Voice over
Hi, Welcome to Finroot’s Youtube channel.
Voice over
Today we are going to have a discussion about Futures 'n' Options.
Voice over
Thousands of people lose money in the stock market every day, and that is not because of "bad luck",
it is purely because of "lack of knowledge".
Voice over
When it comes to the stock market, any stock can be in 3 types of situations. Either it goes up or down, or it remains within the
range.
Voice over
Here's a quick example that we'll carry throughout this discussion.
The current market price of "Reliance" share is around Rupees 1500, and in the near future, it can either go up or down or
there is also a possibility that stock remains near to 1500 only.
Voice over
If you are expecting the reliance stock to go up, here are your available options:
1. Buy Reliance stock in the cash market 2. Buy Reliance future at current market price
3. Buy a call of reliance 4. Sell a put of reliance
Voice over
All 4 options will give profit when the stock price goes up and will present losses
when the stock price goes down.
Voice over
If you buy the stock in cash, stocks will be delivered in your Demat account.
While the rest of the cases have nothing to do with your Demat account as those are the cases of derivatives that are settled in
a trading account only.
Voice over
Now, let's talk about the case when you buy a call or sell a put. For buying a call, you have to select a strike price, but what is
"Strike Price"? To put in simple words, strike price is nothing but an expectation.
Voice over
If you expect Reliance to go to 1600 levels, then you can buy 1600 strike call option. If you expect Reliance to go to 1700 levels,
then you can buy 1700 Strike call option.
Voice over
The further option you choose, the lesser will be the premium because there is a lesser probability that the stock
price will actually reach that strike.
Voice over
In the current scenario, let's discuss a case where the trader chooses to buy 1600 strike call option.
Voice over
Since you are buying, you have to pay some premium for that, Let's say 40 rupees. So, the total money you need
to pay to buy this call option is 500*40= 20,000
Voice over
Since you have paid only 20,000, your maximum loss is limited to 20,000, and breakeven for this trade is 1640 because 1600 is
strike price that trader has chosen and the trader has paid 40 rupees for it.
Voice over
So, on expiry, let's take the below cases:
Price on Expiry Net position on expiry
1540 40 Loss 1560 40 loss 1580 40 loss 1600 40 loss 1620 20 loss 1640 Breakeven (no profit no loss) 1660 20 profit 1680 40
profit 1700 60 profit
Voice over
Therefore, on expiry, any price above 1640 will give profit in our call option, To summarize, Buying a call option has the
following features: 1. Limited Risk 2. Unlimited Return
Voice over
But to complete a trade there has to be a seller. You cannot buy an option until someone has sold it.
Voice over
So what is the seller expecting from this trade? The Total Opposite,
The trader who is selling 1600 call strike simply thinks that the stock will not cross 1600 levels so that he can keep the entire
premium.
Voice over
Let's analyze the case of Call option seller:
Price on expiry Position of call option seller
1540 40 profit 1560 40 profit 1580 40 profit 1600 40 profit 1620 20 profit 1640 0 1660 20 loss 1680 40 loss 1700 60 loss
Voice over
To summarize, selling a call option has the following features:
1. Unlimited risk 2. Limited Return
Voice over
Always remember that someone's loss is someone else's gain. So, the loss of option buyer is the gain of option seller and vice
versa.
Voice over
But the real question is "If everybody understands that option buyer has limited return, why isn't everyone a millionaire?"
Voice over
And if the situation is as simple as it looks, "Why are people selling options?"
Voice over
"Does an option buyer actually has unlimited return and option seller faces
unlimited risk?"
Voice over
We'll find out in Finroot’s next video
