TRADING BASICS GUIDE

Nothing can substitute knowledge. if you have the inclination, then we are providing here the links to such resources which will help you take a studied and wise investment decision.

Indian markets have recently thrown open a new avenue for retail investors and traders to participate: commodity derivatives. For those who want to diversify their portfolios beyond shares, bonds and real estate, commodities is the best option.

However, with the setting up of three multi-commodity exchanges in the country, retail investors can now trade in commodity futures without having physical stocks!

Commodities actually offer immense potential to become a separate asset class for market-savvy investors, arbitrageurs and speculators. Retail investors, who claim to understand the equity markets may find commodities an unfathomable market. But commodities are easy to understand as far as fundamentals of demand and supply are concerned. Retail investors should understand the risks and advantages of trading in commodities futures before taking a leap. Historically, pricing in commodities futures has been less volatile compared with equity and bonds, thus providing an efficient portfolio diversification option.

In fact, the size of the commodities markets in India is also quite significant. Of the country's GDP of Rs 13,20,730 crore (Rs 13,207.3 billion), commodities related (and dependent) industries constitute about 58 per cent.

Currently, the various commodities across the country clock an annual turnover of Rs 1,40,000 crore (Rs 1,400 billion). With the introduction of futures trading, the size of the commodities market grow many folds here on.

Like any other market, the one for commodity futures plays a valuable role in information pooling and risk sharing. The market mediates between buyers and sellers of commodities, and facilitates decisions related to storage and consumption of commodities. In the process, they make the underlying market more liquid.

Here's how a retail investor can get started:

You have three options - the National Commodity and Derivative Exchange, the Multi Commodity Exchange of India Ltd and the National Multi Commodity Exchange of India Ltd. All three have electronic trading and settlement systems and a national presence.

Several already-established equity brokers have sought membership with NCDEX and MCX. The likes of Refco Sify Securities, SSKI (Sharekhan) and ICICIcommtrade (ICICIdirect), ISJ Comdesk (ISJ Securities) and Sunidhi Consultancy are already offering commodity futures services. Some of them also offer trading through Internet just like the way they offer equities. You can also get a list of more members from the respective exchanges and decide upon the broker you want to choose from.

You can have an amount as low as Rs 5,000. All you need is money for margins payable upfront to exchanges through brokers. The margins range from 5-10 per cent of the value of the commodity contract. While you can start off trading at Rs 5,000, other brokers have different packages for clients.

The prices and trading lots in agricultural commodities vary from exchange to exchange (in kg, quintals or tonnes), but again the minimum funds required to begin will be approximately Rs 25,000.

You can do both. All the exchanges have both systems - cash and delivery mechanisms. The choice is yours. If you want your contract to be cash settled, you have to indicate at the time of placing the order that you don't intend to deliver the item.

If you plan to take or make delivery, you need to have the required warehouse receipts. The option to settle in cash or through delivery can be changed as many times as one wants till the last day of the expiry of the contract.

As of now you will need only one bank account. You will need a separate commodity demat account from the National Securities Depository Ltd to trade on the NCDEX just like in stocks.

You will have to enter into a normal account agreements with the broker. These include the procedure of the Know Your Client format that exist in equity trading and terms of conditions of the exchanges and broker. Besides you will need to give you details such as PAN no., bank account no, etc.

The brokerage charges range from 0.10-0.25 per cent of the contract value. Transaction charges range between Rs 6 and Rs 10 per lakh/per contract. The brokerage will be different for different commodities. It will also differ based on trading transactions and delivery transactions. In case of a contract resulting in delivery, the brokerage can be 0.25 - 1 per cent of the contract value. The brokerage cannot exceed the maximum limit specified by the exchanges.

Daily financial newspapers carry spot prices and relevant news and articles on most commodities. Besides, there are specialised magazines on agricultural commodities and metals available for subscription. Brokers also provide research and analysis support.

But the information easiest to access is from websites. Though many websites are subscription-based, a few also offer information for free. You can surf the web and narrow down you search.

The exchanges are regulated by the Forward Markets Commission. Unlike the equity markets, brokers don't need to register themselves with the regulator.

The FMC deals with exchange administration and will seek to inspect the books of brokers only if foul practices are suspected or if the exchanges themselves fail to take action. In a sense, therefore, the commodity exchanges are more self-regulating than stock exchanges. But this could change if retail participation in commodities grows substantially.

The commodities market will have three broad categories of market participants apart from brokers and the exchange administration - hedgers, speculators and arbitrageurs. Brokers will intermediate, facilitating hedgers and speculators.

Hedgers are essentially players with an underlying risk in a commodity - they may be either producers or consumers who want to transfer the price-risk onto the market.

Producer-hedgers are those who want to mitigate the risk of prices declining by the time they actually produce their commodity for sale in the market; consumer hedgers would want to do the opposite.

For example, if you are a jewellery company with export orders at fixed prices, you might want to buy gold futures to lock into current prices. Investors and traders wanting to benefit or profit from price variations are essentially speculators. They serve as counterparties to hedgers and accept the risk offered by the hedgers in a bid to gain from favourable price changes.

Though the government has essentially made almost all commodities eligible for futures trading, the nationwide exchanges have earmarked only a select few for starters. While the NMCE has most major agricultural commodities and metals under its fold, the NCDEX, has a large number of agriculture, metal and energy commodities. MCX also offers many commodities for futures trading.

No. If the trade is squared off no sales tax is applicable. The sales tax is applicable only in case of trade resulting into delivery. Normally it is the seller's responsibility to collect and pay sales tax.

The sales tax is applicable at the place of delivery. Those who are willing to opt for physical delivery need to have sales tax registration number.

Both the exchanges, NCDEX and MCX, maintain settlement guarantee funds. The exchanges have a penalty clause in case of any default by any member. There is also a separate arbitration panel of exchanges.

Are any additional margin/brokerage/charges imposed in case I want to take delivery of goods?

Yes. In case of delivery, the margin during the delivery period increases to 20-25 per cent of the contract value. The member/ broker will levy extra charges in case of trades resulting in delivery.

As of now, there is no stamp duty applicable for commodity futures that have contract notes generated in electronic form. However, in case of delivery, the stamp duty will be applicable according to the prescribed laws of the state the investor trades in. This is applicable in similar fashion as in stock market.

As in stocks, in commodities also the margin is calculated by (value at risk) VaR system. Normally it is between 5 per cent and 10 per cent of the contract value.

The margin is different for each commodity. Just like in equities, in commodities also there is a system of initial margin and mark-to-market margin. The margin keeps changing depending on the change in price and volatility.

Yes the exchanges have circuit filters in place. The filters vary from commodity to commodity but the maximum individual commodity circuit filter is 6 per cent. The price of any commodity that fluctuates either way beyond its limit will immediately call for circuit breaker.

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What is Daytrading

Day traders buy and sell stocks throughout the day in the hope that the price of the stocks will fluctuate in value during the day, allowing them to earn quick profits.

A day trader will hold a stock anywhere from a few seconds to a few hours, but will always sell all of those stocks before the close of each day.

The day trader will therefore not own any positions at the close of any day, and there is no overnight risk.

The objective of day trading is to quickly get in and out of any particular stock for a profit anywhere from a few cents to several points per share on an intraday basis.

Scalpers: This style of day trading involves the rapid and repeated buying and selling of a large volume of stocks within seconds or minutes. The objective is to earn a small per share profit on each transaction while minimizing the risk.

Momentum Traders: This style of day trading involves identifying and trading stocks that are in a moving pattern during the day, in an attempt to buy such stocks at bottoms and sell at tops.

What basic characteristics should a stock have in order to make it a suitable candidate for potential day trading? In my view, the most important attributes are:

Liquidity, broadly defined, is the existence of a sufficiently large number of buyers and sellers in a stock to permit one to quickly and easily acquire or exit a position in the stock. Good liquidity is important to the day trader who requires fast executions at relatively predictable prices. High liquidity also has the additional advantage of (generally) reducing the bid-ask spread for a particular stock therefore reducing execution costs for the day trader.

Most of the stocks of the larger companies on NSE and the BSE (particularly 'A' and 'B1' group shares) will have a sufficient degree of liquidity to make them potential day trading candidates. This is particularity true of stocks included in the major indexes such as Sensex or Nifty and Nifty Junior. On the other hand, relatively few small-cap companies would have sufficient liquidity to be attractive to most day traders.

Volume is a component of liquidity and is easily measurable. A good day trading stock should trade at least 200,000 shares a day and preferably much more. Stocks with high volumes permit the day trader to acquire or sell a large quantity of stock without unduly affecting the price of the stock.

Volatility refers to the actual or expected price movement of a stock (either up or down) over a particular period of time. In the case of day trading, the period of time to look at is a single day. Stocks which tend to exhibit little movement in price during a typical trading day are not good candidates for day trading. A good rule of thumb is to select for trading only those stocks which tend to fluctuate in price by at least rs. 7-10 in a typical trading day.

Price transparency refers to the ability to obtain information as to the order flow for a particular stock. This is also referred to as market depth. The NSE and BSE quote system provides information on all the bids and asks at various price levels for a particular stock. In addition, the quantities of stock being offered and bid for at the various price levels are made available. For day traders who have arranged for access to NSE terminals, this greatly helps the trader in assessing the relative strength or weakness of a stock and its likely direction in price.

What are the key personality traits that successful day traders tend to have in common? Here are some of the most important ones:

This is perhaps the most important personality trait of good day traders. You won't succeed at day trading unless you have a high measure of confidence in yourself. Lack of self-confidence will result in doubt, indecision and second-guessing which, in turn, will lead to missed trading opportunities and frequent losses. You must believe in yourself when day trading. If not, you will be better off pursuing some other endeavor.

In order to day trade successfully, you must develop a trading plan and consistently stick to it. You must avoid a "shooting from the hip" or a "seat of the pants approach" to day trading.

Get out of the market when you have reached your objective and do not let emotions like fear and greed influence your trading decisions.

Good day traders do not hesitate to "pull the trigger" when entering and exiting trades. Traders who are in the habit of being tentative or indecisive will never become successful.

Most successful day traders have a true love or passion about their trading activities. If you do not enjoy reading charts, dealing with numbers, reading market news, interpreting quote screens, learning new trading strategies and working independently in a fast-paced environment, then day trading is probably not your cup of tea.

Good day traders know that many of their trades will fail to meet the original objective. They do not, however seek to blame someone else for their loss, and they don't dwell on it. They attempt to learn from their mistakes and move on to the next trade.

Another personality trait of good traders is that they are comfortable with risk and are prepared to lose money from time to time. If you are afraid that you will, on occasion, lose money, then day trading is not for you.

Good traders do not rush into trades. They take the time to select good trading opportunities and do not place orders simply for the sake of holding a position in the markets at all times. On some market days, where few good trading opportunities exist, they are content to simply stand aside and wait.

In day trading, a great deal of real-time information has to be absorbed, analyzed and acted upon in intense bursts throughout the trading day. This requires a great deal of concentration and stamina on the part of the trader, and the ability to avoid distractions. Day trading can be very hard work and a lack of concentration can doom a trader to failure.

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Swing Traders

The principal difference between day trading and swing trading is that swing traders will normally have a slightly longer time horizon than day traders for holding a position in a stock. As is the case with day traders, swing traders also attempt to predict the short term fluctuation in a stock's price. However, swing traders are willing to hold stocks for more than one day,

if necessary, to give the stock price some time to move or to capture additional momentum in the stock's price. Swing traders will generally hold on to their stock positions anywhere from a few hours to several days.

Swing trading has the capability of providing higher returns than day trading. However, unlike day traders who liquidate their positions at the end of each day, swing traders assume overnight risk. There are some significant risks in carrying positions overnight. For example news events and earnings warnings announced after the closing bell can result in large, unexpected and possibly adverse changes to a stock's price.

Advantages: Slower cycle of trades, meaning fewer trades to make, fewer commissions, less chance of error and the ability to catch the more significant multi-day profitable swing trades. Technical analysis is used primarily to identify these opportunities. Average profit target percentage is much higher typically than day trading.

Disadvantages: With those higher profit targets comes higher risk per trade. If you are looking to trade over a longer timeframe, you have to expect your average risk per trade will need to be higher simply to account for the retracements that are common in all stock and futures markets trading. There is also overnight exposure and you would be exposed to any major developments.

Exact Swing Points -Support And Resistance

This is a particularly important lesson! Just about every system or method of trading at least takes note of where the key support and resistance levels are. I have found a double use for my method of identifying these points - They are also Swing Points!

The problem with Support and Resistance (S&R) is that it is not a definite number. It is not an exact point on the chart at which price will, without any hesitation stop.

In fact S&R is actually an area - it is not an exact number as we would all like to think.

The dilemma of course, is that in order to do our calculations we need an exact point. You can't enter $50.10/20 area when using fibonacci or working out your stops and limits. You need an exact number even though S&R is not an exact number.

Try telling your broker that you want a stop loss at somewhere between 50 and 55 and watch him burst a blood vessel.

This is what I want to concentrate on in this lesson. This is a technique I have found to be particularly good at not only identifying strong S&R points but also swing points.

In order to find S&R we must first identify market swing points. There are various ways of doing this but I am going to use the one I have used for years.

For the purpose of swing points we are not interested in the open or close of the bars only the high and low.

Take any bar and think of that bar as the start bar (S). If there are two consecutive higher highs than the bar you marked (S) then that is a swing up e.g. bar (1) has a higher high than bar (S) and bar (2) has a higher high than bar (1). If there are not two higher highs than bar (S) then you move to the next bar and see if there are two consecutive higher highs.

This can be particularly useful if the market is trading sideways and you are trying to determine the breakout point. There may be many peaks and valleys but for me there is only one real point - that is the most recent swing up or swing down.

You can see that although there were a few highs and lows that you could have taken as support or resistance, but it wasn't until bar (M) that a definite swing point had been identified and you could mark bar (K) with an (S).

To work out the swing down point - take any bar on a chart and think of that bar as your start point - bar (S). If the next two consecutive bars make lower lows than the previous bar then that is a swing down e.g. bar (1) has a lower low than bar (S) and bar (2) has a lower low then bar (1). If there are not two consecutive lower lows then it is not a swing point and you move to the next bar.

Just as in the example above you can see exactly the same thing with the swing down. Even though price made a few highs and lows it wasn't until bar (M) that you could mark bar (K) as the (S) point.

Only once we have clearly marker swing points can we go on to identify our support and resistance points.

As you can see from the chart I have marked all the swing up points and swing down points. When we are in a down trend then the swing down points act as resistance and when we are in an up trend the swing up points
act as support.

Marking the support and resistance points using this method of first identifying the swing points will give you definite points on a chart from which to calculate your stops, limits and projections.

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Futures are a financial derivative known as a forward contract. A futures contract obligates the seller to provide a commodity or other asset to the buyer at an agreed-upon date. Futures are widely traded for commodities such as sugar, coffee, oil and wheat, as well as for financial instruments such as stock market indexes, government bonds and foreign currencies.

The earliest known futures contract is recorded by Aristotle in the story of Thales, an ancient Greek philosopher. Believing that the upcoming olive harvest would be especially bountiful, Thales entered into agreements with the owners of all the olive oil presses in the region. In exchange for a small deposit months ahead of the harvest, Thales obtained the right to lease the presses at market prices during the harvest. As it turned out, Thales was correct about the harvest, demand for oil presses boomed, and he made a great deal of money.

By the 12th century, futures contracts had become a staple of European trade fairs. At the time, traveling with large quantities of goods was time-consuming and dangerous. Fair vendors instead traveled with display samples and sold futures for larger quantities to be delivered at a later date. By the 17th century, futures contracts were common enough that widespread speculation in them drove the Dutch Tulip Mania, in which prices for tulip bulbs became exorbitant. Most money changing hands during the mania was, in fact, for futures on tulips, not for tulips themselves. In Japan, the first recorded rice futures date from 17th century Osaka. These futures offered the rice seller some protection from bad weather or acts of war. In the United States, the Chicago Board of Trade opened the first futures market in 1868, with contracts for wheat, pork bellies and copper.

By the early 1970s, trading in futures and other derivatives had exploded in volume. The pricing models developed by Fischer Black and Myron Scholes allowed investors and speculators to rapidly price futures and options on futures. To supply the demand for new types of futures, major exchanges expanded or opened across the globe, principally in Chicago, New York and London.

Exchanges play a vital role in futures trading. Each futures contract is characterized by a number of factors, including the nature of the underlying asset, when it must be delivered, the currency of the transaction, at what point the contract stops trading, and the tick size, or minimum legal change in price. By standardizing these factors across a wide range of futures contracts, the exchanges create a large, predictable marketplace.

Futures trading is not without significant risk. Because futures contracts generally entail high levels of leverage, they have been at the heart of many market blowups. Nick Leeson and Barings Bank, Enron and Metallgesellshaft are just a few of the infamous names associated with futures-driven financial disasters. The most famous of all may well be Long Term Capital Management (LTCM); despite having both Fischer Black and Myron Scholes on their payroll, both Nobel Laureates, LTCM managed to lose so much money so rapidly that the Federal Reserve Bank of the United States was forced to intervene and arrange a bailout to prevent a meltdown of the entire financial system.

In the United States, futures transactions are regulated by the Commodity Futures Trading Commission.

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In their simplest form, stock options are a contract between two parties that expires at an agreed-upon time in the future. The contract purchaser is buying the right, but not the obligation, to buy (a "call" option) or sell (a "put" option) an asset (the "underlying") at a specific price, on or before the agreed-upon date. The contract seller is accepting the obligation to take the other side of the transaction.

The earliest known options trade dates from 7th century BCE. Thales of Miletus speculated that the year's olive harvest would be especially bountiful, and put a deposit on every olive press in his region of Greece. The harvest was bountiful, demand for olive presses skyrocketed, and Thales sold his rights, or options, to the presses at substantial profit. The modern history of stock options trading begins with the 1973 establishment of the Chicago Board Options Exchange (CBOE) and the development of the Black-Scholes option pricing model.

Stock options are defined by several key characteristics. The expiration date specifies when the option contract becomes null and void. The underlying is the asset upon which the stock option is based. The strike price, or exercise price, is the price at which the underlying asset will be bought or sold should the option holder decide to exercise their right to buy or sell. European-style stock options are only exercisable on the expiration date; American-style stock options are exercisable at any time before the expiration date.

An ATM, or at-the-money option, is one where the strike price is roughly the same as the current underlying price. An OTM, or out-of-the-money option, is one where the underlying price is far enough away from the strike price that there is no incentive for the holder to exercise the contract. Conversely, an ITM, or in-the-money option, is one where the holder can exercise the option profitably.

The simplest stock options trading strategy is to buy an OTM call (or put) option if the expectation is for a dramatic increase (or decrease) in the price of the underlying. Spreads involve buying one option and selling another; they are often used to lower the initial cost of the position at the expense of lower maximum potential profit. Examples of spreads are verticals, backspreads, bull and bear spreads, ratio spreads, butterflies, and condors.

Stock options allow speculators to make bets on market movement without having to pick an up or down direction. For example, buying both an ATM put and an ATM call would give the holder exposure to a dramatic move in either direction. Because of this, stock options traders are often said to be trading volatility rather than price.

An option's price can be influenced by a number of factors, each of which can either help you or hurt you depending on the type of option position you have established. To become a successful option trader, it is essential to understand what factors influence the price of an option, which requires learning about the so-called "Greeks" - a set of risk measures that indicate how exposed an option is to these influences: time-value decay, implied volatility and changes in the underlying price of the commodity. In this article, I discuss four risk measures - delta, theta, vega and gamma - and explain their importance. But first, I will review some related option characteristics that will help you better understand the Greeks.

Influences On An Option's Price
Figure 1 below lists the major influences on both a call and put option's price. The plus or minus sign indicates an option's price direction resulting from a change in one of the price variables in figure 1. For example, taking call options and looking at the impact of a change in implied volatility shows that when there is a rise in implied volatility, there is an increase in the price of an option, all other things remaining the same.

Bear in mind that results will differ depending on whether you long or short an option. Naturally, if you long a call option, a rise in implied volatility will be favorable since rising implied volatility typically gets priced into the option premium. But if you establish a short call option position, a rise in implied volatility will have an inverse (or negative sign) effect. The writer of a naked option, be it a put or a call, would therefore not benefit from a rise in volatility since writers desire the price of the option to decline.

Figures 2 and 3 below present the same variables, but in terms of long and short call options (figure 2) and long and short put options (figure 3). Note that a decrease in implied volatility, a reduced time to expiration and a fall in the price of the underlying will benefit the short call holder. At the same time, an increase in volatility, a greater time remaining on the option and a rise in the underlying will benefit the long call holder.

Figure 3 shows that a short put holder benefits from a decrease in implied volatility, a reduced time remaining until expiration and a rise in the price of the underlying. Meanwhile, an increase in implied volatility, a greater time remaining until expiration and a decrease in the price of the underlying will benefit the long put holder.

Because interest rates play a negligible role in a position during the life of most option trades, we will be excluding this price variable from the discussion. It is worth noting, however, that higher interest rates make call options more expensive and put options less expensive, all other things remaining the same.

This summary of the influences on option price provides a nice backdrop for an examination of the risk measures used to gauge the degree to which an option's price is influenced by these price variables. Let's now take a look at how the Greeks permit us to project changes in an option's price.

The Greeks
Figure 4 below contains four major risk measures - our so-called Greeks - all of which a trader should take into account before taking any option position. I will explain each of these measures, and then I will touch on some aspects of their relationship to each other. Since the Greeks are actually represented by letters of the Greek language alphabet, let's take them in alphabetical order.

Delta
Delta is a measure of the change in an option's price (premium of an option) resulting from a change in the underlying security (i.e. stock) or commodity (i.e. futures contract). The value of delta ranges from –100.0 to 0 for puts and 0 to 100 for calls (here delta has been multiplied by 100 to shift the decimal). Puts have a negative delta because they have what is called a "negative relationship" to the underlying: put premiums fall when the underlying rises, and vice versa.

Call options, on the other hand, have a positive relationship to the price of the underlying: if the underlying rises, so does the premium on the call, provided there are no changes in other variables like implied volatility and time remaining until expiration. And if the price of the underlying falls, the premium on a call option, provided all other things remain constant, will decline. An at-the-money option has a delta value of approximately 50 (0.5 without the decimal shift), which means the premium will rise or fall by half a point with a one-point move up or down in the underlying. For example, if an at-the-money wheat call option has a delta of 0.5, and if wheat makes a 10-cent move higher (which is a large move), the premium on the option will increase by approximately 5 cents (0.5 x 10 = 5), or $250 (each cent in premium is worth $50).

As the option gets further in the money, delta approaches 100 on a call and –100 on a put, which means that at these extremes there is a one-for-one relationship between changes in the option price and changes in the price of the underlying. In effect, at delta values of –100 and 100, the option behaves like the underlying in terms of price changes. This occurs with little or no time value, as most of the value of the option is intrinsic. I come back to the concept of time value below when we discuss theta.

Three things to keep in mind with delta: (1) delta tends to increase as you get closer to expiration for near or at-the-money options; (2) delta is not a constant, a fact related to gamma, our next risk measurement, which is a measure of the rate of change of delta given a move by the underlying; and (3) delta is subject to change given changes in implied volatility.

Gamma
Gamma, also known as the 'first derivative of delta', measures the rate of change of delta. The table below shows how much delta changes following a one-point change in the price of the underlying. This is a simple concept to grasp. When call options are deep out of the money, they generally have a small delta. This is because changes in the underlying bring about only tiny changes in the price of the option. But as the call option gets closer to the money, resulting from a continued rise in the price of the underlying, the delta gets larger (see figure 5).

In figure 5, delta is rising as we read the figures from left to right, and it is shown with values for gamma at different levels of the underlying. The column showing P/L (profit/loss) of -200 represents the at-the-money strike of 930, and each column represents a one-point change in the underlying. As you can see, at-the-money gamma is -0.79, which means that for every one-point move of the underlying, delta will increase by exactly 0.79 (for both delta and gamma the decimal has been shifted two digits by multiplying by 100). If you move right to the next column (which represents a one-point move higher to 931 from 930), you can see that delta is -53.13 (an increase of .79 from -51.34). As you can see, delta rises as this short call option gets into the money, and the negative sign means that the position is losing because it is a short position (in other words, the position delta is negative). Therefore, with a negative delta of -51.34, the position will lose 0.51 (rounded) points in premium with the next one-point rise in the underlying.

There are some additional points to keep in mind about gamma: (1) gamma is smallest for deep out-of-the-money and deep in-the money options; (2) gamma is highest when the option gets near the money; and (3) gamma is positive for long options and negative for short options (as seen above in figure 5 with our example of a short call).

Theta
Theta is not used much by traders, but it is an important conceptual dimension. Theta measures the rate of decline of time-premium resulting from the passage of time. In other words, an option premium that is not intrinsic value will decline at an increasing rate as expiration nears. Figure 6 shows theta values at different time intervals for an S&P 500 Dec at-the-money call option. The strike price is 930. As you can see, theta increases as expiration gets closer (T+25 is expiration). At T+19, which is six days before expiration, theta has reached 93.3, which in this case tells us that the option is now losing $93.30 per day, up from $45.40 per day at T+0, when we hypothetically opened the position.

Some additional points about theta to consider when trading: (1) theta can be very high for out-of-the- money options if they contain a lot of implied volatility; (2) theta is typically highest for at-the-money options; and (3) theta will increase sharply in the last few weeks of trading and can severely undermine a long option holder's position, especially if implied volatility, which I discuss next, is on the decline at the same time.

Vega

Vega, our fourth and final risk measure, quantifies risk exposure to implied volatility changes. Vega tells us approximately how much an option price will increase or decrease given an increase or decrease in the level of implied volatility. Option sellers benefit from a fall in implied volatility, and it's just the reverse for option buyers. Referring to figure 5 above, you can see that the short call has a negative vega, which tells us that the position will gain if implied volatility falls (hence the inverse relationship indicated by the negative sign). The value of vega itself indicates by how much the position will gain in this case. Using at-the-money vega, which is –96.94, we know that for each percentage-point drop in implied volatility, a short call position will gain by $96.94.

Conversely, if there should be a one-percent rise in implied volatility, the position would lose $96.94. Additional points to keep in mind regarding vega include the following: (1) vega can increase or decrease even without price changes of the underlying because implied volatility is the level of expected volatility; (2) vega can increase from quick moves of the underlying, especially if there is a big drop in the stock market, or if there is a sudden upwards burst in a commodity like coffee after a reported frost in Brazil; and (3) vega falls as the option gets closer to expiration.

Conclusion
While this overview is only an intermediate level discussion of delta, gamma, theta and vega (an advanced level analysis would involve mathematical nuances which are not practical in terms of trading), it should nonetheless help clarify not only how the price of an option is influenced by changes in the underlying, the time to expiration and the implied volatility, but also how we measure the impact of these variables on an option's price.

Finally, always remember that there is a risk of loss when trading futures and options. Trade only with risk capital.

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Stock Fundamentals

Nothing can substitute knowledge. if you have the inclination, then we are providing here the links to such resources which will help you take a studied and wise investment decision.

To understand and value a company, look at its financial position. If you borrow money from a bank, you have to list the value of all your significant assets, as well as all your significant liabilities. Your bank uses this information to assess the strength of your financial position; it looks at the quality of the assets, such as your car and your house, and places a conservative valuation upon them. The bank also ensures that all liabilities, such as mortgage and credit card debt, are properly disclosed and fully valued. The total value of all assets less the total value of all liabilities gives your net worth, or equity.

Evaluating the financial position of a listed company is quite similar, except investors need to take another step and consider financial position in relation to market value.

Like your own financial position, a company's financial position is defined by its assets and liabilities. (But a company's financial position also includes shareholder equity.) All this information is presented to shareholders in the balance sheet.

Let's look at the 2003 financial statements of publicly-listed retailer, The Gap, to provide a real world example of evaluating financial position. The company's annual report can be downloaded from The Gap's website. The standard format for the balance sheet is assets, followed by liabilities, then shareholder equity.

Current Assets and Liabilities

Assets and liabilities are broken into current and non-current items. Current assets or liabilities are those with an expected life of less than 12 months. For example, the inventories that The Gap reported as of Jan 31, 2004, are expected to be sold within the following year, whereupon the level of inventory will fall and the amount of cash will rise.

Like most other retailers, The Gap's inventory represents a big proportion of its current assets, and so should be carefully examined. Since inventory requires a real investment of precious capital, companies will try to minimize the value of inventory for a given level of sales, or maximize the level of sales for a given level of inventory. The Gap appears to have managed its inventory well, as it saw a 20% fall in inventory value together with a 23% jump in sales over the prior year. This reduction makes a positive contribution to the company's operating cash flows.

Current liabilities are the obligations the company has to pay within the coming year, and includes existing (or accrued) obligations to suppliers, employees, the tax office and providers of short-term finance. Companies try to manage cash flow to ensure that funds are available to meet these short-term liabilities as they come due.

The Current Ratio

The current ratio - which is total current assets divided by total current liabilities - is commonly used by analysts to assess the ability of a company to meet its short-term obligations. An acceptable current ratio varies across industries, but should not be so low that it suggests impending insolvency, or so high that it indicates an unnecessary build-up in cash, receivables or inventory. Like any form of ratio analysis, the evaluation of a company's current ratio should take place in relation to the past: for The Gap, the current ratio is 2.68 - up from 2.11 the previous year.

Non-current assets or liabilities are those with lives expected to extend beyond the next year. For The Gap, the biggest non-current asset is the property, plant and equipment the company needs to run its business. The $3.3 billion shown in its balance sheet is the written-down or depreciated value of the property, plant and equipment.

The Gap's biggest long-term liabilities are $1.178 billion in long-term debt and $1.38 billion in convertible notes. The footnotes at the back of the annual report reveal that most of this amount relates to obligations under property, plant and equipment leasing contracts, but importantly the note also shows that the company has access to around $732 million in borrowings.

Financial Position: Book Value

If we subtract $5.56 billion in total liabilities from $10.34 billion in total assets, we are left with shareholder equity of $4.78 billion. Essentially, this is the book value, or accounting value, of the shareholders' stake in the company. It is principally made up of the capital contributed by shareholders over time and profits earned and retained by the company, including that portion of the 2003 profit not paid to shareholders as a dividend.

While the book value of The Gap was just $4.78 billion at Jan 31, 2004, the market value of the company (900 million shares x the share price of $22.53) was around 4.2 times that, or $20.3 billion.

Market-to-Book Multiple

By comparing the company's market value to its book value, investors can in part determine whether a stock is under or over-priced. The market-to-book multiple, while it does have shortcomings, remains a key tool for value investors. Extensive academic evidence shows that companies with low market-to-book stocks perform better than those with high multiples. This makes sense since a low market-to-book multiple signals the company has a strong financial position in relation to its price tag.

Determining what can be defined as a high or low market-to-book ratio also depends on comparisons. To get a sense of whether The Gap's book-to-market multiple of 4.2 is high or low, you need to look at the multiples of other publicly-listed retailers.

Conclusion
Financial position, embodied by its accounting value, tells investors about a company's general well being. A study of it (and the footnotes in the annual report) is essential for any serious investor wanting to understand and value a company properly.

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