Trading Strategy::Richard Donchian

Richard Donchian was born in Hartford, Connecticut in September 1905 was born over 100 years ago and although the vast majority of traders have never heard of him yet, he is one of the most influential traders of all time and the father of technical trend following.

Many modern trend following systems, such as the Turtle Trading system, are based on his work and legendary trader Richard Dennis was a huge fan and Ed Seykota used him as an inspiration.

Richard Donchian didn't begin trading his successful trend following system until the age of 65. He started making large returns after that and continued to trade until into his 90s - showing your never to old to trade. While he operated mostly in the field of commodities his technical analysis is applicable to any market.

His 4 week trading rule system has been at the heart of many successful trading systems and is one of the simplest, easiest and most profitable ways to trade trending markets.

People tend to think complicated is better but the 4 week rule is simplistic but will get you on the right side of every profitable trend and help you make money.

Apart from the 4 week rule he did a lot of work with a five and twenty day moving average crossover signal system and used buy and sell rules using a weekly time period.

The following trading guidelines were first published in 1934 and there are applicable today as they ever were and are re-produced in their original format below:

General Guides

1. Beware of acting immediately on a widespread public opinion. Even if correct, it will usually delay the move.

2. From a period of dullness and inactivity, watch for and prepare to follow a move in the direction in which volume increases.

3. Limit losses and ride profits, irrespective of all other rules.

4. Light commitments are advisable when market position is not certain. Clearly defined moves are signaled frequently enough to make life interesting and concentration on these moves will prevent unprofitable whip-sawing.

5. Seldom take a position in the direction of an immediately preceding three-day move. Wait for a one-day reversal.

6. Judicious use of stop orders is a valuable aid to profitable trading. Stops may be used to protect profits, to limit losses, and from certain formations such as triangular foci to take positions. Stop orders are apt to be more valuable and less treacherous if used in proper relation to the chart formation.

7. In a market in which upswings are likely to equal or exceed downswings, heavier position should be taken for the upswings for percentage reasons - a decline from 50 to 25 will net only 50% profit, whereas an advance from 25 to 50 will net 100%

8. In taking a position, price orders are allowable. In closing a position, use market orders."

9. Buy strong-acting, strong-background commodities and sell weak ones, subject to all other rules.

10. Moves in which rails lead or participate strongly are usually more worth following than moves in which rails lag.

11. A study of the capitalization of a company, the degree of activity of an issue, and whether an issue is a lethargic truck horse or a spirited race horse is fully as important as a study of statistical reports.

Technical Guides

1. A move followed by a sideways range often precedes another move of almost equal extent in the same direction as the original move. Generally, when the second move from the sideways range has run its course, a counter move approaching the sideways range may be expected.

2. Reversal or resistance to a move is likely to be encountered:

- 0n reaching levels at which in the past, the commodity has fluctuated for a considerable length of time within a narrow range

- On approaching highs or lows

3. Watch for good buying or selling opportunities when trend lines are approached, especially on medium or dull volume. Be sure such a line has not been hugged or hit too frequently.

4. Watch for "crawling along" or repeated bumping of minor or major trend lines and prepare to see such trend lines broken.

5. Breaking of minor trend lines counter to the major trend gives most other important position taking signals. Positions can be taken or reversed on stop at such places.

6. Triangles of ether slope may mean either accumulation or distribution depending on other considerations although triangles are usually broken on the flat side.

7. Watch for volume climax, especially after a long move.

8. Don't count on gaps being closed unless you can distinguish between breakaway gaps, normal gaps and exhaustion gaps.

9. During a move, take or increase positions in the direction of the move at the market the morning following any one-day reversal, however slight the reversal may be, especially if volume declines on the reversal.

His work has stood the test of time and you can still trade using the above rules as you could 100 years ago markets still move to the influence of greed and fear as they did 100 years ago and the above guidelines will never go out of date.

Richard Donchian may not be that well known but when a man can influence some of the greatest traders of all time like Richard Dennis, you know that he has something worth saying, he was a true market legend who traders everywhere can learn from.

Satyam imbroglio: Surprised? Shocked? Stunned?

Courtsey:M.R.Venkatesh (Writer on Stock Markets)

The big daddies of accounting – better known as the Big Four - have had more than fair shares of fraud, fudging, fiddling et al.

In contrast to the public image each of them enjoys, (especially in the media) of being a sophisticated, high end accounting and consulting player at a global level, a brief perusal of the history of these firms would reveal that these firms have not been all that honourable and in fact had indulged in all these with an uninhibited brazenness or remorse. And more. They are viewed with awe and respect in India. Consider these:

KPMG was reported to be involved in laundering millions of dollars of the corrupt and ill-gotten wealth of Pilipino dictator Ferdinand Marcos. Despite this ‘remarkable’ history behind it, KPMG, without compunction, conducts annual fraud surveys in India. Corporates are unaware that they are rated by an organisation whose conduct is more than suspect.

Deloitte was penalised for reckless auditing practices, negligence and frauds in several cases. Their negligence in audit is reported to have resulted in many companies going belly-up. Yet, in India even to this day they could be called upon by Insurance companies to conduct their audits or by banks to write secret security codes!

Ernst & Young have their quota of sordid history too but were more in the news for a ‘stink’ operation, as they were caught conducting “Pristine Audits” in 2003 and reported by the Guardian. To the uninitiated, Pristine Audits refers to inspecting toilet seats and U bends – yes inspecting toilets - for stains. Yet, this firm bestows the annual entrepreneur award in a much-hyped annual affair. Most of our entrepreneurs are unaware of this fact.

Price Waterhouse Coopers – They are the guardians of Truth – “Satyam”! Need we elaborate?

Put pithily, the big four accounting firms are globally reputed for fudging and falsification. Put bluntly, only those who need to fudge, falsify and fabricate without any fear of guilt or conscience need these “reputed” firms of accountants. Others don’t.

It may be recalled that a group of Chartered Accountants came out with a White Paper on the functioning of these Multinational Accounting Firms (MAFs) exposing in detail their operating methodologies worldwide.

Yet, when la affaire’ Satyam exploded, analysts, media and perhaps the entire corporate and accounting world were stumped, more so, given the fact that the auditor of Satyam happens to be one of the big daddies.

Frankly I am not. Given the lax way we operate our financial system and the efficacy of our regulators it is only surprising to me that it took so long to happen.
Interestingly, as we had warned in the aforesaid White Paper, these firms are Head quartered in some tax havens with the ultimate ownership virtually unknown. And, despite such huge security risks associated with them, we allow these firms to audit our banks, insurance companies and other sensitive sectors either by themselves or through their surrogates.

With the steadfastness of Pakistan which dismisses any evidence provided by the world about its terrorist connections, India Inc. continued to ignore the facts staring at them and continued to appoint them. Media continued to patronise them. Analysts went on believing them. No wonder, all of them collectively are surprised, shocked and stunned.

Whither the Regulators?
The standard operating procedure of these firms is to claim global status whenever it suits them. And having collectivised themselves into a network of firms across countries, in case of any problem, these firms reflexively claim to be separate independent firms, not linked to the other.

In the infamous BCCI case, partners of Price Waterhouse (PW) in US denied any knowledge or responsibility of the audit of BCCI, which was conducted by PW, London, UK. So would PW in US in the extant case involving Satyam and PW India (interestingly, the global head of PwC was reported to travel to India after the news broke out).

This nebulous manner of arranging their network has ensured that they have entered India by networking with existing accounting firms as well as opening separate management consulting companies. Commenting on this arrangement the ICAI stated, in June 2002 “The Government should review the alternative route of entry of accounting firms in India in the name of management consulting firm, and, circumvention of the law of the land taking place directly and indirectly by performing accounting services by them.”

Well, much water has flown through the Ganges since then. Yet ICAI has been unable to take action on the alleged “circumvention of the law of the land” by its own members in India.

The reason for the same is obvious. As on date two partners / associates of PW – the firm under cloud – are members of the Council of ICAI, the governing body that is in charge of disciplinary matters of auditors. Normally, basic morality would demand that these members must resign from the Council to ensure a free and fair investigation. But, even to have such high expectations on morality are considered amateurish here!

It is equally interesting to note that some past Presidents of the ICAI went on become partners of these firms that were networked with the MAFs. Naturally, instead of actually using their office to control this illegitimate presence of MAFs, many leaders within the profession actually went on to use their office to legitimise the presence of these MAFs!

The net effect of the rot is there for all to see. All that we have done over the years to import the fraudulent working methodologies of these MAFs into India. In fact, there is extraordinary peer pressure on local firms to adopt these practices, else be condemned to play eternally a secondary role to these biggies.

Remember Greesham’s law when bad circulates with good, bad would drive out good. Yet ICAI chose to remain silent or complacent in this fight against the bad. In the process ICAI itself makes itself “questionable” by many, when a messy affair like Satyam happens.

Be assured that ICAI is known to take tough action against errant members normally but when high profile cases surface, abnormality rules the roost! Yes, beginning from the securities scam in the early 90’s ICAI has been unable to walk its talk of brining erring big players, especially its Council members, to book. When it concerns the MAFs, the hunter becomes the hunted.

GTB the cause, Satyam the effect
What is interesting to know here is that the election to the office of the Vice-President of the ICAI is so bitterly fought by these Council members that every vote of every member becomes crucial.

And that is where the quid pro quo begins, I suspect. Despite the claims of Chinese walls by ICAI, it is well known that till date, the disciplinary case pending against the auditors of Global Trust Bank (presumed to have been initiated on the instructions of RBI itself) is pending resolution.

In all fairness, the enquiry might be going on and probably even in an advanced level but as long as the whole process is decidedly opaque, a normal member keeps his consternation levels high. And, by chance, if the enquiry comes to a culmination anytime now and ICAI comes out with its long awaited decision, the general perception would only be that it needed a Satyam affair to make GTB affair end. A speedier justice dissemination system would have saved the Institute this ignominy!

It may be recalled that in the GTB case RBI initially alleged (as it did in the securities scam in early 90’s) violations by auditors. Yet, it did not take the matter to the logical conclusion on both occasions. Given this track record, it is very doubtful whether the errant players, especially the high profile ones would ever be nailed.

So is SEBI or for that matter, the Registrar of Companies or the Finance Ministry or the Ministry of Company affairs. A job offer for the son-in-law of the Joint Secretary here or the daughter of the Assistant Secretary there, preferably in exotic locations that might do the trick.

Even assuming that PWC is not guilty (it is quite possible that it is a victim of circumstance rather than villain of the piece), if justice is to be done and seen to be done, all the partners of PW or associated firms should resign from the council of ICAI forthwith as well as from government sponsored committees. Crucially, men of proven integrity must be in-charge of these probes, not those known to be of easy virtue.

As I write this piece it is disheartening to note some of our corporates are still dithering on the issue of continuing their relationship with PW. It is important to note that capital markets quickly need to restore investor’s confidence. Given the magnitude of events it is suggested that PW should volunteer to resign as auditors of listed companies. Believe me; nothing of else will restore confidence in PW, capital markets and lo! in audits.

Corporate honchos, media, analysts, ICAI, RBI, SEBI, Government, shareholders and of course you and me are responsible for la affaire Satyam. Therefore, nothing at all will happen to anyone. In future also, do not be surprised if MAFs continue to violate laws of the land. Do not be shocked if managements loot corporates. Do not be stunned by the inaction of our regulators. It is all part of the game, man. Enjoy the show!

1. Who has to pay Income tax?
Any individual, corporate, firm, society or any judicial legal entity having income earned & received in India will be liable to pay Income tax to the Income tax Department of India.

2. Who is an assessee in Income Tax?
Assessee is a person by whom Income tax is payable under Income tax Act, 1961 of India.

3. What is Assessment year in Income Tax?
Let's say your Financial Year is from 1st April-2007 to 31st March-2008, then Assessment year for Income Tax purpose is year ending on 31st March, 2009 (1st April 2008 to 31st March 2009). In this case Financial Year would be called previous year.

4. What is a PAN (permanent account number)?
The permanent account number is allotted by the assessing officer to any person for the purpose of identification. It's a Unique 10 digits number for e.g. KKJMN6994P.

5. Do I have to apply for a permanent account number (PAN)? How do I apply?

If you fall under any of the below mentioned categories, you have to apply for PAN in Form 49A:
If your total income in the previous year exceeds maximum amount not chargeable to tax.
If you are carrying on business or profession, whose total sales, turnover or gross receipts, are or is likely to exceed Rs 500,000.
If you are assessable as charitable trust.

You have to quote your PAN on:
--Income tax return
--Any correspondence with Income Tax Authority
--Challans for payment of direct taxes
--Application for installation of a telephone connection (including a cellular telephone)
--Application for opening a bank account
--Application for opening DMAT account
--Documents pertaining to sale or purchase of a motor vehicle (other than two wheelers) & immovable property valued at Rs 500,000 or more.
--Documents pertaining to a time deposit/fixed deposits exceeding Rs 50,000 with a bank
--Documents pertaining to deposits exceeding Rs 50,000 in any account with a Post-Office Savings Bank.
--Documents pertaining to a contract of a value exceeding Rs 1 million (Rs 10 lakhs) for sale or purchase of securities (shares, debentures)
--At the time of purchase of Mutual fund units.
--Payment to hotels and restaurants against their bills for an amount exceeding Rs. 25,000 at any one time

However following people may not apply for PAN:
--Who have agricultural income and are not in receipt of any other income chargeable to income tax
--NRIs
--Central Government, State Government and Consular Officers, in transactions where they are the payers.
--Application for allotment of PAN can be submitted in form No. 49A.

6. What are the types of income chargeable to Income tax?
1. Salary Income
2. House Property Income
3. Income from business or profession
4. Income from sale of capital assets
5. Other income

7. What is residential status under Income Tax Act?
In India, as in many other countries, the charge of income tax and the scope of taxable income vary with residential status of the assessee.

There are three categories of taxable entities viz.
(1) Resident and ordinarily resident (ROR)
(2) Resident but not ordinary resident (RNOR)
(3) Non-residents (NR)

The law prescribes two alternative criterions to decide the residential status of an assessee. Both criterions relate to the physical presence of the taxpayer in India in the course of the previous year which would be the twelve months from April 1 to March 31.

A person is said to be "resident" in India in any previous year if he -
(a) Is in India in that year for an aggregate period of 182 days or more; or
(b) having within the four years preceding that year been in India for a period of 365 days or more, is in India in that year for an aggregate period of 60 days or more.

The above provisions are applicable to all individuals irrespective of their nationality. However, as a special concession for Indian citizens and foreign citizens of Indian origin, the period of 60 days referred to in Clause (b) above, will be extended to 182 days in two cases: (i) where an Indian citizen leaves India in any year for employment outside India; and (ii) where an Indian citizen or a foreign citizen of Indian origin (NRI), who is outside India, comes on a visit to India.

In the above context, an individual visiting India several times during the relevant "previous year" should note that judicial authorities in India have held that both the days of entry and exit are counted while calculating the number of days stay in India, irrespective of however short the time spent in India on those two days may be.

A "non-resident" is merely defined as a person who is not a "resident" i.e. one who does not satisfy either of the two prescribed tests of residence.

An individual, who is defined as Resident in a given financial year is said to be "not ordinarily resident" in any previous year if he has been a non-resident in India 9 out of the 10 preceding previous years or he has during the 7 preceding previous years been in India for a period of, or periods amounting in all to, 729 days or less.

Conditions ROR RNO RNR
In India >= 182 days in FY Yes Yes No
NR in India in 9 out of 10 preceding FYs No Yes NA
In India for <=729 days in preceding 7 FYs No Yes NA

In India >= 60 days in FY and >= 365 days in
preceding 4 FYs NA NA No
(FY = Current Financial Year)

* Threshold limit for resident women assessees below 65 years of age and resident individuals of 65 years and above to be further increased to Rs. 1,35,000/- and Rs. 1,85,000/- respectively.
• Plus surcharge @ 10% applicable if total income exceeds Rs. 10,00,000/
• Education Cess @ 2% is payable on tax plus surcharge
However if you are a company or a partnership firm you will have to pay tax on all income earned. Till 31st March 2003, "not ordinarily resident" was defined as a person who has not been resident in India in 9 out of 10 preceding previous years or he has not during the 7 preceding previous years been in India for a period of, or periods amounting in all to, 730 days or more.

8. Is it compulsory to maintain books of accounts?
Yes, IF you are carrying on legal, medical, engineering or architectural profession or the profession of accountancy or technical consultancy or interior decoration or any other notified profession. And Yes, IF you are carrying on business or profession (other than professions mentioned earlier) and IF the income from business or profession exceeds Rs.1,20,000/- or the total sales, turnover or gross receipts in the business or profession exceeds Rs. 10 lakhs in any one of the three years immediately preceding the previous year.

9. Is it compulsory to get the books audited?
(i) Every person carrying on business shall get his accounts audited if the total sales, turnover or gross receipts in business exceed Rs. 40 lakhs in the previous year.
(ii) Every person carrying on profession shall get his accounts audited if his gross receipts exceed Rs. 10 lakhs in the previous year

Selling Puts!!

Welcome to Selling Puts, where you will be taught:

--The obligations involved with selling puts
--The profit and risk potential of selling puts
--How and why a conservative investor might sell puts
--How and why an aggressive trader might sell puts
--Trading considerations when selling puts

Selling Puts - The Obligations Involved

--Put buyers have the right to sell the underlying stock.
--Put sellers are obligated to buy the underlying stock if the put buyer decides to exercise the right to sell.
--Put sellers must be financially and psychologically prepared to buy the underlying stock.

Selling Puts - Profit and Risk Potential
Example: XYZ stock @ $71.25
Sell 1 XYZ April 70 Put @ 3.5

If the put buyer exercises, the put seller must buy the underlying stock and assume all of the related risks.

At expiration: put expires and premium is kept as income.

Note: Put sellers must make a margin deposit.
The potential risk is usually larger than the margin deposit.

Selling Puts - The Conservative Investor
Conservative Carl has the cash to buy 100 shares of XYZ stock at $71.25 per share, its current price.

But Conservative Carl predicts that XYZ will trade lower in the short term and that XYZ can be purchased at a price below $70.

Strategy: Conservative Carl sells 1 XYZ April 70 Put @ 3.5 and deposits $7,000 in a money market account.

If the forecast is right, XYZ trades below $70, the put buyer exercises the put and Conservative Carl buys the stock. Effective purchase price = $70 - $3.50 = $66.50.

If the forecast is wrong, XYZ trades higher and the XYZ April 70 Put expires and Conservative Carl keeps the $3.50 per share premium received.

Selling Puts - The Aggressive Trader
Aggressive Amy believes that XYZ stock, currently $71.25, will trade between $70 and $75 until the option expires.

Strategy: Aggressive Amy sells 1 XYZ April 70 Put @ 3.5 and maintains the minimum margin deposit required by her firm.

If the forecast is right, XYZ stays above $70, and the XYZ April 70 Put decreases in value with the passage of time. If it expires worthless, Aggressive Amy can keep the full premium as income.

If the forecast is wrong and XYZ declines below $70, then Aggressive Amy may be forced to repurchase the XYZ April 70 Put at a loss or may be forced to buy 100 shares at 70. The loss could be substantially greater than the initial margin deposit.

Put Selling - Trading Considerations
Selling puts has limited profit potential for Aggressive Amy. For Conservative Carl it is a good way to acquire a stock at a specific price if the near term market forecast is bearish while the long term forecast remains bullish.

"I think the stock price can be purchased at a price below $70."

Put selling may be appropriate for the conservative investor when this is the objective.

"I think the stock price will close above $70 on expiration."

Put selling may be appropriate for the aggressive trader when this is the forecast.

If assigned, a put seller must be willing and able to purchase the stock at a price significantly higher than the current market price.

Options Pricing 1

--Options premiums
--Options pricing models and the Options Calculator
--In-, At- and Out-of-the-Money contracts
--Put/Call Parity, Time Premium and Volatility

You will also learn about the fundamentals involved in determining the price of an option, sometimes called its theoretical value, as well as how you can use Black-Scholes to make your trading decisions.

The Black-Scholes Model
Options Pricing was revolutionized in 1973 with the publication of the Black-Scholes Model, the Nobel-prize winning equation which virtually created the options marketplace.

While looking at this formula completely written out would be, for most people, absolutely confounding, a comprehension of options pricing is well within the realm of understanding of anyone with simple math skills and knowledge of their auto insurance policy.

Black-Scholes tells us that options on stocks can be priced using almost the exact same inputs that your insurance agent uses to quote your auto policy premium. Both depend primarily on (a) the value of the asset (the price of the car or the stock) and (b) the risk (your driving record or the stock's average price changes). A comparison of all the inputs is as follows:

Insurance Agent
--Value of car
--Deductible
--Time span of policy
--Interest Rates
--Risk

Options Trader

--Current stock price
--Strike price
--Time until expiration
--Cost of money
--Volatility

High Risk Equals High Premium
Compare for one moment, Driver A and Driver B.

Driver A is a 17-year old male high school senior with two speeding tickets since he got his license, and whose parents have bought him a Ferrari with a bumper sticker that reads, "I can't drive 55!"

Driver B is a 35-year old female homemaker with no traffic tickets in the last ten years who drives a Ford Taurus.

Obviously, who is going to have the higher risk and, henceforth, the higher insurance premium? The insurance agent might even take to following Driver A around just to cover himself.

Now, make that same comparison to someone trying to price an option on a $20 paper company stock versus a $200 dot.com stock... you see the method here.

NOTE: The larger the deductible, the lower the premium, and vice versa. The insurance deductible can be compared to the option strike price.

Components of Option Pricing
Let's analyze the different components which are used to determine the theoretical value of an option:

--The price of the underlying stock
--The strike price of the option
--The time until the option expires
--The cost of money (interest rates less dividends, if any)
--The volatility of the underlying stock

Theoretical Values

If we take all these components and plug them into the Black-Scholes formula, the model will calculate an option's theoretical value. Let's do that now:

Imagine we want to price a Call and a Put on a Stock XYZ, and that XYZ presently is at $50 a share. Imagine further that we want to price the 30-Day 50-strike Call and Put, and that interest rates right now are around 4%. Imagine, as well, that XYZ Stock pays no dividends, and that its historical volatility is approximately 16%.

NOTE: A detailed description of volatility will be covered later in this lesson. If you would like to review the historical volatility of a particular stock, please go to www.cboe.com and look at Historical Volatilities.

Option Pricing
So, what did you learn?

That Stock Price, Strike Price, Time to Expiration, Interest Rates and Dividends (combined to make the Cost of Money) and Volatility are the inputs to pricing options, and that all are conceivably known except Volatility.

OK, but how can you, the public investor, use this knowledge? Are you to be expected to become a theoretical mathematician?

Actually, we've already made it easier for you...

In-, At-, and Out-of-the-Money Options

--Another concept you must be aware of is the designation of options as In-the-Money, At-the-Money and Out-of-the-Money.
--An In-the-Money option has a strike price which, for Calls, is below the present market price and, for Puts, is above the current market price.
--An Out-of-the-Money option has a strike which, for Calls, is above the present market price and, for Puts, is below the current market price.
--An At-the-Money option has a strike whether Call or Put which is equal to or near equal to the present price of the underlying.

Intrinsic Value and Time Value
The distinctions of whether an option is In-, At- or Out-of-the-Money are also important because they help to illustrate the concepts of Intrinsic Value and Time Value.

Remember earlier how we covered the factors that go into pricing an option? Well, once you have an option price, you can break that figure down into two parts; its "Intrinsic Value," or the In-the-Money amount of an option's price, and its "Time Value," or the opportunity value that the option may become more valuable in the future.

Now, only In-the-Money options have Intrinsic Value. A 50 Call on a $55 stock is intrinsically worth at least $5, since you could exercise the option right away, buy the stock at $50 and sell it at $55, earning $5.

However, options will almost always trade at more than that. This is because all options, whether In-, At- or Out-of-the-Money have Time Value. Time Value is the extra premium the option has because of the possibility for additional price movements in the underlying security.

Let's break this down with real numbers.

If the 50 Call premium is 6, and the stock is trading at $55, the Intrinsic or In-the-Money amount is $5. The remainder, or $1, is the Time Value. Thus, this option is valued at 6 even though, intrinsically, it is only worth 5 right now. The additional 1 exists because of the stock's volatility (i.e., the possibility that it may move more than where it is right now).

The 55 Call, however, is trading for 3, or the 60 Call is trading for 1. With the stock trading at $55, neither of these options have any Intrinsic Value, but they have Time Value because of the possibility that the stock may move that way.

Options cannot have negative values, and neither Intrinsic Value nor Time Value can ever be negative.

Put/Call Parity

The general concept of how options prices are related to each other is known as Put/Call Parity. The basic concept is that stock prices, Call prices, and Put prices must have a certain relationship with each other or else professional traders would be able to make nearly risk-free trades.

Option traders, both professional and non-professional, use the concept of Put/Call parity to help them understand different option price behaviors and, therefore, make trading decisions.

Time Premium (Time Decay)
Time affects options prices. In fact, if the price of a stock remains the same, options decrease in value the closer they get to the expiration date. This concept is known as Time Decay.

As an option owner or writer, you want to consider time decay when trading options so you understand which options best fit your strategy outlook. Look at the graph to see how the option value decreases from 90 days to expiration.

NOTE: In the last 30 days before expiration, time decay increases exponentially.

Volatility
If you trade stocks, you are already familiar with Volatility. In the stock trader's world, it is known as risk. The larger the price fluctuations, the riskier the stock, and the more expensive the options for that stock.

With stocks, price fluctuations are measured by the direction of the price and the size of the price change. With options, we are only concerned with the size of the price change, not the direction. Volatility is a percentage which reflects the average or expected size of the price change without regard to the direction of the change.

Emphasizing Changes in Volatility
As a user of options, not only should you be familiar with changes in time decay, but also with changes in volatility. Volatilities are stated in percentages (e.g., 25%, 65%, 105%, etc.). If XYZ stock, currently at $50, has a volatility of 16%, that would imply that it is expected to trade in the range up or down of $42-$58.

You should be aware that lower volatilities mean less movement in the stock price, while higher volatilities mean more movement in the stock price.

Volatilities of different options can be compared just like stock traders compare the price/earnings ratios (p/e) of different stocks.

When an option price has a low volatility, a big move is considered unlikely.

And when an option price has a high volatility, a big move is considered more likely.

Options-Expiration, Exercise, and Assignment!!

For investors who choose to use options, it is important to understand how to manage options positions, and that means understanding such topics as:

--When options expire?
--The process for exercising them..
--What it means if you have been assigned?

Management of Options

--Most people believe that 90% of options expire worthless. However, this is untrue.
--Normally, only about 30% of options expire worthless in each monthly cycle.
--Only about 10% of options are exercised during each monthly cycle, usually in the final week before expiration.
--In fact, over 60% of all options are traded out in the marketplace. This means that buyers sell their options in the market, and writers buy their positions back to close.

Exercising your options means that you buy the underlying stock if it is a Call option, or you sell the underlying stock if it is a Put option.

The following is the process for exercising a Call option.

1)The Call Owner:The call owner notifies the brokerage firm
2)The Brokerage Firm: The brokerage firm notifies the Options Clearing Corporation (OCC)
3)The Options Clearing Corporation(OCC):The OCC randomly chooses a brokerage firm with a short call position in the same class and series.
4)Assignment Notice:The brokerage firm then randomly calls one of its customers with a short call position, and gives an assignment notice informing the customer that a call owner has exercised the right to buy.
5)A Stock Transaction:A stock transaction has occured, and the brokerage firm credits the funds to the seller and delivers the share of stock to the buyer.

The obligations of Assignment:
When someone exercises their options and the process goes through the OCC, and the OCC notifies a certain brokerage firm that they are being assigned, that firm assigns those options to their customers who are short the same series as the exercised options.

If you exercise an XYZ December 50 Call, only writers of the XYZ December 50 Call could be assigned.

Writers of the XYZ December 40 Call, in this case, could not be assigned.

However, if you exercise this option, which is an option to buy 100 shares at $50 a share, you must have $5,000 ($50 per share x 100 shares) available to purchase the stock upon exercise in a cash account or equivalent buying power in a margin account.

If you are short this option and are assigned, you will get this cash credit, but you must deliver the stock.

NOTE: As an option writer (seller), you should always prepare yourself for the possibility of early assignment. Selling uncovered Calls involves unlimited risk.

Introduction to Options Strategies!!

Uses of Options
The first lesson covered what options are, but perhaps you are still not quite sure how you can use them. The next few screens will describe the Core Options Strategies; when they are used and how they can enhance your investment choices.

In order to understand the fundamentals of options, you need to learn the basics of Calls and Puts. In this section, you will be taught:

How rights and obligations are involved with options?
What it means to have a long or short position?
The Core Options Strategies: Long Call, Protective Equity Puts,Buying Put Options, and Covered Call Selling.

The first lesson covered what options are, but perhaps you are still not quite sure how you can use them. The next few screens will describe the Core Options Strategies; when they are used and how they can enhance your investment choices.

Rights Vs. Obligations
Remember that a Call Option gives its owner the right, but not the obligation, to buy stock at a certain price and before a certain date.

A Put Option gives its owner the right, but not the obligation, to sell stock at a certain price and before a certain date.

Also, recall that options sellers (writers) are obligated to sell or buy the underlying security, depending if they have sold Calls or Puts, respectively.

In this sense, writers of options are like insurance companies, and those that take on too much risk can expose themselves to substantial losses. In this section, we will cover how to write options responsibly.

Long and Short Positions-Calls
You were taught earlier that Call owners (buyers) have the right to buy stock if they exercise their options. Call writers (sellers), on the other hand, have the obligation to sell that stock to the owner, if they are assigned to.

When investors open a position by buying Calls, they are long those options. When investors open a position by selling Calls, they are short those options.

To close the positions, the buyer could sell his long Calls back in the marketplace, and the seller could buy the short Calls back in the marketplace.

Another way to remember the difference between long and short option positions is if you are long options, you have the right to exercise; if you are short options, you have the obligation of assignment.

Long and Short Positions-Puts
Put Positions are different from Call positions in that the owner has the right to sell, not buy, the underlying security.

When investors open a position by buying Puts, they are long those options. When investors open a position by selling Puts, they are short those options.

Once again, if you are long options, you have the right to exercise; if you are short options, you have the obligation of assignment.

You can, however, always close either position in the marketplace, by simply selling if long and buying back if short.

Using Equity Calls
Remember, in lesson 1 we were following XYZ , which was at $29 a share, and chose to buy an XYZ May 30 Call for 2, instead of buying the stock outright.

This option gave us the right to buy 100 shares of XYZ Stock at $30 a share any time before May expiration. For this right, we paid $200.

NOTE: Remember, most prices need to be multiplied by 100, since options are usually for 100 shares.

Values of the Call
On expiration Friday, XYZ was at $35 per share. We had our Call option, which we could have exercised to purchase 100 shares of XYZ Stock at $30 per share.

We could then sell that stock back in the market and make a $5 return per share, or $500. Since our initial Call premium was $200, our net profit is $300.

We could also have kept the stock, or, we could have simply sold the option back in the market.

NOTE: Most options are never exercised; holders choose to take their profits simply by trading out of the options.

If we had been wrong about XYZ and it had gone down to $10 a share, our only loss would be the premium amount we paid for the Call - $200 ($2 per share), since the option would be worthless.

Using Protective Equity Puts
In our other example, we had bought some XYZ at a price of $31 a share, and it was trading up at $32 a share.

But, we were concerned that an adverse market move might have caused our investment in XYZ to lose money, so we bought an XYZ Aug 30 Put for 1.

This gave us the right to sell our stock at a price of $30 a share in the event it had gone down in value. Since we owned 100 shares, and each option is for 100 shares, we bought one Put, and for this, we paid $100.

Values of the Protective Puts
We bought the XYZ Aug 30 Put, which gave us the right to sell our stock at $30 a share, no matter how low it went.

Protective Puts act like an insurance policy on our stock, and protect us against losses below $30 a share.

We did not have to exercise the Put, since we were the holder and had the choice.

Buying a Put Option
We've looked at how to use Calls if you're bullish on a stock, and how to use Protective Puts if you're bullish, but nervous, on a stock you already own.

But suppose you have an opinion that a stock is going to fall in price. Is there a way to take advantage of that outlook using options? Well, yes.

Remember that Puts are options to sell at a fixed price, and, as such, they increase in value as a stock price falls. Therefore, if you just buy Puts, not Protective Puts where you own the underlying stock, you can potentially profit from down moves in a stock.

Take a look at XYZ again, at $31 a share. Assume you are bearish on this stock, and think that it will fall to, say, at least $27 by August option expiration.

You could take advantage of this outlook by purchasing an XYZ Aug 30 Put by itself for 1 ($100). If the stock falls, you can profit from the increase in the value of the Put.

Assume you turn out to be right, and at expiration XYZ is at $25. Since you bought the XYZ Aug 30 Put, you own the right to sell XYZ stock to someone at a fixed price of $30 a share. This option is now worth something.

In fact, at expiration, it is worth $5 ($500). Since you paid $1 for it, you earned $4 profit per share, or $400. And you never had to take a position, like a short sale, in the underlying stock.

Selling a Covered Call
Let's do one more strategy. We've looked at how to use options if you're bullish on a stock, and how to use Puts if you're bearish on a stock.

But what if you're neutral on a stock, meaning you think it will remain relatively unchanged?

This can be especially aggravating if it's a stock you own. However, there is a way to potentially profit from this; it's called Covered Call Selling.

Now, when you sell a Call "Covered," what that means is that you already own the underlying stock. So, if the stock goes up in price, past the Call strike and the buyer of the Call exercises their option, you have to deliver the stock in your possession, but that's it.

If you sell a Call "Uncovered," that is to say, without owning the underlying stock, that exposes you to unlimited risk.

Assume that you are long 100 shares of XYZ currently at $29 a share, and you think that, for whatever reason (expected earnings, market slowdown, etc.) this stock is going to remain relatively unchanged through May expiration. You could sell one XYZ May 30 Call for 1.75.

This means that you get an immediate cash credit of $175.00, with the obligation that if the stock goes up past 30 and the holder exercises the Call, you will deliver your stock at $30 a share.

If this happens, since you sold the Call for 1.75 and would sell the stock for $1 over its present price of $29, you stand to earn a maximum profit of 2.75 if the stock increases past 30.

However, if the stock stands still, remaining at $29 at May expiration, you get to keep the $175.00. That is Covered Call Selling.

NOTE: If the stock price falls, you are still a stock owner, and are subject to the full loss of your stock investment, reduced only by the $175 credit from the sale of the Call. Covered Call Selling is not a protective strategy. Also, keep in mind writing an option on a stock with a low cost basis, there are tax consequences to consider upon assignment.

Options: A Fundamental Overview!!

The fundamentals of listed options

What options are?
What makes up an option?
The benefits of trading options
What is an Option?
An option is a contract giving the buyer the right, but not the obligation, to buy or sell an underlying asset (a stock or index) at a specific price on or before a certain date (listed options are all for 100 shares of the particular underlying asset).

An option is a security, just like a stock or bond, and constitutes a binding contract with strictly defined terms and properties.

Listed options have been available since 1973, when the Chicago Board Options Exchange, still the busiest options exchange in the world, first opened.

The World with and without Options:
Prior to the founding of the CBOE, investors had few choices of where to invest their money; they could either be long or short individual stocks, or they could purchase treasury securities or other bonds.

Once the CBOE opened, the listed option industry began, and investors now had a world of investment choices previously unavailable.

In order for you to better understand the benefits of trading options, you must first understand some of the similarities and differences between options and stocks.

Options Vs. Stocks
Similarities:

Listed Options are securities, just like stocks.
Options trade like stocks, with buyers making bids and sellers making offers.
Options are actively traded in a listed market, just like stocks. They can be bought and sold just like any other security.

Differences:

Options are derivatives, unlike stocks(i.e, options derive their value from something else, the underlying security).
Options have expiration dates, while stocks do not.
There is not a fixed number of options, as there are with stock shares available.
Stockowners have a share of the company,with voting and dividend rights. Options convey no such rights.

Call Options and Put Options
Some people remain puzzled by options. The truth is that most people have been using options for some time, because option-ality is built into everything from mortgages to auto insurance. In the listed options world, however, their existence is much more clear.

To begin, there are only two kinds of options: Call Options and Put Options.

A Call Option is an option to buy a stock at a specific price on or before a certain date. In this way, Call options are like security deposits.

If, for example, you wanted to rent a certain property, and left a security deposit for it, the money would be used to insure that you could, in fact, rent that property at the price agreed upon when you returned.

If you never returned, you would give up your security deposit, but you would have no other liability. Call options usually increase in value as the value of the underlying instrument increases.

When you buy a Call option, the price you pay for it, called the option premium, secures your right to buy that certain stock at a specified price, called the strike price.

If you decide not to use the option to buy the stock, and you are not obligated to, your only cost is the option premium.

Put Options are options to sell a stock at a specific price on or before a certain date. In this way, Put options are like insurance policies

If you buy a new car, and then buy auto insurance on the car, you pay a premium and are, hence, protected if the asset is damaged in an accident. If this happens, you can use your policy to regain the insured value of the car. In this way, the put option gains in value as the value of the underlying instrument decreases.

If all goes well and the insurance is not needed, the insurance company keeps your premium in return for taking on the risk.

With a Put Option, you can "insure" a stock by fixing a selling price.

If something happens which causes the stock price to fall, and thus, "damages" your asset, you can exercise your option and sell it at its "insured" price level.

If the price of your stock goes up, and there is no "damage," then you do not need to use the insurance, and, once again, your only cost is the premium.

This is the primary function of listed options, to allow investors ways to manage risk.

Options Premiums
In this case, XYZ represents the option class while May 30 is the option series. All options on company XYZ are in the XYZ option class but there will be many different series.

An option Premium is the price of the option. It is the price you pay to purchase the option. For example, an XYZ May 30 Call (thus it is an option to buy Company XYZ stock) may have an option premium of $2.

This means that this option costs $200.00. Why? Because most listed options are for 100 shares of stock, and all equity option prices are quoted on a per share basis, so they need to be multiplied times 100. More in-depth pricing concepts will be covered in detail in other sections of the course.

NOTE: There are times when an options contract is adjusted for an amount other than 100 shares as a result of a merger or stock split.

Strike Price
The Strike (or Exercise) Price is the price at which the underlying security (in this case, XYZ) can be bought or sold as specified in the option contract.

For example, with the XYZ May 30 Call, the strike price of 30 means the stock can be bought for $30 per share. Were this the XYZ May 30 Put, it would allow the holder the right to sell the stock at $30 per share.

The strike price also helps to identify whether an option is In-the-Money, At-the-Money, or Out-of-the-Money when compared to the price of the underlying security. You will learn about these terms in another section of the course.

Expiration Date
The Expiration Date is the day on which the option is no longer valid and ceases to exist. The expiration date for all listed stock options in the U.S. is the third Friday of the month (except when it falls on a holiday, in which case it is on Thursday).

For example, the XYZ May 30 Call option will expire on the third Friday of May.

Types of Options
Here is a pictorial overview of the rights and obligations of people who buy options (called "holders") and those who sell options (called "writers").

Exercising Options
People who buy options have a Right, and that is the right to Exercise.
For a Call Exercise, Call holders may buy stock at the strike price (from the Call seller).

For a Put Exercise, Put holders may sell stock at the strike price (to the Put seller).

Neither Call holders nor Put holders are obligated to buy or sell; they simply have the rights to do so, and may choose to Exercise or not to Exercise based upon their own logic.

Assignment of Options

When an option holder chooses to exercise an option, a process begins to find a writer who is short the same kind of option (i.e., class, strike price and option type). Once found, that writer may be Assigned.

This means that when buyers exercise, sellers may be chosen to make good on their obligations.

For a Call Assignment, Call writers are required to sell stock at the strike price to the Call holder.

For a Put Assignment, Put writers are required to buy stock at the strike price from the Put holder.

Using Equity Calls
Let's do an example. Assume for a moment that it is April 5th, and you are following XYZ, which is presently at $29 a share. You think that this stock will go up in price in the next month and a half or so, to well past $30 a share.

Knowing about options, you choose to buy an XYZ May 30 Call for 2, instead of buying the stock outright. This option gives you the right to buy 100 shares of XYZ Stock at $30 a share any time before May expiration

NOTE: For this right, you pay $200. Remember, all prices need to be multiplied by 100, since all options are usually for 100 shares.

Values of the Call
Here's what happens. Remember, you bought the XYZ May 30 Call. On expiration Friday, assume XYZ is at $35 per share. You have a Call option, which can be exercised to purchase 100 shares of XYZ Stock at $30 per share.

If you do that, you can then sell that stock back in the market and make a $5 return per share, or $500. Since your initial Call premium was $200, your net profit is $300.

You could also keep the stock, if you choose, knowing you got to buy it at a discount to the present value.

Or, you could simply sell the option back in the market, at any time before expiration, and take the profit on the option itself.

NOTE: Most options are never exercised; holders choose to take their profits simply by trading out of the options.

If you had been wrong about XYZ and it had gone down to $25 a share, your only loss would be the premium amount you paid for the Call, $200 ($2 per share), since the option would be worthless.

Let's do another example. Assume it is a few days later and you have bought some XYZ, and at a price of $31/share.

It is now at $32 a share, but you are concerned that an adverse market move may cause you to lose money on your XYZ stock position, though you are not afraid enough to sell the stock.

You could buy an XYZ Aug 30 Put for 1, which would give you the right to sell your stock at a price of $30 a share in the event XYZ goes down in value.

For every 100 shares you own, you would buy one Put, and for this right, you pay $100.

Here's what happens. Since you bought the XYZ Aug 30 Put, you have the right to sell your stock to someone at $30 a share, no matter how low it goes.

In this sense, it is like an insurance policy on your stock, fixing your maximum risk at $200. ($1 cost of the Put option and the $1 you could lose on each of your 100 shares if it falls from your purchase price of $31 to your exercise price of $30).

However, if the stock does decline to, say, $29 a share, you do not have to exercise the Put.

Since you are the holder, you have the choice, and you may decide to simply sell the Put back in the market and continue holding the stock.

The position you get is reflected in the diagram at the left, and is identical to being long a Call. It has a limited risk, with unlimited upside.

These previous examples introduced how options can provide investors with more alternatives, allowing them to specify, precisely, the amount of risk they are willing to take in their holdings.

If used on a 1-to-1 basis with the underlying shares, then options can be used to invest in stocks with limited risk, to insure stock investments held, or to set levels of market exposure consistent with one's investment strategy.

Options can also be used as alternatives to stock investments (one option for each 100 shares), giving investors the ability to profit from favorable market moves just as if they held the underlying security, but with lower potential risk due to a lower initial investment.

Given the numerous opportunities that options convey, it is also important to know that there are options available which can be used to implement longer-term strategies (not one, two or three months, but those with holding times of one, two or more years).

These are called LEAPS (for Long Term Equity Anticipation Securities), and are yet another alternative that options offer to investors.

LEAPS are options with expiration dates of up to three years from the date they are first listed, and are available on a number of individual stocks and indexes.

LEAPS have different ticker symbols than short-term options (options with less than nine months until expiration) and, while not available on all stocks, are available on most widely held issues and can be traded just like any other options.

Each of the following multiple choice questions will test your understanding of this lesson.

Lessons to be learnt from TRADING!!

Trading is a crucible of life: it distills, in a matter of minutes, the basic human challenge: the need to judge, plan, and seek values under conditions of risk and uncertainty. In mastering trading, we necessarily face and master ourselves. Very few arenas of life so immediately reward self-development–and punish its absence.

So many life lessons can be culled from trading and the markets:

1) Have a firm stop-loss point for all activities: jobs, relationships, and personal involvements. Successful people are successful because they cut their losing experiences short and ride winning experiences.

2) Diversification works well in life and markets. Multiple, non-correlated sources of fulfillment make it easier to take risks in any one facet of life.

3) In life as in markets, chance truly favors those who are prepared to benefit. Failing to plan truly is planning to fail.

4) Success in trading and life comes from knowing your edge, pressing it when you have the opportunity, and sitting back when that edge is no longer present.

5) Risks and rewards are always proportional. The latter, in life as in markets, requires prudent management of the former.

6) Happiness is the profit we harvest from life. All life’s activities should be periodically reviewed for their return on investment.

7) Embrace change: With volatility comes opportunity, as well as danger.

8) All trends and cycles come to an end. Who anticipates the future, profits.

9) The worst decisions, in life and markets, come from extremes: overconfidence and a lack of confidence.

10) A formula for success in life and finance: never hold an investment that you would not be willing to purchase afresh today.

Arbitrage!!

In economics, arbitrage is the practice of taking advantage of a state of imbalance between two or more markets: a combination of matching deals are struck that capitalize upon the imbalance, the profit being the difference between the market prices. When used by academics, an arbitrage is a transaction that involves no negative cash flow at any probabilistic or temporal state and a positive cash flow in at least one state. A person who engages in arbitrage is called an arbitrageur. The term is mainly applied to trading in financial instruments, such as bonds, stocks, derivatives and currencies.

If the market prices do not allow for profitable arbitrage, the prices are said to constitute an arbitrage equilibrium or arbitrage free market. An arbitrage equilibrium is a precondition for a general economic equilibrium.

Attempting to profit by exploiting price differences of identical or similar financial instruments, on different markets is arbitrage.

for e.g. If the price of Reliance Industries is 1120 in Cash Market and 1140 in Futures market, a person with money will go in to buy in cash and sell in FNO, thereby gaining 20Rs per share for each lot and gain the profits. Again there are reverse arbitrageurs. Those who had ONGC delivery on hand were provided opportunity for the last 5-6 months by market which gave them 10-20Rs over and above the FNO rates. One could have sold in Cash segment and Bought in FNO segment still making that money and could have restored the position in the last week or so wherein the FNO is again quoting at a premium of 4-7 Rs making a cool profit of approx Rs 50/- for the last 6 months(deducting brokerages and all).

These are various opportunities presenting themselves in various markets and these vultures sit and wach for such situations to exploit to their advatage.

8 Strict NOs in your Financial Planning!!

Investing is an activity most of us try to defer to a much later date. And those who do claim to 'invest' end up making all the mistakes that ultimately lead them to a messy financial situation. Here are 8 mistakes you should avoid while managing your money.

1.Delaying investment till later
The principal rule of investing is to 'start early'. And you should do that to get he benefit of compounding. To explain with an example. Person A started investing Rs 10,000 per year at the age of 30. Person B started investing the same amount every year at the age of 35. When they attained the age of 60 respectively, person A had built a corpus of Rs 12.23 lakh while person B's corpus was Rs 7.89 lakh, assuming a return of 8% every year. So the difference of Rs 50,000 in amount invested made a difference of more than Rs 4 lakh to their end corpus. That difference is due to the effect of compounding. The longer the compounding period, the better for you.

2.Ignoring the impact of inflation
Inflation is a devil that can stab you in the back. If you invest in an instrument like a bank fixed deposit, on the face of it, your money is safe. But what you won't know is that the value of that money is actually depreciating with time. For example, if you have invested Rs 10,000 in a bank fixed deposit for a period of 3 years at an interest rate of 5.5%, you will be assured of a maturity amount of Rs 11,742. Suppose during this period of 3 years, average inflation was at 6%, the real value of your maturity amount would be Rs 9,859. In simple terms, if the rate of inflation is more than the rate of return, the real value of your investment is negative.

3.Being careless in market investments
The only way to beat inflation in the long run is to invest a part of your total portfolio in equity markets. But you can't go overboard. A common mistake that people make is to invest too much in equity markets without diversifying risks. Equities give the much-needed kick to your portfolio in the long run, but too much of equity can cause harm. Depending on your profile you must allocate a right proportion in debt and equity. Another common mistake is to try and time the market. Only the likes of Warren Buffet have successfully timed the markets. Most others end up burning their fingers in trying to do so. Instead, adopt a method that will give you returns in equity without the need to time the market. Mutual fund systematic investment plan (SIP) is one such option.

4.Neglecting your retirement planning
Using your retirement funds to pay for your child's school fees is the worst mistake you can make. Your retirement funds are meant to provide for your life after retirement. By cashing that to pay for your child's fee is a disaster. Look for other means to pay for fees. There are loans aplenty. Create a separate corpus and name it 'Child education fund', if need be. But do not liquidate your retirement fund. You will never be able to build enough corpus if you do not let the money accumulate.

5.Cashing out your EPF when you switch jobs
This is another invitation to disaster. And laziness is the root cause. When you switch jobs, it's easier to encash your Employee's Provident Fund rather than go through the hassle of transferring it. But this doesn't make sense because that money is like a windfall and you will end up spending it to meet ends that are not your needs.

6.Going overboard on your credit card
This is no new advice. With credit cards available for free these days, the temptation to spend is irresistible. But watch your wallet. Don't spend beyond your means. If you are a spend thrift and yet must have plastic money, think about a debit card. Credit card is one of the first steps to a debt trap. So stay clear of it and keep it for emergencies.

7.Not making the most of your tax saving tools
Make the best of your tax saving investments like PPF, NSC and the like.While it is true that tax saving instruments must not be your only investments, make sure that you don't end up paying taxes when you could have actually saved them by making fruitful investments. Even investing in a pension policy or an insurance policy can save you tax, but make sure you don't do that just to save on tax.

8.Not buying enough insurance
This is something most of us are guilty of. We buy insurance to save tax and combine it with an investment option. After making all other tax saving investments, a 35 year old is willing to invest up to Rs 25,000 in an insurance policy. He opts for endowment insurance and thinks he has saved the best tax possible as well as got himself insurance and investment. But for that kind of premium, the maximum sum insured on an endowment policy that he will get will be around Rs 5 lakh. That by no standard would be enough to protect his family of 2 kids.

We are also almost always guilty of not buying enough medical insurance.This is a very very important cover and its best to buy it at a young age.

Disclaimer:This article is for academic purposes and the readers are requested not consider this as an investment advice and asked to consult an investment advisor before doing any investments.

How good are Cash back Offers?

Growing competition among credit and debit card issuers has led to several innovations that have greatly benefited the customers. After doling out 'free for life' cards, 'cash back' offers are now their new mantras. Of course, the bottom line is that they want you to spend, spend and spend.

These cash back offers are on almost all kinds of expenditures. That is, besides spends on shopping and eating out, even balance transfers and bill payments are eligible. And you can have fun through these offers as well. Let us look at some samples.

Almost all the travel portals have tie-ups with some bank. For instance, ezeego1.com offers 50 per cent cash back for platinum, 25 per cent on gold and 15 per cent on silver cards. However, you need to have an ICICI Bank [Get Quote] credit card to get the benefit. Travelguru.com has a similar offer on Visa cards.

Also, this offer is limited to tickets booked only on certain airlines and only on the 'basic fare' (and not any airport taxes and levies) is eligible for such cash back. The portal is also offering a flat 10 per cent money back for bookings made in select hotels abroad, irrespective of the type of credit card. But there is a maximum cash back ceiling of Rs 20,000 per card.

Then there is makemytrip.com which has a tie-up with HSBC credit card and offers a 3 per cent cash back on domestic airline tickets, 5 per cent on international airline tickets and 10 per cent on hotels and holiday packages.

Holders of HDFC Bank gold card can get 5 per cent back on railway tickets purchased at the Indian Railways website www.irctc.co.in. ICICI Bank has an offer of 30 per cent back (For both credit and debit cards) for specially designed holiday packages to Malaysia. Since all banks want to encourage internet usage, they are dangling carrots of Rs 50 to 250 for online payments.

Sounds well doesn't it? But before you get into the buying mood remember to look at a few pointers:

The amount of cash refunded varies from bank to bank. It usually ranges from 1 per cent to 5 per cent. Also, there are ceilings on the amounts refunded. For instance, HSBC has a cash back limit of Rs 1,000 for online transactions.

Many banks offer this incentive for a fixed period only, say during festive seasons. However, there are certain cards which are positioned as cash back credit cards. For instance, Citibank or SBI's [Get Quote] cash back cards provide you with this facility all through the year. However, there are some annual fees on such cards.

Many banks have a pre-set list of establishments which are in the approved list of the banks. The offer is only available to you, if you spend in such places. It is therefore important to check whether that particular establishment is on the approved list of the bank. For instance, in case of HDFC credit cards, you can get a refund of 2.5 per cent of the amount spent at Bharat Petroleum (BPCL [Get Quote]) petrol pumps only. Nowadays, certain banks do not include restaurants in their approved list as they would like the expenses to be larger in nature.

The minimum value of each transaction that will qualify as 'spend' also varies from bank to bank. For instance, the HSBC debit card has a threshold limit of Rs 2,000 per transaction.

Certain banks offer this incentive only if the card is swiped on their electronic data capture terminal (EDCT) (commonly known as the swiping machine). ICICI Bank usually has this rider for many of its cash back offers.

These offers work like reward points for making purchases. However, all reward point programs demand a minimum accumulation of points, unlike many cash back programmes. Also, there is more latitude in the latter, as the amount accumulated can be used for any transaction, unlike the former where the points can be redeemed only on the purchase of certain products.

Types of Derivatives!!

Linear – derivatives where the payoff is linearly related to the price of the underlying asset.
When the spot price increase, the price of the derivative also rises, and when the price falls, the derivatives price falls.

Forwards – Contracts that give the right to buy/sell an asset at a future date (maturity or exercise date), but at a price that is fixed today (futures price).
Futures – Forwards contracts with contract features that are standardised and is traded only at an exchange.

Non–linear – derivatives where the payoff is non–linearly related to the price of the underlying.

Options – Contracts which gives the buyer right to purchase/sell an asset at a pre–determined price (strike price) at or before a pre–determined time (maturity or
exercise date).

How to Value a Stock?

How much is a share of stock really worth? Not just in terms of analysts' opinions, but logically, based on facts?

In theory, the answer is simple: a company is worth the total amount of cash it will generate over its lifetime, discounted to its present value.(And don't panic if you don't really understand that last sentence, because the next page explains it. You do not need any background to read this article.)

This article presents a simple discounted cash flows calculator, along with some popular variations and shortcuts, to make stock valuation make sense.

But before we get started.... When you use any kind of value formula, it's a good idea to remember Warren Buffett's advice, that "it's far better to buy a wonderful company at a fair price than a fair company at a wonderful price". The idea is to find a company whose prospects you really believe in, and then use a valuation technique as a reality check, to make sure the purchase price is acceptable. And try to make your valuation estimates realistic and conservative: you're trying to protect yourself from overpaying, not justify your surplus of enthusiasm.

A company is valuable to stockholders for the same reason that a bond is valuable to bondholders: both are expected to generate cash for years into the future. Company profits are more volatile than bond coupons, but as an investor your task is the same in both cases: make a reasonable prediction about future earnings, and then "discount" them by calculating how much they are worth today. (And then you don't buy unless you can get a purchase price that's less than the sum of these present values, to make sure ownership will be worth the headache.)

Let's take an example. Suppose you are interested in a company that earned $10 per share over the last twelve months. Assume you expect the company to grow over the foreseeable future, so that its earnings will grow at a rate of 8% annually for the next 10 years; then, to play it safe, you make no assumptions about earnings after that, but just expect the company to stay at the same size from then on. Your earnings expectations look like this:

Here the height of each blue bar is the earnings per share that you expect for a particular year in the future. (The first bar is earnings over the next twelve months: that is, it's what you expect the company's reported annual earnings to be one year from now.)

Now for the discounting, finding how much each "blue bar of the future" is worth to you in the present. We'll be using a discount rate of 11%, which is about the average annual return rate of the stock market over the past many decades. The idea is that earnings of $1.11 next year is only worth $1.00 to you right now, since you could invest the $1.00 in the S&P 500 and expect it to grow to $1.11 in one year's time. Finding the present value of all of the blue bars gives a new graph:

Here each green bar is the value to you, today, of each corresponding blue bar in the first graph.

If you want to check into this in a little more detail, use the popup calculator in future value mode to find that $10 per share growing at 8% annually will grow to $21.59 in 10 years (that's the height of the blue bar at year 10); and then in present value mode to find that $21.59 10 years from now is worth $7.60 today assuming a discount rate of 11% (that's the height of the green bar at year 10).

We've drawn both graphs with forty bars, but the valuation formulas we'll use in the calculators assume the company will keep going forever: an infinite number of bars. But the key is that the green bars are shrinking so rapidly that, even though there are an infinite number of them, if you stacked them up they would only reach a finite height: in this example, the height would be $155.40. That total - the sum of the present values of all future earnings - is the theoretical value of the investment right now.

How Long is Forever?
The last paragraph said we'd assume earnings would be going on forever into the future - not exactly a realistic assumption. But it turns out that assumption isn't really important: the rapid shrinkage of the green bars means that any contribution from the distant future is negligible. In this example, all earnings after year 50 contribute only about one dollar - less than 1% - to the stock's value today:

What are "Earnings"?
Purists would say that a company is worth the present value of its future free cash flows rather than its earnings. The trouble is that you would have to know a lot about the company (and use fancier calculators!) to find values with FCF. So we'll assume that earnings and free cash flow are equivalent in the long run, and that both approximate real cash profits.

What about Debt?
What does debt do to the value of a company? The quick answer is that any valuation based on earnings has already accounted for debt. That's because interest payments - the "cost" of the debt - are an expense, and have already been deducted from earnings. So if the present value of future earnings adds up to $20 a share, the company's stock is worth $20 a share, regardless of the amount of debt it has.

Of course the real world is more complicated than that glib theoretical answer; for example:

Debt is better than that: interest is an expense, so debt financing gives business a tax break unavailable with other forms of financing.

Debt is worse than that: interest is an absolute obligation, so debt increases the risk that some years will have low reported earnings (not to mention the risk of bankruptcy).

If you put those two contradictory statements together they actually form a coherent whole: Debt is a cheap way for a company to raise capital; and the superior profits that result will be a reward for stock investors willing to accept the added risk.

Options-Buying stock with Ratio Call Spread!!

Welcome to Buying Stock with Ratio Call Spread, where you will be taught:

The mechanics of the Buy Stock with a Ratio Call Spread strategy

Risk and reward potentials
When to implement ratio call spreads alongside long stock positions
How a stock repair strategy works
When to implement a stock repair strategy

Buy Stock with Ratio Call Spread: Defined
This strategy involves buying stock and, at the same time, buying an at-the-money call for each 100 shares purchased and simultaneously selling an equal number of out-of-the-money calls.

Example 1: Buy 100 shares of stock at 50,buy an April 50 call, and, sell 2 April 55 calls.
Example 2: Buy 200 shares of stock at 75,buy 2 June 75 calls, and sell 4 June 85 calls.

There are no uncovered short calls. One short call is covered by long stock; the other is covered by the long call. (i.e. a bullish vertical call spread).
This is a stock-oriented strategy and does not involve leverage if the stock price declines.Losses from price decline equal to owning stock only if done at zero cost - if ratio spread done for a credit, the stock loss is reduced by amount of credit and, if done for a debit, the stock loss is increased by amount of debit.
Leverage is involved when the stock price rises.
This strategy has a limited profit potential.

Buy Stock with Ratio Call Spread Profit/Loss Diagram
Notice that greater leverage is involved when the stock rises, and is represented by a steeper line.
The horizontal line represents the limited profit potential of this strategy.

Mechanics at Expiration
For the Buy Stock with Ratio Call Spread strategy there are three possible outcomes. The stock price might be any of the following:

1. At or below the lower strike: Long stock
2. Between the strikes: Long stock & Long call
3. Above the upperstrike: No position

Below the Lower Strike: Long Stock
Given the following example with zero cash outlay:

Buy XYZ Stock @ 50
Buy 1 XYZ March 50 call @ 3
Sell 2 XYZ March 55 calls @ (1.50)

If the stock price is at or below $50 at expiration, all options expire worthless. The amount of the loss depends entirely on the long stock position. Therefore, at expiration, this strategy will lose $1 per share for each $1 that the stock price is below $50.

Between the Strikes: Long Stock & Long Call

Observe the following example:

Buy XYZ Stock @ 100
Buy 1 XYZ March 100 call @ 6
Sell 2 XYZ March 110 calls @ (3)

Given a stock price above 100 and below 110, the profit is twice what the stock profit profit would be with only 100 shares.

Above the upper strike: No Position

Observe the following example:

Buy XYZ Stock @ 50
Buy 1 XYZ March 50 call @ 3
Sell 2 XYZ March 55 calls @ (1.50)

If the stock price is above 55 on expiration day, the 50 call will be exercised and the 55 calls will be assigned. All 200 shares will be sold upon assignment. There is a possibility of early assignment on the 55 calls which may result in an obligation to pay a dividend.

Trade-offs for This Strategy

Some of the disadvantages to this type of strategy vs. buying additional shares of stock are:
Limited upside potential while a long stock position gives unlimited profit potential
Commission costs for options
Stock holder may have voting rights and receive cash dividends.

Another Application - The Stock Repair
Consider a scenario when you forecasted XYZ stock to move from $50 to $60 a share. However, instead of going up as you predicted, the stock lost $10 a share and is now trading at $40 a share. At this point you can take a loss if you have changed your mind about the stock or, at $40 a share, you are even more optimistic and may want to "double up."

Doubling Up: Disadvantages
Buying an additional 100 shares when the stock is down is known as "dollar cost averaging" or in laymen's terms "doubling up." The two disadvantages to this tactic are as follows:
1. Additional capital investment
2. The risk is doubled

Instead of automatically buying more stock, an investor could consider the ratio call spread for stock repair.

The advantages that the Buy Stock with Ratio Call Spread strategy has compared to simply buying an additional 100 shares of stock are as follows:
1. A lower breakeven price is achieved
2. No additional capital investment is required
3. The risk is not doubled if the stock price declines
4. Lower downside risk by using options

Summary - Buy Stock Ratio Call Spread
The Buy Stock with Ratio Call Spread is a prime example of how options give the investor a different set of trade-offs. Even if your forecast does not match this particular strategy's characteristics, you still gain understanding about controlling risk while increasing leverage.

Statistical and percentage based thinking in financial planning establishes the foundation needed to analyze a multitude of markets in order to meet your specific investment goals.

Options and their uses!!

An option is a derivative.
That is, its value is derived from something else.
In the case of a Index option, its value is based on the underlying Index value.
In the case of a Stock option, its value is based on the underlying Stock value.

Call Option and Put Option

Call option gives the holder the right, not the obligation, to buy underlying Stock at a fixed price and for a fixed period of time.
A put option gives the holder the right, not the obligation, to sell underlying Stock for a fixed price and for a fixed period of time.
In India Stock Options are American type and settlement is by cash. Index Options are European type and settlement is by cash.


The Four Components to an Option
The underlying Stock Value,
The type of option (put or call),
The strike price, and
The expiration date.
At-The-Money, In-The-Money, Out-Of-The-Money

If the stock is trading at a price of 100, the call option at the strike price of 100 is considered to be trading 'at-the-money'.
If the stock is trading above a price of 100, the call option at the strike price of 100 is considered to be trading 'in-the-money'
If the stock is trading below a price of 100, the call option at the strike price of 100 is considered to be trading 'out-of-the-money'
Intrinsic Value
When an option is in-the-money, the price difference between the underlying Stock and the option's strike price is the intrinsic value.

Time Value
Time value is the amount by which the price of the option exceeds its intrinsic value. The time value premium of an option declines as the expiration date approaches.

Intrinsic Value + Time Value = Option Price

Factors Influencing the Price of an Option

There are four major factors which determine the price of an option. They are:

· The price of the underlying Stock
· The strike price of the option itself
· The time remaining until the option expires
· The volatility of the underlying Stock

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.

F&O Investing Guide!!

Many of the Indian individual investors who are into F&O segment, might have a common concern i.e., why I always end up losing money in F&O…why I always end up squaring off earlier and end up minimizing my loss…There are few rules which we grossly violate and thereby design our operations for disaster….Following tips are aimed at helping you in ensuring that you are SUCCESSFUL IN F&O INVESTING IN FUTURE .

Rule 1
No shorting in Individual Stocks….U need to accept that stock markets always go to extremes i.e, Individual stocks are taken to abysmally low levels and also to abnormally high levels….U go short and the stock goes up by another 5% or more…you end up losing…

Rule 2
F&O Investing also must be for long term…and for only those stocks wherein you have done your homework with clear INPRICE…OUTPRICE…POSSIBLE DOWNSIDE…

Rule 3
DO NOT OVER LEVERAGE…U need to use only max upto 60% of your F&O corpus for investing e.g. If you have blocked 1 lakh for investing in F&O route, you need to commit only 60000 max for investment…balance 40000 must be kept for taking care of POSSIBLE DOWNSIDE…and also for buying some more lots in case of further downside…If you have invested more than 80% of your corpus, even a 5% decline will force you to compulsorily book losses (WHICH WE ALWAYS DO METICULOUSLY).

Rule 4
DO NOT AVERAGE OUT TILL THERE IS ATLEAST 10% DECLINE FROM YOUR ENTRY PRICE e.g. you have invested in Infosys at 1800 one lot…wait for it to go down by another 10% i.e., to 1620 for buying your next lot to average out.

Rule 5
SPREAD YOUR INVESTMENT OVER THREE / FOUR SECTORS…This is necessary to take care of uncontrollable developments…You will be able to utilize any upsurge in one / two of the shares you have taken position , to make good the loss you are making in others.

Rule 6
LIMIT YOUR LOSSES …DO NOT LIMIT YOUR PROFIT…You need to always have the practice of putting stop loss limits to ensure that you limit your losses at all times…Even in case of an abnormal market crash your loss will be limited.e.g.If you have bought one lot of BHARTI AIRTEL at 900…and you do not expect the price to go down below 850…then have the practice of putting a STOPLOSS at 850 on day one…and on a daily basis later on, keep revising the stop loss to previous day closing minus a little more than the expected volatility , say Rs. 50/- , so that your loss is always limited.

Rule 7
Stay till you get the OUTPRICE…You need to wait till you get the targeted OUTPRICE…You also need to be content on booking the profits once you get your OUTPRICE…Most of the investors become greedy once the Share reaches their Target price…and they tend to UNDULY REVISE THE TARGET PRICE UNREALISTICALLY…and their profits will be always notional.

Rule 8
PLS KEEP DAILY TRACK OF THE MACRO / MICRO FACTORS AFFECTING THE COMPANIES / SECTORS YOU HAVE INVESTED…e.g., If you have invested in Software sector, you need to at least track the Rupee/ Dollar movements and also the US recession trends , to take a call on your investments.

Rule 9
Always check for RESEARCH REPORTS by various Investment Bankers / Companies on your stocks to get more related data which can help you in fixing your INPRICE / OUTPRICE / buying quantity / Investment period.

Short Selling

Short-selling has always been a much-maligned and poorly understood activity among many investors. A certain type of investor always tries to explain away his losses by blaming short-selling, the implication being that the poor guy bought a great stock but short-sellers ruined it all. To be fair, this wasn't always an exaggeration.

In the cowboy era of the Indian stock markets, there were some fairly plausible stories about notorious short-sellers holding promoters to ransom by shorting their stock. It is said that sometimes such activity was literally for ransom, meaning the shorting wouldn't stop till the promoter coughed up a few suitcases full of cash. But some promoters managed to turn tables on the shorters, most famously, Dhirubhai Ambani sometime in the 1980s, in an incident that I think is even referred to in the movie Guru.

In fact, the genesis of the Reliance equity cult is supposed to be Dhirubhai's idea that the only way to escape short-sellers was to build an army of retail shareholders as a counterweight. I'm not sure whether this is actually true but the point is that many of us have always believed that short selling is an evil activity. Investor wants stocks to go up and instinctively feel that anyone who wants them to go down must be up to no good.

The dictionary meaning of short selling is to make money from a fall in a stock's price. In simplified terms, if an investor thinks that a stock is overpriced then he sells the stock without owning it. Later, when the price falls, he buys it at the lower price and delivers it to whomever he had originally sold it too. Clearly, like any normal ('long') trade, shorting is also about buying low and selling high, the only difference being that here the selling is done first and the buying later. This enables one to profit from a falling price. Of course, if the prices rise instead then a short-seller will make losses because he will have to buy at a higher price to deliver the stock. In most stock markets, shorters have to borrow (or make some other arrangements for) the stock they are shorting. It must be noted that short-selling holds the risk for unlimited losses. For example, a short-seller could sell a stock at Rs 100 and if the price later goes down to Rs 85, he could earn Rs 15.

Theoretically, at best the price could go down to zero and the shorter could make Rs 100. But if the price starts going up it could go to Rs 200 or 300 or Rs 1000 or whatever, thus losing the shorter any amount of money. In practice, there are loss-control measures at the market and broker level as well as at the level of institutional investors like mutual funds but being short is probably more inherently risky than being long. It is easy to select from a market full of overpriced stocks (as today) and say that this one or that one is bound to fall but as the economist John Maynard Keynes said, "The market can stay irrational longer than you can stay solvent".

Still, short-selling is a very useful activity. Without short-selling, the general tendency if for everyone to look for stocks that will rise and just ignore the ones they think are overpriced. In today's situation it would be good to have some investment researchers and investors seriously hunting for overpriced stocks and seeking to knock them down.

10 Keys to Financial Success!!

Regardless of when we begin our financial planning, the basics of it remain the same. Here are my top ten keys to getting ahead financially.

1. Get Paid What You're Worth and Spend Less Than You Earn
It sounds simplistic, but many people struggle with this first basic rule. Make sure you know what your job is worth in the marketplace, by conducting an evaluation of your skills, productivity, job tasks, contribution to the company, and the going rate, both inside and outside the company, for what you do. Being underpaid even a 1000 or 2000 ruppees a month can have a significant cumulative effect over the
course of your working life.

No matter how much or how little you're paid, you'll never get ahead if you spend more than you earn. Often it's easier to spend less than it is to earn more, and a little cost-cutting effort in a number of areas can result in big savings. It doesn't always have to involve making big sacrifices.

2. Stick to a Budget
One of my favorite subjects: budgeting. It's not a four-letter word. How can you know where your money is going if you don't budget? How can you set spending and saving goals if you don't know where your money is going? You need a budget whether you make thousands or hundreds of thousands of ruppees a year.

3. Pay Off Credit Card Debt
Credit card debt is the number one obstacle to getting ahead financially. Those little pieces of plastic are so easy to use, and it's so easy to forget that it's real money we're dealing with when we whip them out to pay for a purchase, large or small. Despite our good resolves to pay the balance off quickly, the reality is that we often don't, and end up paying far more for things than we would have paid if we had used cash.

4. Contribute to a Retirement Plan
With opening up of doors for the private insurance players in the Indian market, today we have a wider choice of options in retirement planning. Every life insurance player has got pension plans.Pick up one which suits your requirements.If you are already contributing, try to increase your contribution.

5. Have a Savings Plan
You've heard it before: Pay yourself first! If you wait until you've met all your other financial obligations before seeing what's left over for saving, chances are you'll never have a healthy savings account or investments. Resolve to set aside a minimum of 5% to 10% of your salary for savings BEFORE you start paying your bills. Better yet, have money automatically deducted from your paycheck and deposited into a separate account.

6. Invest!
If you're contributing to a retirement plan and a savings account and you can still manage to put some money into other investments, all the better.

7.Maximize the benefits of investment through proper planning.
Yes, it is not only investing which matters but how do you do it matters a lot. The returns would vary if the investment is made systematically taking advantage of ups and downs in the market rather than investing in lumpsum.

8. Review Your Insurance Coverages
Too many people are talked into paying too much for life and disability insurance, whether it's by adding these coverages to car loans, buying whole-life insurance policies when term-life makes more sense, or buying life insurance when you have no dependents. On the other hand, it's important that you have enough insurance to protect your dependents and your income in the case of death or disability.

9.Contribute regularly to PPF
Going by the old adage "Don't put all the eggs in one basket" it is necessary to contribute some savings to PPF. This would surely minimize the risk.

10. Keep Good Records
If you don't keep good records, you're probably not claiming all your allowable income tax deductions and credits. Set up a system now and use it all year. It's much easier than scrambling to find everything at tax time, only to miss items that might have saved you money.