Rolling Settlement: Rolling settlement stands for a settlement mechanism in a stock exchange where outstanding transactions are settled on the day-to-day basis. Unlike in the old system where trades during the five-day settlement period were aggregated and the net outstanding positions were settled, in Rolling Settlements, trades done on a single day are settled separately from the trades of other day on Trade days. The netting of trades is done only for the day and not for multiple days. In Rolling Settlement, settlement is carried out on a daily basis. Also Rolling Settlements in any capital markets represent best international practice as well.

Working of rolling settlement:

We have a "T + 3" settlement period for this system. In simpler words, it means that if you purchase shares, say on a Monday, then you will have to pay up for your purchase on Thursday (trade day plus three working days). You will also receive the shares that you have purchased on the day you pay up.

The critical factor that differentiates rolling settlement from the previous weekly settlement is that previously you could sell the shares you bought on a Monday, on the following day or on any other day during the week before your transaction was actually settled.

However in the rolling settlement if you sell the shares you bought on a Monday on the following day, i.e. on Tuesday, then it would become a "short position". So if you do not have shares to deliver, you will need to borrow them. You cannot offset your Monday's purchase with your Tuesday's sell.

Presently all the stocks traded are stocks under the compulsory rolling settlement (CRS).

Settlement under rolling settlement system

In the old system the exchange looked at the outstanding net positions to be settled at the end of the five-day settlement period. Then on the Thursday of the following week there would be " Pay In ", where people who bought, paid up for their delivery and those who sold, delivered their shares. And on the following Saturday there would be "Pay Out", where those who bought got their shares and those who sold got their money.

Example: Under the old system, a trader could buy 300 shares of stock XYZ Ltd at Rs 200 on Monday, sell 200 shares of the stock at Rs 220 and maybe buy 300 shares of the same stock on Friday at Rs210. Then, for the settlement the trader would have bought 400 shares (300-200+300) and would have had to pay Rs 79, 000 (60000-44000+63000). So he would have paid up Rs 79,000 on the following Thursday and received 300 shares of the stock on the following Saturday.

Trades in the new segment are settled on T+3 basis and every day is taken as separate settlement. The trades done on a day cannot be netted off against those done on the earlier day.

Example: The trader's purchase of 300 shares on Monday at Rs200 will get settled the Thursday of the same week. In other words, every day the net outstanding positions will be settled after three days and cannot be squared off for the next day sale if made. The squaring off can be done only on the same day before the closing of trading on that day.

The advantages of rolling settlement: Since the intra-settlement speculation would be weeded out, the price trends can be more realistic. Also unlike in the past, where an investor who sold on Monday to realize a good profit would have realized his money only after a fortnight, with rolling settlement the investor will realize the cash in a week's time.

An option is the right, but not the obligation, to buy or sell something at a stated date and at a stated price. Option just like Futures are part of the Derivatives tools. That is, its value is derived from an underlying asset. However, unlike Futures, Options have an insurance cost, which a speculator pays for a view on an asset. This cost is termed as option premium or option price.

In the case of a stock option, its value is based on the underlying stock (equity). In the case of an index option, its value is based on the underlying index (equity). In case of currency option the underlying asset is currency.

Options can be undertaken on:

• Stocks

• Foreign Currencies

• Stock Indices

• Commodities

• Others - Future options are options on the futures contracts or underlying assets are future contracts. The futures contract generally matures shortly after the options expiration

Important terminologies used in Option :

Underlying: The specific security / asset on which an options contract is based.

Option Premium /Option Price - is the price paid by the buyer to the seller to acquire the right to buy or sell

Writing of the Option: The selling of the option (selling of right to buy or sell) is called writing of an option and the person who does that is known as writer of an option.

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)

Option Holder: is the one who buys an option that 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: Whether it is a call option or a put option.

Option Series: An option series consists of all the options of a given class with the same expiration date and strike price. E.g. BSXCAUG3700 is an options series which includes all Sensex Call options that are traded with Strike Price of 3700 & Expiry in August.

(BSX Stands for BSE Sensex (underlying index), C is for Call Option, June is expiry date & strike Price is 3700) And the option is a call (the holder has the right, not the obligation, to buy XYZ at a price of 100).

Puts And Calls A Call is a right to buy and a Put is a right to sell

A call option gives the holder the right, not the obligation, to buy a specific quantity of underlying asset fixed period and at a fixed price.

Example: An investor buys One European call option on Satyam at the strike price of Rs. 500 at a premium of Rs. 50. If the market price of Satyam on the day of expiry is more than Rs. 500, the option can be exercised. The investor will earn profits once the share price crosses Rs550 (500+50, strike price +premium). Suppose the share price of Satyam is Rs 600 at the time of expiry, the investor can make a gain of Rs 50 (600-550) by excising the option. On the other hand if the stock price is 400, buyer of the option will not exercise the option and loses Rs 50 paid as a premium.

A put option gives the holder the right, not the obligation, to sell 100 shares of the underlying stock for a fixed price and for a fixed period of time

Example: An investor buys One European put option on Satyam at the strike price of Rs. 500 at a premium of Rs. 50. If the market price of Satyam on the day of expiry is less than Rs. 500, the option can be exercised. The investor will earn profits once the share price is below 450 (500-50). Suppose the share prices of Satyam are Rs. 400 at the time of expiry, the investor can make a gain of Rs 50 (450-400) by excising the option, he will buy Satyam at Rs 400 in the market and exercise the option of selling it at 500. On the other hand if the stock price is 600 buyer of the option will not exercise the option and loses Rs. 50 paid as a premium.

Market Players:

Hedgers: The objective of these kind of traders is to reduce the risk. They are not in the derivatives market to make profits. They are in it to safeguard their existing positions. Apart from equity markets, hedging is common in the foreign exchange markets where fluctuations in the exchange rate have to be taken care of in the foreign currency transactions or could be in the commodities market where spiraling oil prices have to be tamed using the security in derivative instruments.

Speculators: They are traders with a view and objective of making profits. They are willing to take risks and they bet upon whether the markets would go up or come down.

Arbitrageurs: Riskless Profit Making is the prime goal of Arbitrageurs. Buying in one market and selling in another, buying two products in the same market are common. They could be making money even without putting there own money in and such opportunities often come up in the market but last for very short timeframes. This is because as soon as the situation arises arbitrageurs take advantage and demand-supply forces drive the markets back to normal.

The European & American style of options There are two different types of options with respect to expiration. The European style option cannot be exercised until the expiration date. Once an investor has purchased the option, it must be held until expiration. An American style option can be exercised at any time after it is purchased. In most exchanges the options trading starts with European Options, as they are easy to execute and keep track of. This is the case in the BSE and the NSE

The concept of
At-The_money, In-The_money, Out-Of-The_money There are three different terms for describing where an option is trading in relation to the price of the underlying security. These terms are 'at-the_money', 'in-the_money', and 'out-of-the money'.

	CALL OPTION	PUT OPTION
In-the-money	Strike price < Spot price of underlying asset	Strike price > Spot price of underlying asset
At-the-money	Strike price = Spot price of underlying asset	Strike price = Spot price of underlying asset
Out-of-the-money	Strike price > Spot price of underlying asset	Strike price < Spot price of underlying asset

Example for the terms for call option Let's use our Satyam call as an example. If Satyam is trading at a price of 500, at the time of expiry it is considered to be trading 'at-the_money'. If it is trading at a price greater than 500, say 510, the call option is considered to be 'in-the_money'. And it is trading at a price less than 500, say 400, the call option is considered to be trading 'out-of-the_money.

Conversely, if it was an Satyam put option we owned at a strike price of 500 and premium of 50, at the time of expiry if the price of Satyam is above 500 the put option it would be considered to be 'out-of-the_money. And if it were trading at a price below 500 say 440, the put option would be considered to be trading 'in-the_money'. If Satyam stock were trading at 500, the put option would be 'at-the_money'.

Intrinsic Value The intrinsic value: is the value of the option if it is exercised today. It can be defined as the amount by which an option is in the money or the price difference between the strike price of underlying asset and the current market price

For call option it is Maximum (Spot Price - Strike Price, 0)

For put option it is Maximum (Strike Price - Spot Price, 0)

The intrinsic value of an option must be a positive number or 0. It can't be negative.

Time Value: Is defined as the excess of option value over the intrinsic value

Time Value = Option Price - Intrinsic Value.

For example: -- if a Reliance call option is has a strike price of 400 and a premium of 25.

If the market price of Reliance at the time of expiry is Rs 410

Then

Intrinsic value = Max (410-400,0)

= Rs 10

And time value = 25 -10.

= Rs 15.

And if the price is Rs 350 then

Intrinsic value = Max (350-400,0)

= 0

And time value = 25 - 0

=Rs. 25

And if Reliance put option have a strike price of 400 and a premium of 25.

If the market price of Reliance at the time of expiry is Rs 410

Then

Intrinsic value = Max (400-410,0)

= Rs 0

And time value = 25 - 0.

= Rs 25.

And if the price is Rs 380 then

Intrinsic value = Max (400-380,0)

= 20

And time value = 25- 20

=Rs. 5

Factors Influencing the Price of an Option

Factors that can be Quantified:

• Underlying stock price.

• The strike price of the option.

• The volatility of the underlying stock.

• The time to expiration and.

• The risk free interest rate.

Non-Quantifiable Factors:

• Market participants' and individuals' varying estimates on the future volatility and performance of the underlying asset's

• The effect of supply & demand- both in the options marketplace and in the market for the underlying asset.

• The "depth" of the market for that option - the number of transactions and the contract's trading volume on any given day.

The primary influence on an options price is the price of the underlying security. An options price decays each day it is in existence. Further, the closer the option gets to expiration, the faster it decays. The rate of decay is related to the square root of the time remaining. An option with two months remaining decays at twice the speed of a four month option etc.

Volatility

The volatility part of the pricing model is a measure of the range the underlying security is expected to fluctuate over a given period of time. The measurement of volatility is the standard deviation of the daily price changes in the security. The more volatile the underlying security, the greater the price of the option.

There are two kinds of volatility. There is historical volatility; and there is implied volatility. Historical volatility estimates volatility based on past prices. Implied volatility starts with the option price as a given and works backward to ascertain the theoretical value of volatility equal to the market price minus any intrinsic value.

Black Scholes Option Pricing Model The original breakthrough for option pricing was in the Black-Scholes model 'BSOPM' as it is called is a model to price a call option based on certain variables like time period to expiry, volatility, dividend on the underlying stock etc. These are theoretical values and just give a trader an idea of a fair value of the Option. Speculative view today will need much more than 'BSOPM' to price the Option correctly.

Covered calls and Naked Calls

A call option position when covered by the opposite position, in the underlying instrument is called a covered call. Where as in naked calls the position is not covered.

Example: A writer writes a call on L&T and at the same time holds the share of L&T, so that in case if the buyer exercises the call, he can deliver the stock.

Covered calls are far less risky than naked calls (where there is no opposite position in the underlying), since the worst that can happen is that the investor is required to sell shares already owned at below their market value. But in case of naked call, if the buyer exercises the option, the writer will have to purchase the underlying asset to meet his call obligation and his loss will be the excess of the purchase price over the exercise price of the call reduced by the premium received for writing the call.

The kinds of Nifty options being traded:

The strike prices and expiration dates for traded options are selected by the exchange. For example, NSE may choose to have three expiration months, and five strike prices (1200,1300,1400,1500,1600). There would be two types of options: put and call. This gives a total of 30 distinct traded options (3 × 5 ×2), with 30 distinct order books and prices.

A typical set of option prices is shown in Table below illustrates the intriguing nature of option prices. When Nifty is at 1500, the right to buy Nifty at 1600 one month away is worth little (Rs.13). The buyer of this option puts down Rs.13 when the option is purchased, and this fee is non -refundable. If Nifty turns out to be above 1600 after a month, this option will prove to be valuable. If Nifty proves to be at 1602 after a month, the option will pay Rs.2. Conversely when Nifty is at 1500, the right to sell Nifty at 1400 one month away isn't worth much (Rs.8): this is the "insurance premium " for protecting yourself against a fall in Nifty of worse than a hundred points.

However, when we increase the time to expiration of the option, there is a greater chance that prices can move around, and these same options become more valuable: e.g: the right to sell Nifty at 1600 is worth Rs.25 when we consider a three month horizon (i.e. insurance against a hundred point drop on a three month horizon).

Working of index option :

As with index futures, index options are cash settled.

Table Option prices: some illustrative values

		1400	1450	1500	1550	1600
Calls		117	79	48	27	13
3 Months		154	119	90	67	48
Puts
1 Months		8	19	38	66	102
3 Months		25	39	59	84	114

Assumptions: Nifty spot is 1500,Nifty volatility is 25% annualised interest rate is 10%,Nifty dividend yield is 1.5%. Suppose Nifty is at 1500 on 1 July 2000.Suppose L buys an option which gives him the right to buy Nifty at 1600 from S on 31 Dec 2000.It turns out that this option is worth roughly Rs.90. So a payment of Rs.90 passes from L to S for having this option.
On 31^st Dec 2000, if Nifty is below 1600, the option is worthless and lapses without exercise. Suppose Nifty is at 1650. Then (in principle) L can exercise the option, buy Nifty using the option at 1600,and sell off this Nifty on the open market at 1650.So L has a profit of Rs.50 and S has a loss of Rs.50.In this case," cash settlement " consists of NSCC (National Securities Clearing Corporation) imposing a charge of Rs.50 upon S and paying it to L.

The contract specifications of Sensex Options.

BSE's first index options is based on BSE 30 Sensex. The Sensex options would be European style of options i.e. the options would be exercised only on the day of expiry. They will be premium style i.e. the buyer of the option will pay premium to the options writer in cash at the time of entering into the contract. The Premium & Options Settlement Value (difference between Strike & Spot price at the time of expiry), will be quoted in Sensex points. The contract multiplier for Sensex options is INR 100, which means that monetary value of the Premium & Settlement value will be calculated by multiplying the Sensex Points by 100. For e.g. if Premium quoted for a Sensex options is 50 Sensex points, its monetary value would be Rs. 5000 (50*100).

The expiration day for Sensex option is the last Thursday of Contract month. If it is a holiday, the immediately preceding business day will be the expiration day. There will be three contract month series (Near, middle and far) available for trading at any point of time. The settlement value will be the closing value of the Sensex on the expiry day. The tick size for Sensex option is 0.1 Sensex points ( INR 10). This means that the minimum price fluctuation in the value of the option premium can be 0.1. In Rupee terms this translates to minimum price fluctuation of Rs 10. ( Tick Size * Multiplier =0.1* 100).