Strategies Using Equity Futures and Equity Options

1Hedging with futures

A hedge takes a futures position opposite to the risk you already carry.

• Long hedge: you will buy shares later (for example when money arrives) and fear prices will rise. Buy futures now. If the price rises, the futures gain offsets the higher purchase price, so your net cost stays close to the futures price you locked in.
• Short hedge: you hold shares and fear a fall. Sell futures. A fall in the share is offset by the futures gain, so your net sale value stays close to the futures price.
• Portfolio hedge: sell index futures in proportion to the portfolio's beta.

Formula Contracts to sell = (Portfolio value × Beta) ÷ (Index futures price × Lot size)

Example Portfolio ₹90 lakh, beta 1.3, Nifty futures 17,700, lot 50. Contracts = (90,00,000 × 1.3) ÷ (17,700 × 50) ≈ 13.

Remember

• Long hedge protects a future purchase; short hedge protects a holding.
• Hedging removes upside as well as downside.

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2Trading and arbitrage with futures

Traders use futures for leverage: margin is a fraction of contract value, so the same price move gives a much higher return on money invested (and a much bigger loss if wrong). A trader with a bearish view can short futures without owning the stock.

Example A share rises about 3.6%. Bought in the cash market, the return is about 3.6%; bought through futures with roughly 20% margin, the return on margin is several times higher (about 17.7% in the workbook's illustration).

Arbitrage compares the futures price with its fair value (spot + cost of carry − dividends):

• Cash and carry: futures overpriced → buy spot, sell futures, hold to expiry. The profit is locked in whatever the closing price.
• Reverse cash and carry: futures underpriced → sell spot (or sell shares you hold), buy futures, invest the sale proceeds and earn interest until expiry.
• Calendar spread: buy one expiry and sell another on the same underlying, betting on the difference between them, not the direction of the market. It carries lower risk and lower margin than a naked position.

Exam trap Arbitrage profit does not depend on where the price ends. Any question showing two settlement outcomes with the same profit is describing arbitrage.

Remember

• Futures > fair value → cash and carry. Futures < fair value → reverse cash and carry.

3Bullish and bearish spreads

A vertical spread buys and sells options of the same type and expiry but different strikes. It caps both profit and loss and costs less than a single option.

Bull call spread: buy a lower-strike call, sell a higher-strike call. You pay a net premium (net debit).

• Maximum loss = net premium paid.
• Maximum profit = difference in strikes − net premium.
• Break-even = lower strike + net premium.

Example Index at 17,500. Buy the 17,500 call at ₹185, sell the 17,800 call at ₹61. Net cost ₹124. Maximum loss ₹124; maximum profit 300 − 124 = ₹176; break-even 17,624.

Bull put spread: buy a lower-strike put, sell a higher-strike put. You receive a net premium (net credit).

• Maximum profit = net premium received.
• Maximum loss = difference in strikes − net premium.
• Break-even = higher strike − net premium.

Example Buy the 17,000 put at ₹34, sell the 17,500 put at ₹125; net credit ₹91: maximum profit ₹91, maximum loss 500 − 91 = ₹409, break-even 17,409.

Bear call spread: sell the lower-strike call, buy the higher-strike call (net credit). Bear put spread: buy the higher-strike put, sell the lower-strike put (net debit). Both profit from a moderate fall, with limited profit and limited loss.

Horizontal (calendar) spread: same strike, different expiries, for example sell the near month and buy the far month to earn from faster time decay of the near option. Diagonal spread: different strikes and different expiries.

Remember

• Bull spreads: buy the lower strike, sell the higher. Bear spreads: the reverse.
• Call spreads that you buy cost money; put spreads that are bullish earn a credit.

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4Volatility strategies: straddles and strangles

These are bets on how much the price moves, not which way.

Long straddle: buy a call and a put with the same strike and expiry (usually ATM). You expect a big move either way.

• Maximum loss = total premium paid (if the price ends exactly at the strike).
• Profit unlimited on the upside; large on the downside.
• Two break-evens: strike + total premium and strike − total premium.

Example Strike 6,000; call ₹257, put ₹136; total ₹393. Break-evens 5,607 and 6,393; maximum loss ₹393.

Short straddle: sell both. You expect the price to stay near the strike. Maximum profit = premium received; loss is unlimited if the price moves sharply.

Long strangle: buy an OTM call and an OTM put (different strikes). Cheaper than a straddle, but needs a bigger move to profit.

Example Stock at 6,100. Buy the 6,200 call for ₹145 and the 6,000 put for ₹140; total ₹285. Maximum loss ₹285 anywhere between 6,000 and 6,200. Break-evens: 6,000 − 285 = 5,715 and 6,200 + 285 = 6,485.

Short strangle: sell an OTM call and an OTM put. Profits if the price stays between the strikes; unlimited risk outside them.

Remember

• Straddle = same strike. Strangle = different strikes (both OTM).
• Long = expects volatility. Short = expects calm.

5Covered call, collar and butterfly

Covered call: own the stock and sell a call on it (usually OTM). You earn the premium but give up gains above the strike. It suits a neutral to mildly bullish view. Its payoff matches a short put, so it is called a synthetic short put.

Collar: own the stock, buy a put below the current price and sell a call above it. The call premium pays for (part of) the put. Losses are limited below the put strike and gains capped above the call strike.

Example Buy a share at 1,590, sell the 1,600 call for ₹10, buy the 1,580 put for ₹7. Worst case (share falls below 1,580): 1,580 − 1,590 + 10 − 7 = loss of ₹7. Best case (share above 1,600): 1,600 − 1,590 + 10 − 7 = gain of ₹13.

Long butterfly (calls): buy one lower-strike call, sell two middle-strike calls, buy one higher-strike call, with equal gaps between strikes. Low cost, limited risk; profits most if the price ends at the middle strike. It suits a view that the price will stay in a narrow range.

• Maximum loss = net premium paid.
• Maximum profit = gap between strikes − net premium.
• Break-evens = lower strike + net premium and higher strike − net premium.

Example Buy the 6,000 call at ₹230, sell two 6,100 calls at ₹150 each, buy the 6,200 call at ₹100: net cost 230 + 100 − 300 = ₹30. Maximum loss ₹30; maximum profit 100 − 30 = ₹70; break-evens 6,030 and 6,170.

Remember

• Covered call = long stock + short call = synthetic short put.
• Butterfly = a bet on low volatility with limited risk.

6Hedging with options: long call and protective put

• A short seller of a stock can buy a call to cap the loss if the price rises.
• A holder of a stock can buy a put (a protective put) to set a floor on the loss.

Example Hold a share bought at ₹1,600 and buy a 1,600 put for ₹20. If the share falls to 1,500, the stock loses 100 but the put gains 80, so the net loss is ₹20 (the premium). If it rises to 1,700, the stock gains 100 and the put expires, so the net gain is ₹80. Break-even is 1,620.

A protective put has the payoff of a long call: limited loss, unlimited gain. So it is a synthetic long call. It is a hedged position, unlike short straddles or short strangles.

Remember

• Protective put = long stock + long put = synthetic long call.
• Maximum loss of a protective put = premium (plus any gap between purchase price and strike).

7Arbitrage with options: put-call parity

Put-call parity links a call and a put on the same underlying with the same strike and expiry. It applies to European options.

Formula c + X·e^(−rt) = p + S₀ (c = call premium, p = put premium, X = strike, S₀ = spot, r = interest rate, t = time to expiry)

If the actual put (or call) price differs from the price the formula implies, there is a risk-free arbitrage.

Example Stock ₹1,251, one-month 1,240 call at ₹47.50, interest 8%. Fair put = 47.50 + 1,240 × e^(−0.08/12) − 1,251 ≈ ₹28.26. If the put trades at ₹23.15 it is cheap: buy the put and the stock, sell the call, and borrow the net ₹1,226.65. At expiry, whether the stock ends at 1,275 or 1,200, the profit is about ₹5.14, the gap between fair and traded put prices.

In practice this is hard: all three legs must execute at once, and a missed leg leaves an unhedged position.

Remember

• Put-call parity: same underlying, same strike, same expiry.
• Underpriced put → buy put + buy stock + sell call.

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8Delta hedging

Delta tells you how much an option's price moves for a ₹1 move in the underlying. A futures contract has a delta of about 1. A delta-neutral position has a total delta of zero, so small price moves do not change its value.

Example Sold 10 lots of calls (lot 50) with delta 0.5. Position delta = −0.5 × 10 × 50 = −250. Buying 5 lots of futures adds +1 × 5 × 50 = +250, making the position delta-neutral.

Delta changes as the price moves (if the stock rises and delta becomes 0.6, the short calls' delta is −300, so you need a 6th futures lot). Re-balancing again and again to keep delta near zero is delta hedging. It works only for small moves between adjustments.

Remember

• Futures delta ≈ 1. Delta-neutral = total delta zero.
• Delta hedging needs continuous re-balancing.

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9Open interest

Open interest (OI) is the number of positions opened and not yet closed. SEBI (May 2025) changed how OI is measured for limits: it is now future-equivalent OI (FutEq OI), calculated at portfolio level by delta-adjusting option positions and netting them with futures for each underlying.

Example A client long 500 calls with delta 0.5 had notional OI of 500; FutEq OI is 500 × 0.5 = 250. In the workbook's four-client illustration, market-wide OI falls from 2,800 (notional) to 900 (FutEq), aligning derivatives positions more closely with the cash market.

Remember

• FutEq OI = delta-adjusted, netted at portfolio level.

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10Reading price, OI and the put-call ratio

Traded volume is the number of contracts traded in a day; open interest is what remains outstanding. Combining futures price and OI:

Put-call ratio (PCR) = put volume (or OI) ÷ call volume (or OI).

Example Put OI 8,000, call OI 12,000 → PCR = 8,000 ÷ 12,000 = 0.67.

PCR is treated as a contrarian indicator: below 1 (more calls written) is read as bearish, because option sellers do not expect a rise; above 1 (more puts written) is read as bullish, because sellers do not expect a fall.

Exam trap Rising price with rising OI is the bullish combination. Rising price with falling OI is short covering, not fresh buying.

Remember

• PCR < 1 bearish; PCR > 1 bullish (contrarian reading).

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