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1.What is Day Trading?
2.What is Swing Trading?
3.What are Derivatives?
4.What are Futures?
5.What are Options?
6.When to Buy a Call Option?
7.When to Buy a Put Option?
8.When to Sell a Call Option?
9.When to Sell a Put Option?
10.How are Options different from Futures?
11.What are European & American Style of options?
12.What is an Option Calculator?
13.Who are the likely players in the Options Market?
14.What are Stock Index Options?
15.What are the uses of Index Options?
16.Who would use index options?
17.What are Options on individual stocks?
18.what are important terminologies used in F&O?
19.What is the difference between a market order, a limit order, and a stop loss order?
20.What are most deadly mistakes in Trading?
21.What are most popular golden rules for successful Trading?
1.What is Day Trading?
Day Traders usually buy and sell (or sell first and then buy) securities
(including Stocks, Bonds, Commodities, currency, options, futures etc) during
the same day and, as a general rule, do not hold the securities overnight. They
are therefore said to have "Zero Position” at the end of the day. (However some
Brokers have started providing facility to square up the Buy-Trades on next
market day). Many Day Traders make dozens of trades every day hoping to capture
profits that arise from small intra-day price fluctuations.
2.What is Swing Trading?
Swing traders usually hold a security from one day to 2 weeks or so. Most of the
swing traders concentrate on Breakouts on just a few selected High Volume stocks
that they believe will likely make a significant move in price in the near-term.
3.What are Derivatives?
Derivatives are financial instruments which derive their value from the
underlying assets or securitues. For example if a Buyer enters into a contract
with a Seller to buy a specified number of shares (or Index/ Commodity) of a
particular company at a specified price after a specified period, the buyer is
said to have entered into a Futures contract.
It is interested to note that Buyer has bought the contract and not the stock of
shares(or Index/ Commodity) under reference. This type of Future contract is
called Derivative. There are many other type of Derivatives commonly used all
over the world like Options, Convertibles and Warrants etc.
4.What are Futures?
It is an Agreement between the Buyer and the Seller for the Purchase or Sell of
a Particular Asset ( like Equity Stock/ Index etc) at a Specified Price and on a
specified future date (1 Month/ 2 Months/ 3 Months). It conveys an OBLIGATION on
both Buyer and Seller to Fulfill the Terms of the Agreement. Futures are Settled
on Last Thursday of the Specified Month and both buyer and seller have to pay
minimum Initial Margin as per the requirement of stock exchange and account
between buyer and seller is settled Everyday till the expiry of the Futures
contract.
Nifty Future contract have a multiplier of 50 that means Nifty Futures contract
gives rise to an obligation to deliver at settlement cash payment equal to 50
times the difference between the Nifty Index value at the close of the last
trading day of the contract and the price at which the Futures Contract was
negotiated.
Example
Suppose 'A' enters (Buys) a Nifty futures contract at 5600 for Nov.2007(expiring
on last Thursday of Nov.) with 'B'. Both 'A' & 'B' will deposite the required
margin with the Stock exchange. On last Thursday of Nov., Nifty closes at 5750.
Now 'A' will get Rs. 7500/- {( 5750-5600) x 50 = 7500} from 'B'. In case Nifty
closes at 5400, 'B' will get Rs. 10000/- {(5600-5400) x 50 = 10000 } from 'A'.
But their account will be credited or debited from their Margin Account and
their position will be 'marked to market' at the end of session each day. In
case the Margin account falls below the maintenence level, cash is sought from
the customer to replenish the margin account back to original level. Either of
the customers having surplus margin beyond original margin can withdraw the
funds.
5.What are Options?
An option is a contract, which gives the Buyer of Option (holder) the right, but
not the obligation, to Buy or Sell specified quantity of the underlying assets,
at a Specific (Strike) Price on or before a Specified Time (expiration date) i.e
1 Month/ 2 Months/ 3 Months etc. The underlying may be physical commodities like
wheat/ rice/ cotton/ gold/ oil or financial instruments like equity stocks/
stock index/ bonds etc.
There are 2 types of Options i.e. Call Options and Put Options.
CALL OPTIONS
A Call Option gives the holder (buyer/ one who is long call), the right (No
obligation) to buy specified quantity of the underlying asset at the strike
price on or before expiration date. The seller (one who is short call) however,
has the obligation to sell the underlying asset if the buyer of the call option
decides to exercise his option to buy.
Option buyer or option holder - Buys the right (No obligation) to buy the
underlying asset at the specified price
Option seller or option writer - Has the obligation to sell the underlying asset
(to the option holder) at the specified price
PUT OPTIONS
A Put Option gives the holder (buyer/ one who is long Put), the right (No
obligation) to sell specified quantity of the underlying asset at the strike
price on or before a expiry date. The seller of the put option (one who is short
Put) however, has the obligation to buy the underlying asset at the strike price
if the buyer decides to exercise his option to sell.
Option buyer or option holder - Buys (No obligation) the right to sell the
underlying asset at the specified price
Option seller or option writer - Has the obligation to buy the underlying asset
(from the option holder) at the specified price.
6.When to Buy a Call Option?
If you are Bullish on a particular Scrip/Index. For example, you are Bullish on
ICICI BANK (CMP- Rs.1150/-) and expecting it to touch Rs.1300/- in a month's
time (or any particular period say 2/3 months). So you will Buy ICICI BANK Call
Option for 1 month (or any particular period) by paying a premium of Rs.15/share
(Say). During the course of month you will get Right to excercise your Call
Option to Buy ICICI BANK at 1150 from the seller of Call Option. Suppose it does
not move up, you are free NOT to excercise your option to Buy and your loss is
limited to the Premium you have paid.
7.When to Buy a Put Option?
If you are Bearish on a particular Scrip/Index. For example, you are Bearish on
MTNL (CMP -Rs.160/-) and expecting it to touch 130/- in a month's time. So you
will Buy MTNL Put Option for 1 month by paying a premium of Rs.8/share (Say).
During the course of month (you are Free to Buy MTNL from market any time at
lower price) you will get Right to excercise your Put Option to Sell MTNL at
160/- to the seller of Put Option. Suppose it does not decline, you are free NOT
to excercise your option to Sell and your loss is limited to the Premium you
have paid.
8.When to Sell a Call Option?
If you are Bearish on a particular Scrip/Index. For example, you are Bearish on
NTPC (CMP- Rs.250/-) and expect that it will not move up significantly(or rather
decline) in a month's time. So you will Sell NTPC Call Option at a strike rate
Rs.270/- (say) for 1 month and Receive the Premium. (Say Rs.6/share). During the
course of month Buyer of Call Option will have Right (Not the Obligation) to
take NTPC at 270/- from you and you are obliged to honour your commitment.
Remember that you are Holding risk of umlimited loss if Price of NTPC moves up
significantly just at the cost of Premium you have received.(you should sell
Call Option Only if you are sure that Price of Share will Fall/or not move up or
you are holding shares with you to part with, if required)
9.When to Sell a Put Option?
If you are Bullish on a particular Scrip/Index. For example, you are Bullish on
SAIL (CMP - Rs.240/-) and expect that it will not Decline significantly (or
rather move up) in a month's time. So you will Sell SAIL Put Option at a strike
rate Rs.260/- (say) for 1 month and Receive the Premium. (Say Rs.10/share).
During the course of month Buyer of Put Option will have Right (Not the
Obligation) to Sell SAIL at 260/- to you and you are obliged to honour your
commitment. Remember that you are Holding risk of umlimited loss if Price of
SAIL goes down at the cost of Premium you have received. (you should Sell Put
Option Only if you are sure that Price of Share will Move up or you will take
Delivery of shares, if required)
10.How are Options different from Futures?
The significant differences in Futures and Options are as under:
I. Futures are agreements/contracts to buy or sell specified quantity of the
underlying assets at a price agreed upon by the buyer & seller, on or before a
specified time.
Both the buyer and seller are obligated to buy/sell the underlying asset.
II. In case of Options the buyer enjoys the right & not the obligation, to buy
or sell the underlying asset.
III. Futures Contracts have symmetric risk profile for both the buyer as well as
the seller, whereas options have asymmetric risk profile. In case of Options,
for a buyer (or holder of the option), the downside is limited to the premium
(option price) he has paid while the profits may be unlimited. For a seller or
writer of an Options however, the downside is unlimited while profits are
limited to the premium he has received from the buyer.
IV. The Futures contracts prices are affected mainly by the prices of the
underlying asset. The prices of Options are however, affected by prices of the
underlying asset, time remaining for expiry of the contract & volatility of the
underlying asset.
V. It costs nothing to enter into a Futures contract whereas there is a cost of
entering into an Options contract, termed as Premium.
11.What are European & American Style of options?
An American style option is the one which can be exercised by the buyer on or
before the expiration date, i.e. anytime between the day of purchase of the
option and the day of its expiry. The European kind of option is the one which
can be exercised by the buyer on the expiration day only & not anytime before
that.
12.What is an Option Calculator?
An option calculator is a tool to calculate the price of an Option on the basis
of various influencing factors like the price of the underlying and its
volatility, time to expiry, risk free interest rate etc. It also helps the user
to understand how a change in any one of the factors or more, will affect the
option price.
13.Who are the likely players in the Options Market?
Financial institutions, Mutual Funds, Domestic & Foreign Institutional
Investors, Brokers, Retail Participants are the likely players in the Options
Market.
14.What are Stock Index Options?
The Stock Index Options are options where the underlying asset is a Stock Index
for e.g. Options on S&P 500 Index/ Options on BSE Sensex etc. Index Options were
first introduced by Chicago Board of Options Exchange (CBOE) in 1983 on its
Index 'S&P 100'. As opposed to options on Individual stocks, index options give
an investor the right to buy or sell the value of an index which represents
group of stocks.
15.What are the uses of Index Options?
Index options enable investors to gain exposure to a broad market, with one
trading decision and frequently with one transaction. To obtain the same level
of diversification using individual stocks or individual equity options,
numerous decisions and trades would be necessary. Since, broad exposure can be
gained with one trade, transaction cost is also reduced by using Index Options.
As a percentage of the underlying value, premiums of index options are usually
lower than those of equity options as equity options are more volatile than the
Index.
16.Who would use index options?
Index Options are effective enough to appeal to a broad spectrum of users, from
conservative investors to more aggressive stock market traders. Individual
investors might wish to capitalize on market opinions (bullish, bearish or
neutral) by acting on their views of the broad market or one of its many
sectors. The more sophisticated market professionals might find the variety of
index option contracts excellent tools for enhancing market timing decisions and
adjusting asset mixes for asset allocation. To a market professional, managing
the risk associated with large equity positions may mean using index options to
either reduce their risk or to increase market exposure.
17.What are Options on individual stocks?
Options contracts where the underlying asset is an equity stock, are termed as
Options on stocks. They are mostly American style options cash settled or
settled by physical delivery. Prices are normally quoted in terms of the premium
per share, although each contract is invariably for a larger number of shares,
e.g. 100.
18.what are important terminologies used in F&O?
Underlying - The specific security / asset on which an options contract is
based.
Option Premium - Premium is the price paid by the buyer to the seller to acquire
the right to buy or sell
Strike Price or Exercise Price - The strike or exercise price of an option is
the specified/ pre-determined price of the underlying asset at which the same
can be bought or sold if the option buyer exercises his right to buy/ sell on or
before the expiration day.
Expiration date - The date on which the option expires is known as Expiration
Date. On Expiration date, either the option is exercised or it expires
worthless.
Exercise Date - is the date on which the option is actually exercised. In case
of European Options the exercise date is same as the expiration date while in
case of American Options, the options contract may be exercised any day between
the purchase of the contract & its expiration date (see European/ American
Option)
Open Interest - The total number of options contracts outstanding in the market
at any given point of time.
Option Holder - is the one who buys an option which can be a call or a put
option. He enjoys the right to buy or sell the underlying asset at a specified
price on or before specified time. His upside potential is unlimited while
losses are limited to the Premium paid by him to the option writer.
Option seller/ writer - is the one who is obligated to buy (in case of Put
option) or to sell (in case of call option), the underlying asset in case the
buyer of the option decides to exercise his option. His profits are limited to
the premium received from the buyer while his downside is unlimited.
Option Class - All listed options of a particular type (i.e., call or put) on a
particular underlying instrument, e.g., all NIFTY Call Options (or) all NIFTY
Put Options
Option Series - An option series consists of all the options of a given class
with the same expiration date and strike price. E.g. NIFTYNOV5600CE is an
options series which includes all NIFTY Call options that are traded with Strike
Price of 5600 & Expiry in Nov. (NIFTY Stands for NIFTY INDEX (underlying index),
CE is for Call Option , Nov. is expiry date & strike Price is 5600)
19.What is the difference between a market order, a limit
order, and a stop loss order?
Here are the key differences between each type of order:
I. A market order instructs your Trading Terminal or shares broker to buy or sell
shares immediately at the current market price. This will usually take place at
the "ask" price
II. A limit order instructs your Trading Terminal or shares broker to buy or
sell shares at certain price specified by you. When (and if) the price of the
stock reaches the price you previously specified, your order will be executed at
that price.
III. A stop loss order instructs Trading Terminal or shares broker to liquidate
your position if the share price drops or rises above a certain amount specified
by you. (Imp. Note - Give sufficient spread between Stop Loss limit and Trigger
Price to avoid any non-materialization of Stop Loss Order)
20.What are most deadly mistakes in Trading?
The following are 10 most common but deadly Trading Mistakes, which traders
should avoid at all costs. Anyone of them can literally destroy one's financial
dreams and goals!
I. Trading for excitement & thrill Not for profits.
Many traders consider stock market as casino and trade for thrill and fun only.
As soon as one has a losing trade, he wants to quickly make back the lost money.
He thinks about the other things he could have done with the money, regret
taking the trade and want to recover as quickly as possible. This in turn leads
to further mistakes. Be patient and wait for the next high probability
opportunity. Don't rush back in.
II. Trading with a high ego.
Many individuals who have remained highly successful in other business ventures
have failed miserably in trading game. Because they have a fairly big ego and
thought they couldn't fail. Their egos become their downfall because they can
not accept that they would be wrong and refuse to get out of bad trades. Once
again, whoever or wherever has any one come from does not concern the markets.
All the charm, powers of persuasion, number of degrees & diplomas of business
management on the wall or business savvy will not budge the market when you are
wrong.
III. Three 4-letter words that will kill you! HOPE--WISH--FEAR--PRAY
If you ever find yourself doing one or more of the above while in a trade then
you are in big trouble! Markets has own system of moving up & down. All the
hoping, wishing and praying or being fearful in the world is not going to turn a
losing trade into a winning one. When you are wrong just use a simple 6-letter
word to correct the situation-GET OUT!
IV. Trading with money you can't afford to lose.
One of the greatest obstacles to successful trading is using money that you
really can't afford to lose. Examples of this would be money that is supposed to
be used in any other business, money to be paid for college/school fee, trading
with borrowed money etc. Ultimately what happens is that when someone knows in
the back of their mind that they are risking the money they can not afford to
lose, they trade out of fear and emotion versus logic and no emotion. If you are
in this situation It is highly recommend that you stop trading until you earn
enough to put into an account that you truly can afford to lose without causing
major financial setbacks.
V. No Trading Plan
If you consider yourself a trader, ask yourself these questions: Do I have a set
of rules that tell me what to buy, when to buy and how much to buy, not just for
the next trade, but for the next 10 trades? Before I enter a trade, do I know
when I will take profits? Do I know when I will get out if I am wrong? These
questions form the first part of a trading strategy. There simply cannot be any
expectation of success if we can't answer these questions clearly and concisely.
VI. Spending profits before you make them.
Nothing is more exciting then getting into a trade that blasts off and puts you
into a highly profitable situation. This can cause major problems however,
because this type of trade puts you in a highly euphoric state and leads to
daydreaming about the huge profits still to come. The real problem occurs as you
get caught up in the daydream and expectations. This causes you to not be
prepared to get out as the market reverses and wipes off all your profits
because you have convinced yourself of the eventual outcome and will deny the
reality of the situation. The simple remedy for this is to know where and how
you will take profits once you enter the trade.
VII. Not Cutting Losses or letting Profits run
One of the most common mistakes made by traders is that they let their losses
grow too large. Nobody likes to take a loss, but failing to take a small loss
early will often result in being forced to take a large loss later. A great
trader is not someone who has never had a loss. Great traders have made many
losses. But what makes them great is their ability to recover quickly from a
string of losses.
Every trader needs to develop a method for getting out of losing trades quickly.
Research and learn to apply the best methods for placing protective stoploss
orders.
The only way to recover from many (small) losing trades is to make sure the
winning trades are much larger. After a series of losing trades, it becomes
difficult to hold a winning trade because we fear that it will also turn into a
loss. Let your profitable trades run. Give them room to move and give them time
to move.
VIII. Not Sticking to your plans & Changing strategies during market hours
If you find yourself changing your strategy during the day while the markets are
still open, be mindful of the fact that you are likely to be subject to
emotional reactions of fear and greed. With rare exception, the most prudent
thing to do is to plan your trading strategy before the market opens and then
strictly stick to it during trading hours.
IX. Not knowing how to get out of a losing trade.
It's amazing that most of the traders don't have any clear escape plan for
getting out of a bad trade. Once again they hope, pray wish and rationalize
their position. It must be kept in mind that market does not care what you
think. It does what it does and when you are wrong you are wrong! The easiest
way to keep a bad trade from going really bad is to determine before you get in,
where you will get out.
X. Falling in love with a stock (Just Flirt).
Many traders get fascinated by just a stock or two and look for opportunities to
trade in those stocks only ignoring the other profitable trading opportunities.
It is because they have simply fallen in love with a stock to trade with. Such
tendencies can be suicidal as for as trading is concerned. It may cost any one
dearly.
21.What are most popular golden rules for successful Trading?
The following are 10 most important rules which can turn you a consistent Winner
if applied properly with discipline
I. Divide your Risk Capital in 10 Equal Parts.
As part of the Successful money management, it is always advised to divide your
Risk Capital (which you can afford to lose) into 10 equal Parts and at any given
time none of your Single Trade should have more than 3 parts of your capital in
it even if you are in a winning position. At the same time always keep some
spare money for any Buying Opportunity, which may come any time.
II. Trade ONLY in active & high Volume Stocks/ Futures.
Many Traders get stuck with stocks for want of liquidity. Always rely upon
Stocks which have reasonably high volume over a period of time. High Volume are
always advised for easy Entry, Exit and Stop Loss. In low volume stocks the
spread is too high and chance of Stop Loss limit getting failed is too high as
there would be no Buyer or seller at your Stop Loss Level.
III. Come Prepared with a Trading Plan
Successful traders always keep their Trading Plans ready before entering into
any transactions. One must prepare a Watch List or Probable candidates for Day's
trading and remain focused on the movement of those stocks only. For example a
Stock 'X' is on verge of a Bullish Breakout from any pattern or stock 'Y' has
declined substantially after an initial sharp upmove or stock 'Z' is close to an
important support level. Successful trader would concentrate on the movement of
those stocks only and enter the trade as soon as stock 'X' gives the anticipated
breakout or stock 'Y' starts an upmove or stock 'Z' breaks the support level to
initiate a trade for quick gains.
IV. Never Over Trade
This is the most common mistake committed by Traders, particularly after a
Streak of winning Trades. This mistake generally not only wipes off all the
profits, but puts traders in heavy losses. In order to remain in market while
making consistent Profits, under no circumstances, traders should go beyond
their Risk Capital.
V. Trade in 2 to 4 Stocks at a time with strict Stop Loss.
In a Bull move, most of the stocks move up and similarly in any Bear Move, most
of the stock moves southwards. As a Trader you know this fact but can you Buy 20
Stocks and try to make profit in all the 20 stocks just because all are moving
up or vice versa in a Down trend? What will happen if market reverses without
any indication on any bad news? Would you be able to monitor all your trades in
such situation? Smart and Successful trader would trade in 2 to 4 stocks with
strict Stop Loss and keep a strict vigil to avoid any misfortune in case of any
eventuality.
VI. Sell Short as often as you go Long.
More than 90% of common investors/ Traders are 'Bulls' by nature. Because they
love to see prices going up only. Stocks are bought by anybody/ corporate/
financial institutions/ Mutual Funds to make profit on rise. They have large
holdings and mentally they wish and pray for the market to rise only. But facts
are different. History shows that Bull Phases have shorter duration that Bear
phases. So every stock that moves up will retrace back to 38%-50%-66%. Since 90%
investors are Bulls by heart they normally do not book profit at higher levels
to re-enter later at lower levels instead they prefer to increase their
portfolio at lower levels. Successful Traders know how to capitalize such
correction. They are always prepared to go 'Short' as often as they trade on
'Long' side.
VII. Don't Trade if you are not Clear.
Many Traders, because of their daily habits trade even when there are no signals
to buy or short. Normally such situation arrives after a sharp rise or decline
when stocks are adjusting their values. While some stocks attempt to move up,
few may be taking breather before next move. Such situation are often confusing.
There is no harm in taking rest for a day or two or short period if the trend is
choppy, unclear or doubtful, instead of putting your money at higher risk.
VIII. Don't expect Profit on Every Trade.
If you consider you are a smart trader who can make profit on every trade, you
are 100% wrong. Always be flexible and accept the fact as soon as you realize
that you are on wrong side of the trade. Simply get out of the trade without
changing your strategy during the market; it may cause you double losses.
IX. Withdraw portion of your profits.
The business of Trading is excellent as long as you are making profits. Unlike
other business your losses can be unlimited and rapid if market does not move as
per your expectations. While in other businesses you may have other remedial
measures available but in trading it is you only who has to control it. Traders
have large egos particularly after series of successful trades and their
tendency to enlarge commitments in overconfidence may cause major financial set
back. There fore it is must that trader must take a portion of the profit and
put it in separate account. This is absolutely must for long term stability in
the market.
X. 'Rumors' can ruin you sooner or later- Don't follow them. Rumors are part of
the game in Stock market. In most cases these are spread by vested interests
through brokers, media or other rumor mongers in the interest of any particular
company well before their IPO's, or to reduce/enlarge holdings or whatever
reason may be.You may be lucky if you have made profits on such 'Rumors' but
there are 100% chances that you are likely to be trapped in sooner or later if
trading on 'Rumors' is part of your strategy. Believe in Charts,good Technical
analists. There is no second best option.
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