Short selling (also known as shorting) is not very popular among Indian retail investors and I get lot of questions about short selling. So let me try to explain the concept of short selling in very simple language.

Short selling is when you sell a stock but you don’t own that stock. The reason you can sell those stocks without having them is because you don’t need to deliver them immediately. You can deliver them to the buyer after some time period, usually end of the current month or few months down the line depending on your contract.

Pretty much a definition; now let us take a very simple example from our shopping experience to understand the concept of short selling.

Short Selling Example

Let us say you are planning to buy some furniture from a showroom. When you step in, you realize that they only have few options for you to choose from the display area but they have lot more options to choose from the catalogue. The shop owner or sales people tell you that as they have limited space the option they show in the book is ready to be delivered in godown. You selected one of such furniture, which is available, but not in the display. You pay for it and they tell you that furniture of your choice will be delivered to you within one week.

Sounds pretty normal.

Now let us look at the same transaction from the perspective of the showroom. They actually do not have the exact furniture set of your choice ready in the show room and most possibly not in godown as well but they have actually sold the same to you. They have taken some time before they will actually deliver those items to you and within this timeframe they know they can manage to get it constructed and deliver.

So they actually sold good they don’t have it but they know they will be able to get the goods created in market and deliver in the stipulated timeframe.

How Short Selling Works in Market?

The same concept of shorting or short selling works in market especially futures market. You actually do not need to deliver the stock you shorted the same day but you can deliver that on the settlement day for your cycle period and this period is normally last Thursday of particular month.

Let us say you expect some securities may go down from the current levels and so you decided to short that particular stock. If the stock prices move as per your expectation, you buy the stock few percentages down your shorting price and make the delivery of your stock on or before the given timeframe to the buyer. This is short covering.

It can happen that stock price did not move as you expected. So you may have to buy the stock higher than your shorted levels and it is termed as short squeeze where you are forced to cover your short to minimize your loss.

Points to Remember about Short Selling in India

1. In India shorting is only possible in Nifty stocks in futures market. You cannot short stocks and hold your shorts over night that is not traded in futures market. This is not the case in other World market especially NASDAQ. You can short any stock you wish and buy back at later date.
2. Mutual Fund houses in India are not allowed to short the stock and they can only trade buying and investing majority of their money. They cannot even remain liquid below certain percentage of the total assets and so when market is going down and even if the fund manager’s knows, he cannot do anything.

Hope this helps fellow Indian retail investors understand short selling. Share your views in comments below.

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What is “Commodity”?

Any product that can be used for commerce or an article of commerce which is traded on an authorized commodity exchange is known as commodity. The product should be movable of value, something which is bought or sold and which is produced or used as the subject or barter or sale.

What is a commodity exchange?

A commodity exchange is an association or a company or any other body corporate organizing futures trading in commodities for which license has been granted by regulating authority.

What is Commodity Futures?

A Commodity futures is an agreement between two parties to buy or sell a specified and standardized quantity of a commodity at a certain time in future at a price agreed upon at the time of entering into the contract on the commodity futures exchange.

The need for a futures market arises mainly due to the hedging function that it can perform. Commodity markets, like any other financial instrument, involve risk associated with frequent price volatility.

Major Exchanges in India

1. National Commodities & Derivatives Exchange Limited (NCDEX).
   Commodities Traded at NCDEX
   • Bullion:- Gold KG, Silver, Brent
   • Minerals:- Electrolytic Copper Cathode, Aluminum Ingot, Nickel Cathode, Zinc Metal Ingot, Mild steel Ingots
   • Oil and Oil seeds:- Cotton seed, Oil cake, Crude Palm Oil, Groundnut (in shell), Groundnut expeller Oil, Cotton, Mentha oil, RBD Pamolein, RM seed oil cake, Refined soya oil, Rape seeds, Mustard seeds,Caster seed, Yellow soybean, Meal
   • Pulses:- Urad, Yellow peas, Chana, Tur, Masoor
   • Grain:- Wheat, Indian Pusa Basmati Rice, Indian parboiled Rice (IR-36/IR-64), Indian raw Rice (ParmalPR-106), Barley, Yellow red maize
   • Spices:- Jeera, Turmeric, Pepper
   • Plantation:- Cashew, Coffee Arabica, Coffee Robusta
   • Fibers and other:- Guar Gum, Guar seeds, Guar, Jute sacking bags, Indian 28 mm cotton, Indian 31mm cotton, Lemon, Grain Bold, Medium Staple, Mulberry, Green Cottons, Potato, Raw Jute, Mulberry raw Silk, V-797 Kapas, Sugar, Chilli LCA334
   • Energy:- Crude Oil, Furnace oil
2. Multi Commodity Exchange of India Limited (MCX)
   Commodities Traded at MCX:-
   • Bullion:- Gold, Silver, Silver Coins,
   • Minerals:- Aluminum, Copper, Nickel, Iron/steel, Tin, Zinc, Lead
   • Oil and Oil seeds:- Castor oil/castor seeds, Crude Palm oil/ RBD Pamolein, Groundnut oil, Mustard/ Rapeseed oil, Soy seeds/Soy meal/Refined Soy Oil, Coconut Oil Cake, Copra, Sunflower oil, Sunflower Oil cake, Tamarind seed oil,
   • Pulses:- Chana, Masur, Tur, Urad, Yellow peas
   • Grains:- Rice/ Basmati Rice, Wheat, Maize, Bajara, Barley,
   • Spices:- Pepper, Red Chili, Jeera, Cardamom, Cinnamon, Clove, Ginger,
   • Plantation:- Cashew Kernel, Rubber, Areca nut, Betel nuts, Coconut, Coffee,
   • Fiber and others:- Kapas, Kapas Khalli, Cotton (long staple, medium staple, short staple), Cotton Cloth, Cotton Yarn, Gaur seed and Guargum, Gur and Sugar, Khandsari, Mentha Oil, Potato, Art Silk Yarn, Chara or Berseem, Raw Jute, Jute Goods, Jute Sacking,
   • Petrochemicals:- High Density Polyethylene (HDPE), Polypropylene (PP), Poly Vinyl Chloride (PVC)
   • Energy:- Brent Crude Oil, Crude Oil, Furnace Oil, Middle East Sour Crude Oil, Natural Gas

INTERNATIONAL COMMODITY EXCHANGES

• The New York Mercantile Exchange (NYMEX)
• London Metal Exchange
• The Chicago Board of Trade
• Tokyo Commodity Exchange (TOCOM)
• Chicago Mercantile Exchange

Terms used in Futures and options and commodities market

Accruals – Commodities on hand ready for shipment, storage and manufacture

Arbitragers – Arbitragers are interested in making purchase and sale in different markets at the same time to profit from price discrepancy between the two markets.

At the Market – An order to buy or sell at the best price possible at the time an order reaches the trading pit.

Basis – Basis is the difference between the cash price of an asset and futures price of the underlying asset. Basis can be negative or positive depending on the prices prevailing in the cash and futures.

Basis grade – Specific grade or grades named in the exchanges future contract. The other grades deliverable are subject to price of underlying futures

Bear – A person who expects prices to go lower.

Bid – A bid subject to immediate acceptance made on the floor of exchange to buy a definite number of futures contracts at a specific price.

Breaking – A quick decline in price.

Bulging – A quick increase in price.

Bull – A person who expects prices to go higher.

Buy on Close – To buy at the end of trading session at the price within the closing range.

Buy on opening – To buy at the beginning of trading session at a price within the opening range.

Call – An option that gives the buyer the right to a long position in the underlying futures at a specific price, the call writer (seller) may be assigned a short position in the underlying futures if the buyer exercises the call.

Cash commodity – The actual physical product on which a futures contract is based. This product can include agricultural commodities, financial instruments and the cash equivalent of index futures.

Close – The period at the end of trading session officially designated by exchange during which all transactions are considered made “at the close”.

Closing price – The price (or price range) recorded during the period designated by the exchange as the official close.

Commission house – A concern that buys and sells actual commodities or futures contract for the accounts of customers.

Consumption Commodity – Consumption commodities are held mainly for consumption purpose. E.g. Oil, steel

Cover – The cancellation of the short position in any futures contract buys the purchase of an equal quantity of the same futures contract.

Cross hedge – When a cash commodity is hedged by using futures contract of other commodity.

Day orders – Orders at a limited price which are understood to be good for the day unless expressly designated as an open order or “good till canceled order.

Delivery – The tender and receipt of actual commodity, or in case of agriculture commodities, warehouse receipts covering such commodity, in settlement of futures contract. Some contracts settle in cash (cash delivery). In which case open positions are marked to market on last day of contract based on cash market close.

Delivery month – Specified month within which delivery may be made under the terms of futures contract.

Delivery notice – A notice for a clearing member’s intention to deliver a stated quantity of commodity in settlement of a short futures position.

Derivatives – These are financial contracts, which derive their value from an underlying asset. (Underlying assets can be equity, commodity, foreign exchange, interest rates, real estate or any other asset.) Four types of derivatives are trades forward, futures, options and swaps. Derivatives can be traded either in an exchange or over the counter.

Differentials – The premium paid for grades batter than the basis grade and the discounts allowed for the grades. These differentials are fixed by the contract terms on most exchanges.

Exchange – Central market place for buyers and sellers. Standardized contracts ensure that the prices mean the same to everyone in the market. The prices in an exchange are determined in the form of a continuous auction by members who are acting on behalf of their clients, companies or themselves.

Forward contract – It is an agreement between two parties to buy or sell an asset at a future date for price agreed upon while signing agreement. Forward contract is not traded on an exchange. This is oldest form of derivative contract.

Futures Contract – It is an agreement between two parties to buy or sell a specified and standardized quantity and quality of an asset at certain time in the future at price agreed upon at the time of entering in to contract on the futures exchange.

Futures commission merchant – A broker who is permitted to accept the orders to buy and sale futures contracts for the consumers.

Futures Funds – Usually limited partnerships for investors who prefer to participate in the futures market by buying shares in a fund managed by professional traders or commodity trading advisors.

Futures Market – It facilitates buying and selling of standardized contractual agreements (for future delivery) of underlying asset as the specific commodity and not the physical commodity itself. The formulation of futures contract is very specific regarding the quality of the commodity, the quantity to be delivered and date for delivery.

Hedging – Means taking a position in futures market that is opposite to position in the physical market with the objective of reducing or limiting risk associated with price.

In the money – In call options when strike price is below the price of underlying futures. In put options, when the strike price is above the underlying futures. In-the-money options are the most expensive options because the premium includes intrinsic value.

Index Futures – Futures contracts based on indexes such as the S & P 500 or Value Line Index. These are the cash settlement contracts.

Investment Commodities – An investment commodity is generally held for investment purpose. e.g. Gold, Silver

Limit – The maximum daily price change above or below the price close in a specific futures market. Trading limits may be changed during periods of unusually high market activity.

Limit order – An order given to a broker by a customer who has some restrictions upon its execution, such as price or time.

Liquidation – A transaction made in reducing or closing out a long or short position, but more often used by the trade to mean a reduction or closing out of long position.

Local – Independent trader who trades his/her own money on the floor of the exchanges. Some local act as a brokers as well, but are subject to certain rules that protect customer orders.

Long – The buying side of an open futures contract or futures option; (2) a trader whose net position in the futures or options market shows an excess of open purchases over open sales.

Margin – Cash or equivalent posted as guarantee of fulfillment of a futures contract (not a down payment).

Margin call – Demand for additional funds or equivalent because of adverse price movement or some other contingency.

Market to Market – The practice of crediting or debating a trader’s account based on daily closing prices of the futures contracts he is long or short.

Market order – An order for immediate execution at the best available price.

Nearby – The futures contract closest to expiration.

Net position – The difference between the open contracts long and the open contracts short held in any commodity by any individual or group.

Offer – An offer indicating willingness to sell at a given price (opposite of bid).

On opening – A term used to specify execution of an order during the opening.

Open contracts – Contracts which have been brought or sold without the transaction having been completed by subsequent sale, repurchase or actual delivery or receipt of commodity.

Open interest – The number of “open contracts”. It refers to unliquidated purchases or sales and never to their combined total.

Option – It gives right but not the obligation to the option owner, to buy an underlying asset at specific price at specific time in the future.

Out-of-the money – Option calls with the strike prices above the price of the underlying futures, and puts with strike prices below the price of the underlying futures.

Over the counter – It is alternative trading platform, linked to network of dealers who do not physically meet but instead communicates through a network of phones & computers.

Pit – An octagonal platform on the trading floor of an exchange, consisting of steps upon which traders and brokers stand while trading (if circular called ring).

Point – The minimum unit in which changes in futures prices may be expressed (minimum price fluctuation may be in multiples of points).

Position – An interest in the market in the form of open commodities.

Premium – The amount by which a given futures contract’s price or commodity’s quality exceeds that of another contract or commodity (opposite of discount). In options, the price of a call or put, which the buyer initially pays to the option writer (seller).

Price limit – The maximum fluctuation in price of futures contract permitted during one trading session, as fixed by the rules of a contract market.

Purchase and sales statement – A statement sent by FMC to a customer when his futures option has been reduced or closed out (also called ‘P and S”)

Put – In options the buyer of a put has the right to continue a short position in an underlying futures contract at the strike price until the option expires; the seller (writer) of the put obligates himself to take a long position in the futures at the strike price if the buyer exercises his put.

Range – The difference between high and low price of the futures contract during a given period.

Ratio hedging – Hedging a cash position with futures on a less or more than one-for-one basis.

Reaction – The downward tendency of a commodity after an advance.

Round turn – The execution of the same customer of a purchase transaction and a sales transaction which offset each other.

Round turn commission – The cost to the customer for executing a futures contract which is charged only when the position is liquidated.

Scalping – For floor traders, the practice of trading in and out of contracts through out the trading day in a hopes for making a series of small profits.

Settlement price – The official daily closing price of futures contract, set by the exchange for the purpose of setting margins accounts.

Short – The selling of an option futures contract. (2) A trader whose net position in the futures market shows an excess of open sales over open purchases.

Speculator – Speculator is an additional buyer of the commodities whenever it seems that market prices are lower than they should be.

Spot Markets – Here commodities are physically brought or sold on a negotiated basis.

Spot price – The price at which the spot or cash commodity is selling on the cash or spot market.

Spread – Spread is the difference in prices of two futures contracts.

Striking price – In options, the price at which a futures position will be established if the buyer exercises (also called strike or exercise price).

Swap – It is an agreement between two parties to exchange different streams of cash flows in future according to predetermined terms.

Technical analysis (charting) – In price forecasting, the use of charts and other devices to analyze price-change patters and changes in volume and open interest to predict future market trends (opposite of fundamental analysis).

Time value – In options the value of premium is based on the amount of time left before the contract expires and the volatility of the underlying futures contract. Time value represents the portion of the premium in excess of intrinsic value. Time value diminishes as the expiration of the options draws near and/or if the underlying futures become less volatile.

Volume of trading (or sales) – A simple addition of successive futures transactions (a transaction consists of a purchase and matching sale).

Writer – A sealer of an option who collects the premium payment from the buyer.

Many Definitions are collected from Wiki

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When I talk with many people and tell them that its time to invest in Nifty / Sensex listed companies they have fairly little idea about which companies are listed and so thought I would list them here for reference.

Remember this is as of Today ( December 29th, 2008 ) and at times some scripts replace other.

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Derivatives are financial instruments, traded on or off an exchange, the price of which is based on or directly dependent upon i.e., “derived from” the value of one or more underlying asset, reference rate or index. The underlying asset can include securities, commodities, bullion, currency, livestock, etc., the reference rate includes interest rates, exchange rates and index consist of stock market index, consumer price index(CPI). This trading of rights or obligations based on the underlying product, for hedging, speculating or arbitraging purposes is termed Derivatives Trading, Financial Derivatives or Trading Derivatives. The main types of derivatives are,

1. Forwards
2. Futures
3. Options
4. SWAPs

Derivative trading in India can take place either on a separate and independent Derivative Exchange or on a separate segment of an existing Stock Exchange. Derivative Exchange/Segment function as a Self-Regulatory Organization (SRO) and SEBI acts as the oversight regulator.

Futures Trading & Pricing

A Futures Contract is a standardized agreement between a buyer and a seller; obligating the seller to deliver a specified asset of specified quality and quantity to the buyer on a specified date at a specified place and the buyer, in turn, is obligated to pay to the seller a pre-negotiated price in exchange of the delivery. The trading in these contracts is termed Futures Trading. In this type of trading, the contracting parties negotiate on, not only the price at which the commodity is to be delivered on a future date but also on what quality and quantity to be delivered and at what place.

Based upon their reason for choosing futures trading, people engaging in it can be typically classified as-

1. Hedgers
2. Speculators & Arbitragers

In case of Hedgers, Future contracts are used a risk minimizing tool. For example, in case of commodity as the underlying asset, a wheat farmer and a wheat miller could enter into a futures contract to exchange cash for wheat in the future. The farmer agreeing to sell the wheat is said to assume the short position and the wheat miller agreeing to buy it is said to assume the long position. Both parties have reduced a future risk: for the wheat farmer, the uncertainty of the price and a sure buyer, and for the wheat miller, the availability of wheat. Farmers, manufacturers, importers and exporters, etc, are Example of Hedgers who trade in futures for protection from price risks.

Though it minimizes risk, hedging has a black side to it also, if the wheat prices surge in the near future, the farmer will not be able to increase his prices and will lose the excess profit possible in that case and if the wheat prices fall down the buyer will still have to pay the agreed upon price in the contract, thus paying more than the market price.

Speculators, trade with hedgers and other speculators and consider futures trading as a means to earn profits and not for minimizing risk purposes (like hedgers). They aim to profit from the very price change that hedgers are protecting themselves against. Hedgers want to minimize their risk no matter what they’re investing in, while speculators want to increase their risk and therefore maximize their profits.

They speculate the value of the underlying asset and buy if they feel its value will increase, selling later when it has indeed increased and sell when they feel its value will decrease. As the name indicates, this is pure speculation on their part, based on what they perceive as market conditions. If their speculation is right, it will result in profits, else loss. This is a risk they are willing to take in order to earn quick profits.

Arbitragers are those who attempt to profit by exploiting price differences of identical or similar financial instruments, on different markets or in different forms.

Unlike the stock market, where the capital gains or losses from movements in price aren’t realized until the investor decides to sell the stock or cover his or her short position, futures positions are settled on a daily basis, which means that gains and losses from a day’s trading are deducted or credited to a person’s account each day. The profits and losses depend upon the daily movements of the market for that contract and are calculated on a daily basis.

For example, consider the futures contract between a wheat farmer and bread maker of INR 40 per bushel, if in the next day, the price of the futures contract for wheat increases to INR 50 per bushel, the farmer, as the holder of the short position, has lost INR 10 per bushel because the selling price just increased from the future price at which he is obliged to sell his wheat. The bread maker, as the long position, has profited by INR 10 per bushel because the price he is obliged to pay is less than what the rest of the market is obliged to pay in the future for wheat.

On the day the change occurs, the farmer’s account is debited INR 50,000 (INR 10 per bushel X 5,000 bushels) and the bread maker’s account is credited by INR 50,000 (INR 10 per bushel X 5,000 bushels). As the market moves every day, these kinds of adjustments are made accordingly.

Apart from functioning as a risk reduction tool, Futures contracts are used for Price Discovery. Due to its highly competitive nature, the futures market has become an important economic tool to determine prices based on today’s and tomorrow’s estimated amount of supply and demand.

Futures Market is fast-paced and its prices depend upon a continuous flow of information from around the world and thus require a high amount of transparency. Factors such as weather, war, debt default, refugee displacement, land reclamation and deforestation can all have a major effect on supply and demand and, as a result, the present and future price of a commodity. In such a market into which information is continuously being fed, speculators and hedgers bounce off of – and benefit from – each other. The closer it gets to the time of the contract’s expiration, the more solid the information entering the market will be regarding the commodity in question. Thus, all can expect a more accurate reflection of supply and demand and the corresponding price. This process is termed as competitive price discovery or simply price discovery.

Futures prices have a price change limit that determines the prices between which the contracts can trade on a daily basis. The price change limit is added to and subtracted from the previous day’s close and the results remain the upper and lower price boundary for the day and can be revised if the exchange feels it is necessary.

Say that the price change limit on silver per ounce is INR 2.50. Yesterday, the price per ounce closed at INR 50. Today’s upper price boundary for silver would be INR 52.25 and the lower boundary would be INR 47.5. If at any moment during the day the price of futures contracts for silver reaches either boundary, the exchange shuts down all trading of silver futures for the day. The next day, the new boundaries are again calculated by adding and subtracting INR 2.50 to the previous day’s close. Each day the silver ounce could increase or decrease by INR 2.50 until an equilibrium price is found. One drawback is that as trading shuts down if prices reach their daily limits, there may be occasions when it is NOT possible to liquidate an existing futures position at will.

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It should be pretty clear after the Iraq incident that United States is playing the oil game all over again but in a different way now. And this is the desperate gamble of a country whose economy is neck deep in trouble.

Now what’s the OIL Game

Oil is internationally traded in New York and London and denominated in USD only. Oil prices are no longer controlled by OPEC (Organization of Petroleum Exporting Countries). Rather, it is now done by Wall Street. This shift in the determination of international oil prices from the hands of producers to the hands of speculators is crucial to understanding the oil price rise. Today oil prices are believed to be determined by the four Anglo-American financial companies-turned-oil traders, viz., Goldman Sachs, Citigroup, J P Morgan Chase, and Morgan Stanley.

Past few years, the US financial sector has begun to turn its attention from currency and stock markets to commodity markets. According to Rediff News site about $260 billion has been invested into the commodity market — up nearly 20 times from what it was in 2003 and using $260 billion they can buy $5 trillion of commodities contracts due to margin and limits in futures. In India we are seeing huge FII’s sell-off and no support is seeing in the equity market. According to CNBC TV18 around $6 Billion has gone out of India alone and similar may be the situation for many other Emerging markets and I would like to know where is the money going. Definitely not for personal consumption but its been pumped into commodities.

Can Wall Street increase the demand?

When you trade in commodities such speculators do not own real oil. Every barrel they buy in the futures markets they sell back again before the contract ends. That may raise the price of ‘paper barrels,’ but not of the black stuff refiners turn into petrol.

Now as a speculator you have $5 Trillion margin to buy any commodity what would happen is create a fake demand till you start selling and when countries who buy black gold they would have to be buying at much higher prices due to the speculators and this causing the ripple effects and many countries creating stock of OIL going forward. As an example US strategic oil reserves were at approximately 350 million barrels for a decade till 2006. However, for the past year and a half these reserves have doubled to more than 700 million barrels. Naturally, this build-up of strategic oil reserves by the US (of 350 million barrels) is adding enormous pressure on the oil demand and consequently its prices.

In today’s prices of approximately $140 per barrel, this means that approximately $100 per barrel could be attributed to speculation! At an average price of even $100 per barrel, the entire cost for the purchase of this additional 350 million barrels by the US works out to a mere $35 billion. Needless to emphasis, this can be funded by the US by allowing it currency printing presses to work overtime. After all, it has a currency that is acceptable globally and people worldwide are willing to exchange it for precious oil but same is not the case for India where it need to buy USD before it can purchase OIL. No wonder Goldman Sachs predicts that oil will touch $200 to a barrel shortly, knowing fully well that the US government will back its prediction.

Reliance and the OIL Prices

Mukesh Ambani in the recent press appearance mentioned that he will be starting the RPL operation in September and will be providing the oil at around 25-30 USD and which means that around that level could be the actual price of Crude.

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Reliance

Open interest in RELIANCE has gone up with rise in prices. The gain in OI with rise in price indicates that counter saw built up of long positions as prices moved up from lower levels. On the last day of the week, counter saw gain in OI with marginal drop in prices indicating built of short positions and profit booking in the counter at current levels. The counter may show further strength if it sustains above 2200 levels where we may see fresh buying emerging in the counter.

Tata Steel

Open interest in TATASTEEL has gone marginally down with marginal rise in prices. The drop in OI with fall in price indicates counter witnessed short covering of positions at current levels as prices moved up from lower levels thus suggesting strength in the counter. On the last day of the week, counter saw drop in OI with fall in prices indicating liquidation of long position in the counter from current levels thus suggesting uncertainty prevails in the counter. The counter may show strength if it sustains above 850 levels where we may see fresh buying emerging in the counter.

My disclosure is I have investment in both the above stocks but not in Futures but in Cash Market.

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When one has to deal with shares you should always know that others are fearful or greedy? To know more about others you should know about VIX which is also called as Volatility index. It is an index that is using range of S&P 500 options to find the level of volatility that is expected in the next 30 days.The Volatility index goes up when there is fear and down when there is “less fear” and that helps us to understand when we should be fearful and when we should be greedy.

VIX give traders a volatility to do trading without having a fear factor like change in price, dividends, interest rates, or limited time which affects regular trading or index options. It helps trading to concentrate exclusively on trading. VIX have become an excellent tool for traders. It helps them in speculating things more easily.

It is calculated from the Call and Put and it is also called as “investor fear gauge”. Now currently in market factors seems to fearful but still it seems that some investors are greedy and so they are trying to increase the share prices though conditions are not good and food and oil prices are increasing.

So experts advice to investors seeing the current inflation one should check Volatility index and also go for long term investments for at least two-three months till the confusion in the markets reduces or market comes to a stable position.

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I have also been hit hard by the crash and lost almost 30 % of the total portfolio weight but there are some lessons to be learnt from this which I have started following and just thought would share it here as well.

1. Never run after stock when its running off.
2. Try getting out of the stock when they are flying and don’t try to hold them for more profit.
3. Get your greed out of the stocks.
4. If you wish to get into high flying stock get the money into the bank and wait for the crash.
5. Future and Options is not for retailers and is for professional traders and so stay out of it if you cannot follow strict stop loss and profit booking.

Follow the principle of Sell when everyone buys and buy when every one sell because its suggested and followed by the best in the business. Now if you ask yourself, why stocks like RNRL, Ispat, RPL, Essar oil and Nagarjuna fertilisers have lost 50-70% of their value. The simple reason could be that they just went up at that rate. Now if you tend to get into the stock after the rise then you are at the risk of making some quick bucks if it continues to fly the second / third day running but then you can get hit the hardest because there is no reason for any stock to go up by almost 30-50 %.

Now what you should be doing for stocks which can double your money in a weeks time. Simple put the money into bank account and wait for the stock to fall more than half percent-rise in a day. Say the stock price of ‘X’ previous day close is at Rs 100 and suddenly you see a 30% price rise for the stock and its at 130. Now should you try to catch the stock at 130. The answer is no. Wait for the stock to correct at least 15% in a day. i.e. half of 30%. ‘X’ stock cannot go all out moving in one direction but when the stock starts correcting 15% then that does mean you will get the stock when its stabilizing at some price and then that will become a good support level. Ultimately it may so happen that the stock you buy would be at 150 but that 150 would be the price where stock has a good support and also have the option of getting the benefit of fast movement.

Say if you invest in the equity you would get benefit of around 25% per annum but as we become more and more greedy we tend to find ways of getting 25% per month and then we tend to be in a position from where we cannot recover the money and that is with the future and options. With cash market your invested amount cannot become zero but in future and options it can become zero and that could lead you to the out of equity and so then you need to be settling into 8-10% Fixed deposit savings.

Now the question would definitely come as to how you can get your money to zero in future and options. Say you have invested 1 lacs in future and options and you get an exposure of 4 to 5 times and then you can buy equity upto 5 lacs and so you tend to get more equity than your capacity helping you giving more money. Now if you happen to invested in stock which move almost 20% in a day where in 1 lac you can gain one lac or loose the same.

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All stock trading depends on 2 terms. Either you could be bullish or bearish. Depending on whether you are bullish or bearish on the underlying stock, you could purchase either a call option or a put option.

Buying a call Option

When you buy a call option, you hold the right to buy a specified quantity of the underlying stock at the strike price on or before the expiration date.

If you are bullish on a stock you could purchase a call option at a predetermine (Called it as the strike price) that is lower than the appreciation you expect then, if all goes well and the stock price does rise beyond the strike price + the premium you have paid, on or before the expiration of the contract, you can exercise your option to buy the stock at the strike price and simultaneously sell it in the spot market. i.e. the cash market to book your profit.

If, on the other hand the price of the stock in the cash market does not rise beyond the strike price + premium, you can let the contract lapse, i.e. you do not buy the underline stock at the strike price. Your loss in such a case would be premium you have paid. However in India equity options and futures are currently cash settled and are not settled by delivery.

Example

Current spot price per share = Rs 100
Premium payable per share = Rs 10
ABC company has a lot size = 50 shares

If the spot prices rises to Rs 120 per share before the contract expires you could exercise your option to buy the shares at Rs 100 and then sell them in the market for Rs 120. Your profit in this transaction would be Rs 500 (Sale price of Rs 120 x 50 – purchase of 100 x 50) – premium of 10 x 50)

If, on the other hand if the price does not go beyond Rs 100 until the expiry date, you could just let the contract lapse. In this case, your loss would be equal the premium that you have paid. i.e. Rs 500

Buying a put Option

When you buy a put option, you hold the right to sell a specified quantity of the underlying stock at the strike price on or before the expiration date.

If you are bearish on a stock you could purchase a put option at a pre-determine (strike price) that is higher than the fall you expect in the price of the stock,

If all goes well and the stock price does fall beyond the strike price + the premium you have paid, on or before the expiration of the contract, you can exercise your option to sell the stock at the strike price and simultaneously buy it in the spot market. i.e. the cash market to book your profit.

If, on the other hand the price of the stock in the cash market does not fall to the strike price + premium you can let the contract lapse, i.e. you do not sell the underlying stock at the strike price. Your loss in such a case would be premium you have paid.

Going with the above example if the spot prices depreciate to Rs 80 per share before the contract expires you could exercise your option to sell the shares at Rs 100 and then buy them in the market for Rs 80. Your profit in this transaction would be Rs 500 (Sale price of Rs 100 x 50 – purchase of 80 x 50 – premium of 10 x 50)

If, on the other hand if the price does not fall below Rs 100 until the expiry date, you could just let the contract lapse. In this case, your loss would be equal the premium that you have paid. i.e. Rs 500

Selling Call and put Options

You buy options from the seller called (Option Writer) who is obliged to comply with your decision for which he receive a fee. (The premium you pay to but an option)

If you exercise your option the option writer bears a loss which is the price differential between the spot price and the strike price less the premium income he has earned. However, when you let your option lapse, the option writer’s income is the premium you have paid to buy the option.

Remember the Option writer “return is limited” and “risk is un-limited”.

When to use which call and put options

1. If you expect the price of the stock to move upward, buy a call option
2. If you expect the price of the stock to move downward buy a put option
3. If you expect no upward movement, sell a call option.
4. If you expect no downward movement, sell a put option.

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