How to Trade Options on the Nifty (Indian Index)

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Options on the Nifty are mainly used by large fund managers to hedge their cash positions against large losses. They are also used by institutional and retail investors to speculate on the direction of the markets. This article is for someone who understands the basics of options and is interested in trading options in the Nifty. It details on the contract specifications, expiration dates and liquidity on the NSE for Nifty Options. It does not help with the Option Basics. Follow the steps to learn how to trade options on the Nifty.

Steps

1. Open an account with an Indian Brokerage. Activate the Derivatives Trading (some brokerages refer to it as F&O account) facility and transfer money to the separate Derivative account. Check out the Brokerage firms execution rate and reliability before creating an account with them.
   
2. The options contracts are European style and cash settled and are based on the popular market benchmark S&P CNX Nifty index.
   
3. 1 Lot or Contract of Nifty Option consists of 50 shares. 90% of the trades take place in the Near Expiration Contracts and liquidity is good.
   
4. S&P CNX Nifty options contracts have 3 consecutive monthly contracts, additionally 3 quarterly months of the cycle March / June / September / December and 5 following semi-annual months of the cycle June / December would be available, so that at any point in time there would be options contracts with atleast 3 year tenure available. On expiry of the near month contract, new contracts (monthly/quarterly/ half yearly contracts as applicable) are introduced at new strike prices for both call and put options, on the trading day following the expiry of the near month contract.
   
5. An option is bought or sold by paying the option price * 50. eg. The Nifty is currently trading at 5018, the May 2010 Exp 5000 call is trading at 137. So, to buy one contract we pay 137*50 = 6850 Rs.
   
6. The most active option in the Nifty normally trades around 2,00,000 contracts. ie. 1,00,00,000 shares.
   
7. The Option moves with the Nifty Futures and not the SPOT Nifty prices. So if the Nifty futures move up, the Calls too move up regardless of the SPOT Nifty price.
   
8. NSE Options expire on the last Thursday of the month. And in case the last Thursday is a holiday then the day before the last Thursday is the Expiration Day.
   

Tips

• If trading or speculating with options, it is best to have a fixed plan before entering a trade, that way there are no emotional decisions involved.
  
• Nifty Options follow Nifty Future prices and not the Nifty Spot price. You have to follow both the Nifty Futures and Nifty Spot prices.
  
• Options are best used to trade intra-day or hedge already existing cash or future positions. Its better to stick with Futures for trading with a longer time frame.
  
• Annual advance brokerage fees can be used to reduce commissions on trades. Money is paid in advance for trades which are taken over the course of the year. Paying advance brokerage significantly reduces the commissions. Most Indian Brokerages offer this facility.
  
• Trend following strategies with stop losses work best for trading.
  
• Take positions giving more importance to the underlying price (in the case, the nifty price) than the option price. Give room for the trade to move and set stop losses with the underlying in mind.
  

Warnings

• Options are very volatile instruments and many factors influence its price.
  
• Unlike futures, options continually loose value and cannot be carried forward.
  
• Volatility, time value and the underlying price all have effect on the option price.
  
• It is always wise to trade only a small portion of the total capital until you understand the risks and rewards.
  
• Stop-losses have to be decided on before entering a trade.
  
• Carrying Option trades to the next day can result in extra commissions and factors like volatility and loss of time value come into effect.
  

Things You'll Need

• An account with a brokerage which supports Derivative Trading.
  
• A Telephone.
  
• Computer with decent Internet Connection (OPTIONAL).
  
• An Online Trading Account (OPTIONAL).
  

Related wikiHows

• How to Choose a Hedge Fund Manager
  

Sources and Citations

• http://www.nseindia.com/content/fo/fo_niftyoptions.htm#1
  

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