NCFM Options Trading Strategies flashcards

32 cards. Read the term and the definition here. The deck at the top of this page is optional.

Option contract multiplier

In India, one standard equity/index option contract represents the specified lot size (e.g., Nifty lot = 50). Premium quoted per unit; total premium = premium × lot size.

American vs European exercise

American options can be exercised any trading day before expiry; European only at expiry. Indian index options are European (cash-settled); stock options are American (physically settled).

Expiry day rule

Monthly contracts expire on the last Thursday of the expiry month; weekly contracts on the Thursday of the expiry week. If Thursday is a holiday, expiry is the previous trading day.

Intrinsic value formula

Call intrinsic = max(0, spot − strike); put intrinsic = max(0, strike − spot). Time value = premium − intrinsic value; time value is zero at expiry.

Put-call parity

For European options: C − P = S·e^(−qT) − K·e^(−rT). For non-dividend stocks (q=0): C − P = S − K·e^(−rT). Violations imply arbitrage.

Black-Scholes call formula

C = S·e^(−qT)·N(d1) − K·e^(−rT)·N(d2), with d1 = [ln(S/K)+(r−q+σ²/2)T]/(σ√T), d2 = d1 − σ√T. N(·) is the standard normal CDF.

Implied volatility

The volatility input that makes the BSM model price equal the observed market price. It reflects market expectations of future volatility and supply/demand for options.

Dividend effect on options

Dividends reduce call value and increase put value because they lower the expected ex-dividend stock price. The adjustment uses the dividend yield q in BSM.

Delta definition

Delta = ∂V/∂S. Call delta ranges 0 to +1; put delta ranges −1 to 0. ATM delta ≈ ±0.5. Delta approximates the risk-neutral probability of finishing ITM.

Gamma definition

Gamma = ∂Δ/∂S = ∂²V/∂S². It measures the rate of change of delta. Gamma is highest for ATM options near expiration; long options have positive gamma.

Theta definition

Theta = ∂V/∂t, the change in option price per day (time decay). Long options have negative theta; short options positive. Theta accelerates in the final 30 days.

Vega definition

Vega = ∂V/∂σ, the sensitivity of option price to a 1% change in implied volatility. Long options have positive vega; short options negative. Vega is highest for ATM, long-dated options.

Volatility skew

The pattern where OTM puts trade at higher implied volatility than ATM or OTM calls, reflecting demand for downside protection and crash risk. It creates a downward slope in IV vs. strike.

Covered call strategy

Long stock + short call. Max profit = (strike − stock price) + premium; max loss = stock price − premium; breakeven = stock price − premium. Generates income but caps upside.

Protective put strategy

Long stock + long put. Max loss = (stock price − strike) + premium; max profit unlimited; breakeven = stock price + premium. Acts as portfolio insurance.

Bull call spread

Buy lower-strike call, sell higher-strike call. Max profit = (higher strike − lower strike) − net debit; max loss = net debit; breakeven = lower strike + net debit. Moderately bullish.

Bear put spread

Buy higher-strike put, sell lower-strike put. Max profit = (higher strike − lower strike) − net debit; max loss = net debit; breakeven = higher strike − net debit. Moderately bearish.

Bull put spread

Sell higher-strike put, buy lower-strike put (credit spread). Max profit = net credit; max loss = (higher strike − lower strike) − net credit; breakeven = higher strike − net credit. Moderately bullish.

Bear call spread

Sell lower-strike call, buy higher-strike call (credit spread). Max profit = net credit; max loss = (higher strike − lower strike) − net credit; breakeven = lower strike + net credit. Moderately bearish.

Long call payoff

Max loss = premium paid; max profit unlimited; breakeven = strike + premium. Profits from a rise in the underlying above breakeven; loses if price stays below strike.

Long put payoff

Max loss = premium paid; max profit = strike − premium; breakeven = strike − premium. Profits from a fall in the underlying below breakeven; loses if price stays above strike.

Long straddle

Buy ATM call + ATM put (same strike, expiry). Max loss = net debit; profit potential unlimited on call side; breakevens = strike ± net debit. Profits from large moves; loses from time decay and falling IV.

Short straddle

Sell ATM call + ATM put. Max profit = net credit; max loss unlimited. Profits from low volatility and time decay; loses from large moves and rising IV.

Long strangle

Buy OTM call (higher strike) + OTM put (lower strike). Max loss = net debit; breakevens = call strike + debit and put strike − debit. Cheaper than a straddle but needs a larger move.

Short strangle

Sell OTM call + OTM put. Max profit = net credit; max loss unlimited on call side, large on put side. Profits from a range-bound market; loses from large moves.

Long butterfly (call)

Buy 1 lower-strike call, sell 2 middle-strike calls, buy 1 higher-strike call (equidistant strikes). Max profit = (middle − lower) − net debit; max loss = net debit; breakevens = lower + debit and higher − debit.

Short butterfly

Reverse of long butterfly: sell 1 lower-strike call, buy 2 middle-strike calls, sell 1 higher-strike call. Max profit = net credit; max loss = (middle − lower) − net credit. Profits from large moves away from middle strike.

Long condor

Buy 1 lower-strike call, sell 1 lower-middle call, sell 1 upper-middle call, buy 1 higher-strike call (four strikes). Max profit = net credit (if credit) or width − debit; max loss = net debit. Profits from range-bound market.

Ratio spread (call)

Buy 1 lower-strike call, sell 2 higher-strike calls. Net debit or small credit. Max profit at higher strike; max loss unlimited above higher strike. Bearish/neutral strategy.

SPAN margin

Initial margin = max(loss under price scan range, loss under volatility scan range) + short option minimum margin. Exposure margin is additional. Hedged positions receive lower margin.

Position limits

SEBI prescribes client-level, trading-member-level, and market-wide limits on open interest for index and stock options to prevent concentration and manipulation.

STT on options

Securities Transaction Tax: 0.05% of premium on sale of options; 0.125% of intrinsic value on exercise. Higher STT on exercise discourages exercising ITM options.