Financial Daily from THE HINDU group of publications
Sunday, Sep 08, 2002
Markets - Derivatives Markets
Arbitrage trading, calendar spread
WE are relatively new to futures and options. Please suggest one or two books to get in depth knowledge in futures and options. - Arunachalam Ramaswamy, Anand Krishnan
To understand the basics of derivatives, you can refer to the following books:
* Options, Futures and Other Derivatives by John C Hull or
* Understanding Options by Robert W Kolb. These books will help you in understanding the concepts on futures and options in general.
* For more information on derivatives as traded in India, you can obtain information from the NCFM course on derivatives offered by the National Stock Exchange of India Ltd.
* Please refer to www.nse-india.com for more information on these courses and course material as well as on futures and options markets (Data and FAQs - frequently asked questions).
* You can also refer our Web site www.thehindubusinessline.com for more information on basics and on concepts on derivatives
I have the following queries for you:. I desire to do spread/arbitage trading between
a) Calendar spread
b) Call (or put) and Future
c) Future and Cash
How and when these can be applied? On the screen of NEAT FO there is window of SPREAD trading but we do not know how and for what purpose we can use it. Kindly advise me on this.
Please guide me with other strategies to gain small profits without taking risk (or by taking small risk). My expenses are 0.2% + Servise Tax. Are you giving advice on regular/daily basis? If yes, kindly send me the details. Deepak Dhody
* You can do arbitrage between two instruments when they are related to each other, but they are temporarily mis-priced. For example, the futures price and spot price are related by the interest rate, time to maturity and corporate benefit, if any, in the interregnum.
If the two prices do not move in tandem, then it throws up arbitrage opportunity. An arbitrageur will buy what is cheap and sell what is costly and lock in profits without any risk. In the case of options, if there is a violation of put call parity, it may lead to arbitrage opportunities.
Option prices should move within a range. The upper boundary and lower boundary off both call and put options are determined by certain variables. If the actual option price is outside this range, it will lead to arbitrage opportunity. Substantial difference between the historical volatility and implied volatility may also lead to arbitrage. A calendar spread is when an investor buys a particular month contract and then sell the same strike of a different month. If the spread leads to net debit it is called long and when it leads to credit, the investor is short on this spread. With a calendar spread, the trader is expecting the stock to remain in a narrow range, the trade is actually a play on time-decay and volatility as opposed to direction.
The NEAT F&O trading system enables investors to enter spread/combination trades. This enables the user to input two or three orders simultaneously into the market. These orders will have the condition attached to it that unless and until the whole batch of orders finds a counter match, they shall not be traded.
For example, you may be interested to enter into a Bull Call Spread in say BPCL. For this, you may buy a call option with a strike price of 260 and sell a call option with a strike price of 280, both maturing on 26th September. You can either enter both these legs separately in the F&O as two orders, either as a limit order or as a market order.
If you place the two orders separately, you are exposed to price risk, i.e. one order may get executed and not the other. Alternatively, you can use the spread order entry facility wherein you have to specify the maximum amount you are willing to pay for both the orders.
These are usually called debits (as in the above case). You can also have net credits in a spread strategy (which will be the case if you use put instead of call for the same bullish outlook). The spread order entry enables the investor to enter orders with minimum price risk.
We will be providing trading strategies in futures and options on a regular basis. Keep reading the Investment World of Business Line.
For low risk, low return, you can try the following strategies. It depends on your outlook for the market (whether you are bullish, bearish or neutral) and the implied volatility of the stock/index (whether it is high or low). For example, if you are neutral on the market and the implied volatility is low, then you can think of writing straddles or strangles.
We provide daily advice through our column `On the hedge' which appears in our market watch page of Business Line.
If you have any queries relating to the futures/options markets and strategies that can be used in these markets, please mail them to Futures & Options, Kasturi & Sons, 859-869, Anna Salai, Chennai 600 002 or email them to email@example.com with a mention of futures/options in the subject line of the mail.
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