NISM Certifications · NISM-Series-VIII: Equity Derivatives

Strategies using Equity Futures and Equity Options

This chapter covers how traders use equity futures and options to speculate, hedge and earn arbitrage profits. You solve questions by drawing the payoff at expiry: compute profit or loss for each price, add premiums paid or received, then find breakeven and maximum gain or loss. Learn each strategy's shape and numbers.

What this chapter covers

This chapter turns the instruments you studied earlier into working strategies. You start with the payoff of a single futures position, then move to hedging and arbitrage. After that you cover options: long and short calls and puts, then combinations such as covered calls, protective puts, spreads, straddles and strangles.

Every strategy is built from a few basic payoffs. A long futures position gains when the price rises and loses when it falls. A long call or long put has limited loss (the premium) and, for a call, unlimited gain. A short option has the reverse profile. If you know these building blocks, you can derive any combination by adding payoffs.

The chapter links to the rest of the paper. Pricing of futures (cost of carry) and option premium factors feed into arbitrage and strategy choice. Trading, clearing and settlement, margins and risk management explain how these positions work in practice. Questions here are often numerical, so the chapter also tests your arithmetic under time pressure.

NISM-Series-VIII has 100 questions in 2 hours, a 60% pass mark and negative marking of 25% of the marks assigned to a question. Strategy questions are usually calculation-based: breakeven, maximum profit, maximum loss, net premium. These have one definite answer, so you can get them right every time with practice, and you avoid the penalty for wrong guesses. The chapter also tests the logic of hedging and arbitrage, which appears again in other parts of the paper.

Strategies using Equity Futures and Equity Options: topics in the order to study them

1Futures Payoffs: Long and Short FuturesIt is the simplest payoff, linear and symmetric, and it sets up the profit-or-loss method you use everywhere else.
2Hedging with Futures and Basis RiskIt applies futures payoffs to a real purpose and introduces basis, the gap between spot and futures price.
3Arbitrage: Cash and Carry and Reverse Cash and CarryIt uses the same futures positions with spot trades and depends on fair futures value from cost of carry.
4Option Payoffs: Long and Short Calls and PutsThese four payoffs are the building blocks of every option strategy, so they must be solid before combinations.
5Covered Call, Protective Put and Hedging with OptionsThese combine a stock position with one option, an easy first step into combined payoffs.
6Spreads: Bull, Bear, Butterfly and CalendarSpreads need two or more options, so you add payoffs and track net premium, maximum gain and maximum loss.
7Straddles and StranglesThey combine a call and a put on volatility views, so study them last, once you can add payoffs quickly.

How to prepare Strategies using Equity Futures and Equity Options

Learn by drawing and calculating, not by memorising names. Each strategy should reduce to a payoff you can build in under a minute.

Write the payoff formula for each of the four basic option positions and for long and short futures. Include the premium in each.
For every strategy, list its view (bullish, bearish, neutral, volatile), net premium paid or received, breakeven, maximum profit and maximum loss.
Solve each strategy with a made-up example: pick three prices (below, between and above the strikes) and compute total profit or loss.
Learn the hedging logic: which side of futures you take for a long stock position or a short one, and why basis risk remains.
For arbitrage, compare the actual futures price with fair value and decide which trade (cash and carry or reverse) is profitable.
Practise timed MCQs and note which wrong options tempt you, such as ignoring premium or reversing buyer and seller.
On the last day, redo only the strategies where you made errors, using the quick revision list.

Common mistakes in Strategies using Equity Futures and Equity Options

Ignoring the premium when finding breakeven or profit.
Fix: Always start with net premium. Call breakeven is strike plus premium; put breakeven is strike minus premium.
Mixing up buyer and seller payoffs.
Fix: Remember the seller's profit is the buyer's loss. Check the sign of the premium cash flow first.
Choosing the wrong arbitrage trade.
Fix: Compare actual futures price with fair value. Overpriced futures: cash and carry. Underpriced: reverse cash and carry.
Believing a futures hedge removes all risk.
Fix: Remember basis can change before the hedge is closed, so basis risk remains.
Getting maximum profit and loss of spreads wrong.
Fix: Compute net premium, then use the strike difference. Test with prices below, between and above the strikes.
Confusing straddle with strangle, or long with short.
Fix: Straddle means one strike; strangle means two strikes. Long means you pay premium and need a big move.

Last-day revision: Strategies using Equity Futures and Equity Options

Long futures gains when price rises; short futures gains when price falls; both have unlimited potential on one side.
Long call: loss limited to premium, gain unlimited; breakeven = strike + premium.
Long put: loss limited to premium; breakeven = strike − premium.
Short option seller earns only the premium as maximum profit; call seller's loss is unlimited.
Option buyer pays premium; seller receives it. Always include it in profit calculations.
Hedging with futures reduces price risk but leaves basis risk.
Cash and carry: buy spot, sell futures when futures are overpriced relative to fair value.
Reverse cash and carry: sell spot, buy futures when futures are underpriced.
Covered call: long stock plus short call; protective put: long stock plus long put.
Bull spread suits a rising view; bear spread suits a falling view; both limit profit and loss.
Straddle: same strike call and put; strangle: different strikes, usually cheaper.
Long straddle or strangle profits from a large move in either direction; short ones profit from small moves.

Strategies using Equity Futures and Equity Options practice questions

Strategies using Equity Futures and Equity Options in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Strategies using Equity Futures and Equity Options: frequently asked questions

Are the questions in this chapter mostly numerical?

Many are. You are often asked for breakeven, profit, loss or net premium for a given position. Others test which strategy fits a market view. Practise both types.

Do I need to memorise payoff diagrams?

You should understand their shape, but it is safer to calculate. Work out profit or loss at a few prices and the shape follows.

How does negative marking affect strategy questions?

A wrong answer costs 25% of the marks assigned to that question. Since these questions have a calculable answer, solve them rather than guess. Skip only if you cannot narrow the options.

Which topics should I revise last?

Spreads, straddles and strangles. They combine several payoffs, so they fade quickly. Redo a few examples of each before the exam.