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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.