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Fundamentals - Mentoring - Financial instruments - Options and indices…
Fundamentals - Mentoring - Financial instruments - Options and indices
(1) Financial instruments - Stocks (cash or spot), futures,
options, indexes.
(2) Capital allocation for trading: (a) 5lk index options, mainly Nifty; (b) 10lk index options, index futures, mainly Nifty; (c) 15lk and above, index options, index futures, stock futures. Never trade stock options in India.
(3) What is a stock index? An index is an indicator of a general trend.
(4) It comprises a basket of well-traded securities/stocks that have large market capitalization.
(5) Indices can be weighted as per market capitalization or price. Generally, market capitalization weighted indices are preferred. S&P 500 (top 500 stocks by market value) and Nifty 50 (top 50 stocks by market value) are weighted as per market capitalization. Dow Jones is a price based index.
(6) An index is not just an indicator of direction. It is used to build and hedge portfolios. That is the most important role of an index.
(7) Futures are made out of an index and are actively traded to hedge portfolios.
(8) An index is a diversified product and hence it is most preferred by all players. Hence liquidity is very good. in an index future or option.
(9) An index also has futures and options. Index futures are very good to trade but require a bit higher capital. Index options are also good but there is risk of capital loss completely.
(10) What are options? Options are contracts that given the buyer a right but not an obligation to buy or sell a stock in cash segment.
(11) A call option gives a right but not an obligation to buy cash stock. A put option gives a right but not an obligation to sell cash stock.
(12) An index call option gives right but not an obligation to buy index. Since index cannot be bought, it is settled in cash money.
(13) An option can be of three types. (a) At the money (ATM) option; (b) in the money (ITM) option; (c) out of the money (OTM) option
(14) A call can be ATM or ITM or OTM. Similarly a put can be ATM or ITM or OTM.
(15) For an option a strike price is very important. Selecting a right strike determines your profit for a trade.
(16) ALWAYS prefer ATM calls and puts. That's it. Ignore OTM and ITM puts and calls.
(17) Why we should ignore OTM and ITM options? Because an option is driven not only by direction but also time, volatility, interest rates, and many more variables.
(18) An option is driven mostly by time and volatility. When volatility is more an option price is more. When volatility is less an option price is less.
(19) When time is more towards expiry, option price is more. When time is less, option price is less.
(20) All these variables of time, volatility and other things interact at the same time, making option pricing very very complex.
(21) An option has an intrinsic value and an extrinsic value. Intrinsic value is like a air in balloon. It is controlled by time and volatility. So we will also not care about this impact.
(22) An options time value (or intrinsic value) falls drastically as time towards expiry reduces. This is called theta decay. Similarly an option's time value (or intrinsic value) falls when volatility declines drastically. This is called gamma effect.
ASSIGNMENT: (a) Read Nifty index methodology; (b) Find out index component weights from NSE website or Moneycontrol or any other source; (c) Find out sector weightages in NSE and sector components with weights.