ABOUT THIS BOOK Hello friends, I am Moonmoon Biswas, an Equity Research Analyst in

India having more than decade’s experience in option treading. Today I am very glad
to introduce this Option trading book to all retail option traders in India. It
doesn’t matter whether you are a beginner or an expert, this book will help you to
build a new perspective towards option trading. In India, option trading is still
at its nascent stage. Trading and option trading still are consider as same as
gambling and professional trading is not considered a prestigious work. But option
trading requires good knowledge, planning and research to make right strategies as
per requirements. These strategies also require adjustments time to time depending
on the market movement. I have worked in ASX options market along with Indian
options market for quite some time. I have shared my experience towards Indian
option trading market along with relevant practical examples from my trading. After
reading this book, you will have clear knowledge on the following topics: (i) Basic
concepts on options (ii) Importance of option Greeks in option strategy (iii)
Drawing option strategy pay-off charts in excel (iv) Calculating Volatility of
stocks or index (v) Few option strategies which are applicable on Indian market and
their adjustments (vi) How to select right strategy depending on market condition,
stock movement and other parameters (vii) Name of the stocks which are good for
trading in Indian option market from 209 F&O stocks (viii) Screener /points to
select different option trading strategies specially for Indian option market I
have tried to bring in practical touch in the book instead of making it a book of
theories. All most all the sections of this book is illustrated with examples,
charts and tables so that reading experience becomes interesting. I hope you all
will like the book and will be benefited out of it. Always remember that trading
does not make you rich overnight. Trading requires in depth knowledge and practice
to get success like any other work. So you need to work hard and work smart in the
correct way.

Wish you a successful trading career! Happy Trading, Moonmoon Biswas Kolkata, India
14.6.2018

Table of Contents Basic Discussion on Option Trading Why Option Trading? What is an
option? Some important terms related to option Explanation of different term with
an Example Two most important factors affecting option Price other than asset price
Option Greeks Delta Gamma Theta Vega Calculation of historical volatility How to
draw Payoff diagram in Excel Payoff diagram of a long call option Payoff diagram of
a long Put option Payoff diagram of a Short call option Payoff diagram of a Short
Put option Option Strategy Pay-off Diagram Long straddle Pay-off diagram Pay-off
Diagram of Bear Call option Strategy Some Useful Option Trading strategies Iron
Condor option strategy When to applicable Method Iron Condor case 1 Calculation of
maximum Profit

Calculation of Maximum Loss Breakeven Points More Explanation of the above case
study under different scenario IRON Condor Adjustment Where to adjust How to adjust
Explanation with Practical Example Second Option Strategy: Horizontal Calendar
Spread Construction of Calendar Spread Calculation of Maximum Profit Calculation of
Maximum Loss Finding out break-even points When to close the position More
Explanation with Practical Example Example2: Neutral to Bullish Calendar Spread on
ONGC Third Option Strategy: Bear Put and Bear Call Spread option Strategy Bear Put
Spread Construction Pay-off graph Calculation of Maximum profit Calculation of
maximum Loss How to determine the breakeven Point Practical Example Adjustments in
Bear Put spread option Strategy Bear Call Spread Construction Pay-Off Graph
Calculation of Maximum profit Calculation of maximum Loss How to determine
breakeven Point Explanation of the given example Adjustment of bear call spread
option Strategy Which strategy is better; Bear call Spread or Bear Put Spread?
Fourth Strategy: Bull call and bull put option strategy Bull Call option Strategy
Construction Pay-Off Diagram

Calculation of maximum Profit Calculation of maximum Loss Finding out break-even

point Example on Yes bank Adjustment of Bull call spread Bull Put Spread
Construction Pay Off Diagram Maximum Profit calculation Maximum Loss Calculation
Finding out break-even point Closing off the given example Adjustment of Bull Put
spread Bullish on Volatility option strategies Reverse Iron Condor Reverse Iron
Condor Construction Reverse Iron Condor Case1 Calculation of maximum Profit
Calculation of maximum loss Break-even points of Reverse Iron Condor Strategy
Explanation of Case 1 example under different situations Reverse Iron Condor
Adjustment before Expiration Short Put Ladder Strategy Construction of Short Put
Ladder Strategy Case study1 Calculation of Maximum Profit Calculation of Maximum
loss Finding out break-even points Practical Example of short put Ladder on Bank of
Baroda Long Straddle and long strangle option strategies Formation of Long Straddle
Formation of Long Strangle Example Practical Example: Long Straddle on Infosys in
January’2018 Adjustment of Long Straddle and Long Strangle spread Easy Guide for
Indian option market General Guidance

Special advice for Indian Market Trading tips for long strangle/Long straddle
option strategy Trading tips for Short-put ladder option strategy Trading tips for
Iron Condor option Strategy Trading tips for Bear Call and Bear Put option strategy
Trading tips for Bull Call and Bull Put option strategy Trading Tips for Reverse
Iron Condor Strategy Trading Tips for Calendar Spread Option Strategy Declaration

Chapter1:

Basic Idea on Option Trading

Basic Discussion on Option Trading Why Option Trading? Option trading is getting
popular day by day due to its simplicity and lower risk profile. It is turning out
to be one of the regular income streams because it requires very little amount of
money and very basic knowledge to start with. Another advantage of option trading
is that one can make profit irrespective of the market condition. The only one
point of caution is that one has to select right strategy depending on the type of
stock or index and depending on market condition. Let me discuss the advantages of
option trading one by one:Leverage: Option trading allows small amount of capital
to control over larger monetary amount of underlying asset. A trader requires Rs.1,
20,000 to own 1000 shares whose stock price is Rs.120. But in option, the trader
will require fraction of that amount to control such amount of shares. This smaller
investment indicates higher amount of profit as quantity of the shares will be
same. Flexibility: Option trading is a very flexible investment tool. In case of
trading with future or underlying asset, one can trade under two situations i.e.
underlying asset price is in rising mood or the underlying asset price is
declining. One has nothing to do when market is stagnant. But option trading allows
trading and making profit in below mentioned any situation: Underlying asset price
is Moving Higher /Lower Underlying asset price is moving too slowly Active Market
Direction/stock price movement is not clear Volatility Increasing /Decreasing
Limited Risk-Unlimited Profit: The maximum loss is limited when one buys an option
but the possible profit amount is unlimited but this situation may also change
depending on the option strategy.

From the above chart it is clear that one has limited risk while owning a call
option and this risk amount is limited to the premium paid for buying the option
whereas owning same amount of underlying asset has unlimited loss. The factors
which can affect the option price are underlying asset price, time and volatility.
Option strategies can be created or adjusted by manipulating these parameters as
per one’s risk-reward tolerance ratio. Portfolio protection is also possible by
creating hedge with option to fight with adverse situation.

What is an option? An option is the right either to buy or to sell a specified

amount of a particular underlying asset, at a pre-determined price by pre-
determined expiration time frame. Option is known as derivative because its value
is derived from an underlying asset and its price fluctuates as the price of the
underlying asset rises or declines. There are two types of options; Call option and
Put option. Call option: A call option is the right but not the obligation to buy a
fixed amount of share at fixed price on or before the expiry period. If the trader
is expecting an upside movement of the stock or market then he should buy call

option of that stock or call option of the market (here generally Nifty). E.g.-If
the trader has bullish view on the banking stocks for near term then he should buy
call option of Bank-Nifty. Put option: A put option is the right but not the
obligation to sell a fixed amount of shares at fixed price on or before the expiry
period. If the trader has a bearish view on market or a particular stock then he
should buy put option of the market or put option of that particular stock.

Some important terms related to option Underlying asset: Each option is based on an
asset; this is known as underlying asset. This asset may be shares of a stock or
value of an index. Strike Price The strike price (or exercise price) is the
predetermined price at which the underlying asset may be bought by the call holder
or sold by the put holder. Expiration Date This is the date on which an option
expires. The trader may close his position before or on the expiry day. Normally
the monthly option expires in the last Thursday of every month in India. Option
premium The price paid for buying the option is known as option premium or simply
option price. The buyer pays the option premium to own the option and the seller of
the option receives that premium. The premium depends on different parameters. This
premium can be divided into two parts; intrinsic value and time value. These parts
will be explained with examples at the later part of this chapter. Parameters
affecting option premium A trader should have clear knowledge on the parameters
which affect the option pricing. The option price generally depends on the
underlying asset, volatility, time left for expiry and interest rates. All of these
factors will be discussed in details in option Greeks chapter. In-the-money option
A call option will be known as in-the-money option (ITM) when the strike price is
lower than the underlying asset price. On the other hand, a put option will be in-
the-money option when strike price is higher than the underlying asset price. At-
the-money option

When underlying asset price is equal to strike price of the option, the option is
known as at-the-money option. Out-of-the-money option A call option will be known
as out-of-the-money option when the strike price is higher than the underlying
asset price. On the other hand, a put option will be known as out-of-the-money
option when strike price is lower than the underlying asset price.

Explanation of different term with an Example This is the option chain of State
Bank of India (SBIN) when the underlying asset price or SBIN price was Rs.250.

Here expiry period is 26th April’2018. It indicates that these listed options
should be traded on or before 26th April’18. The call options are listed on left
hand side and put options are listed on right hand side. Strike Price of the
options is listed just middle of the two types of options. As the underlying stock
price is Rs.250, so the call and put option of strike price Rs.250 are at-the-money
option. The call and put options of strike prices below Rs.250 are in-the-money
call option and out-of-the-money put options respectively.

The call and put options above Rs.250 are out-of-the-money call options and in-the-
money put options respectively. In the above table, option premium or option price
is denoting by three columns; “LTP” or Last Traded Price, Bid Price and Ask Price.
Bid Price is the price at which buyers in the market are interested to buy that
particular option so that you can sell your option at that price. Ask price is just
opposite to that. “The price of SBIN call option of strike price Rs.240 of April’18
expiry is Rs.15.05 as on 29th March when the price of SBIN is Rs.250. Lot size of
SBIN is 3000 shares.” The above statement is indicating the below mentioned
facts:a) The SBIN call option of strike price Rs.240 is in-the-money option as
strike price is lower than the underlying asset price. b) The buyer of this option
trader has the right but not the obligation to buy 3000 shares of SBIN at Rs.240
(strike price) per share within the pre-mentioned time frame i.e. last Thursday of
April’18 or 26th April’2018. To buy this right, he has paid Rs.15.05 per share
(option premium). Hence, he should exercise the option when it will be profitable
for him i.e. when the underlying asset price will be above Rs.
(240+15.05)=Rs.255.05. c) Intrinsic value is the in-the-value portion of an option
premium i.e. the difference between the underlying asset price and the strike price
when the option is in-the-money option. Here intrinsic value of the call option of
strike price Rs.240 is (underlying stock price i.e. Rs.250-strike price i.e.
Rs.240) = Rs.10 But the option premium is Rs.15.05. Hence the difference between
the option premium and intrinsic value is the time value of the option premium.

Two most important factors affecting option Price other than asset price Volatility
Volatility refers to the price fluctuation of an underlying asset. This volatility
can be of two types: Historical volatility and Implied volatility.

Normally option premium increases as volatility increases and vice versa.

Historical Volatility Historical volatility is the historical price fluctuation of
the underlying asset in percentage terms. Normally it is calculated as standard
deviation of daily fluctuation of historical closing prices. Calculation of
historical volatility will be discussed in chapter3. Implied Volatility Implied
Volatility (IV) is one of the most important deciding factors of option price. We
found Historical Volatility is the annualized standard deviation of the past price
movement of a stock or index. But Implied Volatility is the volatility that matches
with the current option price and indicates current and future perception of the
market risk. In one sentence, implied volatility is the volatility which market
implies about the stock’s volatility in the future. It is important because option
price increases if implied volatility increases keeping other parameters remain
constant. You can get implied volatility of option prices in NSE websites or any
other financial websites or softwares where option chains are available.

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

Chapter 2: Option Greeks

Option Greeks Option Greeks are quite interesting. These are collection of
statistical values named after Greek letters. If you want to get success in option
trading and if you wish to take this profession as your full time earning option
then you should understand each and every Option Greek. The Option Greeks can be
very useful to help you to predict future option price because they effectively
measure the sensitivity of the price compared to some of the factors that affect
price. In particular, these factors are underlying share price, decay in time,
interest rate and the volatility. If you know how option price changes with respect
to these factors, you are in a better position to know how transactions will take
place in future. The Greeks will give you an indication of how the price of an
option will move compared to the way the underlying share price movements and they
also help you to determine the amount of time an option loses on daily basis. The
Greeks are also risk management tools because they can be used to determine the
risk of a particular position and find out how to mitigate that risk. First time,
these terms may look cumbersome or may feel difficult to understand but once you
will understand their role in option trading; the work will be easier for you. Of
course, you can learn how to calculate the Greeks, but it is a complex and lengthy
process. There are many softwares available in the market which can be used for
this and most of the best online brokers offer automatic values for the Greeks in
their display box of option chain. There are five types of option Greeks but here I
will discuss the most important four Option Greeks. They are:

Delta Option Delta is the most important Greek to understand because it indicates
sensitivity of option prices in relation to the price of underlying. In simply
terms, it’ll tell you changes in option price due to change in 1 unit of underlying
price. An option with high delta will move in price significantly in proportion to
the price movements of the underlying security, while one with low delta will move
less often. The delta value of an option is usually expressed as -1 to 1. Normally
delta of a call option is expressed from 0 to 1 and delta of a put option is
expressed as -1 to 0. The value depends mainly on the moneyness of a particular
option i.e. whether the option is in-the-money or at-the-money or out-of-the-money.
Delta of any option can tell you the type of the option. Please follow the table to
know in details:-

Normally, delta of a call option is positive. It means when we buy a call its delta
value will be positive and when we buy a put its delta value will be negative. But
this positive/negative sign will be opposite in case of selling. Table showing
positive/negative sign of call and put option

How to calculate option price with respect to underlying’s price change depending
on delta value Suppose a trader holds a call option which is slightly in-the-money
with a

delta of 0.6 and market price of 10. This call option gives you the right to buy
100 shares of company X for Rs.150. Currently the company X is trading at Rs.160.
What will happen if the stock price increases to Rs.170? Solution Here the strike
price of the given call option is Rs.150. As per given problem, market price of
call option (150 strike price) will increase by Rs. 0.6 for an increase of stock
price by Rs.1. Therefore, if stock price increases by Rs.10 then the option price
will increase by 10*0.6=6 i.e. the call option price will be approx. (10+6)=16 if
the stock price increases to Rs.170.

How to calculate the delta of an option strategy/Portfolio You can easily calculate
the total delta of an option strategy or a portfolio by summing up deltas of all
individual options. For Example, Suppose a trader have made an option strategy with
the following option:1 ITM long call with delta 0.55 1 ITM long put with delta -0.6
1 OTM short call with a delta 0.3 1 OTM short put with a delta -0.4 The total delta
of this position is:0.55 + (-0.6)-0.3 +0.4 = 0.05 It indicates that the market
value of your option strategy or portfolio will increase by 0.05 unit for 1 unit
move of the underlying’s market price. Note: Normally sign of delta of a put option
is negative. Delta sign will also be negative when we short any call option.
Whereas the sign will be positive for a shorting put option. Importance of Delta
Neutral Option Strategies As you know, trading in derivative is somehow speculative
because most of the action depends on trader’s view on the stock or the market.
This market outlook of the trader may be faulty and may end in huge losses. In this
case, delta neutral strategy helps a lot. A delta-neutral strategy is a weapon of a
trader which he can use to earn profit without forecasting the direction of the
market. The term “Delta Neutral” refers to any strategy where the sum of delta
values of all the options is equal to zero. For an example, if you buy 2 call

options, each having a delta of 0.60 and you buy 4 put options also, each having a
delta of -0.30 then you have the following: Summing up the delta value = (2 x 0.60)
+ (4 x -0.30) = 1.2-1.2= 0 Hence, position delta (total delta) is zero here this is
known as Delta Neutral. In practical, this type of option strategy will not get
affected due to small movement in stock price or market but delta neutral position
will not necessarily remain neutral if price of the underlying security moves to
any side at great degree. Because, delta value of the option will change a lot if
stock price moves in any one direction significantly.
Gamma Gamma is the rate of change of an option’s delta i.e. gamma denotes how an
option delta value change with 1unit movement in underlying’s market price. You
need to reduce the gamma if you want to make a delta hedge option strategy for a
wider price range. Mathematically, delta is the first derivative of the option
market price and gamma is the second derivative of the option price. When the
option is deep in-the-money or out-of-the-money then the gamma value is small but
when the option is near or at-the-money, gamma value is the largest. All long
option have positive gamma and short option have negative gamma. Hence, the trader
can calculate the positional gamma for a particular option strategy by summing up
gamma of all individual options.

In the above figure, the strike price of the stock is Rs.30. So, when the stock
price moves up or down from Rs.30, the option moves in or out-of-themoney. As you
can see that the price of the option for at-the-money call changes more
significantly than the other two types call i.e. in-the-money or out-of-the-money
call. Also it is clear from the gamma value that the rate of change in price is

higher in case of near term option than the longer term option.

What to see as a trader As an option buyer, your primary aim will be for higher
gamma value. Your option Delta will move towards the value 1 more rapidly as the
call price will be move towards in-the-money. Hence, you will gain more if your
prediction is correct. On the other hand, if your prediction goes wrong then this
higher gamma value may bring big losses. So, always try to keep balance between all
Greeks.

Theta Theta, the third option Greek, indicates the decaying of option value over
time. It is the ‘silent-killer’ for option buyer as it takes away all the option
time value as the expiration comes near and theta value of option becomes zero at
expiry. As you know the option value = intrinsic value + Time value Here this “Time
value” depends on the value of theta. If the theta value is high for any option
then its time value will decrease fast. Theta values are always negative for option
buyers and always positive for the option writers or sellers.

As you can observe in the graph, effect of theta is low on the option premium when
expiry is far and the effect of theta becomes high on option premium as expiry
comes near. Being an option trader, you can take advantage of theta by opening
credit spread position or by simply selling options. As time passes on, if the
stock price remains same or does not change significantly or simply stays out-
ofthe-money then option value will decrease a lot and you will be able to keep the
selling option premium with you. On the other hand, if you are an option buyer then
try to close down your

position within few days as theta can takes back your profit as the option reaches
near to expiry.

Vega Vega measures the change in option premium due to one unit change in implied
volatility. Implied volatility indicates the expected volatility of the underlying
asset over the life span of the option and not the historical volatility of the
underlying asset.

The above table is the nifty options of March’2018 expiry with their Greek values.
If you observe the values carefully you will find that the Vega value is higher for
at-the-money options compare to the in-the-money or outof-the-money options.
Normally option price increases if implied volatility increases. Long options have
positive Vega and short options have negative Vega. Like the other Option Greeks,
you can calculate the positional Vega of a strategy by summing up all the
individual Vega value.
Chapter 3: Calculation of Historical Volatility

Calculation of historical volatility To calculate historical volatility of a stock

or index, first decide the time frame for which the metric will be calculated. I
normally prefer to use last 1 year time frame to calculate daily and annual
historical volatility. But here I will show the calculation of historical
volatility of bank nifty on 10days time frame. Step1: First collect historical data
i.e. closing price of bank nifty from NSE. The data should be collected for “t+1”
days where “t” is the time frame for calculating the volatility. Here I have to
collect last 11 days bank nifty data. To collect data, first I went to the below
link and then chose Nifty Bank:
https://www.nseindia.com/products/content/equities/indices/historical_index_data.ht
m I took only date and closing price data and put those in to the excel sheet.

Step2: Calculate Log return of closing price data The easiest calculation procedure
of historical volatility is the standard deviation of logarithmic returns. So, we
first need to calculate log return. Daily log return of closing prices is simply
the natural logarithm (ln) of the ratio of closing price and the closing price the
day before. By Formula, Log Return = ln (Ci/Ci-1) To calculate this in excel, we
will use “LN” function.

Here cell C4 data is the closing price and cell C3 data is previous date’s data.
Copy the formula of log return data and calculate all log return data for rest of
the column.

Step3: Calculate Standard deviation of Log Returns Now the third and final step is
to calculate standard deviation of logarithmic returns. For this purpose, we will
use sample standard deviation and the Excel formula for that is STDEV.S.

The result of this calculation will give us daily volatility of the stock/index
based on given data. I normally use 1 year or 252 days data to calculate daily and
annual historical volatility. But you can use any timeframe which suits you better.
Now to convert the daily volatility into annual volatility, you have to use Square
root (In excel, SQRT).

You can also get daily and annualized historical volatility of NSE stocks from NSE
website.

You can go to www.nseindia.com, search by writing the stock name, the below screen
will appear. Then click on the “Get Derivatives Quote” link as shown in the below
picture.

Now a new window will appear. Click on “other information” on the new window. You
will get your information.

Chapter4: How to Draw Pay-off Diagram in Excel

How to draw Payoff diagram in Excel Payoff diagram is nothing but the graphical
representation of potential outcome or in simple terms, possible profit and loss of
an option or option strategy. It is the general procedure of drawing payoff diagram
before entering buying/selling an option or before entering into option strategy
because it gives us a clear picture of risk-reward ratio. There are many methods to
draw pay-off diagram in excel. Some of them are easy and some of them are hard to
understand. Here I shall discuss a very simple method to draw payoff diagram in
excel. But before starting you have to keep in mind some important points or terms
which I will use in rest of my discussions of this book. Long option: Buying an
option. Short option: Selling an option Option Buyer: The trader who has bought the
option i.e. he has paid the option premium to buy the right. It indicates cash
outflow from that trader. Option writer: The trader who has sold the option i.e. he
has received option premium from the option buyer. It indicates cash inflow of that
trader. Call option: Buying call option means if the asset price increases then
value of call option will also increase. Hence the trader will buy the call option
if he is expecting an upside movement of the underlying asset. Put Option: Buying
Put option means if the asset prices decreases then value of put option price will
increase. Hence the trader will buy the put option if he is expecting a downwards
movement of the underlying asset. When to close option: Every option buyer will
exercise his right or close the option only when he is in profit because he has the
right but not the obligation. In case of call option, the buyer will be in profit
when the underlying asset price will be higher than the strike price. It means the
call option buyer have the right to buy the fixed amount of shares at lower price
(strike price) than the market price (underlying asset price) within a fixed time-
frame. If the strike price is higher than the underlying asset price then the call
option buyer will not exercise his option because buying from market will be
cheaper for him. In case of put option, the whole thing will be just opposite. For
drawing pay-off diagrams, we’ll use following terms and formulas:

Strike Price is the pre-determined price at which option right will be exercised by
its buyer. Exercise Price is the price of the underlying asset when the option
position was open. Initial Cash flow (CF0) i.e. cash inflow or cash outflow at the
time of opening the trade. If option is bought then cash outflow and if it is sold
then cash inflow. Cash Flow at expiry or time T (CFT) : This is the cash flow at
expiry. This will be calculated depending on the underlying asset price at that
time. To draw pay-off diagram, we will assume that all the options will be closed
at expiry date only. Total Cash Flow= Initial Cash Flow+ Cash Flow at expiry =
CF0+CFT Formulas: To determine cash flow at expiry, we will use the following
formula:

I am explaining the first formula here so that one can understand the whole table.
When the trader buys a call option, he will exercise his call option at expiry only
when the underlying asset price will be higher than the strike price otherwise he
will be in in loss. So he should choose the maximum of (differences between
underlying price and strike price) and “0”. Here “0” indicating that the call
option buyer is not exercise his right.

Payoff diagram of a long call option Suppose a trader buys Rs.400 strike price call
option at the rate of Rs.40 per share. Let see what will be the payoff diagram at
expiry. Here, Strike Price = Rs.400 Premium paid or option premium = Rs.40 per
share, i.e. CF0= -40 If at expiration the stock price is below Rs.400, the option
holder will not exercise its option. So loss is restricted to the paid premium i.e.
Rs.40. The break-even point is (exercise price + premium paid) = Rs.440

Explanation of calculating CFT CFT calculation when stock price at expiry was
Rs.410 i.e. CFT= Max ((410-400), 0) = 10 By plotting the stock price at time T
(first column) against X axis and Total cash flow (last column) against Y axis we
get the below chart:

Payoff diagram of a long Put option Suppose a trader buys Rs.400 strike price Put
option at the rate of Rs.40 per share. Let see what will be the pay-off diagram at
expiry. Here, Strike Price = Rs.400 Premium paid or option premium = Rs.40 per
share, i.e. CF0=-40 If the stock price at expiration is less than the exercise
price then put has value. The max profit is Rs. 360 (Rs.400-Rs.40) when stock price
closes to zero. If price at expiration period is more than Rs.400, the put buyer
will not exercise his option, so max loss is equal to paid premium, i.e. Rs.40.

Calculation of CFT in the above table at level when stock price at expiry is Rs.370
isCFT= Max ((400-370), 0) = 30 By plotting the stock price at time T (first column)
against X axis and Total cash flow (last column) against Y axis we get the below
chart:

Payoff diagram of a Short call option Suppose a trader sells Rs.400 strike price
call option at the rate of Rs.40 per share. Let see what will be the pay-off
diagram at expiry. Here, Strike Price = Rs.400 Premium received or option premium
received = Rs.40 per share, i.e. CF0= 40 If the stock price expires below Rs.400 or
less then the option holder will not exercise its option. So this option writer
will keep the premium i.e. writer has the max profit of Rs.40.

Formula of Calculating of CFT at level when stock price at expiry is Rs.370. CFT=
Min ((price at expiration-strike price), 0) = Min ((370-400), 0) = Rs.0 By plotting
the stock price at time T (first column) against X axis and Total cash flow (last
column) against Y axis we get the below chart:

Payoff diagram of a Short Put option Suppose a trader sells Rs.400 strike price put
option at the rate of Rs.40 per share. Let see what will be the pay-off diagram at
expiry. Here, Strike Price = Rs.400 Premium received or option premium received =
Rs.40 per share, i.e. CF0= 40 If at expiration date, price is Rs.400 or higher, put
buyer will not exercise its option, so the seller will keep the premium i.e. Rs40
which is maximum profit. Besides this, Breakeven is at Rs.(400-40)=Rs.360 level and
there will be loss below this level.

Here, calculation of CFT at the level when stock price at expiry is Rs.370 CFT= Min
((strike price- price at expiration), 0) = Min((400-370),0)

= Rs. -30 By plotting the stock price at time T (first column) against X axis and
Total cash flow (last column) against Y axis we get the below chart:

Option Strategy Pay-off Diagram The option strategy pay-off diagram can be made
just by mixing up and using the above formulas which are applicable. Now I will
show you how to draw option strategy pay off diagram with the help of practical
example.

Long straddle Pay-off diagram I will share a practical example of trade from my
experience to explain how to draw long straddle pay-off diagram. This is the
formation of long straddle when Infosys was trading at Rs.1080 level.

Here strike price of long call is Rs.1080 and option premium is Rs.24.60 per share.
Strike price of long put is Rs.1080 and option premium is Rs.30.70 per share.

The above table was calculated was in the following way:

The first column is stock price at expiry. The difference between two rows of the
stock price is Rs.10 and started from Rs.980 (1080-100) and ended at Rs.1180
(1080+100) level. The second column is cash flow of long call at expiry day. The
formula I have used to calculate this column is [{Max ((stock price at expiry-
strike price), 0) - absolute amount of initial premium paid}*no of lot] Number of
lot is 1 here. The third column is cash flow of long put at expiry. The formula I
have used to calculate this column is [{Max ((strike price- stock price at expiry),
0) +absolute amount of initial premium received}*no of lot] Number of lot is 1
here. The last column is total cash flow from the trade. This is calculated by
adding the amount of second column and third column of each row separately. Now by
plotting the value of first column and the last column, we get the following pay-
off chart:

Pay-off Diagram of Bear Call option Strategy I will share one practical example of
trade from my experience to explain how to draw bear call pay-off diagram. This is
the formation of bear call option strategy when IOC was trading at Rs.410 level.
Here, strike price of long call is Rs.420 and option premium is Rs.3.90 per share.
Strike price of long put is Rs.400 and option premium is Rs.12.80 per share.

The above table was calculated was in the following way: The first column is stock
price at expiry. The difference between two rows of the stock price is Rs.5 and
started from Rs.380 and ended at Rs.450 level. The second column is cash flow of
long call at expiry day. The formula I have used to calculate this column is [{Max
((stock price at expiry-strike price), 0) - absolute amount of initial premium
paid}*no of lot]

Number of lot is 1 here. The third column is cash flow of short call at expiry. The
formula I have used to calculate this column is [{Min ((stock price at expiry-
strike price), 0) +absolute amount of initial premium received}*no of lot] Here
number of lot is 1. The last column is total cash flow from the trade. This is
calculated by adding the amount of second column and third column of each row
separately. Now by plotting the value of first column and the last column, we get
the following pay-off chart:-

Conclusion: You should draw pay-off diagram before entering into an option strategy
because graphical representation is very important while entering into such trade.
This graphical representation will help you to identify the practical situation.
But there is one problem while creating pay-off chart in excels i.e. this will show
you the pay-off diagram at expiry day and not before that. The break-even points
generally differ in other days than expiry. Break-even points are changed every day
due to option Greeks. So, it is better to use any option strategy builder software
(e.g. OptionsOracle software of Indian version) or make broker website to build
option strategy payoff diagram. You can search the internet with the terms “option
oracle for Indian market” or “free option strategy builder for Indian market” and
you will get free software/online tools for creating the option strategy pay-off
diagram.

Chapter 5: Some Useful Option Strategies

Some Useful Option Trading strategies Option strategy trading is the most
profitable trading technique under less risk scenario. I will discuss some easy and
profitable option trading technique in this book. If you search the internet or
read any ordinary book on option strategies, you will get more than 60 types of
option strategies available in the market. You can also make option strategy as per
the requirements. I will discuss 10 option strategies in this book which I
regularly use in Indian option market. I am sure that you will be able to earn good
regular income if you use these option strategies as per the guidelines provided
here. Option trading strategies can be classified into different categories
depending on the expiry time frame or depending on volatility. This time frame may
vary from 60 days before expiry to the date of expiry. I personally do not like to
keep any option trade open overnight if there is less than 10 days of expiry, Of-
course, there are some exceptions as well. Following are the option strategies
which will be discussed. Iron Condor Option strategy: This strategy is a low risk -
limited profit earning option strategy. One can open this option strategy before 60
days of expiry on the low volatile stocks and can hold it for long time. The trader
can also make necessary adjustments if necessary. Horizontal Calendar Spread Option
Strategy: This strategy can also be held for a long time. Time decay is the main
reason of earning profit under this strategy. Bear Put Spread and bear Call spread
option strategies: These strategies can be open when the trader has the bearish
view on the underlying stock or market. Bull Put Spread and Bull Call Spread option
Strategies: These strategies can be open when the trader has the bullish view on
the underlying stock or market. Reverse Iron Condor, Long Straddle and Long
Strangle option strategies: These strategies are applicable under the situation
when the trader is expecting volatility may increase and the stock may move on
either side. Short Put Ladder: This strategy is applicable when the trader is
expecting that underlying stock may go down but he is not sure. The ratio of
prediction of downside vs upside is almost 80:20. I shall discuss the above option
strategies one by one in different

chapters. The discussion of these strategies will be in the following manner:➢

Basic Idea ➢ When to applicable ➢ Construction ➢ Calculation of maximum profit,
maximum loss and break-even points ➢ Explanation with case study and practical
example ➢ Adjustment of the option strategy under different scenario After
discussing all the option strategies one by one, I’ll discuss the points of
selecting the right strategy at right time i.e. screener for each and every option
strategy.

Chapter 5A: Iron Condor option Strategy

Iron Condor option strategy This strategy is applicable for stocks which have low
volatility. This is basically non-directional option strategy where there is high
probability of earning limited profit with less risk. This strategy has a positive
impact of time frame if other parameters (i.e. underlying price, volatility) remain
constant. It means if the stock price stays within the given range then the trader
will earn more when expiry dates/time will decrease.

When to applicable When the trader expects that there will be insignificant move in
stock price or will be in narrow range up to the expiry period, he/she can opt for
this strategy. Normally this strategy should be applied to the index option or very
less volatile stocks.

Method Here is simple construction of Iron Condor option strategy:Sell 1 OTM Put
Buy 1 OTM Put (Lower Strike) Sell 1 OTM Call Buy 1 OTM Call (Higher Strike) All
above options should be expired on same expiry date. The logic behind such action
is, the trader expects that underlying price will be in between put writing strike
price and call writing strike price upon expiration. But he buys both the call and
a put to protect his position under unfavorable situations.

Iron Condor case 1 Suppose stock A is trading at Rs.45 as on 1st June. The trader
executes an Iron Condor by buying a July 35 Put at Rs.1 , writing a July 40 put at
Rs.2, writing a July 50 call at Rs.2 and buying another July 55call at Rs.1. Let’s
assume that the lot size is 100. Analysis Here, the trader is assuming that stock
price will be in between 40 to 50 which are the strike prices of short put and
short call. For the protection purpose and minimize his loss potential, he has
bought one put and one call option.

Calculation of maximum Profit Under this strategy, maximum profit is equal to net
credit received at opening time of trade. Maximum profit is attained when the stock
price is expired in between the call and put writing strike price. Maximum
Profit=Premium received from writing of call and putpremium paid for buying call
and put – commission paid In Iron condor case 1, Maximum profit= (Premium received
from writing the put + Premium received from writing the call-premium paid on
buying the call and put)* Lot size = (Rs.2+ Rs.2- Rs.1- Rs.1)*100

= Rs.200 Note: We are not calculating the commission part because it may vary
trader to trader Maximum profit is achievable when Price of Underlying is in
between Strike Prices of the Short Put and the Short Call.

Calculation of Maximum Loss Maximum loss amount is limited but higher than maximum
profit amount under this strategy. The trader will incur loss if stock price falls
at or falls below the lower strike of the put purchased or rise above or equal to
the higher strike of the call purchased. Under both the circumstances, maximum loss
is will be: Max Loss = {(Strike Price of Long Call - Strike Price of Short
Call)*Lot size} - Net Premium Received + Commissions Paid Max Loss Occurs When
Price of Underlying >= Strike Price of Long Call OR Price of Underlying