Chapter 7: Market Analysis for Futures and Options

F&O Trading Chapter 7: Market Analysis for Futures and Options Futures and Options I Premium Section 7.1 Technical Analysis for Derivatives Trading Technical analysis involves studying past market data, primarily price and volume, to forecast future price movements. In the context of futures and options, technical analysis is essential for traders to identify trends, support and resistance levels, and key market signals that help in making informed decisions. Key Concepts in Technical Analysis: Charts: Price Charts: The most common tool for technical analysis, showing historical price movements over a defined time period. The three main types of price charts are: Line Chart: A simple line connecting the closing prices over a set time period. Bar Chart: Displays the open, high, low, and close (OHLC) for a specific time period. Candlestick Chart: A more advanced chart displaying the same information as a bar chart but in a visual format that’s easy to interpret (candles show the range between opening and closing prices, with the color indicating bullish or bearish movement). Trends: Trend is the direction in which the market is moving, and understanding the trend is critical in technical analysis. Uptrend: Higher highs and higher lows. Downtrend: Lower highs and lower lows. Sideways Trend (Consolidation): A market that moves within a defined range with no clear direction. Trend Indicators: Moving Averages: Moving averages (e.g., Simple Moving Average (SMA), Exponential Moving Average (EMA)) smooth out price data over a specific time period to identify the direction of the trend. Common periods used are 50-day and 200-day moving averages. Trendlines: Lines drawn above or below price action that act as support or resistance. Connecting a series of highs in a downtrend or lows in an uptrend can help identify the trend. Support and Resistance: Support: A price level at which an asset tends to find buying interest, stopping the price from falling further. Resistance: A price level at which selling interest is strong enough to prevent the price from rising further. Breakout: When the price breaks above resistance or below support, it can signal the start of a new trend. Indicators and Oscillators: Relative Strength Index (RSI): Measures the speed and change of price movements on a scale of 0-100. An RSI above 70 indicates overbought conditions, while an RSI below 30 signals oversold conditions. Moving Average Convergence Divergence (MACD): A momentum oscillator that shows the relationship between two moving averages of an asset’s price. The MACD is commonly used to identify bullish and bearish trends. Bollinger Bands: A volatility indicator that uses standard deviation around a moving average to form upper and lower bands. Prices tend to bounce between the bands, and a breakout may indicate a significant price movement. Volume: Volume is an important indicator in technical analysis. It can confirm trends and provide insight into the strength of a move. Rising volume suggests strong conviction, while falling volume can signal a reversal or weakening trend. Chart Patterns: Head and Shoulders: A reversal pattern that signals a trend reversal from bullish to bearish or vice versa. Triangles: Continuation patterns that form when the price moves within converging trendlines. An upward breakout suggests a bullish move, while a downward breakout signals a bearish move. Flags and Pennants: Short-term continuation patterns that indicate a brief consolidation before the price resumes in the direction of the prior trend. Technical Analysis in Futures and Options: Futures: Futures traders use technical analysis to predict price movements in commodities, stock indices, and other underlying assets. Trends, chart patterns, and technical indicators are widely used to time entries and exits in the futures market. Options: Options traders use technical analysis to identify key support and resistance levels, predict volatility, and find optimal entry points for various strategies (e.g., buying calls, puts, or using spreads). Objective This chapter provides an in-depth understanding of the different methods of market analysis used in futures and options trading. It covers both technical analysis and fundamental analysis, as well as how to apply them effectively to the derivatives markets. Additionally, we’ll touch on sentiment analysis and the role of market psychology in shaping market movements and decision-making. Section 7.2 Fundamental Analysis for Derivatives Fundamental analysis involves evaluating the economic, financial, and qualitative factors affecting the underlying asset. In futures and options markets, fundamental analysis is essential for understanding the long-term drivers of prices and the broader economic environment in which trading takes place. Economic Indicators: GDP (Gross Domestic Product): A measure of a country’s total economic output. Strong economic growth typically leads to higher demand for commodities and an increase in the value of financial assets. Interest Rates: Central banks set interest rates to control inflation and stabilize the economy. Changes in interest rates directly impact the cost of carrying positions in futures and options. Inflation: The rate at which prices for goods and services rise. Inflation affects the purchasing power of currencies and is a key driver for many commodity prices. Employment Data (Non-Farm Payrolls): The unemployment rate and the number of jobs created can indicate the health of the economy and influence investor sentiment. Earnings Reports (for Stock Index Futures and Options): Earnings reports provide insight into a company’s financial health and future prospects. Strong earnings reports may drive the price of stock index futures and options higher, while weak earnings can lead to a bearish outlook. Geopolitical Events: Political instability, natural disasters, or trade policies can affect commodity prices and overall market sentiment. For example, tensions in the Middle East can impact oil prices, while trade negotiations between major economies can influence global stock markets. Market Sentiment and News: The overall sentiment in the market, often driven by news reports, can impact futures and options prices. Traders often track news on central bank policies, inflation data, and other macroeconomic factors that can create volatility in the markets. Section 7.3 Sentiment Analysis and Market Psychology Sentiment analysis involves gauging the mood or sentiment of market participants. While technical and fundamental analysis are grounded in data, sentiment analysis looks at the

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Chapter 6: Advanced Options Strategies

F&O Trading Chapter 6: Advanced Options Strategies Futures and Options I Premium Section 6.1 Introduction to Advanced Options Strategies Advanced options strategies typically involve a combination of buying and selling multiple options contracts simultaneously, enabling traders to manage risk, hedge positions, or profit from different market conditions. These strategies can range from risk-averse strategies like spreads and covered calls to more complex strategies like straddles, strangles, and iron condors. Learning Tip Index investing using trend involves selectin a benchmark index like Nifty 50 or Sensex 30 then apply trend study and use the trend based system to invest in all those stocks included in the index for long term. Section 6.2 Options Spreads An options spread involves buying and selling options of the same type (either calls or puts) on the same underlying asset but with different strike prices or expiration dates. The primary goal of a spread is to limit the potential risk while capping the potential reward. 2.1 Vertical Spread A vertical spread involves buying and selling options with the same expiration date but different strike prices. This strategy is typically used when a trader expects a moderate move in the price of the underlying asset. Bull Call Spread: Strategy: Buy a call option at a lower strike price and sell a call option at a higher strike price. Market View: Bullish, but with limited upside potential. Max Profit: Difference between strike prices minus the net premium paid. Max Loss: The net premium paid for the spread. Example: Buy a call at ₹100 and sell a call at ₹110, with a net premium of ₹5. Bear Put Spread: Strategy: Buy a put option at a higher strike price and sell a put option at a lower strike price. Market View: Bearish, but with limited downside potential. Max Profit: Difference between strike prices minus the net premium paid. Max Loss: The net premium paid for the spread. Example: Buy a put at ₹100 and sell a put at ₹90, with a net premium of ₹5. 2.2 Horizontal (Calendar) Spread A horizontal spread involves buying and selling options with the same strike price but different expiration dates. This strategy profits from differences in time decay and volatility. Strategy: Buy a longer-term option and sell a shorter-term option at the same strike price. Market View: Neutral to slightly bullish/bearish. Traders expect volatility to increase or price to stay relatively flat. Max Profit: Occurs if the price of the underlying asset is near the strike price at the expiration of the short option. Max Loss: The net premium paid for the spread. Section 6.3 Straddle and Strangle Straddles and strangles are strategies used when traders expect high volatility in the underlying asset but are uncertain about the direction of the price movement. 3.1 Long Straddle A long straddle involves buying both a call and a put option with the same strike price and expiration date. The strategy profits from large price movements in either direction. Strategy: Buy a call and a put option with the same strike price and expiration date. Market View: Expecting large volatility, but uncertain about direction (price movement could be up or down). Max Profit: Unlimited (if the price moves significantly in either direction). Max Loss: The total premium paid for both options. Example: Buy a call and a put on stock XYZ, both at ₹100 strike price, paying a total premium of ₹15 for both options. The underlying stock needs to move significantly away from ₹100 to make a profit. 3.2 Long Strangle A long strangle is similar to a long straddle but uses different strike prices for the call and put options. It is slightly cheaper than a straddle, but requires a more significant move in the underlying asset to break even. Strategy: Buy a call and a put option with different strike prices (both out-of-the-money) and the same expiration date. Market View: Expecting significant volatility in the underlying asset, but uncertain whether the price will go up or down. Max Profit: Unlimited, if the price moves significantly in either direction. Max Loss: The total premium paid for both options (cheaper than a straddle). Example: Buy a call at ₹110 and a put at ₹90, both expiring in a month. The underlying stock needs to move beyond ₹115 or below ₹85 to break even or make a profit. Section 6.4 Iron Condor An iron condor is a neutral strategy that combines a bear call spread and a bull put spread. The goal is to profit from low volatility in the underlying asset, with the price staying within a specific range. 4.1 Iron Condor Structure Strategy: Sell a lower strike put, buy an even lower strike put, sell a higher strike call, and buy an even higher strike call — all with the same expiration date. Market View: Neutral. The trader expects the underlying asset to stay within a defined range. Max Profit: The premium received from the sold options (the maximum profit occurs when the asset’s price stays between the strike prices of the short puts and calls). Max Loss: The difference between the strike prices of the puts or calls, minus the premium received. Example: Sell a put at ₹90, buy a put at ₹85, sell a call at ₹110, and buy a call at ₹115. If the stock stays between ₹90 and ₹110 at expiration, the options expire worthless, and the trader keeps the premium received. 4.2 Adjusting the Iron Condor If the stock price moves outside the expected range, the trader can adjust the position by rolling up/down the short strikes (selling different strikes) or by closing the entire position to cut losses. Section 6.5 Iron Butterfly The iron butterfly is a variation of the iron condor but with a narrower range of profitability. It involves selling a call and a put at the same strike price (at-the-money) while buying a call and a put at higher and lower strikes, respectively. 5.1 Iron Butterfly Structure Strategy: Sell a put and a call

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Chapter 5: Understanding Options Pricing

F&O Trading Chapter 5: Understanding Options Pricing Futures and Options I Premium Section 5.1 Factors Affecting Option Pricing Option pricing is influenced by several key factors, each contributing to the option’s total premium. These factors are critical to understand for anyone trading or analyzing options. Let’s break down each one. 1. Underlying Asset Price The underlying asset price (the spot price of the asset) is perhaps the most influential factor in determining the price of an option. Here’s how it affects different types of options: For Call Options: The higher the underlying asset price, the more valuable a call option becomes. This is because the option holder has the right to buy the asset at a lower strike price than its current market price. For Put Options: Conversely, as the underlying asset price decreases, the value of a put option increases because the option holder has the right to sell the asset at a higher strike price than its current market value. 2. Time to Expiry The time to expiry of an option refers to how much time remains until the option expires. The more time there is before expiration, the greater the possibility that the option will end up in-the-money, and hence the higher its value. Time Decay (Theta): As the expiration date approaches, the option loses value, primarily because there is less time for the underlying asset’s price to make significant moves. This phenomenon is known as time decay. Longer Expiry = Higher Premium: All else being equal, options with longer expiration periods tend to have higher premiums due to the greater time value. 3. Volatility Volatility is a critical factor that drives option prices. It refers to how much the price of the underlying asset fluctuates over time. There are two main types of volatility: Historical Volatility (HV): This measures past price fluctuations of the underlying asset. It is based on historical data and is often used to estimate future price movements. Implied Volatility (IV): Implied volatility is the market’s expectation of future volatility, derived from the price of the option itself. Higher implied volatility increases the probability of larger price movements, making options more expensive. Impact of Volatility: Higher Volatility = Higher Option Prices: If the underlying asset is expected to be more volatile, both call and put options tend to become more expensive because the potential for larger moves increases the chances of ending up in-the-money. 4. Interest Rates Interest rates also influence option pricing, particularly for long-term options. The basic relationship is: For Call Options: When interest rates rise, the price of call options increases. This is because the present value of the strike price (paid later) decreases, making it more attractive to hold the option instead of the underlying asset. For Put Options: Conversely, when interest rates rise, put options tend to decrease in value for the same reason—the present value of the strike price increases. 5. Dividends When the underlying asset (usually stocks) pays a dividend, it affects the price of options: For Call Options: When a dividend is expected, the underlying asset’s price typically drops by the dividend amount when it goes ex-dividend. This decreases the value of call options, as the underlying asset is worth less. For Put Options: The value of put options may increase because the underlying asset price drops by the dividend amount, making the strike price more valuable in comparison. Learning Tip Index investing using trend involves selectin a benchmark index like Nifty 50 or Sensex 30 then apply trend study and use the trend based system to invest in all those stocks included in the index for long term. Section 5.2 The Black-Scholes Model The Black-Scholes model is one of the most widely used methods for pricing European-style options (options that can only be exercised at expiration). The model uses several key inputs (the factors mentioned above) to calculate the theoretical price of an option. Key Inputs to the Black-Scholes Model: S₀: Current price of the underlying asset K: Strike price of the option T: Time to expiration (in years) r: Risk-free interest rate (typically the rate of return on government bonds) σ: Volatility of the underlying asset N(x): Cumulative normal distribution function (for calculating the probabilities associated with the option’s outcome) The formula for a European call option is: C=S0⋅N(d1)−K⋅e−rT⋅N(d2)C = S₀ cdot N(d₁) – K cdot e^{-rT} cdot N(d₂)C=S0​⋅N(d1​)−K⋅e−rT⋅N(d2​) Where: d1=ln⁡(S0/K)+(r+0.5⋅σ2)TσTd₁ = frac{ln(S₀ / K) + (r + 0.5 cdot σ²) T}{σ sqrt{T}}d1​=σT​ln(S0​/K)+(r+0.5⋅σ2)T​ d2=d1−σTd₂ = d₁ – σ sqrt{T}d2​=d1​−σT​ The formula for a put option is similar, with adjustments for the different payoff structure. Though the Black-Scholes model is powerful, it assumes constant volatility and interest rates, and it’s designed for European options, which can only be exercised at expiration. Section 5.3 Greeks and Their Significance The Greeks are key risk management tools in options trading, helping traders understand how different factors (like changes in price or time) affect the price of an option. The main Greeks are: 1. Delta (Δ): Sensitivity to Underlying Price Delta measures how much the price of an option changes with respect to a change in the price of the underlying asset. For Call Options: Delta is positive. As the underlying asset price increases, the value of the call option increases. For Put Options: Delta is negative. As the underlying asset price decreases, the value of the put option increases. 2. Gamma (Γ): Sensitivity of Delta Gamma measures the rate of change of delta as the price of the underlying asset changes. It helps assess how stable delta is. Gamma is highest for options that are at-the-money and decreases as the option moves further in- or out-of-the-money. 3. Theta (Θ): Sensitivity to Time Decay Theta measures the sensitivity of an option’s price to the passage of time. It shows how much the option’s price will decrease as time passes, assuming all other factors remain constant. Time Decay: Theta is typically negative for both calls and puts, meaning options lose value as expiration approaches. 4. Vega (V): Sensitivity

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Chapter 4: Options Contracts

F&O Trading Chapter 4: Options Contracts Futures and Options I Premium Section 4.1 Introduction to Options Contracts Definition: An options contract is a financial derivative that gives the buyer the right, but not the obligation, to buy or sell an underlying asset (such as stocks, indices, commodities, etc.) at a specified price (called the strike price) within a specified time frame (called the expiration date). Options come in two types: Call options and Put options. Key Characteristics: Right but not obligation: The key difference between options and futures contracts is that with options, the buyer has the right (but not the obligation) to exercise the contract. Premium: The buyer of an option pays an upfront cost known as the premium to the seller (also called the writer) for this right. Exercise: The option can be exercised by the buyer at any time before expiration (for American-style options) or only at expiration (for European-style options). Purpose of Options: Hedging: Options can be used to protect against adverse price movements in the underlying asset. Speculation: Traders use options to profit from price movements in the underlying asset without actually owning the asset. Income Generation: Investors can write (sell) options to earn the premium, providing income while taking on the obligation to fulfill the option if exercised. Learning Tip Index investing using trend involves selectin a benchmark index like Nifty 50 or Sensex 30 then apply trend study and use the trend based system to invest in all those stocks included in the index for long term. Section 4.2 Types of Options Contracts Call Options A call option gives the holder the right, but not the obligation, to buy the underlying asset at a predetermined price (strike price) within a specific time period. Example: A trader buys a call option for ABC stock with a strike price of ₹1,000 and an expiration date of 30 days. If ABC’s stock price rises to ₹1,200, the trader can exercise the option to buy the stock at ₹1,000, making a profit of ₹200 per share.   Put Options A put option gives the holder the right, but not the obligation, to sell the underlying asset at a predetermined price (strike price) within a specified time period. Example: A trader buys a put option on XYZ stock with a strike price of ₹500. If XYZ’s stock price falls to ₹400, the trader can exercise the option to sell at ₹500, making a profit of ₹100 per share. American vs. European Options American Options: Can be exercised at any time before or on the expiration date. European Options: Can only be exercised at the expiration date, not before. Exotic Options These are customized options contracts that have unique characteristics (such as barrier options, Asian options, and others), and are traded on over-the-counter (OTC) markets rather than exchanges. Example: A barrier option becomes active only if the price of the underlying asset hits a certain level. Section 4.3 How Options Work Options Premium: The price paid for an option is called the premium. The premium consists of two components: Intrinsic Value: The amount by which the option is in-the-money (ITM). Time Value: The value of the option based on the amount of time left until expiration and other factors like volatility. Example: For a call option with a strike price of ₹1,000, if the current market price of the stock is ₹1,200, the intrinsic value is ₹200. If there are 30 days left before expiration and volatility is high, the time value might be ₹50. Hence, the total premium is ₹250. In-the-Money (ITM), At-the-Money (ATM), and Out-of-the-Money (OTM): In-the-Money (ITM): Call Option: When the current price of the underlying asset is above the strike price. Put Option: When the current price of the underlying asset is below the strike price. At-the-Money (ATM): When the current price of the underlying asset is equal to the strike price. Out-of-the-Money (OTM): Call Option: When the current price of the underlying asset is below the strike price. Put Option: When the current price of the underlying asset is above the strike price. Exercise or Assignment: The holder of a call or put option can choose to exercise the option if it is in-the-money. The writer of the option (the seller) is obligated to fulfill the contract if the option is exercised by the buyer. Section 4.4 Factors Influencing Options Pricing (The Greeks) Options pricing is influenced by several factors, collectively known as The Greeks. These metrics help traders understand how different factors affect the price of an option. Delta (Δ): Measures the sensitivity of the option’s price to changes in the price of the underlying asset. A call option typically has a delta between 0 and 1, while a put option has a delta between -1 and 0. Example: If a call option has a delta of 0.5 and the underlying asset increases by ₹10, the price of the option will increase by ₹5.   Gamma (Γ): Measures the rate of change of delta with respect to changes in the price of the underlying asset. Gamma is important because it helps options traders understand how delta changes as the underlying asset moves. Theta (Θ): Measures the sensitivity of the option’s price to the passage of time, also known as time decay. Options lose value as they approach expiration due to the decreasing time value. Example: If a call option has a theta of -0.1, it will lose ₹0.10 in value every day, all else being equal. Vega (V): Measures the sensitivity of the option’s price to changes in the volatility of the underlying asset. Higher volatility generally increases option premiums because the likelihood of profitable price movement increases.   Rho (ρ): Measures the sensitivity of the option’s price to changes in interest rates. Interest rate changes have a bigger effect on options with longer expiration dates, and typically, call options are positively impacted by higher interest rates, while put options are negatively impacted. Section 4.5 Option Strategies Basic Strategies: Covered Call: This

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Chapter 3: Futures Contracts

F&O Trading Chapter 3: Futures Contracts Futures and Options I Premium Section 3.1 Introduction to Futures Contracts Definition: A futures contract is a standardized agreement between two parties to buy or sell an underlying asset (like a commodity, stock, or currency) at a predetermined price on a specified future date. Futures contracts are traded on exchanges (such as the NSE, CME, or EUREX), and their terms are standardized to ensure consistency in the contract specifications. Unlike forward contracts, futures are regulated and marked-to-market daily, minimizing counterparty risk. Purpose of Futures Contracts: Hedging: Futures are widely used by companies and investors to hedge against the risk of adverse price movements in the underlying asset. Speculation: Traders also use futures to speculate on price movements, aiming to profit from future price changes in the asset. Arbitrage: Futures contracts are used in arbitrage strategies to exploit price differences between markets. Learning Tip Index investing using trend involves selectin a benchmark index like Nifty 50 or Sensex 30 then apply trend study and use the trend based system to invest in all those stocks included in the index for long term. Section 3.2 Key Features of Futures Contracts Standardization: Futures contracts are standardized, meaning that all contracts for a specific asset share the same terms, such as the size of the contract, expiration date, and settlement procedures. For example, a crude oil futures contract on the CME typically represents 1,000 barrels of oil. Settlement: Physical Settlement: In some futures contracts, the actual underlying asset is delivered at the contract’s expiration. For example, in commodity futures, such as crude oil or gold, the seller delivers the physical commodity to the buyer. Cash Settlement: In other contracts, the position is closed with a cash payment based on the difference between the contract price and the market price of the underlying asset at expiry. Financial futures (such as index futures) are typically cash-settled. Speculation: Traders can use derivatives to speculate on the price movement of an underlying asset. Unlike investing in the asset itself, derivatives offer leverage, meaning a small investment can lead to larger returns (or losses). Example: A trader may speculate that the price of gold will rise, and purchase a gold futures contract. Expiration Date: Each futures contract has an expiration date, at which point the contract is settled. The trader can either: Hold until expiration (and receive the physical asset or settle in cash), or Close the position before expiration to avoid delivery and settle the profit/loss. Marking to Market: Futures contracts are marked-to-market daily, meaning that the gains and losses of the position are calculated and settled on a daily basis. Margin Calls: If the market moves against a trader’s position, a margin call may be issued, requiring the trader to add funds to maintain the position. Section 3.3 How Futures Contracts Work The Mechanics: A futures contract is created when two parties agree on the terms (price, quantity, expiry). A buyer agrees to purchase the underlying asset at the agreed price, and the seller agrees to deliver it. The buyer of the contract is said to be long, and the seller is said to be short the contract. Example: Suppose a trader enters into a futures contract to buy 1,000 barrels of crude oil at $60 per barrel, with a contract expiration in 3 months. If the price of crude oil rises to $65 per barrel by expiration, the buyer profits by $5 per barrel. If the price falls to $55 per barrel, the buyer incurs a loss of $5 per barrel. Mark-to-Market Process: Each day, the exchange calculates the difference between the contract price and the current market price of the underlying asset. This difference is credited or debited to the traders’ margin accounts. If the position moves in the trader’s favor, the trader’s margin account is credited with profits. If it moves against them, their account is debited. A margin call occurs when a trader’s margin falls below the required minimum, and additional funds must be deposited to maintain the position. Section 3.4 Types of Futures Contracts Futures contracts can be classified based on the underlying asset, which can range from commodities to financial instruments. Commodity Futures: These futures contracts are based on the price of physical goods such as agricultural products, metals, and energy. Examples: Crude oil futures: The price of oil is highly volatile, and oil producers or consumers use futures to lock in prices. Gold futures: Traders use gold futures to speculate on or hedge against the price of gold. Corn futures: Used by farmers to lock in prices for their crops. Financial Futures: These futures contracts are based on financial instruments like stock indices, interest rates, and foreign currencies. Examples: Stock index futures (e.g., S&P 500 futures, Nifty futures): These track the performance of an index and are popular for hedging equity portfolios. Currency futures: Contracts that involve the future exchange of currencies, such as EUR/USD futures. Treasury futures: Futures contracts that are based on U.S. government bonds or Treasury notes. Interest Rate Futures: These are used to hedge against or speculate on changes in interest rates. For example, traders might use futures based on U.S. Treasury bills or LIBOR rates. Example: A trader who expects interest rates to rise may sell Treasury futures to lock in a higher yield. Section 3.5 Uses of Futures Contracts Futures contracts serve multiple purposes for various market participants: Hedging: Definition: Hedging involves using futures to offset potential losses in another asset or investment. Example: A wheat farmer: A farmer may sell wheat futures to lock in a price for their crop before harvest. If the price of wheat falls by harvest time, the loss in the value of their crop will be offset by the gain in the futures contract. A multinational corporation: A company that imports raw materials in foreign currency may use currency futures to hedge against the risk of adverse exchange rate movements. Speculation: Traders and investors use futures to speculate on the direction

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