HYDERABADAPRIL 2010 - FUNDAMENTAL APPROACH TO EQUITIES RAGHU IYER TRAINING

This program is designed to help you with the basic fundamentals of financial statements, research reports and understand what is written thereThis will help you to buy shares with a fundamental understanding (profits, reserves, book value, capital, growth, sales revenue) - this will create wealth in the long run

SECOND REASONAs time passes, clients will become more knowledgeableCompetition will become more knowledgeableSo in order to grow (or even survive) as an individual, you need to KNOWThis is knowledge economy

From Adam's days to 1800 - agricultural economyFrom 1800 to 1975 - industrial economyFrom 1975 till date - knowledge economy

AGENDA FOR TWO DAYS1 What drives share prices2 Fundamental approach to investing3 Value versus Price4 Importance of Value Multiples (PE, PBV, EV/EBIDTA)5 Go thro United Phosphorous Research Report (afternoon)6 Discuss your findings on the Report

TOM1 Fair valuation of the Nifty (India)2 Where is the market now and how do you invest in the current market

Can we get a general understanding of markets for all times3 How can you invest to make money in the long run (creation of wealth)4 Derivatives - Combination Strategies - Bull Spread, Ratio Spreads, Butterflies, etc5 Option valuation - Intrinsic, Time value - how do you make money / lose on Time Value6 Indicators - Open Interest, Implied Volatility, Put Call Ratio

Very simpleTechnicals is not part of the program

You don’t need to agree with meIf everybody agreed with everybody in the market placeIf everyone believed that ITC is a good buy - what will happen?Market will stop, BSE will close downThe basic foundation of markets is disagreement

WHAT DRIVES SHARE PRICESResearch study done in the UK, which identified three factors:

1 Liquidity2 Sentiment3 Fundamentals

1 LiquidityCash flow - is cash coming in or is cash flowing out?Who creates cash flow in India?a FIIsb All others - mutual funds, insurance sector, HNIs, retail - quite quite small

In 2007, FIIs brought in around USD 16 bio (Rs 70,000 cr) - market zoomed upIn 2008, FIIs took out around USD 17 bio (Rs 75,000 cr) - market fell 60%In 2009, FIIs brought in around USD 18 bio (Rs 80,000 cr) - market rose 100%Today, the FII community is the single largest cash flow provider and the Indian market dances to their tune

Indian Govt is definitely worried bcoz dependence on foreignors is bad strategyForeignors are affected by global factors which we cannot control or even understand

In the long run, we believe that (a) our domestic insurance sector will become huge and(b) our provident funds will start investing in the equity marketThese will provide reasonable counter-balance to the FIIs

2 SentimentNews flow - continuous news flow from global sources to Indian sources to sectoral sourcesto company level sourcesStock markets react to news all the time, driven by sentiment (not by logic)In Nov 2009, we heard that Dubai is in troubleSensex crashed 300 / 400 points

Now we heard that Greece is in troubleSensex crashed 250 points

Most human beings are emotional beings, not intellectual beingsWe are 99% emotional and 1% intellectual

3 FundamentalsWe mean company's financial performance and financial prospectsHow is it doing and how is it expected to do?Sales, Operating Margins, EBIDTA, PAT, EPS, PE, RoE, RoCE, Debt - Equity ratio, Working Capital Management - Sectoral issues, growth in the sector, customer demand, technological leadership, management quality, dividends, bonuses, investor friendly

WHICH OF THESE FACTORS ARE MORE IMPORTANT THAN THE OTHERSIn the short term, markets are driven by liquidity and sentimentIn the long term, markets are driven by fundamentals

In the short term, fundamentals are uselessMost of the time, you will find that financial results are good, but share price has dropped

If Infosys over the last 15 years has gone from Rs 100 to Rs 20,000 - why?Answer - great fundamental performance

If Infosys in the last 15 minutes has gone from Rs 2,421 to Rs 2,408 - why?Answer - liquidity and sentiment

Someone wanted to sell very rapidly and he was happy to sell below Rs 2,421 also

WHAT IS SHORT TERM AND WHAT IS LONG TERMWhat was the largest investment by the Britishers in India?RailwaysWhat must have been their time horizon while making these investments? When would they have got their money back?25 to 30 years

GMR runs Hyderabad Airport - they built Hyderabad AirportHow long do you think they will take to make money? How long will they run the airport?10 to 15 years payback periodTheir concession agreement with the Govt runs for 60 years

What was Warren Buffet's largest investment last year (2009)?Northern Railroad (railway in America) - Rs 85,000 crVery simple argument - US will grow (slowly) year on year - long termOil prices will rise (crude is short)As oil prices increase, trucking will become expensiveMore and more cargo will move to rail transport and railways will do wellUS grows at 2% plus trucking move to rail - another 2%Time horizon - 30 yearsHis age is 77 years

Planning Commission of IndiaShort term 5 yearsMedium term 5 to 15 yearsLong term More than 15 years

Sharekhan Hyderabad Branch - Derivatives DealerWhat is the time now?Short term Next 10 minutesMedium term Upto lunch timeLong term End of day 330 pm

He will be afraid to keep any position open at 330 pm - overnite risk

In the world of fundamental investing, you need long term thinkingLong term need not mean 30 years, 40 yearsBut you should have the vision for at least 3 years - if you want to make money in the shorter run (less than 3 years), then maybe fundamental approach is not the best approach for youMaybe trading could be tried

Research says that over a 12 year period, almost 90% of the movement in stock prices can be related to fundamentalsIf Infosys 12 years ago was Rs 500Today it is 20000Appreciation 19500

90% 10%

17550 1950Fundamental Liquidity and SentimentFactors

If Him Fut 10 years ago was 2600Today it is 11Appreciation -2589

90% 10%-2330.1 -258.9

Fundamental Liquidity and SentimentFactors

INVESTING VERSUS TRADINGAs stock brokers, your business model is trading orientedYou want fast traders as your clientsIn the long run, investing can create wealth (trading may or may not)

If you allocate 10 - 15% of a good client's portfolio towards investing, that 10-15% may create good wealth in the long runThat can add to customer loyalty and goodwill and bring in a long term relationship

FUNDAMENTAL APPROACH TO INVESTINGBasic beliefs and how do we make money from these beliefs:

1 Price is different from Value2 Price is known every moment in the market3 Value is unknown, unseen, unfelt - but it exists4 If we can understand Value, we can make money5 Price is generally wrong - the market is generally mispriced - overpriced or underpriced6 Market moves based on liquidity and sentiment (over-excited or miserable)7 Market is like a stopped clock - a stopped clock shows the right time twice a day

The market shows the right price rarely (price = value)8 This equilibrium (price = value) is not sustained, soon there is chaos9 If you buy when price < value, and wait wait wait for a situation when price = value, price > value,

you can make money10 We don’t know how long we will have to wait - we need patience bcoz we don’t know when

equilibrium will happen (we believe it will happen sometime)

Price

Sell

Buy

11 We are very happy that market is not logical, market is driven by sentiment and liquidity and this behaviour provides opportunity for us to make money

WHAT IS VALUE?How is it computed / measured?

ExampleThere is a shop in Vijaywada - price of the shop is Rs 15You have some surplus cash, you want to buy this shop and let it out on rent for 5 yearsAfter 5 years, you plan to sell the shopYou want to know what is the "value" of the shop

Reasonable rental for the shop per month Rs 5000Reasonable increment in rental every year 15% 115%Reasonable appreciation in property value annua 10% 110%What is your return on other possible investment 8% 108%

Valuation can be done on Discounted Cash Flow basis as follows:

Year Rental Property Total Present DCFValueFactor 1.000

1 60.00 60.00 0.926 55.56 2 69.00 69.00 0.857 59.16

3 79.35 79.35 0.794 62.99 4 91.25 91.25 0.735 67.07 5 104.94 ### ### 0.681 1,715.55

Value 1,960.33 Price 1,500.00 Value > Price - good buy

If Interest rates rise to 12%, the shop becomes unattractive (not a good buy)If Interest rates fall to 1%, the shop becomes very very attractive

Valuation is not only dependent on shop related data but also your cost of borrowings / opportunity cost of other investments

DCF valuation of companies is difficult - bcoz you need lots of dataShort cut is multiples

PE multiple (Price / Earnings)What is the PE of the shop?Price 1,500 Earnings in year one 60 PE 25 times

For every one rupee of earning, the price is Rs 25Most popular multiple in retail stock market is the PE

When we see the figure of 25, we should be able to understand whether this is too high, too low, interesting, attractive ?

Company PE = CMP / EPSEPS - Earnings per Share = PAT / No of Equity Shares

Share capital Rs 200 crPAT Rs 300 crShare price Rs 450 per share

You need information on Face Value per shareIf Face Value per share is Rs 10No of Shares 200 10 20 cr

EPS = PAT / No of Shares300 20 15.00

PE = CMP / EPS450 15.00 30.00 times

For every one rupee of earnings, the price is Rs 30PE of the shop was 25 timesWhich is cheaper?Shop is cheaper than this share

What is the PE of the Post Office?Price is Rs 100Earnings are Rs 8PE 12.5 times

Comparative PECompany 30.00 Most expensiveShop 25.00 Post Office 12.50 Cheapest

PE tells us what is cheap and what is expensive

Infosys price is Rs 2,600Satyam price is Rs 97Which is cheaper?

Price Earnings PEInfosys 2600 106 24.53 CheaperSatyam 97 1 97.00 Expensive

EPS / PETrailing Based on past 4 quarters profitsForward Based on future projected profits (could be FY 11, 12)

Basic Number of shares as of todayDiluted Number of shares that will be issued in future

Past 4 quarters profit is Rs 250 crFY 11 estimated profit is Rs 325 crCurrent No of Shares 20 crAdditional shares to be issued 3 crFuture No of Shares 23 crCMP 160.00

EPS Rs PE xTrailing / Basic 12.50 12.80 Trailing / Diluted 10.87 14.72 Forward / Basic 16.25 9.85 Forward / Dilut 14.13 11.32

As an investor, which one is the most relevant definition?The investor is very keen on forward earnings and he should be concerned with dilution of equity

Future number of shares are those shares which the company is legally obligated to issueThese are not mere plansExamples:

1 Convertible Debentures2 FCCBs - Foreign Currency Convertible Bonds3 Convertible Preference Shares4 Warrants5 ESOPs

UNITED PHOSPHOROUS RESEARCH REPORT1 P&L2 Bal Sheet3 Ratios as given4 Valuation multiples as given

1 P&LNet Sales 2,449.8 Core IncomeOperating Costs 1,882.7 Raw Materials, Labour, Mfg, Admin, SellingOperating Profit 567.1 Other Income 21.2 Interest, Dividends, Capital Gains (Non Core Income)EBIDTA 588.3 Earnings Before Interest, Depn, Tax and AmortizationDepreciation & Amo 165.6

EBIT 422.7 Interest 104.6 PBT 318.1 Before Exceptional ItemsExceptional Item 7.6 PBT 310.5 After Exceptional ItemsTax 52.5 PAT 258.0 Adjusted PAT 265.6 Regular PAT plus Exceptional Item added back

Exceptional items could be VRS, loss due to floods, strikes (non-routine items, unusual items)PAT is also called Net ProfitAdjusted PAT is the realistic PAT as estimated by the analyst. In this case, he has merely added back Exceptional Items. In other cases, he may make other adjustments.

Amortization is Depreciation of Intangible Assets (Goodwill, Patents, IPR)Depreciation is applied for Tangible Assets (Buildings, Plant, Machinery)

If you buy a car for Rs 8 lakhs and it has a life of 10 years, the annual expense will be Rs 80,000 and this will be called as DepreciationIf you buy a patent for Rs 8 lakhs and it has a life of 10 years, the annual expense will be Rs 80,000 and this will be called as Amortization

RPAT - Reported PAT - Reported as per the Company's P&L in their Annual ReportThis profit would be Profit After Tax before Minority Interest

UPL has many subsidiaries (children) - where UPL holds more than 50% shareholdingIf UPL holds a company in Europe where its shareholding is 60% and Tony Blair holds 40%UPL Europe makes a profit of Rs 100 crHow much of that belongs to UPL India?Rs 60 crRs 40 cr belongs to who?Tony BlairTony Blair is the minority shareholder in UPL Europe

In my P&L, first I will add the entire Rs 100 cr in my PATThen I will deduct Rs 40 cr as Minority Interest

Then I will show Rs 60 cr as PAT after Minority Interest

RPAT 282.1 Minority Interest must be 24.2 PAT after Minority Interest 257.9

EPS = PAT / No of SharesRPAT 282.1 Share Capital 37.5 Face value per Share (Rs) 2.0 No of Shares 18.75 EPS 15.0

Fully Diluted EPS (given) 15.0 This you cannot calculate (company will provide)This depends on CD, FCCB, CPF, W, ESOPs

BV - Book ValueBV = Shareholders Funds / No of SharesShareholders Funds means funds provided by shareholders (owners)Shareholders Funds = Capital + ReservesReserves means past accumulated profits + Share Premium if any

Shareholders Funds 1,495.4 No of Shares 18.75 Book Value per Share Rs 79.8

Book Value indicates the amount invested by shareholders historically into the companyIf you compare this book value with the CMP, you get the PBV (Price to Book Value)

Price 163.0 BV 79.8 PBV 2.0 TimesThe actual PBV is 4.1 Why?There was a bonus issue in FY 09 of 1:1So the price of 163 of today would have been double before FY 09If you want the PBV of FY 07, then the price should be adjusted (double)

Adjusted Price 2 326.0

BV 79.8 PBV 4.1

PBV tells you the quantum of wealth created by the companyIf PBV > 1, it indicates that wealth has been createdIf PBV < 1, it indicates that wealth has been destroyed

Accounting GoodwillArises only on "acquisitions"If UPL acquires a Spanish company for Rs 200 cr but gets assets of only Rs 175 cr, the extra amount paid is recognized as Goodwill

Net Current AssetsAlso called "Working Capital"Current Assets minus Current Liabilities

Current Assets includeInventoriesReceivablesCash and Bank BalancesLoans and Advances and Deposits

Current Liabilities includeVendors PayableBills PayableExpenses Outstanding

Working capital indicates the amount blocked in day to day running of the business

Simple Debt Equity RatioDebt 1959.3Shareholders Fun 1495.4Debt Equity 1.3

Net Debt = Debt minus Cash BalanceCash Balance we don’t know, but we can easily find out

Net Debt Equity 1.0

Equity 1,495.4 Therefore Net Debt will be 1,495.4 Gross Debt is 1,959.3 Cash Balance must be 463.9

RoCE - Return on Capital Employed = EBIT / CEEBIT 422.7 CE - Total of Bal Sheet 3,533.9 RoCE 12.0%

This capital employed includes funds provided by shareholders as well as funds provided by banks

RoNW - Return on Net Worth (also called RoE - Return on Equity)Net Worth = Shareholders Funds = EquityRoE = PAT / NWRPAT 282.1 Shareholders Funds 1,495.4 RoNW 18.9%

BusinessCE RoCEEBIT

Bankers Govt OwnersInterest Inc Tax Equity

PAT

For the Owner to generate a healthy RoE, the business should generate a healthy RoCE

KEY RATIOS1 Check the ratios for FY 09, FY 10, FY 112 Valuation ratios PE, PBV for same 3 years3 From the P&L, check the EPS for same 3 years4 Read the Research Report carefully

Key ratios for FY 09FY 09 FY09 FY 09

OPM 944.9 4,931.7 19.2%EBIDTAM 986.7 4,931.7 20.0%PATM 475.2 4,931.7 9.6% He has considered Adjusted PAT for this purposeNet Debt : Equity 1,562.8 2,604.6 0.6 Gross Debt 2,072.3 RoCE (EBIT/CE) 794.0 4,794.4 16.6%RoNW 485.1 2,604.6 18.6% He has considered RPAT

EBIDTA 986.7 Depreciation 192.7 EBIT 794.0

Debt Equity Ratio means Debt / EquityNet Debt means Gross Debt (Borrowings) minus Cash on HandNet Debt Equity Ratio is givenWe know Equity (Shareholders Funds)We know the Gross DebtWe know the RatioSo we can get the Cash Balance

Net Debt Equity Ratio = Gross Debt - CashEquity

In the year FY 09:0.6 = 2072.3 - Cash

2604.6

1562.76 = 2072.3 - Cash

Cash = 509.54

Valuation RatiosFY 09

PE Multiple 163.0 11.0 14.8 The analyst has considered simple EPS and not diluted EPSBook Value 2,604.6 44.0 59.3 PBV 163.0 59.3 2.7 EPS 485.1 44.0 11.0

Reading the Report and summarizing the contentsPage OneSummary

1 Diversified product portfolio - many products2 India sales are 20% of total sales, Sales abroad are 80%, various geographies3 Patent protection is going off in many products, UPL is a generic player4 India demand is likely to be strong and growing5 Revenue growth was 37% per annum (2005 - 2009) - CAGR6 Future revenue growth will slow down to 13% (2009 - 2011) - lower selling prices7 OPM will improve by 0.80% (lower raw mat cost and Cerexagri)8 Production will shift from India from Australia and Argentina9 PAT will grow at 28% CAGR (2009 - 11)

10 Historically, UPL share price has quoted at 9.4 x EV/EBIDTA multiple - at the moment it is trading at a discount - 7.9 x FY 10 and 6.4 x FY 11

11 He has not considered seed business profits12 Target price is Rs 225 - derived as 8.5 x FY 2011 EV/EBIDTA

Poor man's multiple is PE - retailPE = Price / EPS

Rich man's multiple is EV/EBIDTA - if Vijay Mallya wants to buy Deccan Airways, he will study EV/EBIDTAIf Raghu Iyer wants to buy 2 shares of Deccan Airlines, he will look at PE

What is EV? EV stands for Enterprise Value (value of the enterprise)Market Cap No of Shares x CMP

+ Debt- Cash

What does it mean?If I buy the whole company, what will it cost me

If I spend that much EV, what do I earnYou earn EBIDTA

So what is the relationship between EV and EBIDTA - that becomes the multiple

Enterprise Value of United Phosphorous Ltd - FY 10

Market Cap 44.0 163 7,163.9 Debt 2,472.3

9,636.2 Less : Cash Balance 577.0 Back calculatedEnterprise Value 9,059.2 EBIDTA 1,139.9 EV / EBIDTA Multiple 7.9 Given

Historically, UPL has traded at a multipl 9.4 timesNow it is trading at a discount

Let us apply a discount of 10% 0.9 A reasonable multiple could be 8.5 EBIDTA of FY 11 1,330.5 Target EV ###Estimated Net De 2,072.3 540.0 1,532.3 Estimated Market Cap ###No of Shares 44.0 Target Share Price 221.2

CAGR Fundamental analysis is all about long term - patienceIn the long term, growth is very importantGrowing companies will get good multiples (high multiples)What is growth? How do we measure growth?

YoY, QoQ, Sequential, CAGR - all these are growthFY 08-09FY 08-09 FY 08-09 FY 08-09 FY 09-10 FY 09-10

Q1 Q2 Q3 Q4 Q1 Q2Sales 150 222 201 181 200 212Sequential QoQ 48% -9% -10% 10% 6%

CumuSales 754 YoYQtly YoY 33% -5%

All these are short term growth measurements which are not useful for long term investingThese growth metrics create "noise"

Short term data by itself can be highly volatile and therefore misleading

Practical applicationsExamplesPrice of a bus ticket many years ago 0.50 1995Price of the same bus ticket today 10.00 2010

20 15times years

CAGR 15th root of 20 tim 1.221055 0.221055 22%

Price of house in Guntur 2.50 1998Price of a similar house today 12.00 2010

4.8 12times years

CAGR 1.139646 0.139646 14%

Price of land in Vijaywada 2.50 2003Price of similar land today 80.00 2010

32 7times years

CAGR 1.640671 0.640671 64%

Price of chai - Blue Sea Hotel in Hyderabad 0.50 2002Price of chai today 7.00 2010

14 8times years

CAGR 1.390804 0.390804 39%

Sensex many many years ago 100 1979Sensex today 18,000.00 2010

180 31times years

CAGR 1.182363 0.182363 18%

UPL Sales 2007 - 2011 2,449.8 2007UPL Sales 2007 - 2011 6,335.7 2011

2.5862111 4times years

CAGR 1.268136 0.268136 27%

UPL RPAT 2007 - 2011 282.1 2007UPL RPAT 2007 - 2011 807.4 2011

2.8621056 4times years

CAGR 1.300683 0.300683 30%

This program is designed to help you with the basic fundamentals of financial statements, research reports

This will help you to buy shares with a fundamental understanding (profits, reserves, book value, capital,

So in order to grow (or even survive) as an individual, you need to KNOW

Where is the market now and how do you invest in the current marketCan we get a general understanding of markets for all times

How can you invest to make money in the long run (creation of wealth)Derivatives - Combination Strategies - Bull Spread, Ratio Spreads, Butterflies, etcOption valuation - Intrinsic, Time value - how do you make money / lose on Time Value

All others - mutual funds, insurance sector, HNIs, retail - quite quite small

In 2007, FIIs brought in around USD 16 bio (Rs 70,000 cr) - market zoomed upIn 2008, FIIs took out around USD 17 bio (Rs 75,000 cr) - market fell 60%In 2009, FIIs brought in around USD 18 bio (Rs 80,000 cr) - market rose 100%Today, the FII community is the single largest cash flow provider and the Indian market dances

Indian Govt is definitely worried bcoz dependence on foreignors is bad strategyForeignors are affected by global factors which we cannot control or even understand

In the long run, we believe that (a) our domestic insurance sector will become huge and(b) our provident funds will start investing in the equity market

News flow - continuous news flow from global sources to Indian sources to sectoral sources

Stock markets react to news all the time, driven by sentiment (not by logic)

Most human beings are emotional beings, not intellectual beings

We mean company's financial performance and financial prospects

Sales, Operating Margins, EBIDTA, PAT, EPS, PE, RoE, RoCE, Debt - Equity ratio, Working Capital Management - Sectoral issues, growth in the sector, customer demand, technological leadership, management quality, dividends, bonuses, investor friendly

WHICH OF THESE FACTORS ARE MORE IMPORTANT THAN THE OTHERS

Most of the time, you will find that financial results are good, but share price has dropped

If Infosys over the last 15 years has gone from Rs 100 to Rs 20,000 - why?

If Infosys in the last 15 minutes has gone from Rs 2,421 to Rs 2,408 - why?

Someone wanted to sell very rapidly and he was happy to sell below Rs 2,421 also

What must have been their time horizon while making these investments? When would they have got their

How long do you think they will take to make money? How long will they run the airport?

More and more cargo will move to rail transport and railways will do well

But you should have the vision for at least 3 years - if you want to make money in the shorter run (less than 3 years), then maybe fundamental approach is not the best approach for you

Research says that over a 12 year period, almost 90% of the movement in stock prices can be related to

Liquidity and Sentiment

Liquidity and Sentiment

If you allocate 10 - 15% of a good client's portfolio towards investing, that 10-15% may create good wealth

That can add to customer loyalty and goodwill and bring in a long term relationship

Price is generally wrong - the market is generally mispriced - overpriced or underpricedMarket moves based on liquidity and sentiment (over-excited or miserable)Market is like a stopped clock - a stopped clock shows the right time twice a day

This equilibrium (price = value) is not sustained, soon there is chaosIf you buy when price < value, and wait wait wait for a situation when price = value, price > value,

We don’t know how long we will have to wait - we need patience bcoz we don’t know when

equilibrium will happen (we believe it will happen sometime)

Value

We are very happy that market is not logical, market is driven by sentiment and liquidity and this behaviour provides opportunity for us to make money

lakhsYou have some surplus cash, you want to buy this shop and let it out on rent for 5 years

15

If Interest rates rise to 12%, the shop becomes unattractive (not a good buy)

Valuation is not only dependent on shop related data but also your cost of borrowings / opportunity cost

When we see the figure of 25, we should be able to understand whether this is too high, too low, interesting,

Expensive

Based on future projected profits (could be FY 11, 12)

The investor is very keen on forward earnings and he should be concerned with dilution of equity

Future number of shares are those shares which the company is legally obligated to issue

Raw Materials, Labour, Mfg, Admin, Selling

Interest, Dividends, Capital Gains (Non Core Income)Earnings Before Interest, Depn, Tax and Amortization

Regular PAT plus Exceptional Item added back

Exceptional items could be VRS, loss due to floods, strikes (non-routine items, unusual items)

Adjusted PAT is the realistic PAT as estimated by the analyst. In this case, he has merely added back Exceptional Items. In other cases, he may make other adjustments.

Amortization is Depreciation of Intangible Assets (Goodwill, Patents, IPR)Depreciation is applied for Tangible Assets (Buildings, Plant, Machinery)

If you buy a car for Rs 8 lakhs and it has a life of 10 years, the annual expense will be Rs 80,000

If you buy a patent for Rs 8 lakhs and it has a life of 10 years, the annual expense will be Rs 80,000

RPAT - Reported PAT - Reported as per the Company's P&L in their Annual Report

UPL has many subsidiaries (children) - where UPL holds more than 50% shareholdingIf UPL holds a company in Europe where its shareholding is 60% and Tony Blair holds 40%

This you cannot calculate (company will provide)

Shareholders Funds means funds provided by shareholders (owners)

Reserves means past accumulated profits + Share Premium if any

Book Value indicates the amount invested by shareholders historically into the companyIf you compare this book value with the CMP, you get the PBV (Price to Book Value)

So the price of 163 of today would have been double before FY 09If you want the PBV of FY 07, then the price should be adjusted (double)

If UPL acquires a Spanish company for Rs 200 cr but gets assets of only Rs 175 cr, the extra amount paid

Working capital indicates the amount blocked in day to day running of the business

This capital employed includes funds provided by shareholders as well as funds provided by banks

RoNW - Return on Net Worth (also called RoE - Return on Equity)

RoE

For the Owner to generate a healthy RoE, the business should generate a healthy RoCE

He has considered Adjusted PAT for this purposeDiff is Cash 509.5

He has considered RPAT

The analyst has considered simple EPS and not diluted EPS

India sales are 20% of total sales, Sales abroad are 80%, various geographiesPatent protection is going off in many products, UPL is a generic player

Future revenue growth will slow down to 13% (2009 - 2011) - lower selling pricesOPM will improve by 0.80% (lower raw mat cost and Cerexagri)

Historically, UPL share price has quoted at 9.4 x EV/EBIDTA multiple - at the moment it

Rich man's multiple is EV/EBIDTA - if Vijay Mallya wants to buy Deccan Airways, he will study EV/EBIDTAIf Raghu Iyer wants to buy 2 shares of Deccan Airlines, he will look at PE

So what is the relationship between EV and EBIDTA - that becomes the multiple

FY11 7,163.9 2,072.3 9,236.2

Back calculated 540.0 8,696.2 1,330.5 6.5

FY 09-10FY 09-10Q3 Q4

183 234

-14% 28%

829 10%

-9% 29%

All these are short term growth measurements which are not useful for long term investing

Short term data by itself can be highly volatile and therefore misleading

Day Two

Valuation in more detail History of the PE in IndiaHigh and low levels that we have seen in our past - learnings from themCurrent PE level in IndiaPEG (Price Earnings to Growth)Valuation of the Nifty based on DCFReasonability of the PE based on statistics

You can understand the Nifty level at any time (too high, too low, reasonable band) - buy / hold / sell

Future of IndiaHow to make money from the marketSystematic Investing

What should you see in any Research ReportAre there good and bad levels of some ratios that we should be careful about

Importance of PEWhat is the PE of India today?India PE means Sensex PE or Nifty PE

PE is "number of times"For every one rupee that I am earning, what is the priceThe Nifty PE on 9th April, 2010 was 23.21 timesFor every one rupee that the Indian corporate is earnings, we are paying a price of Rs 23.21

Is this valuation of 23.21 times too high / too low ?What is the PE of the Post Office?

Price 100Earning 8PE 12.5 times

History of the PESensex started in 1979Early 1980s 7 timesMid 1980s 8 - 9 times

Late 1980s 9 - 11 timesEarly 1990s Over 70 times Harshad Mehta periodMid 1990s 10 - 14 timesLate 1990s, Early 2000 28 times Ketan Parekh periodEarly 2000 - mid 2003 10 - 14 timesMid 2003 to Jan 2008 10 - 28 timesJan 2008 - Sept 2008 28 - 10 timesSept 2008 - March 2010 10 - 23 times

21000 Sensex (Jan 2008) is lower than 4600 Sensex (Sept 1994)Sensex PE in Jan 2008 was 28 times, while the PE in Sept 1994 was 72 times

If you compute the average PE over the last five to ten years, it will give you a good sense of valuationAlso study the max PE and the min in this periodWe buy when Price < Value and sell when Price > ValueWhen PE rises too much, that means Price is rising too fast and vice versa

Average PE 18.92 Last five yearsAverage PE 17.68 Last ten years

Max PE 28.29 Last five yearsMax PE 28.29 Last ten years

Min PE 10.68 Last five yearsMin PE 10.68 Last ten years

If PE goes above 28 times, the market looks overpriced and you should be selling and getting outIf PE goes below 11 times, the market looks underpriced and you should be buying buying buying

Standard deviation conceptI want to know the heights of adult males in HyderabadThe population of Hyderabad is 80 lakhs, of which 25 lakhs are adult malesI can take a sample of 30 people and estimate the heights of the entire population using statistics

Data of 30 peopleAverage of these people 165 cmsStandard deviation of this data 15 cms1 sigma 15 cms

2 sigma 30 cms3 sigma 45 cms

Standard deviationDistance from the average 168 165Square of this distanceSum of the squares of 30 observationsSquare root of this sum

Statistical Model - Normal Distribution - Gaussian Distribution66% of the observations will fall within +/- 1 sigma 95% of the observations will fall within +/- 2 sigma 99% of the observations will fall within +/- 3 sigma

66% of adult males in Hyderbad will fall between95% of adult males in Hyderbad will fall between99% of adult males in Hyderbad will fall between

PE - Standard Deviation5 years 3.46 18.92 3.46 6.93 10.39 10 years 3.46 17.68 3.46 6.92 10.38

5 year ProbLess than 3 sigma 8.53 0.50% Very very low pri3 sigma to 2 sigma 8.53 11.99 2.00%2 sigma to 1 sigma 11.99 15.45 14.50%1 sigma to Average 15.45 18.92 33.00%Average to 1 sigma 18.92 22.38 33.00%1 sigma to 2 sigma 22.38 25.84 14.50%2 sigma to 3 sigma 25.84 29.31 2.00%Above 3 sigma 29.31 0.50% Very very high pr

Portfolio rebalancing based on statistical modeling of PE

NIFTY BEES is India, Nifty BeeS is Nifty, Nifty is India

10 year ProbLess than 3 sigma 7.29 0.50% Very very low pri3 sigma to 2 sigma 7.29 10.75 2.00%2 sigma to 1 sigma 10.75 14.21 14.50%1 sigma to Average 14.21 17.68 33.00%Average to 1 sigma 17.68 21.14 33.00%1 sigma to 2 sigma 21.14 24.60 14.50%2 sigma to 3 sigma 24.60 28.06 2.00%Above 3 sigma 28.06 0.50% Very very high pr

Concept of PEGPrice Earnings to GrowthWhat should be the right PE level?The PE multiple should be equal to Growth expected in the EPS

If you expect your EPS to grow by 14%, then your PE should be 14 timesCompanies whose earnings are expected to grow fast can enjoy a higher PE

If we expect Indian corporate earnings to grow by 20% per annum, then the India PE can be 20 times

If the PE is more than the growth rate, market is overpriced (good sell)If the PE is less than the growth rate, market is underpriced (good buy)

PE Growth % PEG Market Action14 14 1.00 Fairly priced Nothing / Hold14 20 0.70 Under priced Buy14 10 1.40 Over priced Sell

PEG was formulated by Peter LynchPeter Lynch was a Fund Manager for Fidelity from 1977 to 1990He ran a fund Magellan FundIn 1977, the corpus of the fund was USD 20 mio (Rs 90 cr)In 1990, the corpus was USD 13 bio (Rs 58,500 cr)

Peter Lynch says that this is a good approximate measure (not an accurate measure, don’t rely on it entirely)

Infosys in early 2000 was quoting at Rs 13,800 (Ketan Parekh scan time)PE of Infosys was 160 timesExperts used to justify this PE (Infosys earnings are growing at 160%, so PE is okay)They used the concept of PEG to justify the Infosys priceOnce the scam broke, all shares collapsed including Infosys (all fell to less than 30%)

The mistake is understanding and defining growth160% was the actual growth of Infosys earningsBut is 160% sustainable over the long term?

Your office boy's salary went up from Rs 3,000 to Rs 5,000Growth in salary 67% 167%If the office boy assumed that this growth will sustain for the long term:Year Salary

0 3,000 1 5,000 2 8,333 3 13,889 4 23,148 5 38,580 6 64,300 7 107,167 8 178,612 9 297,687

10 496,145 11 826,909 12 1,378,181 13 2,296,968 14 3,828,280 15 6,380,467 16 10,634,112 17 17,723,521 18 29,539,201 19 49,232,002 20 82,053,337 21 ###

If actual growth rates are very high (more than 30%), please don’t pay a PE of more than 30 timesPlease don’t follow PEG model, bcoz such high growth rates are not sustainable over the long term

For example, UPL earnings growth rate as we saw yesterday was very highRPAT growth of 30% over 2007-11We don’t necessarily pay a PE of 30 times to UPL - why?Bcoz the growth is not sustainable

PEG model will prevent you from paying high PEShoppers Stop is quoting at 80 PEYou should question whether Shoppers Stop earnings can grow at 80% per annum over the next ten years

Warren Buffet saysYou pay a high price for a cheery consensus

INDIA GROWTH STORYWhat is the GDP growth expected in India?I think minimum growth will be at least 6.50%Real growth vis-à-vis Nominal growthReal is before inflation (without inflation) and Nominal is after inflation

Last yeaThis yearGrowthSteel tons 100 105 5% RealPrice per ton 20 22 10%Sales Revenue 2000 2310 16% Nominal

Economic forecast is on Real growth. India will grow at 6.5% in Real terms.

Real growth is 6.50%Inflation 6.00%Nominal growth will be 12.50%

Sector Real InflationNominalAgri 2.00% 6.00% 8.00% Is not listed on the stock exchangeIndustry 7.50% 6.00% 13.50% ListedServices 8.00% 6.00% 14.00% ListedIndia 6.50% 6.00% 12.50%

Corporate India Sales will grow at 13.5 to 14% over the long termCorporate Profits may rise faster - say 14 to 16% over the long term

Long term means what?Goldman Sachs (the world's best investment bank) produced the BRIC reportBy 2026, India will beat all countries in GDP other than US and China (India will be No 3)In 2046, India will beat the US (and become No 2)India will grow annually at the rate of at least 5.5% GDP till 2050

In 2046, India's population will be at least 8 times the US populationSo, if your GDP = US GDP, your per capita GDP is one-eighth of US per capita

Where will the Sensex be after 30 years 100,000 80,000 50,000

18000 14% 114% 30 917,103 18000 15% 115% 30 1,191,812 18000 16% 116% 30 1,545,298 18000 180 3,240,000 18000 18% 118% 30 2,580,671

Sensex over the long term1E+06

Buy

Buy Sell

Sell18000

2010 2040

Systematic InvestingNifty SIP from Jan 1, 1999 to April 9, 2010 generates 36% return per annumEven if you started on a bad day (Ketan Parekh scam height), you still earn 37% per annumIf you started on Ketan Parekh height and stopped on 27th Oct, 2008, you still earn 11% per annum

RESEARCH REPORT KEY POINTS1 Sales growth CAGR Annual2 PAT growth CAGR Annual3 PE level Current4 PEG (PE / Growth)5 Industry PE level

6 Debt Equity Ratio If this is high say more than 2 times, be carefulInfra sector can borrow upto 4 times, all others should be lower

7 RoE Should be more than 15%8 RoCE Should be more than 13%

High and low levels that we have seen in our past - learnings from them

You can understand the Nifty level at any time (too high, too low, reasonable band) - buy / hold / sell

Are there good and bad levels of some ratios that we should be careful about

For every one rupee that the Indian corporate is earnings, we are paying a price of Rs 23.21

Harshad Mehta period

Ketan Parekh period

Sensex PE in Jan 2008 was 28 times, while the PE in Sept 1994 was 72 times

If you compute the average PE over the last five to ten years, it will give you a good sense of valuation

When PE rises too much, that means Price is rising too fast and vice versa

If PE goes above 28 times, the market looks overpriced and you should be selling and getting outIf PE goes below 11 times, the market looks underpriced and you should be buying buying buying

The population of Hyderabad is 80 lakhs, of which 25 lakhs are adult malesI can take a sample of 30 people and estimate the heights of the entire population using statistics

39

xxyyy

150 180135 195120 210

Equity Debt100% 0%

90% 10%75% 25%60% 40%40% 60%25% 75%10% 90%

0% 100%

Equity Debt100% 0%

90% 10%75% 25%60% 40%40% 60%25% 75%10% 90%

0% 100%

If you expect your EPS to grow by 14%, then your PE should be 14 timesCompanies whose earnings are expected to grow fast can enjoy a higher PE

If we expect Indian corporate earnings to grow by 20% per annum, then the India PE can be 20 times

Peter Lynch says that this is a good approximate measure (not an accurate measure, don’t rely on it entirely)

Infosys in early 2000 was quoting at Rs 13,800 (Ketan Parekh scan time)

Experts used to justify this PE (Infosys earnings are growing at 160%, so PE is okay)

Once the scam broke, all shares collapsed including Infosys (all fell to less than 30%)

If the office boy assumed that this growth will sustain for the long term:

If actual growth rates are very high (more than 30%), please don’t pay a PE of more than 30 timesPlease don’t follow PEG model, bcoz such high growth rates are not sustainable over the long term

For example, UPL earnings growth rate as we saw yesterday was very high

You should question whether Shoppers Stop earnings can grow at 80% per annum over the next ten years

Economic forecast is on Real growth. India will grow at 6.5% in Real terms.

Is not listed on the stock exchange

Goldman Sachs (the world's best investment bank) produced the BRIC reportBy 2026, India will beat all countries in GDP other than US and China (India will be No 3)

So, if your GDP = US GDP, your per capita GDP is one-eighth of US per capita

Nifty SIP from Jan 1, 1999 to April 9, 2010 generates 36% return per annumEven if you started on a bad day (Ketan Parekh scam height), you still earn 37% per annumIf you started on Ketan Parekh height and stopped on 27th Oct, 2008, you still earn 11% per annum

If this is high say more than 2 times, be carefulInfra sector can borrow upto 4 times, all others should be lower

One Up on Wall Street - By Peter LynchBeating the Street - By Peter LynchBuffetology - By Mary Buffetwww.investopedia.comwww.moneychimp.comwww.motleyfool.com

SNMJ

NIFTY - APRIL 9, 2010 1. Go long April Futures and go short April 5400 CallNIFTY INDEX 5362NIFTY APRIL FUT 5367 2. Go long April Futures and go long April 4900 PutCalls PutsLTP Strike LTP 3. Long April Futures, Long April 4900 Put, Short 5400 Call 467.00 4900 6.45 372.50 5000 10.90 4. Long April Futures, Short April 5400 Call and April 5500 Call 282.00 5100 18.00 193.35 5200 32.00 5. Go long April 5200 Call and go short April 5400 Call 116.95 5300 53.80 58.45 5400 92.40 6. Go long April 5400 Call and April 5000 Put 22.90 5500 157.00 6.80 5600 239.00 7. Go short on the same as 6 above

8. Go short April 5000 Put and go long April 4900 Put

9. Go long April Fut and short May Fut

Combinations - StrategiesValuationIndicators

Six positions possible1 Long Futures2 Short Futures3 Long Calls4 Short Calls5 Long Puts6 Short Puts

Six Graphs

Long Futures Unlimited gainsGains Unlimited losses

33 View : BullishUpside Reward

5367 5400 Nifty Price Downside Risk

Losses Bullish position is a position that seeks to gain from upward movement

Short FuturesUnlimited gainsUnlimited lossesView : Bearish

5367 Upside RiskDownside Reward

5400 CallLong Calls Unlimited gains

Limited lossesStrike View : Bullish

5400 Upside RewardDownside Risk (Low)

-58.45Premium The graph will change its direction at the strike price

5458.45BEP

Short Calls Limited gainsUnlimited losses

58.45 View : BearishPremium Upside Risk

Strike Downside Reward5400

BEP for both long and short positions is the same

5200 StrikeLong Put

Unlimited gainsLimited losses

Strike View : Bearish5200 Upside Risk (Low)

-32 Downside RewardPremium

5168BEP

Short PutLimited gains

32 Unlimited lossesView : Bullish

5200 Upside RewardDownside Risk

COMBINATION OF LONG FUTURES AND SHORT 5400 CALLEXERCISE ONE

Covered Call

91

5309 5400

The upside risk on the Short Call is "covered" by Long Futures upside reward

2. Go long April Futures and go long April 4900 Put

Put InsuranceDownside Reward

4900Downside Risk -473

By paying Rs 6 premium, I have limited my downside riskMax Loss is Rs 473 - downsideMax Gain is unlimited - upside

3. Long April Futures, Long April 4900 Put, Short 5400 Call

UpRew DoRew Collar85

DoRisk UpRisk 4900

-415

Limited GainsLimited LossesView : Bullish Very popular in forex marketsUpside RewardDownside Risk

4. Long April Futures, Short April 5400 Call and April 5500 Call

114

5400 5500

Nifty 5367 5367-58-23View : Moderately Bullish 5286I believe that Nifty will move up, but it will not move up beyond 5614High risk startegy - both sides, losses are unlimited

5. Go long April 5200 Call and go short April 5400 Call

Bull SpreadGains limited

65 Losses limitedView : Bullish

5200 5400 Upside rewardDownside risk

-1355335

5. Go long April 5400 Call and go short April 5500 Call

Bull Spread65 Gains limited

Losses limitedView : Bullish

5400 5500 Upside rewardDownside risk

-355435

Success Ratio = 65:35

6. Go long April 5400 Call and April 5000 Put

Long Strangle Unlimited GainsLimited LossesView : VolatileBoth sides : Gains

5000 5400 Mid range : Losses-69

4931 5469

This strategy is useful for "events". A big event is about to happen - Budget, Elections, Election Results, RBI policy, Quarterly Results, Major announcements, Major Court Case hearings

7. Go short on the same as 6 above

Short Strangle Limited GainsUnlimited Losses

69 View : Range boundBoth sides : Losses

5000 5400 Mid range : Gains

High risk strategy

8. Go short April 5000 Put and go long April 4900 Put

Spread using Puts

5

4900 50005362

-954995

9. Go long April Fut and short May Fut - Calendar Spread StrategyApril Futures 5367May Futures - suppose 5380Spread 13 You believe that the spread

will fallAfter 4 days:April 5391May 5401Spread 10

If you square up:April 24May -21Net Net 3

NIFTY - APRIL 9, 2010NIFTY INDEX 5362NIFTY APRIL FUT 5367Calls Puts Call Very VeryLTP Strike LTP BEP Bullish Bullish

5900 RoI 467.00 4900 6.45 ### 533.00 114% 372.50 5000 10.90 ### 527.50 142%

282.00 5100 18.00 ### 518.00 184% 193.35 5200 32.00 ### 506.65 262% 116.95 5300 53.80 ### 483.05 413% 58.45 5400 92.40 ### 441.55 755% 22.90 5500 157.00 ### 377.10 1647% 6.80 5600 239.00 ### 293.20 4312%

If you are very bullish, the Out of the Money Calls (5400, 5500, 5600) are good

Calls Puts Call ModeratelyLTP Strike LTP BEP Bullish Bullish

5432 RoI 467.00 4900 6.45 ### 65.00 14% 372.50 5000 10.90 ### 59.50 16% 282.00 5100 18.00 ### 50.00 18% 193.35 5200 32.00 ### 38.65 20% 116.95 5300 53.80 ### 15.05 13% 58.45 5400 92.40 ### (26.45) -45% 22.90 5500 157.00 ### (22.90) -100% 6.80 5600 239.00 ### (6.80) -100%

If you are moderately bullish, the In The Money Calls are good (4900 to 5200)

The maximum liquidity is at the ATMIf you are a fast trader, then ATM is good bcoz the bid-ask difference will be narrow

In general, selling options is high risk (unlimited losses)Options industry is like the Insurance industryHow many people buy insurance?Crores of peopleHow many people sell insurance?15 companiesWhere is the intellect? Who prices the policies?Sell sideBuy side knows nothing - buy side is all retail simple people who are afraid of deathCompanies are betting mathematically that mortality will remain at reasonable levels too many people will not die too soon

In Options Industry, there are millions of buyers of optionsBut there are very few sellersSellers are experts, they price the options, they control the market, they understand mathematics, they understand Delta, Gamma, Vega, Theta and are constantly rehedging their positionsBuyers think their losses are limited (so they are comfortable)Sellers know that their losses are unlimited (they are very uncomfortable and are constantly monitoring their positions, delta and rehedging)

One selling desk may have a position of Rs 500 cr

OPTION VALUATIONStock price Known 5367Strike price Known 5400Volatility SuspenseCan be back-calcul 15.50%Time to expiry Known 18Interest Zero 0%

Price Known 58.45

That back-calculated volatility is known as "Implied Volatility" IVIV comes from the price of the option as seen in the market

Historical VolatilityWhat has been the Nifty volatility in the past?Standard deviation of daily returns

Nifty CloDaily ChDaily Re Daily VolAnnual Vol 5,246 16 5,263 17 0.32% 5,205 (58) -1.09% 5,225 20 0.39% 5,260 35 0.67% 5,282 22 0.41% 5,303 21 0.39% 5,262 (40) -0.76% 5,249 (13) -0.25% 5,291 41 0.79% 5,368 78 1.47% 0.75% 12.1% 5,366 (2) -0.04% 0.76% 12.1%

5,375 9 0.16% 0.61% 9.8% 5,304 (70) -1.31% 0.80% 12.7% 5,362 57 1.08% 0.84% 13.4%

We can convert Daily Volatility into Annual Volatility (we multiply by 16)

Our Historical Volatility is 13.4%The Implied Volatilty is 15.5%

Nifty Volatility over the past 5 years has been in the range of 15% to 45% most of the timeHigher vol means higher Option prices (both Calls and Puts)Example - during Budget, during Elections, options will become very expensive

In range bound situations, volatility will be lowIn dull markets, volatility will be lowIn slow bullish markets, volatility will be lowIn nervous markets, volatility will be highIn bearish markets, volatility will be highIn panicky markets, volatility will be v v v highDuring events, volatilty will be high

If volatility shoots up during bullish markets, that is a sign of nervousness (Jan 2008)

HistoricaImplied MarketsVolatilit VolatilityPast FutureLow Low Dull, Range Bound, Slow BullishHigh High Nervous, Panic, Crash, BearishHigh Low Expectation is dull marketsLow High Expectation is high vol, crash

I am assuming you are a BuyerWhen Imp Vol is low, buying options may be a good strategyWhen Imp Vol is high (above 40%), options are very expensive and hence staying away may be better

The calculator is very useful for understanding when you will make moneyNifty is at 5367You are bullishYou bott the 5400 Call for Rs 58

After 4 days, Nifty goes to 5381Will you make money on the Call?

Call value will increase bcoz Nifty went upCall value will fall bcoz time has passed

OPEN INTERESTThe number of open positions in any instrument

5400 Calls of NiftyYou Buyer 2 Seller 1 Seller 2 Seller 3

Day 1 2 -2Day 2 3 1 -4

5 -1 -4Day 3 -4 20 1 0 -17

1 20 0 -4 -17

If Open Interest is rising, that means traders are taking fresh positionsIf Open Interest is falling, that means traders are squaring up (they are going away, they are booking profits or booking losses)

One ExampleNifty is at 5367 today5400 Call Open Interest is 10 lakh unitsTom, Nifty moves up to 5391Open Int of 5400 Call reduces to 8 lakh units and Open Int of 5500 Call increases by 2.5 lakh unitsWhat does this mean?

Traders are squaring up 5400 Calls and moving to 5500 CallsWhy? What does this mean?It means traders (sellers) are nervous - why? They are afraid that Nifty may cross 54005400 may not be a strong resistance for the Nifty

Example TwoNifty is at 5367 today5400 Call Open Interest is 10 lakh unitsTom, Nifty moves up to 5391

Open Int of 5400 Calls rises to 11 lakh unitsWhat does this mean?

Traders are quite confident (sellers) that 5400 will be a strong resistanceIt is not likely to be broken

1. Go long April Futures and go short April 5400 Call

2. Go long April Futures and go long April 4900 Put

3. Long April Futures, Long April 4900 Put, Short 5400 Call

4. Long April Futures, Short April 5400 Call and April 5500 Call

5. Go long April 5200 Call and go short April 5400 Call

6. Go long April 5400 Call and April 5000 Put

8. Go short April 5000 Put and go long April 4900 Put

9. Go long April Fut and short May Fut

Unlimited gainsUnlimited lossesView : BullishUpside RewardDownside Risk

Bullish position is a position that seeks to gain from upward movement

Unlimited gainsUnlimited lossesView : BearishUpside RiskDownside Reward

Unlimited gainsLimited lossesView : BullishUpside RewardDownside Risk (Low)

The graph will change its direction at the strike price

Limited gainsUnlimited lossesView : BearishUpside RiskDownside Reward

BEP for both long and short positions is the same

Unlimited gainsLimited losses

View : BearishUpside Risk (Low)Downside Reward

Limited gainsUnlimited lossesView : BullishUpside RewardDownside Risk

The upside risk on the Short Call is "covered" by Long Futures upside reward

Put Insurance

5373

3. Long April Futures, Long April 4900 Put, Short 5400 Call

5400

5367+6-585315

Very popular in forex markets

4. Long April Futures, Short April 5400 Call and April 5500 Call

5614

I believe that Nifty will move up, but it will not move up beyond 5614

Unlimited GainsLimited LossesView : VolatileBoth sides : GainsMid range : Losses

This strategy is useful for "events". A big event is about to happen - Budget, Elections, Election Results, RBI policy, Quarterly Results, Major announcements, Major Court Case hearings

Limited GainsUnlimited LossesView : Range boundBoth sides : LossesMid range : Gains

High risk strategy

9. Go long April Fut and short May Fut - Calendar Spread Strategy

You believe that the spread

If you are very bullish, the Out of the Money Calls (5400, 5500, 5600) are good

If you are moderately bullish, the In The Money Calls are good (4900 to 5200)

If you are a fast trader, then ATM is good bcoz the bid-ask difference will be narrow

Buy side knows nothing - buy side is all retail simple people who are afraid of deathCompanies are betting mathematically that mortality will remain at reasonable levels

Sellers are experts, they price the options, they control the market, they understand mathematics, they understand Delta, Gamma, Vega, Theta and are constantly rehedging

Sellers know that their losses are unlimited (they are very uncomfortable and are constantly

That back-calculated volatility is known as "Implied Volatility" IVIV comes from the price of the option as seen in the market

We can convert Daily Volatility into Annual Volatility (we multiply by 16)

Nifty Volatility over the past 5 years has been in the range of 15% to 45% most of the time

Example - during Budget, during Elections, options will become very expensive

If volatility shoots up during bullish markets, that is a sign of nervousness (Jan 2008)

Dull, Range Bound, Slow BullishNervous, Panic, Crash, Bearish

Expectation is high vol, crash

When Imp Vol is high (above 40%), options are very expensive and hence staying away may

The calculator is very useful for understanding when you will make money

Open Int2

5

21

If Open Interest is rising, that means traders are taking fresh positionsIf Open Interest is falling, that means traders are squaring up (they are going away, they are

Open Int of 5400 Call reduces to 8 lakh units and Open Int of 5500 Call increases by 2.5 lakh

It means traders (sellers) are nervous - why? They are afraid that Nifty may cross 5400

Traders are quite confident (sellers) that 5400 will be a strong resistance

Call Call PutBid Offer Bid 467.20 470.95 6.45 372.00 375.45 10.80 279.55 282.00 17.85 193.50 194.15 32.00 116.90 116.95 53.55 59.00 59.20 92.40 22.75 22.90 156.05 6.90 7.00 235.50

PutOffer 6.50 10.90 18.00 32.25 54.00 92.45 157.50 239.50