Brokerage and STT in Trading
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Questions and Answers

What has research in neuroscience shown about the anticipation of winning the lottery compared to the actual experience of winning?

  • Anticipation is equally exciting as actual winning
  • There is no difference in excitement
  • Anticipation is more exciting than actual winning (correct)
  • Anticipation is less exciting than actual winning

    • The reflexive brain is responsible for analytical thinking and performing calculations.

    False

    What compels a person to buy a lottery ticket even when they know the odds of winning are low?

    The reflexive brain

    Anticipating a win from investments requires a degree of ______.

    <p>skill</p> Signup and view all the answers

    Match the following terms with their correct descriptions:

    <p>Reflexive brain = Intuitive and emotional reaction Reflective brain = Analytical and calculating function Lottery = Game of chance Options trading = Involves financial risk and potential skill</p> Signup and view all the answers

    Why is the experience of winning in trading options considered more exciting than winning the lottery?

    <p>Because of the risk involved and potential skill</p> Signup and view all the answers

    Buying calls and puts in options trading does not carry any risk.

    <p>False</p> Signup and view all the answers

    What is the primary reason people regularly buy options even after experiencing losses?

    <p>Previous large gains</p> Signup and view all the answers

    What is the main disadvantage of trading with a traditional broker?

    <p>Lower profits due to brokerage charges</p> Signup and view all the answers

    An arbitrage opportunity is created when Synthetic long + short futures yields a negative P&L upon expiry.

    <p>False</p> Signup and view all the answers

    What is the benefit of using a discount broker like Zerodha for arbitrage trades?

    <p>Lower breakeven point due to lower brokerage charges.</p> Signup and view all the answers

    The breakeven point for a synthetic long is the ________________________ + net premium paid.

    <p>ATM strike</p> Signup and view all the answers

    Match the following terms with their descriptions:

    <p>STT = Service tax Brokerage = Charge by traditional brokers on a percentage basis Synthetic long = Replicates the long futures payoff using options Arbitrage = Trading strategy that exploits price differences</p> Signup and view all the answers

    Why may an arbitrage trade for 10 points not be profitable?

    <p>All of the above</p> Signup and view all the answers

    A synthetic long can be created by simultaneously buying ATM call and selling ATM put.

    <p>True</p> Signup and view all the answers

    What is the key takeaway from executing an arbitrage trade?

    <p>Execute the arbitrage trade only if the P&amp;L upon expiry makes sense after accounting for expenses.</p> Signup and view all the answers

    What is a characteristic of all strikes in a bull call spread?

    <p>They belong to the same expiry series</p> Signup and view all the answers

    In a bull call spread, the net cash flow is always a credit transaction.

    <p>False</p> Signup and view all the answers

    What is the intrinsic value of a call option upon expiry?

    <p>Max [0, Spot-Strike]</p> Signup and view all the answers

    In a bull call spread, the trade setup involves buying a _______ call option and selling a _______ call option.

    <p>ATM, OTM</p> Signup and view all the answers

    Match the following options with their respective premiums:

    <p>7800 CE = Rs.79/- 7900 CE = Rs.25/-</p> Signup and view all the answers

    The bull call spread is also referred to as a credit bull spread.

    <p>False</p> Signup and view all the answers

    What happens to the 7800 CE option if the market expires at 7700?

    <p>Its intrinsic value becomes 0</p> Signup and view all the answers

    What is the net cash flow in the given bull call spread trade setup?

    <p>Rs.54/- (79 - 25)</p> Signup and view all the answers

    What is the difference between the spread and the strategy's net debit?

    <p>The difference is the maximum profit achievable.</p> Signup and view all the answers

    The maximum profit of a Bull Call Spread is determined by subtracting the net debit from the spread.

    <p>True</p> Signup and view all the answers

    What is the breakeven point for a Bull Call Spread?

    <p>Lower Strike + Net Debit</p> Signup and view all the answers

    The maximum loss for a Bull Call Spread is equal to the ______ of the strategy.

    <p>net debit</p> Signup and view all the answers

    Match the following terms with their correct definitions:

    <p>Spread = The difference between the higher and lower strike price Net Debit = Premium Paid for lower strike – Premium Received for higher strike Breakeven Point = Lower Strike + Net Debit Max Profit = Spread – Net Debit</p> Signup and view all the answers

    What happens to a Bull Call Spread if the underlying asset price expires below the lower strike price?

    <p>The strategy makes a loss, but it is limited to the net debit.</p> Signup and view all the answers

    The Bull Call Spread strategy is always profitable.

    <p>False</p> Signup and view all the answers

    What is the purpose of a Bull Call Spread strategy compared to buying a plain vanilla call option?

    <p>The Bull Call Spread strategy limits the maximum potential loss while still allowing for profit if the underlying asset price increases. This is unlike buying a plain vanilla call option, where the potential loss is unlimited.</p> Signup and view all the answers

    The synthetic long strategy loses money when the market moves higher.

    <p>False</p> Signup and view all the answers

    What is the breakeven point calculated in the strategy?

    <p>7427</p> Signup and view all the answers

    At a price of 7627, the overall payoff from the strategy is _______.

    <p>200</p> Signup and view all the answers

    What is the intrinsic value of the 7400 CE at a price of 7627?

    <p>227</p> Signup and view all the answers

    The synthetic long strategy has payoff symmetry around the breakeven point.

    <p>True</p> Signup and view all the answers

    What is the net loss when the price is at 7227?

    <p>-200</p> Signup and view all the answers

    Match the following terms with their definitions:

    <p>ATM = At-the-money CE = Call option PE = Put option Premium = Price paid for an option</p> Signup and view all the answers

    Study Notes

    Trading with Traditional Brokers vs. Discount Brokers

    • Trading with traditional brokers can eat away profits due to high brokerage charges (8-10 points)
    • Discount brokers like Zerodha can reduce brokerage charges, making breakeven points more achievable (4-5 points)

    Important Considerations for Arbitrage Trades

    • STT (Securities Transaction Tax) can further eat away profits, especially for ITM options
    • Other applicable taxes, such as service tax and stamp duty, must also be considered
    • Arbitrage trades may not be worth the effort for small payoffs (10 points), but can be profitable with higher payoffs (15-20 points)

    Key Takeaways from Synthetic Long and Arbitrage

    • Options can be used to replicate futures payoffs
    • Synthetic longs replicate long futures payoffs
    • A synthetic long is created by simultaneously buying ATM calls and selling ATM puts
    • The breakeven point for a synthetic long is the ATM strike + net premium paid
    • Arbitrage opportunities arise when synthetic long + short futures yield a positive non-zero P&L upon expiry
    • Execute arbitrage trades only if the P&L upon expiry makes sense after accounting for expenses

    Behavioral Finance and Trading

    • Our brains are wired to seek excitement and indulge in activities that provide a rush, even if they are not rational choices
    • Reflexive brain vs. reflective brain: reflexive brain drives impulsive decisions, while reflective brain analyzes and thinks
    • Trading options can be an exciting experience, but it's essential to think critically and consider the risks

    Bull Call Spread

    • A bull call spread is a strategy that involves buying a lower strike call and selling a higher strike call
    • Net debit is the difference between the premium paid for the lower strike call and the premium received for the higher strike call
    • Max loss is equal to the net debit, and max profit is the spread minus the net debit
    • Breakeven point is the lower strike + net debit
    • The payoff diagram of a bull call spread shows a restricted loss and capped profit

    Synthetic Long Payoff

    • The synthetic long payoff behaves similarly to futures, with a linear payoff around the breakeven point
    • The payoff is symmetric around the breakeven point, making it similar to long call futures

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