The Hindu Business Line : What's theta-positive?

In one of the columns in Business Line, it was said that the short Oct 300 Tata Steel call "is theta-positive". Could you kindly elucidate as to what is meant by this phrase and how does one find this aspect out on the option calculator graph (I am using indiainfoline option calculator). — Massey

Theta refers to the time value of an option. The difference between strike price of the option and the spot price is the intrinsic value of an option.

The difference between intrinsic value of an option and option premium is the time value of an option. Theta measures the sensitivity of this time value to passage of time.

Theta of options is always negative for the buyer.

As the time to expiration approaches, the value of the option declines for the buyer since the time available for the position to increase profits keeps coming down.

Theta of options is always positive for the seller.

The passage of time works in favour of the seller. The rate of change in theta increases as the time to expiry approaches.

That is, the change in time value at the beginning is smaller and keeps increasing every passing day. It is the highest when it is closer to maturity.

Consider the Oct 300 calls. The spot price of Tata Steel was Rs 284.

For a seller, the intrinsic value of this option is Rs 16. The option was, however, trading at about Rs 5. The difference of Rs 11 is the time value. It is negative for the buyer and positive for the seller.

As the time to expiration approaches, the probability of the seller pocketing this Rs 11 as profit keeps rising.

Theta is, therefore, positive for the short October position. On the date of expiry with the Tata Steel stock closing at about Rs 294, the short Oct 300 call, made a profit of Rs 6 on settlement apart from the initial premium of Rs 5.

Theta cannot be calculated using the calculator in www.indiainfoline. com.

You will have to use the calculator in the Web site of www.bseindia. com.

Alternatively, you could download option calculators from any of several Web sites such as www.trader-soft. com.

I want to deal in futures & options. Please advise. — Vishal Aggarwal

Prospective dealers in futures & options should consult their financial advisor or a stockbroker.

They should also decide whether they want to hedge their investments in stocks or want to profit from their views about the market or a particular stock.

They should also read the module on derivatives in the NCFM section of the Web site of www.nseindia. com.

The module is comprehensive and can be considered a must for every prospective trader in futures & options segment.

The FAQ section in the websites of BSE, NSE and that of several brokers would also prove useful.

The newsletters of several brokers also contain recommendations on strategies that can be followed.

Business Line too carries reports and recommendations on futures and options on a daily basis.

How are futures and options settled? Are they settled on expiry date or squarable any time before expiry date.

Is settlement allowed only in cash or can be settled by taking or giving delivery also.

Whether settlement has to be done on the spot price of the security/ index on expiry or only at the rates prevailing in the counter in f&o level. — D.S. Kohli

Index options can be settled only on the date of expiry.

An offsetting trade can square off stock options any time before the expiry date. Stock options can also be exercised before expiry.

If such long positions were exercised before expiry, they would be assigned to short option positions on a random basis. Final exercise of option contracts is automatic on the date of expiry.

Settlement is allowed only in cash mode.

Final settlement in the case of futures contracts and index options are credited to the member's bank account on the day after the trade.

Interim exercise and final exercise of stock options are credited to the member's account on the second day after the trade.

In the case of futures on index and stocks, the daily settlement for price for the calculation of margins is the closing price of the futures contracts themselves.

The final settlement price is the closing price of the relevant underlying index or stock.

For options, both interim settlement and final settlement are based on closing price of the underlying security.

Closing price refers to the weighted average price of the trade in the last half an hour.

Queries relating to futures/options may be mailed to

fno@thehindu.co.in

or to Futures & Options, Kasturi & sons, 859-860, Anna Salai, Chennai 600 002.

Suresh Krishnamurthy

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