Any option contract has an underlying, and its premium moves with the underlying. For e.g., Infosys' call option premium will rise if Infosys’ price rises, and its Put option premium will rise with a fall in its price. Basically, option premium is linked to its underlying price.

You can extend this to Index options, too. For instance, if the Nifty Index moves up, then the Nifty Call Option premium increases. Likewise with Bank Nifty. Do note, the underlying for these index options is the index itself, which in turn is a basket of stocks. (3/n)

Before we go deeper, let’s see how option premiums work. Option premiums depend on where the stock/index’s current price is compared to your strike price. Strike price is the price at which you exercise the option. (4/n)

Premiums are high when they are at-the-money or in-the-money. 🔵In-the-money call option - current price is higher than strike price 🔵In-the-money put option - current price is lower than strike price 🔵At-the-money call/put option - current price is close to strike price (5/n)

On expiry days, OTM options are cheap because they are likely to expire worthless. ATM options are most volatile because, well, they are sitting on the fence and anything can happen, and ITM options are fully loaded and expensive. (6/n)

For an options trader, the gravy lies in the transition of premiums. Imagine you can buy a cheap OTM option for 50 paisa or a Rupee, and then watch it grow to Rs.10, 20 or even 100 in a matter of a few hours. We will let you do the insane ROI math 🙂 (7/n)

Given that ROI math, the question is how can you make that work out? Well, it looks like you can, provided you have unlimited money. Which Jane Street (JS), seems to have had. (8/n)

Imagine this - on expiry day, you shore up all the cheap Index OTM options on one hand, and on the other hand, you either buy or sell the index underlying constituents to an extent where the options start to move in your favor. (9/n)

In fact, you can buy/sell just the heavyweight stocks of the index to move it in your favour. Of course, they do this with sophistication. You buy all the cheap options before 3PM, and from 3PM you fire orders worth 100s and 1000s of crores in the heavyweight stocks. (10/n)

The algo knows the quantity, the price, and time, which makes computation of the expiry closing price easy, as the closing price is the weighted average of the last 30 mins. With this, the closing price is in your control, and you are marking it in your favor. (11/n)

In summary - buy cheap options > bump up the stocks > watch the option transition > square off the position > shore up the premiums. Repeat and mint. Sounds like a great strategy, but it is illegal. Why? (12/n)

Well, SEBI sees this as an unfair, deceptive, and manipulative practice that violates the Securities Act. And SEBI says they made 4,843 crores of unlawful gains through this. Jane Street has refuted these allegations and will share its response to SEBI order soon. (13/n)