NISM VIII Chapter 4: Introduction to Options PDF

Parth Verma / The Valuation School NISM VIII CHAPTER 4: INTRODUCTION TO OPTIONS LEARNING OBJECTIVES Concept of Options Payoffs in case of option contracts Difference between futures and options Fundamentals relating to option pr...

Parth Verma / The Valuation School NISM VIII CHAPTER 4: INTRODUCTION TO OPTIONS LEARNING OBJECTIVES Concept of Options Payoffs in case of option contracts Difference between futures and options Fundamentals relating to option pricing Option Greeks and Implied volatility Analysis of options from the perspective of option buyers and sellers 4.1 BASICS OF OPTION What is an option? An option is a financial contract that lets you buy or sell an asset at a fixed price before a specific date. You pay a fee for this right, but you're not obligated to use it. Example - You buy an option to purchase a stock for ₹100 (the strike price) within the next month by paying ₹5 for this option. If the stock price rises to ₹120, you can still buy it for ₹100, making a profit. If the stock price doesn’t go up, you can let the option expire, losing only the ₹5 you paid for the option. Bought an option for Rs 5 to purchase a stock for Rs 100 stock price stock price rises doesn’t go up Made a profit Lose just Rs 5 Option Premium: Cost of buying the option. Parth Verma / The Valuation School  Parth Verma / The Valuation School Buyer of an Option: Has the right but not the obligation. Pays an option premium to the seller. Can buy (call option) or sell (put option) the underlying asset. Buys the option. Writer of an Option: Receives the option premium. Obliged to sell or buy the asset if exercised. Sells the option. Payment: The buyer pays the premium to the seller upfront. TYPES OF OPTIONS Mainly there are 2 types 1. Call option - Buyer of Option gets the Right to BUY 2. Put Option - Buyer of Option gets the Right to SELL OPTION TERMINOLOGY Types of Options: Index Option: Underlying asset is a stock index (e.g. Nifty, Sensex). Stock Option: Underlying asset is an individual stock (e.g. ONGC, NTPC). Option Styles: American Option: Can be exercised anytime on or before expiry. European Option: Can be exercised only on expiry date. (Followed in India) Key Terms: Option Premium: Price paid by the buyer to the seller. Spot Price (S): Current price of the underlying asset in the spot market. Strike Price or Exercise Price (X): Price at which the asset can be bought (call) or sold (put). Open Interest: Total number of outstanding option contracts. Parth Verma / The Valuation School  Parth Verma / The Valuation School Assignment of Options: Allocation of exercised options to one or more option sellers. Opening a Position: Opening Purchase (Long on Option): Creating or increasing a long position. Opening Sale (Short on Option): Creating or increasing a short position. Closing a Position: Closing Purchase: Reducing or eliminating a short position. Closing Sale: Reducing or eliminating a long position. 4.2 CONTRACT SPECIFICATIONS OF EXCHANGE-TRADED OPTIONS 1. Contract Size or Lot Size: Number of units in a contract. Varies by stock/index. Example: Nifty options have a contract size of 50 2. Contract Trading Cycle: Period during which the option is traded. Stock options on NSE: three-month trading cycle (e.g., May, June, July). with monthly expiry Index options: weekly and monthly expiries. 3. Expiration Date: Last trading day of the contract. Nifty and Bank Nifty options expire on the last Thursday of the month. Weekly options expire on the Thursday of each week. 4. Tick Size: Minimum price movement. Set at 5 paisa for stock and index options. 5. Final Settlement Price: No daily settlement for options. Final settlement on expiration date. Based on the closing price of the underlying asset. 6. Trading Hours: 9:15 am to 3:30 pm, Monday to Friday. Exchange publishes annual trading holidays. Parth Verma / The Valuation School  Parth Verma / The Valuation School BSE OPTIONS SLIGHLTY DIFFERENT Features Details Underlying asset BSE Sensex Contract size 10 Tick size Rs.0.05 Contract cycle 7 serial weekly, 3 monthly, 3 quarterly and 8 semi-annually maturing contracts Trading hours 9:15 a.m. to 3:30 p.m. Exercise style European Monthly, Quarterly and Semi-annually – last Friday of the Expiration day contract; Weekly contracts – Friday expiry Cash settlement based on the closing price of the Final settlement underlying index on the expiration day 4.3 MONEYNESS OF AN OPTION In-the-Money (ITM) Option: An option is considered in-the-money if exercising it would result in a positive cash flow for the holder. Call Option: ITM when the spot price is higher than the strike price. Put Option: ITM when the spot price is lower than the strike price.  Example: If the spot price of an asset is ₹185 and the strike price of a call option is ₹180, the call option is ITM because you can buy the asset for ₹180 (lower than the market price) and sell it at ₹185, making a profit. At-the-Money (ATM) Option: An option is at-the-money if exercising it would result in zero cash flow, meaning the strike price is equal to the spot price. Call and Put Options: Both are ATM when the strike price is equal to the spot price. Example: If the index is at ₹18400 and the strike prices available are ₹18350, ₹18400, and ₹18450, the option with the strike price of ₹18400 is the ATM option. Out-of-the-Money (OTM) Option: An option is out-of-the-money if exercising it would result in a negative cash flow for the holder. Call Option: OTM when the spot price is lower than the strike price. Put Option: OTM when the spot price is higher than the strike price. Example: If the spot price of an asset is ₹175 and the strike price of a call option is ₹180, the call option is OTM because you would have to buy the asset for ₹180 (higher than the market price) and sell it at ₹175, resulting in a loss. Parth Verma / The Valuation School  Parth Verma / The Valuation School 4.4 INTRINSIC VALUE AND TIME VALUE OF AN OPTION Option Premium, Consists of two components: intrinsic value and time value. Intrinsic Value: It is the amount by which an option is in-the-money (ITM). Call Option: Intrinsic value = Spot price (S) - Strike price (X). Put Option: Intrinsic value = Strike price (X) - Spot price (S). Only ITM options have intrinsic value; ATM and OTM options have zero intrinsic value. Intrinsic value can never be negative as the option holder won't exercise it at a loss. Example: Put Option (ITM): Strike price (X) = ₹18400, Spot price (S) = ₹18315.10 Intrinsic value = ₹18400 - ₹18315.10 = ₹84.90 Call Option (OTM): Strike price (X) = ₹18400, Spot price (S) = ₹18315.10 Intrinsic value = ₹0 (since the spot price is lower than the strike price).  Time Value: Difference between the option premium and intrinsic value. ATM and OTM Options: Entire premium is the time value as intrinsic value is zero. Example: Put Option: Premium = ₹177.60, Intrinsic value = ₹84.90 Time value = ₹177.60 - ₹84.90 = ₹92.70 Call Option: Premium = ₹124.50, Intrinsic value = ₹0 Time value = ₹124.50 4.5 PAYOFF CHARTS FOR OPTIONS Long Option Long the option: Buyer has the right but not the obligation to buy/sell the underlying asset. When you are long an equity option contract: You have the right to exercise that option. Your potential loss is limited to the premium amount you paid. Profit depends on the asset price at exercise/expiry. Parth Verma / The Valuation School  Parth Verma / The Valuation School Short Option Short the option: Seller has the obligation to sell/buy the underlying asset. When you are short an equity option contract: Your maximum profit is the premium received. You can be assigned an exercised option at any time during the life of the option contract (in the case of American options). Your potential loss is theoretically unlimited. Now, let us understand each of these positions in detail: 1) Long Call: Long Call Option: A long call option gives the buyer the right, but not the obligation, to buy the underlying asset at a specified strike price before or at expiration. Example: Stock index: 17562 Call option strike price: 17500 Premium paid: Rs. 95 Right to Buy: You can buy the index at 17500 on the expiration date. If the index is above 17500, exercise the option; if it is below, let it expire. Break-Even Point (BEP) BEP Formula: Strike Price + Premium = 17500 + 95 = 17595 At BEP (17595): Payoff = 17595 - 17500 = Rs. 95 Net Profit = Payoff - Premium = 95 - 95 = 0 Outcome at Various Levels: Index at 17400: Do not exercise; loss = Rs. 95 (premium paid). Index at 17595: Exercise; receive Rs. 95 (break-even point, no profit or loss). Index at 18000: Exercise; receive Rs. 500. Profit = Rs. 500 - Rs. 95 = Rs. 405. Payoff Table: A payoff table shows the profit or loss for an option at various levels of the underlying asset's price at expiration. Index Value at The payoff on Profit on Expiry Premium Paid (A) Expiry Expiry (B) (A+B) 17400 -95 0 -95 17500 -95 0 -95 17600 -95 100 5 17700 -95 200 105 18000 -95 500 405 Parth Verma / The Valuation School  Parth Verma / The Valuation School The chart above shows some of the possible closing levels of the index on the expiration date on the X-axis. The Y-axis shows the net profit on the long call position at various closing levels of Nifty on the expiration date. Key Points: Contract value: 17500 * 50 = Rs. 8,75,000 Maximum loss: Rs. 95 * 50 = Rs. 4,750 Profit starts when the index closes above 17595. Loss limited to Rs. 4,750 with potentially unlimited profit. No margin is required since loss is limited to the premium paid.  2) Short Call: Short Call Option: A short call option obligates the seller to sell the underlying asset at a specified strike price if the buyer chooses to exercise the option. Example: Stock index: 17562 Call option strike price: 17500 Premium received: Rs. 95 Obligation to Sell: You must sell the index at 17500 if the option is exercised. If the index is above 17500, the buyer will exercise the option; if below, the option expires worthless. Break-Even Point (BEP) BEP = 17595 Outcome at Various Levels: Index at 17400: Option expires worthless; profit = Rs. 95 (premium received). Index at 17595: No profit or loss; profit = Rs. 95 - Rs. 95 = 0. Index at 18000: Must sell at 17500; loss = Rs. 500 - Rs. 95 = Rs. 405. Parth Verma / The Valuation School  Parth Verma / The Valuation School Payoff Table: Index Value at The payoff on Profit on Expiry Expiry Premium Paid (A) Expiry (B) (A+B) 17400 95 0 95 17500 95 0 95 17600 95 -100 -5 17700 95 -200 -105 17800 95 -300 -205 18000 95 -500 -405 The short call payoff chart is just a mirror image of the long call payoff. Key Points: Contract value: 17500 * 50 = Rs. 8,75,000 Maximum gain: Rs. 95 * 50 = Rs. 4,750 (premium received) Potential losses: Unlimited above the BEP (17595) Margin required: Due to the potential for unlimited losses, the exchange requires a margin from the seller.  3) Long Put: Long Put Option: A put option gives the buyer the right, but not the obligation, to sell the underlying asset at a specified strike price before or at expiration. Example: Stock index: 17562 Put option strike price: 17500 Premium paid: Rs. 150 Right to Sell: You can sell the index at 17500 on the expiration date. If the index is below 17500, exercise the option; if above, let it expire. Break-Even Point (BEP) BEP Formula: Strike Price - Premium = 17500 - 150 = 17350 At BEP (17350): Payoff = 17500 - 17350 = Rs. 150 Net Profit = Payoff - Premium = 150 - 150 = 0 Parth Verma / The Valuation School  Parth Verma / The Valuation School Outcome at Various Levels: Index at 17100: Exercise; profit = Rs. 400 - Rs. 150 = Rs. 250. Index at 17350: Exercise; no profit or loss (Breakeven Point) Index at 17600: Do not exercise; loss = Rs. 150 (premium paid). Payoff Table: Index Value at The payoff on Profit on Expiry Expiry Premium Paid (A) Expiry (B) (A+B) 17100 -150 400 250 17300 -150 200 50 17400 -150 100 -50 17500 -150 0 -150 17600 -150 0 -150 The X-axis of the chart above shows the different possible closing levels of the index on the expiration date while the Y-axis shows the net profit on the long-put position corresponding to each closing level of the index. Key Points: Contract value: 17500 * 50 = Rs. 8,75,000 Maximum loss: Rs. 150 * 50 = Rs. 7,500 Profit starts when the index closes below 17350. Loss limited to Rs. 7,500 with potentially high profit (maximum profit at index zero: Rs. 17,350). No margin is required since the loss is limited to the premium paid. 4) Short Put: Short Put Option: A short put option obligates the seller to buy the underlying asset at a specified strike price if the buyer chooses to exercise the option. Example: Stock index: 17500 Put option strike price: 17500 Premium received: Rs. 150 Parth Verma / The Valuation School  Parth Verma / The Valuation School Obligation to Buy: You must buy the index at 17500 if the buyer exercises the option. If the index is above 17500, the option expires worthless; if below, you incur losses. Break-Even Point (BEP) BEP = 17350 Outcome at Various Levels: Index at 17100: Option exercised; loss = Rs. 400 - Rs. 150 = Rs. 250. Index at 17350: Option exercised; no profit or loss (Breakeven Point) Index at 17600: Option expires; profit = Rs. 150 (premium received). Payoff Table: Index Value at Premium Received The payoff on Profit on Expiry Expiry (A) Expiry (B) (A+B) 17100 150 -400 -250 17300 150 -200 -50 17400 150 -100 50 17500 150 0 150 17600 150 0 150 The X-axis of the chart above shows the different possible closing levels of the index on the expiration date while the Y-axis shows the net profit on the short put position corresponding to each closing level of the index. Key Points: Contract value: 17500 * 50 = Rs. 8,75,000 Maximum profit: Rs. 150 (premium received) Potential loss: Large, increasing as the index falls below 17350 Margin required due to the potential for significant losses. RISK AND RETURN PROFILE OF OPTION CONTRACTS A long option position has limited risk (premium paid) and unlimited profit potential. A short option position has unlimited downside risk, but limited upside potential (to the extent of the premium received). Parth Verma / The Valuation School  Parth Verma / The Valuation School Risk Return Long Premium paid Unlimited Short Unlimited Premium received 4.6 DISTINCTION BETWEEN FUTURES AND OPTIONS CONTRACTS Asymmetric Risk and Leverage in Options vs. Futures Asymmetric Risk: Options: Gains and losses are unequal. For example, a call option buyer's loss is limited to the premium paid, but gains are unlimited if the stock price rises. Futures: Gains and losses are equal, resulting in symmetric risk exposure. Leverage: Options: A small premium relative to contract value allows for high leverage. This can lead to large percentage gains from small favorable moves in the underlying asset. Downside: Leverage can also magnify losses if the underlying asset's price doesn't move as expected. If options expire worthless, the premium paid is lost. FEW MAIN DIFFERENCES BETWEEN FUTURES AND OPTIONS CONTRACTS Futures Contracts Options Contracts Symmetric risk. Both Asymmetric risk. Limited parties can have loss to premium paid; Risk Exposure unlimited gains or losses. potential for unlimited gains. Margin payments are A small premium for Leverage required by both buyer market exposure leads to and seller. high leverage. Both buyer and seller Buyer has the right (no Rights & have obligations to obligation) to buy/sell; Obligations buy/sell the underlying seller has an obligation if asset. exercised. Both parties pay the Buyer pays a premium; initial margin and are Payments seller deposits margin subject to daily margin with exchanges. (MTM) payments. Buyer: Unlimited gains, Gains and Both parties can have limited loss (premium Losses unlimited gains or losses. paid). Seller: Limited gains, unlimited losses. Both buyer and seller are Only the seller is subject Daily Margins subject to daily MTM to daily MTM margins. margins. Parth Verma / The Valuation School  Parth Verma / The Valuation School 4.7 OPTION PRICING FUNDAMENTALS Components of Option Premium: 1. Intrinsic Value: Value if the option is exercised now (ITM, ATM, OTM). 2. Time Value: Remaining time until expiration and underlying asset volatility. Option Premium is determined by market participants through price discovery, not fixed by stock exchanges or SEBI. There are five fundamental parameters on which the option price depends: 1. Spot Price: Call options increase in value as the underlying asset price rises. Put options decrease in value as the underlying asset price rises. 2. Strike Price: A higher strike price decreases call option value. A higher strike price increases the put option value. 3. Volatility: Higher volatility increases both call and put option premiums. Lower volatility decreases premiums. 4. Time to Expiration: Longer time to expiration generally increases premiums. Time decay reduces the premium as expiration approaches. 5. Interest Rates: Higher interest rates increase call option value. Higher interest rates decrease put option value. Option Greeks: Option premiums change with changes in the factors that determine option pricing i.e., factors such as strike price, volatility, term to maturity, etc. The sensitivities most commonly tracked in the market are known collectively as “Greeks”. Parth Verma / The Valuation School  Parth Verma / The Valuation School DIFFERENT TYPES OF OPTION GREEKS: 1) Delta (Δ): Measures the sensitivity of an option's value to a small change in the price of the underlying asset. Change in option premium Formula: Δ = Change in price of the underlying asset Call Options: Buyer: Positive Delta (value increases as underlying price rises). Seller: Negative Delta (value decreases as underlying price rises). Put Options: Buyer: Negative Delta (value increases as underlying price falls). Seller: Positive Delta (value decreases as underlying price falls). Example: If a call option has a Delta of 0.60, a Rs.1 increase in the underlying asset's price will increase the option's price by 60 paise. Importance: Heavily used in margining and risk management strategies; often called the hedge ratio.  2) Gamma (γ): Measures the rate of change of Delta with respect to the price of the underlying asset. Change in Delta Formula: γ = Change in price of the underlying asset Example: If a call option has a Delta of 0.50 and Gamma of 0.08, a Rs.1 increase in the underlying asset's price will change the Delta to 0.58. Importance: Indicates how fast an option will go in-the- money or out-of-the-money. 3) Theta (θ): Measures an option’s sensitivity to time decay. Change in option premium Formula: θ = Change in time to expiry Example: If a call option with 5 days to expiry has a Theta of 1.2, the option price will decline by Rs.1.20 per day. Importance: Reflects how time decay affects option positions; typically negative for long options. Parth Verma / The Valuation School  Parth Verma / The Valuation School 4) Vega (ν): Measures the sensitivity of an option's price to changes in market volatility. Change in option premium Formula: ν = Change in volatility Example: If a call option has a Vega of 0.80, a 1% increase in volatility will change the option's premium by 0.80%. Importance: Indicates how changes in volatility affect option prices; positive for both long calls and long puts. 5) Rho (ρ): Measures the sensitivity of an option's price to changes in the risk-free interest rate. Change in option premium Formula: ρ = Change in cost of funding the underlying Importance: Reflects the impact of interest rate changes on option prices. 4.8 OPTION PRICING MODELS 1) The Binomial Pricing Model Developed by: William Sharpe in 1978. Key Features: Price Evolution: Represents the price evolution of the underlying asset as a binomial tree. Assumptions: At each step, the price can move up or down at fixed rates with respective probabilities. Accuracy: Very accurate due to its iterative nature. Complexity: Implementation is complex and time- consuming. 2) The Black & Scholes Model Published by: Fisher Black and Myron Scholes in 1973. Key Features: Simplicity: Relatively simple and fast calculation. Non-iterative: Unlike the binomial model, it does not rely on iterative calculations. Dividends: Ignores dividends paid during the option's life. Key Determinants: Stock price, strike price, volatility, time to expiration, and risk-free interest rate. Parth Verma / The Valuation School  Parth Verma / The Valuation School CALL OPTION PRICE FORMULA: PUT OPTION PRICE FORMULA: Where: S = stock price X = strike price t = time remaining until expiration, expressed in years r = current continuously compounded risk-free interest rate v = annual volatility of stock price (the standard deviation of the short-term returns over one year) In = natural logarithm N(x) = standard normal cumulative distribution function e = the exponential function 4.9 IMPLIED VOLATILITY OF AN OPTION Types of Volatility: 1. Historical Volatility: Measured using past price changes. Example: Calculate the standard deviation of weekly percentage changes in Nifty over the past year. Reflects past market behavior. 2. Implied Volatility: Expected future volatility over the option's life. Derived from current option prices using models like Black-Scholes. Reflects market expectations and sentiment. Factors Influencing Implied Volatility: Major events (e.g., court verdicts, earnings reports). Market sentiment and expectations. Overall market conditions. Benefits for Options Traders: Helps determine the fair value of options. Informs buy/sell decisions based on market conditions. Provides insight into market expectations and potential price movements. Parth Verma / The Valuation School  Parth Verma / The Valuation School 4.10 ANALYSIS OF OPTIONS FROM THE PERSPECTIVES OF BUYER AND SELLER Analysis of Call Option Trading from Buyer’s Perspective Scenario: Index Price: 17562 Strike Prices and Premiums: 17300: Rs. 327 17400: Rs. 250 17500: Rs. 185 17600: Rs. 130 Intrinsic Value: Deep ITM (17300 strike): 17562 - 17300 = 262 (Intrinsic Value), Time Value = 327 - 262 = 65 OTM (17600 strikes): No intrinsic value, entire premium is time value. Break-Even Points (BEP): 17300 Strike: 17627 17400 Strike: 17650 17500 Strike: 17685 17600 Strike: 17730 PROFIT/LOSS ANALYSIS AT EXPIRY: Index Closing Profit for Profit for Profit for Profit for Value 17300 17400 17500 17600 17300 -327 -250 -185 -130 17400 -227 -250 -185 -130 17500 -127 -150 -185 -130 17600 -27 -50 -85 -130 17700 73 50 15 -30 17800 173 150 115 70 Max Loss: Equal to the premium paid. Max Profit: Potentially unlimited as the index rises. Parth Verma / The Valuation School  Parth Verma / The Valuation School RETURN ON INVESTMENT (ROI) AT INDEX VALUE 17800: Strike Price Profit ROI Calculation ROI 17300 173 173/327 53% 17400 150 150/250 60% 17500 115 115/185 62% 17600 70 70/130 54% Analysis: ITM Options: Higher intrinsic value, higher premium, lower ROI but more stable. ATM Options: Balanced premium, higher uncertainty, moderate ROI. OTM Options: Lower premium, higher risk, potentially high ROI if the index moves significantly. Conclusion: Choice of Option: Bullish Traders: Prefer ATM or slightly OTM options for higher ROI. Conservative Traders: Prefer ITM options for more stability and lower risk. Time to expiry, volatility, and market outlook are crucial in deciding the best strike price to trade.  Analysis of Call Option Trading from Seller’s Perspective Scenario: Neutral to Bearish Outlook: The seller expects the underlying asset price to remain stable or decline. PROFIT/LOSS ANALYSIS AT EXPIRY: Index Closing Profit for Profit for Profit for Profit for Value 17300 17400 17500 17600 17300 327 250 185 130 17400 227 250 185 130 17500 127 150 185 130 17600 27 50 85 130 17700 -73 -50 -15 30 17800 -173 -150 -115 -70 Maximum Profit: Equal to the premium received. Profit: When the index closes below the strike price, the seller keeps the entire premium. Loss: When the index closes above the strike price, the seller starts incurring losses. Parth Verma / The Valuation School  Parth Verma / The Valuation School Conclusion: Risk: The seller's profit is capped at the premium received. Potential losses are unlimited as the index price rises. Strategy: Selling call options is advantageous when expecting neutral to bearish market conditions. Risk management is crucial due to the potential for unlimited losses.  Analysis of Put Option Trading from a Buyer’s Perspective Scenario: Index: 17562 Strike Prices and Premiums: 17300: Rs. 65 17400: Rs. 91 17500: Rs. 121 17600: Rs. 167 Intrinsic Value: ITM (17600 strike): 17600 - 17562 = 38, Time Value = 167 - 38 = 129 OTM (17300 strikes): No intrinsic value, entire premium is time value. Break-Even Points (BEP): 17300: 17235 17400: 17309 17500: 17379 17600: 17433 Parth Verma / The Valuation School  Parth Verma / The Valuation School PROFIT/LOSS ANALYSIS AT EXPIRY: Index Closing Profit for Profit for Profit for Profit for Value 17300 17400 17500 17600 17200 35 109 179 233 17300 -65 9 79 133 17400 -65 -91 -21 33 17500 -65 -91 -121 -67 17600 -65 -91 -121 -167 Max Loss: Equal to the premium paid. Profit: When the index closes below the strike price, the buyer makes a profit. Loss: When the index closes above the strike price, the buyer loses the premium paid. RETURN ON INVESTMENT (ROI) AT INDEX VALUE 17000: Strike Price Profit ROI Calculation ROI 17300 235 235/65 362% 17400 309 309/91 340% 17500 379 379/121 313% 17600 433 433/167 259% Conclusion: ITM Options: Higher intrinsic value, higher premium. Lower ROI compared to OTM options but more stable. ATM/OTM Options: Lower premium, higher risk. Higher potential ROI if the index drops significantly. Strategy: For a bearish outlook, buying put options can be profitable. OTM options provide higher ROI if the index falls drastically. ITM options offer more stability with lower ROI. Analysis of Put Option Trading from Seller’s Perspective Scenario: Neutral to Bullish Outlook: The seller expects the underlying asset price to remain stable or rise. Parth Verma / The Valuation School  Parth Verma / The Valuation School PROFIT/LOSS ANALYSIS AT EXPIRY: Index Closing Profit for Profit for Profit for Profit for Value 17300 17400 17500 17600 17200 -35 -109 -179 -233 17300 65 -9 -79 -133 17400 65 91 21 -33 17500 65 91 121 67 17600 65 91 121 167 Maximum Profit: Equal to the premium received. Profit: When the index closes above the strike price, the seller keeps the premium. Loss: The seller starts incurring losses when the index closes below the strike price. Conclusion: Risk: The seller's profit is capped at the premium received. Potential losses are significant as the index price falls. Strategy: Selling put options is advantageous when expecting neutral to bullish market conditions. Risk management is crucial due to the potential for significant losses. Parth Verma / The Valuation School