NIFTY OPTION-Hedging Strategy

Derivative contract is a contract whose value is determined by the changes in the value of underlying asset. A Derivative includes three types of participants: Hedgers, Speculators and Arbitrageurs. Derivative includes: Forwards, Futures, options & Swaps. A forward contract is a non standardized contract between the two parties to buy or sell an asset at a specified future price and time agreed today. Future is best defined as a standardized contract to buy or sell a specified commodity of standardized quality at a certain date in future and at a determined future price. Swaps mean the exchange of one asset or liability for a similar type of other asset or liability for the purpose of changing maturity and raising or lowering of coupon rates.

Options are the most refined form of Derivatives in which one can go for a buy or sell positions and this trade is on the premium because, we pay a premium and buy a right, but there is no obligation on the buyer to buy or to sell, but has the right to buy and right to sell. An option which gives the holder the right to buy an asset at a fixed price during a certain period is called as Call Option, while an option which gives the holder the right to sell a stock at a fixed price is a Put Option. An investor can trade in following types of options- exchange traded option, equity option, bond option, over the counter option, index options etc.

Options pose a limited risk to the investor. The potential profit is also limited to the premium but the potential loss is unlimited. However they are among the most flexible of investment choices. Options may protect or enhance the portfolio of different kind of investors in various market situations. Options are an effective risk management tool as it acts as a tool against drop in stock prices. As an options holder, you risk the entire amount of the premium you pay. But as an options writer, you take on a much higher level of risk. How nifty option (call & put) works is explained through the following example:-

A 5700 call of nifty is trading at a premium of Rs60, if we buy the call option, the maximum loss to the buyer of call option is Rs 60(premium), the Breakeven point will be (5700+60)5760, now if nifty goes below 5760 level, the maximum loss of buyer will be equal to premium only (i.e. Rs60) but the profits will be unlimited if the nifty breaks 5760 level. if we talk about put option a 6000 put (strike price) with a premium of Rs150 the BEP here is 5850(6000-150) now if nifty goes to 6200 level, the maximum loss here in this case is equal to amount of premium paid(i.e. rs150 only) but the profits are unlimited if nifty goes below 5850 levels.

Sumit Singh, a Technical Analyst with NiftyDirect.com recommends-getting a strong understanding of trading techniques and concentrating on risk and rewarding ratio. NiftyDirect.com offers Stock Futures ,Stock advisory services in Indian stock market , much more.