The Hindu Business Line : Using futures/options

You need not get in touch with the National Stock Exchange. You would have to register yourself as a client with a broker before you start trading. You also have to sign a contract with the NSE before starting to trade. Your broker would be able to arrange that.

Non-resident Indians are also allowed to trade. A number of brokers in India provide online trading facilities.

Is there any simulation system available for Indian futures, like the ones that are available in some other countries?

As of now neither the sites of brokers nor the site of the National Stock Exchange hosts any simulator for trading in derivatives. IL&FS Investsmart appeared to have a derivatives game earlier. Their Web site now does not offer that facility.

Are there any regulations that apply if we want to trade from India on futures and options listed in other exchanges such as CME, CBOT, SFE etc.?

The latest RBI rules allow remittances of up to $25,000 a year by an Indian citizen. This can be utilised to open accounts and make investments abroad. This allows residents to open an account to trade in derivatives also. There are, however, legal constraints in host countries such as the US relating to opening of bank accounts and accounts with brokers. These structural problems may need to be sorted out before residents can trade in overseas exchanges.

A few queries regarding pricing. — V. Maruthi Rao

As per the Black-Scholes option pricing model, the price of an option has to be estimated using variables such as spot price, risk-free interest rate, dividends likely to be received, time to expiration and volatility of the underlying asset. Kindly let me know the risk-free rate that is being applied in the market and how the implied volatility is estimated.

The risk-free rate that is being applied in the market should be closer to 4.5 per cent. The National Stock Exchange uses the MIBOR rate, which is now around that level.

The Black-Scholes option pricing model is used to calculate the implied volatility also. The model normally gives out the price of an option using the other inputs. For implied volatility, the market price is used as an input along with other factors to calculate implied volatility.

While reading the derivatives columns in Business Line, I have come across words like `options are trading rich' and 'theta-gamma trade-off'. Can this be explained more clearly?

The term `Options are trading rich' means that the options are not trading `cheap'. This term is used to refer to options that are traded at prices that are higher than what the Black-Scholes model suggests. Strategies that may include selling are constructed around options that are trading rich.

Theta measures the change in option price with reference to the change in time to expiry of the option. Delta measures the change in price of option to change in price of the stock. Gamma measures change in delta to a change in price of the stock. If an option is fast approaching its expiry, the value of option will keep declining. However, there is the possibility that the price of option can be positively influenced by a change in the price of the stock, which is measured by Gamma. The investor, therefore, has to measure the loss in option value due to the approaching expiry date with the possible gain in option value due to a change in price of the stock. This is referred to as the theta-gamma trade-off.

Queries relating to futures/options may be sent to fno@thehindu.co.in or to Futures & Options, Kasturi & Sons, 859-860, Anna Salai, Chennai 600 002.