Presentation on Derivatives and Technical Analysis

PRESENTATION ON DERIVATIVES

AND TECHNICAL ANALYSIS

By Adhvith Dhuddu

Friday, 27th November, 2009

SRN Adarsh College

QUESTION 1BOOK PRIZE: One up on Wall Street

WHICH IS THE LARGEST

CORPORATION IN TERMS OF

MARKET CAPITALIZATION IN MARKET CAPITALIZATION IN

THE WORLD?

www.AdhvithDhuddu.com

Exxon Mobile, PetroChina or Industrial and Commercial

Bank of China (ICBC). Top 3, always switching places.

THE WORLD’S MOST RENOWNED

AND RESPECTED INVESTOR SAID

SOMETHING VERY SHOCKING

QUESTION 2 BOOK PRIZE: Political Economy of the Global Financial Crisis

SOMETHING VERY SHOCKING

AND STARTLING ABOUT

DERIVATIVES. WHO IS IT AND

WHAT DID HE/SHE SAY? www.AdhvithDhuddu.com

QUESTION 3BOOK PRIZE: Options and Futures - An Indian Perspective

CAN ANYONE TELL ME

WHAT IS THE MEANING


WHAT IS THE MEANING

OF COUNTERPARTY RISK?

DERIVATIVES BASICS

A derivative is a financial instrument which DERIVES its value from another

financial product (underlying asset)


There are derivative instruments available which derive their value from:

INDICES COMMODITIESINTEREST RATES CREDITCURRENCY EQUITIES/STOCK

financial product (underlying asset)

DERIVATIVE INSTRUMENTS: OPTIONS AND

FUTURES

TEXT BOOK DEFINITION FOR OPTIONS

AN OPTION CONTRACT GIVES THE BUYER THE RIGHT, BUT NOT THE OBLIGATION, TO BUY OR SELL A CERTAIN NUMBER OF SHARES AT A FIXED PRICE, ON OR BEFORE


NUMBER OF SHARES AT A FIXED PRICE, ON OR BEFORE A FIXED DATE: WHAT A CONFUSING DEFINITION!! AS COMPLICATED AND TORTUOUS AS POSSIBLE!!!

TEXT BOOK DEFINITION FOR FUTURE

FUTURES CONSIST OF CONTRACTS TO BUY OR SELL A SPECIFIC UNDERLYING INSTRUMENT (STOCK/INDEX) AT A SPECIFIC TIME IN THE FUTURE FOR A SPECIFIC PRICE.

If you BUY the option contract for the book, you have the RIGHT to purchase that book at the agreed price from the seller (with whom

you entered the contract with), but you don’t have to buy it from the seller (i.e. not obligated). If you choose to buy it from the seller, the

seller HAS TO SELL IT TO YOU at the agreed contract price.

OPTIONS BASICS


THE RIGHT: To buy or sell 100, 500, 2400 (depends on the market lot) shares of a specific stock or index.

THE EXPIRATION DATE: The date that your right ends or expires

THE EXERCISE PRICE: The price at which you can buy or sell

THE OPTION PRICE (or option premium): The price you paid for the right.

seller HAS TO SELL IT TO YOU at the agreed contract price.

Based on Right to Exercise

Call options and put options

BUYER SELLER

CALL OPTION Right to buy Obligation to sell

OPTIONS BASICS CONTINUED

Based on Time to Exercise

American Options: Can be exercised any time up to maturity date

European options: Can be exercised only on maturity date

CALL OPTION Right to buy Obligation to sell

PUT OPTION Right to sell Obligation to buy


OPTIONS BASICS CONTINUED

VALUING EQUITY OPTIONS• THE OPTION PREMIUM IS HOW MUCH YOU PAY TO

PURCHASE THE OPTION, OR HOW MUCH YOU RECEIVE TOSELL THE OPTION.

• Option Premium can be divided into two components: the• Option Premium can be divided into two components: the‘INTRINSIC VALUE’, and the ‘TIME VALUE’.

• The intrinsic value is the value by which an option is in themoney. It is the difference of stock price & strike price.

• Intrinsic value of a call = max (0, Stock – Strike Price)

• Intrinsic value of a put = max (0, Strike Price – Stock)

OPTION PREMIUM = INTRINSIC VALUE + TIME VALUE


HOW DO I USE DERIVATIVES IN MY

PORTFOLIO AND INVESTMENTS?

YOU CAN USE DERIVATIVES FOR

1. Hedging Risk and protection

2. Speculation and trading

3. Exploit arbitrage opportunities


3. Exploit arbitrage opportunities

STEP 1: Determine your market outlook

STEP 2: Choose a corresponding strategy

STEP 3: Follow up on the strategy

STRATEGY MATRIX

View Strategy

Bullish Strongly Buy futures

Buy out of the money call

Sell deep in money put

Sell call deep in money and buy more nos. of higher strike calls

Moderately Buy at the money call


Moderately Buy at the money call

Sell at the money put

Buy low strike price call and sell high strike price call

Buy low strike price put and sell high strike price put

Buy spot /futures and sell high strike price call

Buy spot/ futures and buy put

Mildly Buy deep in money call

Sell out of the money put

Buy spot /futures and sell at the money /high strike price call

STRATEGY MATRIX…CONTINUED

View Strategy

Bearish Strongly Sell futures

Sell deep in money call

Buy out of the money put

Sell put at higher strike price and buy more nos. of puts at lower price


Moderately Sell at the money call

Buy at the money put

Buy high strike price call/put and sell low strike price call/put

Mildly Sell out of the money call

Buy deep in money put

Buy spot/ futures and buy put

STRATEGY MATRIX…CONTINUED

View Strategy

Stable Sell near month call/put and buy far month call/put with same

strike price and at the money options

Sell one call and one put at the same strike price

Sell one call and one put different strike prices (out of the money)

Buy one call at P1 and one call at P3 and sell two call at P2


Buy one call at P1 and one call at P3 and sell two call at P2

(where P1<P2<P3)

Uncertain but Buy one call and one put at the same strike price

volatile Buy one call and one put at different strike price

Strategy 1 Market Outlook: Bullish

Strategy: LONG (Buy) CALL

EXAMPLE: Initiated on 24th Jan View: Bullish on Infosys TechSpot Price: Rs .2230/-Strategy: Bought INFOSYSTECH 2250 Feb CA @ Rs.45


Strategy: Bought INFOSYSTECH 2250 Feb CA @ Rs.45 (Lot size = 100)

Result: In about a weeks’ time, the call option appreciated to Rs.70 as the stock price rose and we sold off the position resulting in a profit. A graphical representation of this option position is given in the next slide

Payoff Profile

Payoff Profile

2,000 00

4,000 00

6,000 00

8,000 00

10,000 00

12,000 00

14,000 00

Pro

fit/

Lo

ss


BREAK EVEN POINT: Rs.2295, i.e., strike price + premium paidMAXIMUM PROFIT: Unlimited

MAXIMUM LOSS: Rs.4500 per lot

-6,000 00

-4,000 00

-2,000 00

0 00

2,000 00

2,065 2,100 2,135 2,170 2,205 2,240 2,275 2,310 2,345 2,380 2,415

Infosys Tech at Expiry

Pro

fit/

Lo

ss

Strategy 2

Market Outlook: Bearish to stagnant

Strategy: SHORT (Sell) CALL

EXAMPLE: Bearish on ACC and other cement stocks View: Bearish on cement stocksSpot Price: Rs .1020/-Strategy: Sold ACC 1050 Feb CA @ Rs.20 (Lot size = 375)


Strategy: Sold ACC 1050 Feb CA @ Rs.20 (Lot size = 375)Result: Our conviction was right and cement stocks

trended downwards. We therefore kept the premium that we collected which was our net profit. A graphical representation of this option position is given in the next slide.

Payoff Profile

Payoff Profile

-10,000 00

-5,000 00

0 00

5,000 00

10,000 00

975 990 1,005 1,020 1,035 1,050 1,065 1,080 1,095 1,110 1,125

Pro

fit/

Lo

ss


BREAK EVEN POINT: Rs.1070, i.e., strike price + premium receivedMAXIMUM PROFIT: Premium received

MAXIMUM LOSS: Unlimited

-25,000 00

-20,000 00

-15,000 00

-10,000 00

ACC at Expiry

Pro

fit/

Lo

ss

Strategy 3

Market Outlook: Bearish

Strategy: LONG (Buy) PUT

EXAMPLE: Initiated on 23rd FebruaryView: Bearish on the NIFTY indexSpot value: 3930 levelsStrategy: Bought NIFTY 3900 Feb PA @ Rs.120 (Lot size =


Strategy: Bought NIFTY 3900 Feb PA @ Rs.120 (Lot size = 50)

Result: The put option appreciated to Rs.134 as the index fell and we sold off the position resulting in a profit. A graphical representation of this option position is given in the next slide.

Payoff Profile

-4,000 00

-2,000 00

0 00

2,000 00

4,000 00

3,700 3,750 3,800 3,850 3,900 3,950 4,000 4,050 4,100 4,150 4,200

Pro

fit/

Lo

ss

Payoff Profile


-8,000 00

-6,000 00

-4,000 00

Nifty at Expiry

Pro

fit/

Lo

ss

BREAK EVEN POINT: 3780, i.e., strike price - premium paidMAXIMUM PROFIT: Unlimited

MAXIMUM LOSS: Rs.6000 per lot

Strategy 4 Market Outlook: Bullish to Stagnant

Strategy: SHORT (Sell) PUT

EXAMPLE: Initiated on 9th Feb View: Bullish on SAILSpot Price: Rs .114/-Strategy: Sold SAIL 110 Feb PA @ Rs. 2.50 (Lot size = 2700)Result: This is one example where our strategy resulted in a


Result: This is one example where our strategy resulted in a loss. Our outlook was wrong and SAIL stock fell along with the general market. We had to buy back our put at a higher price (at Rs.3.90) as the stock went down and this resulted in a loss of Rs.1.40 per lot. A graphical representation of this option position is given in the next slide

Payoff Profile

-2,000.00

0.00

2,000.00

4,000.00

6,000.00

8,000.00

105 106 107 108 109 110 111 112 113 114 115Pro

fit/

Lo

ss

Payoff Profile


BREAK EVEN POINT: Rs. 107.50, Strike price - Premium receivedMAXIMUM PROFIT: Premium receivedMAXIMUM LOSS: Unlimited

-8,000.00

-6,000.00

-4,000.00

-2,000.00 105 106 107 108 109 110 111 112 113 114 115

SAIL at Expiry

Pro

fit/

Lo

ss

Strategy 5Market Outlook: Moderately Bullish

Strategy: BULL SPREAD

(Buy a call and sell a call at a higher strike OR buy a put and sell a put at a higher strike)

EXAMPLE: Initiated on 31st Jan View: Bullish on SBISpot Price: Rs .1140/-


Spot Price: Rs .1140/-Strategy: Buy SBI 1140 Feb CA @ Rs.42 (Lot size = 250)

Sell SBI 1230 Feb CA @ Rs.10 (Lot size = 250)Result: After executing this strategy, SBI rallied higher and we realized

a net profit in this strategy. We sold the 1140 call for Rs.85 and bought back the 1230 call for Rs.32, hence resulting in a net profit of Rs.21 per lot. A graphical representation of this option position is given in the next slide.

Payoff Profile

5,000 00

10,000 00

15,000 00

20,000 00

Pro

fit/

Lo

ss

Payoff Profile


BREAK EVEN POINT: Rs.1172MAXIMUM PROFIT: Rs.14,500 per lot (250 x 58)

MAXIMUM LOSS: Rs.8000 per lot (250 x 32)

-10,000 00

-5,000 00

0 00

890 940 990 1,040 1,090 1,140 1,190 1,240 1,290 1,340 1,390

SBI at Expiry

Pro

fit/

Lo

ss

Strategy 6Market Outlook: Moderately Bearish

Strategy: BEAR SPREAD

(Buy a put and sell a put at a lower strike OR buy a call and sell a call at a lower strike)

EXAMPLE: Initiated on 12th Feb View: Bearish on NIFTYSpot Value: 4100 levels


Spot Value: 4100 levelsStrategy: Buy NIFTY Feb 4100 PE @ Rs.52 (Lot size = 50)

Sell NIFTY Feb 4000 PE @ Rs.28 (Lot size = 50)Result: Nifty headed lower after this strategy and the puts

increased in value. We sold the 4100 put for Rs.104 and bought back the 4000 put for Rs.51, resulting in a net profit of Rs.29 per lot. A graphical representation of this option position is given in the next slide.

Payoff Profile

1,000.00

2,000.00

3,000.00

4,000.00

5,000.00

Pro

fit/

Lo

ss

Payoff Profile


-2,000.00

-1,000.00

0.00

3,850 3,900 3,950 4,000 4,050 4,100 4,150 4,200 4,250 4,300 4,350

Nifty at Expiry

Pro

fit/

Lo

ss

BREAK EVEN POINT: Rs.4076MAXIMUM PROFIT: Rs.3800 per lot (50 x 76), Nifty below 4000

MAXIMUM LOSS: Rs.1200 per lot (50 x 24), Nifty above 4100

Strategy 7 Market Outlook: Highly Volatile

Strategy: LONG (Buy) STRANGLE

(Buy an equal number of calls and puts at different strike prices and same expiry)

EXAMPLE: Initiated on 9th AprilView: INFOSYSTECH is reporting its earnings on Friday, 13th April.

A significant move to the up or downside depending upon the


A significant move to the up or downside depending upon the results could occur. Therefore one can enter a strangle position.

Spot Price: 2040 levelsStrategy: Buy INFOSYSTECH Apr 2100 CA @ Rs.42 (Lot size = 100)

Buy INFOSYSTECH Apr 1920 PA @ Rs.34 (Lot size = 100)Result: This strategy was initiated on Monday and both the legs are still

open as the result is due tomorrow. If a good move occurs in any one direction, the strategy should span out well. The initial outflow for this strategy was Rs.8000.

Payoff Profile

5,000.00

10,000.00

15,000.00

20,000.00

25,000.00

Profit/Loss

Payoff Profile


BREAK EVEN POINTS: 2176, i.e., upper strike price + premiums paid1844, i.e., lower strike price – premiums paid

MAXIMUM PROFIT: Unlimited

MAXIMUM LOSS: Total premium amount paid

-10,000.00

-5,000.00

0.00

1,610 1,688 1,766 1,844 1,922 2,000 2,078 2,156 2,234 2,312 2,390

INFOSYSTECH at Expiry

Profit/Loss

Strategy 8 Market Outlook: Stagnant to range-bound

Strategy: SHORT (Sell) STRANGLE

(Sell an equal number of calls and puts at different strike prices and same expiry)

EXAMPLE: ITCView: Range bound


View: Range boundSpot Price: 170 levelsStrategy: Sell ITC 180 Mar CA @ Rs.4 (Lot size = 675)

Sell ITC 160 Mar PA @ Rs.7 (Lot size = 675)Result: ITC remained range-bound and the premiums

collected were realized as net profit.

Payoff Profile

-20,000.00

-10,000.00

0.00

10,000.00

20,000.00

120 130 140 150 160 170 180 190 200 210 220

Pro

fit/

Lo

ss

Payoff Profile


BREAK EVEN POINTS: 191, i.e., upper strike price + premiums received149, i.e., lower strike price – premiums received

MAXIMUM PROFIT: Limited to the premiums received

MAXIMUM LOSS: Unlimited

-40,000.00

-30,000.00

-20,000.00

ITC at Expiry

More Strategies

1. Covered Call: Own stock/futures, sell a higher call2. Protective Put: Own stock/futures, buy a put option3. Ratio Call Spread: Buy a call, sell two higher strike calls4. Ratio Put Spread: Buy a put, sell two lower strike puts5. Long Straddle: Buy a call and a put for the same strike price and

expiry. 6. Short Straddle: Sell a call and a put for the same strike price and


6. Short Straddle: Sell a call and a put for the same strike price and expiry.

DEMO IN optionsXpress

TECHNICAL ANALYSIS BASICS

VARIOUS INDICATORS, TECHNIQUES AND MECHANISMS TO MEASURE MARKET

SENTIMENT IN THE BEST POSSIBLE WAY


All technical analysis indicators are derived from ONLY FIVE DATA POINTS. They are:

OPENING PRICE, CLOSING PRICE, HIGH PRICE, LOW PRICE AND VOLUME

BECAUSE FOR ANY GIVEN PERIOD, THE A STOCK GIVES ONLY FIVE DATA POINTS

TECHNICAL ANALYSIS BASICS

The way I look at technical analysis is simple: It’s going from a 50:50 chance of picking the right stock to 60:40 then 70:30 then 80:20 by adding indicators…But you

can NEVER be 100 percent sure about the move a stock


TECHNICIAL ANALYSIS IS ADVISALBE FOR1. Day trading and swing trading2. Deciding exit and entry points3. Helping gauge the stock’s or the market’s short-medium term

sentiment4. Combining with derivative strategy making process5. NOT ADVISABLE for long term investors and

buy-and-holders

can NEVER be 100 percent sure about the move a stock will make.

TECHNICAL ANALYSIS: BASIC INDICATORS

SOME BASIC TECHNICAL ANALYSIS INDICATORS

(I) Chart Formations

1. Support Level2. Resistance Level DEMO IN 2. Resistance Level3. Channel formation4. Upward or downward channel5. Double top formation6. Double bottom formation7. Ascending Triangle8. Descending Triangle

DEMO IN THINKORSWIM

SOFTWARE AND FINVIZ


TECHNICAL ANALYSIS: BASIC INDICATORS

SOME BASIC TECHNICAL ANALYSIS INDICATORS

(II) Momentum Indicators

1. Stochastic Indicator2. Relative Strength Indicator or RSI DEMO IN 2. Relative Strength Indicator or RSI3. More indicators will be shown in

the demo.


DEMO IN THINKORSWIM

SOFTWARE AND FINVIZ

• The leverage factor and the financial crisis

• OTC derivatives and normal derivatives

• Lehman Brothers and Bear Stearns

• John Paulson and the $20 billion dollar trade:

DERIVATIVES IN THE NEWS RECENTLY

• John Paulson and the $20 billion dollar trade: Article in the Wall Street Journal

• “Over the counter, out of sight” --- An incredible article in The Economist about how derivatives aggravated the financial crisis and what’s being done about it.


THANK YOU

ADHVITH DHUDDU

Website: www.AdhvithDhuddu.com


Website: www.AdhvithDhuddu.comwww.AliveNow.in

E-mail: [email protected] or [email protected]: +91-9740247446

Presentation on Derivatives and Technical Analysis

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