocks.
Few of the commodity-derivatives exchanges are:
National Commodity & Derivatives Exchange Limited (NCDEX)
National Multi Commodity Exchange of India Limited (NMCEIL)
Multi Commodity Exchange of India Limited (MCX)

35
And the products traded are: Agro products such as Basmati Rice, Castor Oil,
Chana, Coffee Cotton, Crude Oil, Gaur, Gur, Jeera, Jute, Maize, Mustard, Peas,
Pepper, Red Chilli, Rice, Rubber, Soya beans, Sugar, Turmeric, Urad, Wheat,
Metal products such as Copper, Gold, Silver, Steel. Etc.
ANALYSIS AND INTERPRETATION
SINGLE INDEX MODEL
It is necessary to know the assumptions made before we use the model to find
the optimum portfolio.
ASSUMPTIONS
The companies selected have not issued any dividends to its share
holders from past 104 weeks (10-may-2003 to 9-may-2005).
The market risk free rate of return is 6.5%
No bonus shares are issued.
No splitting of shares has taken place from past 104 weeks
No such activity has taken place where the numbers of outstanding shares
will change.
This model helps in selecting the stocks to construct an optimal portfolio
which is the best way to forecast the co-variance structure of returns.
Steps:

36
1) Find the excess return to beta ratio for each stock under consideration
and rank from highest to lowest.
2) The optimal portfolio consists in investing in all stocks from which excess
return to beta ratio is greater the particular cut-off ratio C*.
THE FORMATION OF OPTIMAL PORTFOLIO:
In this model the desirability is directly related to the excess return to Beta
ratio. Excess return is difference between the expected return of the stock and
the riskless rate of interest. (T-bill). The excess return to Beta ratio measures the
additional return on a security for every unit of non-divisible risk.
Excess return to Beta =
i
f i
R R

Where
Ri = Expected return on stock i,
Rf = Risk free return,
i = The expected change in the return on stock i associated with 1% change in
market return.
If the stocks are ranked according to the excess return to beta ratio, the
ranking represents the desirability of any stocks inclusion in the portfolio. In other
words if a stock with the particular ratio is included in the portfolio all the stocks
with a higher ratio will also be included. And if a stock with a particular ratio is
excluded all stocks with lower ratio will be excluded. How many stocks are
selected depends on the unique CUT-OFF rate.
RANKING SECURITES:
In the table below, the values of sample that illustrate the procedure. It is
the normal output generated by a single index or a beta model, plus the ratio of

37
excess return to beta. This ranking process is the base for the construction of the
portfolio.
Table 1 Ranking of securities on Excess return to beta ratio
Rank
Security
no
Security
Mean
Return
Excess
Return
Beta
Excess return
to beta

1
2
ARVIND MILLS LTD 0.28%
0.26%
1.24609
0.21%
2
7
ICICI 0.19%
0.16%
0.90704
0.18%
3
8
M&M 0.19%
0.17%
1.08246
0.16%
4
10
TISCO 0.21%
0.18%
1.32129
0.14%
5
3
SATYAM COMPUTERS 0.16%
0.14%
1.05077
0.13%
6
6
ONGC 0.12%
0.10%
1.09445
0.09%
7
1
SBI 0.11%
0.09%
1.27080
0.07%
8
5
RELIANCE INDUSTRIES 0.08%
0.05%
1.06079
0.05%
9
9
RANBAXY 0.02%
-0.01%
0.53802
-0.02%
10
4
HLL -0.06%
-0.09%
0.63140
-0.14%
There are 10 stocks in the table which have already been ranked on the
basis of excess return to beta. The application of the step 2 involves the
comparison of the excess return to beta ratio with the C*(CUT-OFF RATE).

SETTING THE CUT-OFF RATE:
The value of C* is computed from the characters of all the securities that
belong in the optimal portfolio. To determine C* it is necessary to calculate its
value as if there were different number of securities in the portfolio. Designate Ci
as the candidate for the C*.
We proceed to calculate the values for variable Ci as if the first ranked
security was in the optimal portfolio (i=1), then again as if security1
st
and 2
nd
ranked securities were in the optimal portfolio (i=2).and then the 1
st
, 2nd, and 3
rd
ranked security were in the optimal portfolio (i=3) and so forth. These Cis are the
candidates fro the C*.
Table 2 Determining the Cut-Off rate.
1 2 3 4 5 6 7

38

Security
Ri-Rf
i
(Ri-Rf)i

2
ei
i
2

2
ei
(Ri-
Rf)i

2
ei

i
2

2
ei
Ci
2 0.21% 4.9093 2364.755 4.909 2364.755 0.00077
7 0.18% 3.7833 2088.292 8.693 4453.047 0.00103
8 0.16% 6.4471 4134.194 15.140 8587.241 0.00120
10 0.14% 8.8003 6489.695 23.940 15076.94 0.00125
3 0.13% 3.7729 2887.64 27.713 17964.58 0.00126
6 0.09% 3.4610 3948.755 31.174 21913.33 0.00120
1 0.07% 5.0010 7471.224 36.175 29384.55 0.00108
5 0.05% 3.7732 7922.629 39.948 37307.18 0.00097
9 -0.02% -0.2590 1390.15 39.689 38697.33 0.00093
4 -0.14% -2.0048 1447.996 37.684 40145.33 0.00085
C*= 0.00126
Determining the cut-off using chart:

CUT-OFF RATE
0.00000
0.00020
0.00040
0.00060
0.00080
0.00100
0.00120
0.00140
1 2 3 4 5 6 7 8 9 10
No OF SCRIPS
C
i

V
A
L
U
E
S
CUT-OFF POINT

Interpretation
In the graph shown above Y-axis represents the possible values of Ci and
the X-axis the no of scrips to be included in the portfolio. The trend line
represents the values of Ci for every additional scrip included in the portfolio. If
we observe the trend properly, after certain no of scrips the trend starts falling.

39
The vertical line exactly cuts the trend line at the maximum value of Ci (0.00126).
According to the model all the scrips, which are left hand side of the vertical line,
have the excess return to Beta ratio greater then the CUT-OFF rate. And only
those scrips, which are LHS of the vertical line, are taken as potential stocks to
construct a portfolio.
CALCULATING THE Ci FOR THE C*:
Stocks ranked by the excess return to Beta from highest to lowest for a
portfolio of i stock Ci is given by
ei
i
m
ei
i f i
m
i
R R
C
2
2
2
2
2
1
) (

Where:

2
m
= Variance of the market index (nifty). (Calculated value =0.00025)

2
ei
= Un-systematic risk. The un-systematic risk is usually the variance of the
stock movement that is not associated with the movement of the
market index.
By using the above formula we calculate the values for Ci (column 7 of
table 1.2) with respect to excess return to Beta ratio ranking. From all the
calculated values of Ci we determine the CUT-OFF rate C* to be 0.00126 as this
is the highest value in the column. And all the securities excluding the Ci with the
highest value will be selected as a optimal portfolio. As the risk to beta ratio of all
the selected securities are higher then the C* and that satisfies the condition of
selecting.
INVESTMENT BREAK

40
After constructing the portfolio of stock, the next thing is to know how
much to invest in each stock.
How much to invest in each stock of the portfolio?
Once the securities that have to comprise the portfolio are determined, it
remains to show the calculation of how much to invest in each stock. The
percentage to be invested in each security is calculated by Zi div sum of Zi
i
i
i

1
1
]
1

,
_

*
2
2
C
R R
I
F I
ei
i
i

The second equation determines the relative investment in each security while
the first equation simply scales the weights on each security. Note that the
residual value
2
ie
plays an important role in determining how much to invest in
each security.
Applying this formula for our table we have the Zi values below stating
what percentage of amount to be invested in each stock in the portfolio.
Table 3: Proportions to be invested in five selected stocks
SECURITY
No
NAME
PROPORTION
TO BE
INVESTED
2 ARVIND MILLS LTD 38.16%
7 ICICI 22.76%
8 M&M 24.39%
10 TISCO 12.13%
3 SATYAM COMPUTERS 2.57%
TOTAL 100.00%
MINIMUM INVESTMENT REQUIRED

41
Minimum investment required to invest in these stocks can be calculated
using formula:
wt
L wt
UV L ) ( * ) (
Table 4: Minimum investment required
SL.NO COMPANIES WEIGTAGE UV
Invst
Break
No. of
Shrs Total
1 ICICI BANK 0.3816 399.4 5296.61 13 5297
2 ARVIND MILLS 0.2276 139.8 3158.97 23 3159
3 M & M 0.2439 517.05 3385.71 7 3386
4 TISCO 0.1213 356.35 1683.82 5 1684
5
SATYAM
COMP 0.0257 356.35 356.35 1 356
13881
RETURNS FOR THE PORTFOLIO
Returns on the portfolio will be gained only when the prices of the stocks
go up. If all the stocks go up the portfolio will have positive returns. Sometimes
few stocks in the portfolio may go down. In such a situation returns on the
portfolio will be positive only if total amount of the stocks moving up is more than
total amount of the stocks moving down.
The return on the portfolio is just the weighted average of the expected
return of the individual security. It is given by:
R
p
= X
1
R
1
+ X2R2 +..X
n
R
n
.
Where X
1 = Proportion of the amount invested in stock 1
R1 = Expected return on the security 1. (All are calculated values).
Rp = Expected return on a portfolio.
Table 5: Expected return on the portfolio

42
SECURITY
No
NAME PROPORTION
TO BE
INVESTED
AVG
RETURNS
EXPECTED
RET
2 ARVIND MILLS LTD 0.38156 0.00285 10.8627%
7 ICICI 0.22756 0.00190 4.3312%
8 M&M 0.24390 0.00195 4.7513%
10 TISCO 0.12129 0.00205 2.4887%
3 SATYAM COMPUTERS 0.02567 0.00163 0.4192%
1 TOTAL 22.853%
Using this method one can take any number of stocks and construct a
portfolio. As the model itself will select the potential stocks .The final part of the
model even tell what proportion of amount to be invested in each stock.

Limitations:
This model helps in constructing a portfolio of only equities.
The selection of the stocks is completely based on the risk free
return to beta ratio, which the model itself wills calculates and selects the
stocks.
CONSTRUCTION OF OPTION COMBINATION STRATEGY
Taking the options of the stocks in the portfolio constructed, a comparison
is made between investment and returns of the portfolio and that of the options.
In each stock one buy option and one call option has been selected, and the pay-
offs of these options are calculated with respect to buying as well as selling these
options. The option selected has same exercise price and same expiry date. It
also finds the best option combination for the selected scrips, which have
maximum profits, thus constructing the best option combination strategy. The
study can also be extended to other scrips and hence forth find the option
combination which is most profitable.
OPTION SELECTION

43
The table below shows the options selected for each of the companies in
the portfolio constructed. The values in the data collected are as on 11-may-05.
Table 6: Options selected for each company
Option pay-off calculations.
Considering the stock movements (increase/decrease), pay-off for each
option is calculated for both buyer and seller positions. The percentage changes
in the stock movements considered for the study are between -6% to +6%.
For each of the company all the four positions of the options are taken, i.e.
A long position in a call option
A short position in a call option
A long position in a put option
A short position in a put option
PAY-OFF FOR A CALL OPTION IS

INSTRUMENT
TYPE
EXPIRY
DATE
OPTION
TYPE
STRIKE
PRICE
PREMIUM
UNDERLYING
VALUE(UV)
ICICI
BANK
OPTSTK
30-Jun-
05
CA 370 28 399.4
OPTSTK
30-Jun-
05
PA 370 16.5 399.4
ARVIND
MILLS
OPTSTK
30-Jun-
05
CA 140 5.95 139.8
OPTSTK
30-Jun-
05
PA 140 5.05 139.8
M & M
OPTSTK
30-Jun-
05
CA 510 12 517.05
OPTSTK
30-Jun-
05
PA 510 31.95 517.05
TISCO
OPTSTK
30-Jun-
05
CA 350 10.05 356.35
OPTSTK
30-Jun-
05
PA 350 13.2 356.35
SATYAM
COMP
OPTSTK
30-Jun-
05
CA 460 10.8 455
OPTSTK
30-Jun-
05
PA 460 21.95 455
44
Pay-off for long position in a call option is:
max (UV-Sp, 0)
Where UV= underlying value.
Sp= Strike price.
That is the option will be exercised if UV>Sp and will not be exercised if UV<Sp.
The pay-off from the holder of the short position is:
-max (UV-Sp, 0) or min (Sp-UV, 0)
PAY-OFF FOR A PUT OPTION IS
Pay-off for long position in put option is:
max (Sp-UV, 0)
And pay-off from a short position is:
-max (Sp-UV, 0) or min (UV-Sp, 0)
For each of these positions, pay-offs are calculated as shown in tables below.
First column shows the percentage change (increase/decrease) in the
stock price. Second column shows change in the value of stock price. The next
four columns show the pay-offs for the four positions of options.
Positive values indicate a positive return, and negative values indicate
negative returns. Zero values indicate that there has not been any exercising of
option.
Table 7: Pay-offs for options when value of stock increases.
%age
increase
Change in
UV
BUY
CALL
SELL
CALL
BUY
PUT
SELL
PUT
ICICIBANK
Sp=370 399.40

0 399.40 29.40 -29.40 0.00 0.00
1 403.39 33.39 -33.39 0.00 0.00
2 407.39 37.39 -37.39 0.00 0.00
3 411.38 41.38 -41.38 0.00 0.00
4 415.38 45.38 -45.38 0.00 0.00
5 419.37 49.37 -49.37 0.00 0.00
6 423.36 53.36 -53.36 0.00 0.00
ARVINDMILL
Sp=140 139.8

0 139.8 0.00 0.00 0.20 -0.20

45
1 141.20 1.20 -1.20 0.00 0.00
2 142.60 2.60 -2.60 0.00 0.00
3 143.99 3.99 -3.99 0.00 0.00
4 145.39 5.39 -5.39 0.00 0.00
5 146.79 6.79 -6.79 0.00 0.00
6 148.19 8.19 -8.19 0.00 0.00
M&M
Sp=510 517.05

0 517.05 7.05 -7.05 0.00 0.00
1 522.22 12.22 -12.22 0.00 0.00
2 527.39 17.39 -17.39 0.00 0.00
3 532.56 22.56 -22.56 0.00 0.00
4 537.73 27.73 -27.73 0.00 0.00
5 542.90 32.90 -32.90 0.00 0.00
6 548.07 38.07 -38.07 0.00 0.00
TISCO
Sp=350 356.35

0 356.35 6.35 -6.35 0.00 0.00
1 359.91 9.91 -9.91 0.00 0.00
2 363.48 13.48 -13.48 0.00 0.00
3 367.04 17.04 -17.04 0.00 0.00
4 370.60 20.60 -20.60 0.00 0.00
5 374.17 24.17 -24.17 0.00 0.00
6 377.73 27.73 -27.73 0.00 0.00
SATYAM.CO
Sp=460 455.00

0 455.00 0.00 0.00 5.00 -5.00
1 459.55 0.00 0.00 0.45 -0.45
2 464.10 4.10 -4.10 0.00 0.00
3 468.65 8.65 -8.65 0.00 0.00
4 473.20 13.20 -13.20 0.00 0.00
5 477.75 17.75 -17.75 0.00 0.00
6 482.30 22.30 -22.30 0.00 0.00
Table 8: Pay-offs for options when value of stock decreases.
%age
decrease
Change in
UV
BUY
CALL
SELL
CALL
BUY
PUT
SELL
PUT
ICICIBANK
Sp=370 399.40

1 395.41 25.41 -25.41 0.00 0.00
2 391.41 21.41 -21.41 0.00 0.00
3 387.42 17.42 -17.42 0.00 0.00
4 383.42 13.42 -13.42 0.00 0.00
5 379.43 9.43 -9.43 0.00 0.00
6 375.44 5.44 -5.44 0.00 0.00
ARVINDMILL
Sp=140 139.80

1 138.40 0.00 0.00 1.60 -1.60
2 137.00 0.00 0.00 3.00 -3.00

46
3 135.61 0.00 0.00 4.39 -4.39
4 134.21 0.00 0.00 5.79 -5.79
5 132.81 0.00 0.00 7.19 -7.19
6 131.41 0.00 0.00 8.59 -8.59
M&M
Sp=510 517.05

1 511.88 1.88 -1.88 0.00 0.00
2 506.71 0.00 0.00 3.29 -3.29
3 501.54 0.00 0.00 8.46 -8.46
4 496.37 0.00 0.00 13.63 -13.63
5 491.20 0.00 0.00 18.80 -18.80
6 486.03 0.00 0.00 23.97 -23.97
TISCO
Sp=350 356.35

1 352.79 2.79 -2.79 0.00 0.00
2 349.22 0.00 0.00 0.78 -0.78
3 345.66 0.00 0.00 4.34 -4.34
4 342.10 0.00 0.00 7.90 -7.90
5 338.53 0.00 0.00 11.47 -11.47
6 334.97 0.00 0.00 15.03 -15.03
SATYAM.CO
Sp=460 455.00

1 450.45 0.00 0.00 9.55 -9.55
2 445.90 0.00 0.00 14.10 -14.10
3 441.35 0.00 0.00 18.65 -18.65
4 436.80 0.00 0.00 23.20 -23.20
5 432.25 0.00 0.00 27.75 -27.75
6 427.70 0.00 0.00 32.30 -32.30
COMBINATION OF OPTIONS
A combination is an option trading strategy that involves taking a position
in both calls and puts on the same stock. Few of the strategies are straddles,
strips, straps and strangles, which have been explained earlier.
This study considers not only straddles, but also other combinations, viz.:
1. Buy call and sell put
2. Buy call and buy put (Straddle)
3. Sell call and buy put

47
4. Sell call and sell put
The following two tables shows the net investment and pay-offs for
combination of options. A positive value of investment indicates a positive
investment, whereas a negative value shows a negative investment, means there
will be a net inflow of money in that particular option combination.
For ex: if you buy a call option which has a premium value of Rs.28 and
sell a put option which has a premium value of Rs.16.5 then your net investment
will be 11.5 (28-16.5). This indicates a positive investment.
On the other hand if you sell a call option which has a premium value of
Rs.28 and buy a put option which has a premium value of Rs.16.5 then your net
investment will be -11.5 (16.5-28). This indicates a negative investment.
Table 9: Decision Tree/Table Showing Pay-offs for combination of options
when value of stock increases
BUY CALL &
SELL PUT
BUY CALL &
BUY PUT
SELL CALL &
BUY PUT
SELL CALL &
SELL PUT
%
INCREASE
INVST RETURN
INVS
T
RETURN
INVS
T
RETURN
INVS
T
RETURN
ICICIBANK
0 11.5 17.90 44.5 -15.10 -11.5 -17.90 -44.5 15.10
1 11.5 21.89 44.5 -11.11 -11.5 -21.89 -44.5 11.11
2 11.5 25.89 44.5 -7.11 -11.5 -25.89 -44.5 7.11
3 11.5 25.89 44.5 -3.12 -11.5 -29.88 -44.5 3.12
4 11.5 33.88 44.5 0.88 -11.5 -33.88 -44.5 -0.88
5 11.5 37.87 44.5 4.87 -11.5 -37.87 -44.5 -4.87
6 11.5 41.86 44.5 8.86 -11.5 -41.86 -44.5 -8.86
ARVINDMILL
0 0.9 -1.10 11 -10.80 -0.9 1.10 -11 10.80

48
1 0.9 0.30 11 -9.80 -0.9 -0.30 -11 9.80
2 0.9 1.70 11 -8.40 -0.9 -1.70 -11 8.40
3 0.9 3.09 11 -7.01 -0.9 -3.09 -11 7.01
4 0.9 4.49 11 -5.61 -0.9 -4.49 -11 5.61
5 0.9 5.89 11 -4.21 -0.9 -5.89 -11 4.21
6 0.9 7.29 11 -2.81 -0.9 -7.29 -11 2.81
M&M
0 -20 27.00 43.95 -36.90 19.95 -27.00 -44 36.90
1 -20 32.17 43.95 -31.73 19.95 -32.17 -44 31.73
2 -20 37.34 43.95 -26.56 19.95 -37.34 -44 26.56
3 -20 42.51 43.95 -21.39 19.95 -42.51 -44 21.39
4 -20 47.68 43.95 -16.22 19.95 -47.68 -44 16.22
5 -20 52.85 43.95 -11.05 19.95 -52.85 -44 11.05
6 -20 58.02 43.95 -5.88 19.95 -58.02 -44 5.88
TISCO
0 -3.15 9.50 23.25 -16.90 3.15 -9.50 -23.3 16.90
1 -3.15 13.06 23.25 -13.34 3.15 -13.06 -23.3 13.34
2 -3.15 16.63 23.25 -9.77 3.15 -16.63 -23.3 9.77
3 -3.15 20.19 23.25 -6.21 3.15 -20.19 -23.3 6.21
4 -3.15 23.75 23.25 -2.65 3.15 -23.75 -23.3 2.65
5 -3.15 27.32 23.25 0.92 3.15 -27.32 -23.3 -0.92
6 -3.15 30.88 23.25 4.48 3.15 -30.88 -23.3 -4.48
SATYAM.CO
0 -11.2 6.15 32.75 -27.75 11.15 -6.15 -32.8 27.75
1 -11.2 10.70 32.75 -32.30 11.15 -10.70 -32.8 32.30
2 -11.2 15.25 32.75 -28.65 11.15 -15.25 -32.8 28.65
3 -11.2 19.80 32.75 -24.10 11.15 -19.80 -32.8 24.10
4 -11.2 24.35 32.75 -19.55 11.15 -24.35 -32.8 19.55
5 -11.2 28.90 32.75 -15.00 11.15 -28.90 -32.8 15.00
6 -11.2 33.45 32.75 -10.45 11.15 -33.45 -32.8 10.45
Table 10: Decision Tree/Table Showing Pay-offs for combination of options
when value of stock decreases
BUY CALL &
SELL PUT
BUY CALL &
BUY PUT
SELL CALL &
BUY PUT
SELL CALL &
SELL PUT
%
DECREASE
INVST RETURN
INVS
T
RETURN
INVS
T
RETURN
INVS
T
RETURN
ICICIBANK
1 11.5 13.91 44.5 -19.1 -11.5 -13.9 -44.5 19.09
2 11.5 9.912 44.5 -23.1 -11.5 -9.91 -44.5 23.09
3 11.5 5.918 44.5 -27.1 -11.5 -5.92 -44.5 27.08
4 11.5 1.924 44.5 -31.1 -11.5 -1.92 -44.5 31.08
5 11.5 -2.07 44.5 -35.1 -11.5 2.07 -44.5 35.07
6 -11.5 6.064 44.5 -39.1 -11.5 6.064 -44.5 39.06
ARVINDMILL
1 0.9 -2.5 11 -9.4 -0.9 2.498 -11 9.402
2 0.9 -3.9 11 -8 -0.9 3.896 -11 8.004

49
3 0.9 -5.29 11 -6.61 -0.9 5.294 -11 6.606
4 0.9 -6.69 11 -5.21 -0.9 6.692 -11 5.208
5 0.9 -8.09 11 -3.81 -0.9 8.09 -11 3.81
6 -0.9 9.488 11 -2.41 -0.9 9.488 -11 2.412
M&M
1 -20 21.83 43.95 -42.1 19.95 -21.8 -44 42.07
2 -20 16.66 43.95 -40.7 19.95 -16.7 -44 40.66
3 -20 11.49 43.95 -35.5 19.95 -11.5 -44 35.49
4 -20 6.318 43.95 -30.3 19.95 -6.32 -44 30.32
5 -20 1.147 43.95 -25.1 19.95 -1.15 -44 25.15
6 19.95 4.023 43.95 -20 19.95 4.023 -44 19.98
TISCO
1 -3.15 5.937 23.25 -20.5 3.15 -5.94 -23.3 20.46
2 -3.15 2.373 23.25 -22.5 3.15 -2.37 -23.3 22.47
3 -3.15 -1.19 23.25 -18.9 3.15 1.19 -23.3 18.91
4 -3.15 -4.75 23.25 -15.3 3.15 4.754 -23.3 15.35
5 -3.15 -8.32 23.25 -11.8 3.15 8.317 -23.3 11.78
6 3.15 11.88 23.25 -8.22 3.15 11.88 -23.3 8.219
SATYAM.CO
1 -11.2 1.6 32.75 -23.2 11.15 -1.6 -32.8 23.2
2 -11.2 -2.95 32.75 -18.7 11.15 2.95 -32.8 18.65
3 -11.2 -7.5 32.75 -14.1 11.15 7.5 -32.8 14.1
4 -11.2 -12.1 32.75 -9.55 11.15 12.05 -32.8 9.55
5 -11.2 -16.6 32.75 -5 11.15 16.6 -32.8 5
6 11.15 21.15 32.75 -0.45 11.15 21.15 -32.8 0.45
COMPANY-WISE RETURNS FOR VARIOUS STRATEGIES
Considering the stock returns of each company, we can find out which
option strategy is best suitable when its stock value increases or decreases.
Based on the market information that whether the value of stock increases or
decreases a speculator can invest in that particular option strategy to gain
maximum profits.
Following are the analysis of the returns on individual strategies for each
company.
The strategies are numbered as:

50
1 Buy call and sell put
2 Buy call and buy put (Straddle)
3 Sell call and buy put
4 Sell call and sell put
Analysis of the returns is basically done using maximin, maximax, and maximum
expected value calculations.
ICICI BANK
Table 11 & 12: Returns of ICICI when the value of stock increases and
decreases.
When value of stock increases When value of stock decreases.

INTREPRETATION:
From the above table it is clear that it is more profitable to invest in
strategy 1 (Buy call and sell put) than investing in other strategies when value of
the stock increases The minimum return for this strategy is 21.89, the maximum
return is 41.86, and the expected return is 31.21.
From the above table it is clear that it is more profitable to invest in
strategy 4 (Sell call and sell put) than investing in other strategies when value of
the stock decreases. The minimum return for this strategy is 19.09, the maximum
return is 39.06, and the expected return is 29.08.

STRATEGY
No
MIN MAX EXP
1 21.89 41.86 31.21
2 -11.11 8.86 -1.12
3 -41.86 -21.89 -31.88
4 -8.86 11.11 1.12
STRATEGY
No
MIN MAX EXP
1 -2.07 13.91 5.94
2 -39.06 -19.09 -29.08
3 -13.91 6.06 -3.92
4 19.09 39.06 29.08
51
ARVIND MILLS
Table 13 & 14: Returns of ARVIND MILLS when the value of stock increases
and decreases
When value of stock increases When value of stock decreases
INTREPRETATION:
From the above table it is clear that strategy 4 (Sell call and sell put) is
more profitable to invest than investing in other strategies when value of the
stock increases. The minimum return for this strategy is 2.81, the maximum
return is 9.80, and the expected return is 6.31.
From the above table it is clear that strategy 3 (Sell call and buy put) is
more profitable to invest than investing in other strategies when value of the
stock decreases. The minimum return for this strategy is 2.50, the maximum
return is 9.49, and the expected return is 5.99.
M & M
Table 15 & 16: Returns of M&M when the value of stock increases and
decreases
When value of stock increases When value of stock decreases

INTREPRETATION:

STRATEGY MIN MAX EXP
1 -8.09 9.49 -2.83
2 -9.40 -2.41 -5.91
3 2.50 9.49 5.99
4 2.41 9.40 5.91
STRATEGY MIN MAX EXP
1 0.30 7.29 3.79
2 -9.80 -2.81 -6.31
3 -7.29 -0.30 -3.79
4 2.81 9.80 6.31
STRATEGY MIN MAX EXP
1 1.15 21.83 10.24
2 -42.07 -19.98 -32.28
3 -21.83 4.02 -8.90
4 19.98 42.07 32.28
STRATEGY MIN MAX EXP
1 32.17 58.02 45.10
2 -31.73 -5.88 -18.80
3 -58.02 -32.17 -45.10
4 5.88 31.73 18.80
52
From the above table it is clear that when value of the stock increases it is
more profitable to invest in strategy 1 (Buy call and sell put) than investing in
other strategies. The minimum return for this strategy is 32.17, the maximum
return is 58.02, and the expected return is 45.10.
From the above table it is clear that when value of the stock decreases it
is more profitable to invest in strategy 4 (Sell call and sell put) than investing in
other strategies. The minimum return for this strategy is 19.98, the maximum
return is 42.07, and the expected return is 32.28.
TISCO
Table 17 & 18: Returns of TISCO when the value of stock increases and
decreases
When value of stock increases When value of stock decreases
INTREPRETATION:
From the above table it is clear that strategy 3 (Sell call and buy put) and
as well as strategy 4 (Sell call and sell put) have same returns which are more

STRATEGY MIN MAX EXP
1 13.06 30.88 21.97
2 -13.34 4.48 -4.43
3 -30.88 -13.06 -21.97
4 -4.48 13.34 4.43
STRATEGY MIN MAX EXP
1 -8.32 11.88 0.99
2 -22.47 -8.22 -16.20
3 8.22 22.47 16.20
4 8.22 22.47 16.20
53
profitable to invest. The minimum return is 8.22, the maximum return is 22.47,
and the expected return is 16.20.
From the above table it is clear that strategy 1 (Buy call and sell put) is
more profitable to invest than investing in other strategies when value of the
stock decreases. The minimum return for this strategy is 13.06, the maximum
return is 30.88, and the expected return is 21.97.
SATYAM COMPUTERS
Table 19 & 20: Returns of SATYAM COMPUTERS when the value of stock
increases and decreases.
When value of stock increases When value of stock decreases
INTREPRETATION:
From the above table it is clear that it is more profitable to invest in strategy 4
(Sell call and sell put) than investing in other strategies when value of the stock
increases. The minimum return for this strategy is 10.45, the maximum return is
32.20, and the expected return is 21.68.
From the above table it is clear that it is more profitable to invest in strategy 4
(Sell call and sell put) than investing in other strategies when value of the stock
decreases. The minimum return for this strategy is 0.45, the maximum return is
23.20, and the expected return is 11.83.
Table 21: Best strategy for each company
COMPANY BEST STRATEGY
When stock value
increases
When stock value
decreases
ICICI BANK Buy call and sell put Sell call and sell put
ARVIND MILLS Ltd Sell call and sell put Sell call and buy put
M & M Buy call and sell put Sell call and sell put
TISCO Sell call and buy put Buy call and sell put

STRATEGY MIN MAX EXP
1 -16.60 21.15 -2.73
2 -23.20 -0.45 -11.83
3 -1.60 21.15 9.78
4 0.45 23.20 11.83
STRATEGY MIN MAX EXP
1 10.70 33.45 22.08
2 -32.30 -10.45 -21.68
3 -33.45 -10.70 -22.08
4 10.45 32.30 21.68
54
SATYAM COMPUTERS Sell call and sell put Sell call and sell put
INTREPRETATION:
From the above table it is clear that when stock value increases the
strategy buy call and sell put would be most suitable. And strategy sell call and
sell put would be more suitable when the stock value decreases.
HYPOTHESIS TEST
ANOVA
Analysis of variance is the statistical method for testing the null hypothesis
that the means of several populations are equal. ANOVA as the name implies,
breaks down or partitions total variability into component parts. It uses squared
deviations of the variance so computation of distances of the individual data
points from their own mean or from the grand mean can be summed
ANOVA test
SUM OF
SQUARES
DF
MEAN
SQUARE
F SIG.
BETWEEN
GROUPS
51254.424 3 17084.808 77.184 .000
WITHIN
GROUPS
56666.287 256 221.353
TOTAL 107920.711 259

55
Interpretation
A low significance value (below 0.05) indicates that there is a significant
difference between the test value and the observed mean. Here in this table we
can see that as the significance value is less than 0.05 which means that there is
significant difference in the returns for different strategies.
T- TEST
T-test is used to determine the statistical significance between a sample
distribution mean and a parameter.
T- TEST 1
GROUP STATISTICS
STRATEGY N MEAN STD. DEVIATION
RETURNS 1 65 13.44702 16.5591639
2 65 -15.2798 12.11299977
INDEPENDENT SAMPLES TEST
T-TEST FOR EQUALITY OF MEANS
t df Sig. (2-tailed)
RETURNS 11.28859 128 3.15E-19
Interpretation
From the table it is clear that the significance level is less than 0.05 which
means that there is significant difference in returns between strategy 1(Buy call
and sell put) and strategy 2(Buy call and buy put), and a positive t-value indicates
that the average returns for strategy 1 (Buy call and sell put) is significantly
higher than the average returns for strategy 2(Buy call and buy put).
T- TEST 2

56
GROUP STATISTICS
STRATEGY N MEAN STD. DEVIATION
RETURNS 1 65 13.44702 16.5591639
3 65 -11.8898 17.82569202
INDEPENDENT SAMPLES TEST
T-TEST FOR EQUALITY OF MEANS
t df Sig. (2-tailed)
RETURNS 8.395785 128 3.66E-14
Interpretation
From the table it is clear that the significance level is less than 0.05 which
means that there is significant difference in returns between strategy 1(Buy call
and sell put) and strategy 3(Sell call and buy put), and a positive t-value indicates
that the average returns for strategy 1 (Buy call and sell put) is significantly
higher than the average returns for strategy 3 (Sell call and buy put).
T TEST 3
GROUP STATISTICS
STRATEGY N MEAN STD. DEVIATION
RETURNS 1 65 13.44702 16.5591639
4 65 15.27985 12.11299977
INDEPENDENT SAMPLES TEST
T-TEST FOR EQUALITY OF MEANS
t df Sig. (2-tailed)
RETURNS -0.72023 128 0.472694
T- TEST 4
GROUP STATISTICS
STRATEGY N MEAN STD. DEVIATION
RETURNS 2 65 -15.2798 12.11299977
3 65 -11.8898 17.82569202
INDEPENDENT SAMPLES TEST
T-TEST FOR EQUALITY OF MEANS
t df Sig. (2-tailed)
RETURNS -1.26819 128 0.207032
Interpretation

57
From the above 2 tables it is clear that the significance level is more than
0.05 which means that there is no significant difference in returns between
strategy 1(Buy call and sell put) and strategy 4(Sell call and sell put), and
between strategy 2(Buy call and buy put) and strategy 3(Sell call and buy put).
T- TEST 5
GROUP STATISTICS
STRATEGY N MEAN STD. DEVIATION
RETURNS 2 65 -15.2798 12.11299977
4 65 15.27985 12.11299977
INDEPENDENT SAMPLES TEST
T-TEST FOR EQUALITY OF MEANS
t df Sig. (2-tailed)
RETURNS -14.3827 128 3.15E-19
Interpretation
From the table it is clear that the significance level is less than 0.05 which
means that there is significant difference in returns between strategy 2(Buy call
and buy put) and strategy 4(Sell call and sell put), and a negative t-value
indicates that the average returns for strategy 2 (Buy call and buy put) is
significantly lower than the average returns for strategy 4(Sell call and sell put).
T- TEST 6
Group Statistics
STRATEGY N MEAN STD. DEVIATION
RETURNS 3 65 -11.8898 17.82569202
4 65 15.27985 12.11299977
INDEPENDENT SAMPLES TEST
T-TEST FOR EQUALITY OF MEANS
t df Sig. (2-tailed)
RETURNS -10.1638 128 3.15E-19
Interpretation
From the table it is clear that the significance level is less than 0.05 which means
that there is significant difference in returns between strategy 3(Sell call and buy
put) and strategy 4 (Sell call and sell put), and a negative t-value indicates that

58
the average returns for strategy 3(Sell call and buy put) is significantly lower than
the average returns for strategy 4(Sell call and sell put).
FINDINGS
After studying the pay-offs of combination of options for each company.
When the value of the stock increases:
The returns for the option strategy Buy Call and Sell Put and for strategy
Buy Call and Buy put increases. For strategy Sell Call and Sell Put
returns decreases, and for strategy Sell Call and Buy Put has negative
returns.
When the value of the stock decreases:
The returns for the option strategy Sell Call and Sell Put and
Sell Call and Buy Put increases. For strategy Buy Call and Sell Put
returns decreases, and for strategy Buy Call and Buy put has negative
returns.
From the T-test carried out it is more profitable to invest in strategy Buy Call and
Sell Put as the average returns are significantly higher than in strategy Buy Call
and Buy Put when the stock value is expected to increase.

59
Similarly when the stock price is expected to decrease it is more profitable to
invest in strategy Sell Call and Sell Put as the average returns is significantly
higher than for strategy Sell Call and Buy Put.
SUGGESTIONS
The study carried out was for speculators who take positions in the market. They
actually bet on the direction of price movements. While profits could be extremely
high, potential for losses are also large.
The study carried out for determining optimal option strategy was only for five
companies. The same study can be extended to any number of stocks to know
the pay-offs for different option strategies and hence invest in the strategy that
would yield high returns.
In India many do not know how to trade in the option derivative market, and this
study can be extended to develop software that would help in determining the
pay-offs. The software would just require the data about the type of option, strike
price, premium and underlying value of the stock be inputted, and the software
would then give pay-offs for
Both the positions of the options,
Both for speculated increase and decrease in the value of the stock.

60
For all the option combinations strategies.
By the result given by the software, it would be clear in deciding which option to
choose, which position to choose and in which option strategy to invest.
CONCLUSIONS
The study was based on developing a model which assists in trading in
option derivative market. The model requires the data regarding the type of
option, strike price, premium and underlying value of the stock as input. The
model thus gives the out put regarding the pay-offs for all option strategies and
assists the speculator in deciding option type, option position, and option strategy
to invest.

61
BIBLIOGRAPHY
WEBSITES
www.nse-india.com
www.finpipe.com
www.bambooweb.com
www.igidr.ac.in
BOOKS
1) John C. Hull, OPTIONS, FUTURES AND OTHER DERIVATIVES ,
Prentice- Hall of India private limited, Third edition.
2) Donald R Cooper & Pamela S Schindler, BUSINESS RESEARCH
METHODS, Tata Mc Graw Hill, Eighth edition.
3) Elton/ Gruber, MODERN PORTFOLIO THEORY AND INVESTMENT
ANALYSIS, John Wiley & Sons, Fifth edition.

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