DISCLAIMER

This brochure has been provided by MDEX for general reference purposes only. Although care has been taken to
ensure the accuracy of the information/data within this brochure, there is no warranty or representation expressed or
implied by MDEX as to the accuracy or completeness of the materials herein, therefore applicable laws, regulations
and current Exchange and Clearing House rules should be consulted.
FUTURES AND OPTIONS TRADING INVOLVES RISK. THEREFORE, KNOW THE RISKS BEFORE YOU TRADE.
The Business Rules of MDEX supersede all matters pertaining derivatives contracts. Current Business Rules of
MDEX should be referred to concerning trading and contract specifications are subject to change from time to time.
Contact your broker or MDEX concerning current contract specifications.
The Kuala Lumpur Stock Exchange (KLSE) owns the KLSE trade name, KLSE trademark and rights to the KLSE
Composite Index (KLSE CI). MDEX has entered into an Agreement with KLSE which permits it to utilise the KLSE
trade names and trademark only in connection with the creation, marketing and trading a contract based upon the
KLSE CI. The composition and calculation of the KLSE CI are in the exclusive control of KLSE. The KLSE CI is
composed and calculated by KLSE without regard to the needs of MDEX, its members or their customers and KLSE
has no obligations to take the needs of those individuals or entities into consideration in composing or calculating the
KLSE CI.
KLSE does not guarantee the accuracy and/or completeness of the KLSE CI or any data included therein. Neither
KLSE, nor its partners, affiliates, employees and agents, shall have any obligations or liability, contingent or otherwise,
to MDEX, its members or their customers, in connection with the trading of any contract based on the KLSE CI.
KLSE makes no warranty, express or implied, as to the results to be obtained by any person or any entity from the use
of the KLSE CI or any data included therein in connection with the trading of the contracts, or for any other use KLSE
makes no express or implied warranties or merchantability or fitness for a particular purpose for use with respect to
the KLSE CI or any data included therein.
All rights reserved. The text of this publication, or any part thereof, may not be reproduced or transmitted in any form
or by any means, electronic or mechanical, including photocopying, recording, storage in an information retrieval
system, or otherwise, without the prior written consent of MDEX.

Introduction
to Options

10th Floor, Exchange Square, Bukit Kewangan

50200 Kuala Lumpur, Malaysia.
(A member of KLSE Group)
Tel: +603 - 2070 8199 Fax: +603 - 2710 2313
E-mail: info@mdex.com.my Website: www.mdex.com.my

MDEX

Margin call

Additional funds required following adverse price

change

Mark-to-market

The daily process of adjusting the value of the position

with respect to the current settlement price of the
option contract

Out-of-the-money

Calls:

Puts:

An option is out-of-the-money when the

exercise price is above the market price of
the underlying asset
An option is out-of-the-money when the
exercise price is lower than the market price
of the underlying asset

Position

Open contracts indicating an interest in the market,

be it long or short

Premium

The amount paid by the holder for the right, but not
the obligation, to buy/sell the underlying asset at a
specified price within a specific period of time

Put option

A contract which gives the holder the right, but not

the obligation, to sell the underlying asset at a
stipulated exercise price within a specified period of
time

Series of options

Options of the same class and type that have the

same exercise price and expiration date

Short

A market position which has been established

through the sale of an option and for which no
offsetting purchase has been made

Time value

Part of the option premium which reflects the excess

over intrinsic value, or the entire premium if there is
no intrinsic value. At given price levels, the option time
value will decline until expiration. It is the decrease in
time value that makes an option a wasting asset

Underlying assets

The assets subject to purchase or sale upon exercise

of the option

Writer

Party who is obligated to sell to a Call holder or buy

from a Put holder the underlying asset at the options
exercise price

U

V

FOREW
ORD
FOREWORD

GLOSSARY
At-the-money

Call option

The exercise/strike price of the option is equal to or

approximately at the market price of the underlying
asset
A contract which gives the holder the right but not
the obligation to buy the underlying asset at the
options stipulated exercise price within a specified
period of time

Class of options

Options contracts of the same type (Call or Put)

covering the same underlying assets

Exercise

Action taken by option holder to take up the rights

of the option contract to buy or sell the underlying
asset. Call holders buy the asset at the stated exercise
price and Put holders sell it at the stated exercise
price

Exercise Price

The price at which an option holder may purchase

or sell the underlying asset upon exercise of an option.
Also called the strike price

Expiration date

The last day when an option may be exercised

Hedge

The purchase or sale of offsetting positions in options

in order to protect all or some portion of the
underlying assets

Holder

The purchaser/buyer of a Call or Put option

In-the-money

Calls: An option is in-the-money when the exercise

price is lower than the market price of the underlying
asset
Puts: An option is in-the-money when the exercise
price is higher than the market price of the underlying
asset

U

V

Intrinsic value

The dollar value of the difference between the option

exercise price and the underlying asset price which
would be realised in the event the option is exercised

Long

A market position which has been established

through the purchase of an option for which no
offsetting sale has been made

Margin

Funds that must be deposited to guarantee fulfilment

of options contracts

Options can be bought on a wide variety of products,

including commodities, stocks, stock indicies, interest rates,
bonds and currencies.
In Malaysia, Stock Options and Stock Index Options are
financial instruments being introduced in response to the rapid
growth in the countrys capital markets and an increasingly
complex and volatile market environment.These new products
are primarily simple and basic tools for risk management which
can be used very effectively by informed market participants,
ranging from fund managers to financial institutions to retail
investors.
Options can broadly be used either for hedging or for
speculation. Their usefulness, both from a buyers and sellers
point of view, is linked to their payouts.
From a hedging perspective, options provide insurance against
unfavourable moves in a products price and the opportunity
to take advantage of favourable moves. There are a myriad
of strategies an investor can use to suit his or her risk profile.
This booklet introduces some basic concepts and aims to
provide an awareness of the risks and rewards in trading
options.

U V

ig
ins of OPTIONS MARKET
Orig
igins
Or
It was first documented in 17th century
Amsterdam, Holland
G
PRODUCT
Options on Tulip Bulbs
G
1934
USA
Options trading legalised
G
1973
Emergence of Chicago Board Options Exchange (CBOE)

Organised options trading started in 1934 in the United States,

although its first use apparently dates as far back as the Middle
Ages. In its simplest form, options were used as a protection or
a hedge against price fluctuations. It offered investors and risk
managers the ability to define and limit risk. Market participants
can reap profits if they were correct in their anticipation of
price movements.
Options trading expanded over the years as interest increased
and investors became more sophisticated. Today, options are
being used to manage investments over virtually any market
condition, be it bullish, bearish or even neutral market trends.
Trading of the Kuala Lumpur Stock Exchange Composite Index
(KLSE CI) Options started in December 2000. Single Stock
Options and other similar instruments may eventually be
introduced on the Malaysia Derivatives Exchange Berhad
(MDEX).

If the underlying stock index stays above the exercise price of

the Put on expiration, the Put option is unlikely to be exercised,
in which case the writer will retain the full amount of the
premium received.
MARKET SENTIMENT

Neutral to Bullish

PLAN OF ACTION

Write Put Option

WRITERS POTENTIAL
OBLIGATION

To buy the underlying

index

WRITERS RIGHT

To liquidate position i.e.

buy back the Put Option

Date

Position

2 January

The underlying index is at 800

Sell January 800 put @ 20.0

31 January

The underlying index closes at 845

Out-of-the-money by 45 index points

Holder does not exercise, thus option expires worthless.

Profit for writer is limited to the premium received = RM2,000
Pr
ofit
Profit

Premium
received

F
G
A=800

ical Note
Historical
A Histor

Underl
ying Inde
Underlying
Indexx

Breake
ven=780
Breakeven=780

Loss

U

V

U ' V

WHA
WHATT IS AN OPTION?

Pr
ofit
Profit

Premium
received

F
G
A=760

Breake
ven=777
Breakeven=777

Underl
ying Inde
Underlying
Indexx

An option is a formal contract which gives the holder the right,

without the obligation, to purchase or sell a certain quantity of
an underlying asset at a stipulated price (exercise price) within
a specific period of time..
To acquire this right, the holder pays an option premium to the
writer of the option contract. In return for assuming this risk, the
seller receives a premium, effectively a risk-taking fee.

Loss

When the Call option is exercised, the writer will need to cashsettle the option in his possession. However, the writer may
cancel his obligation by liquidating his position in the market
by buying an option identical to the one sold.
A loss will normally be incurred if an option is bought for a
premium higher than it was sold for. Conversely, the writer will
realise a profit if he bought the stock index option for a
premium lower than it was sold for. A writer should always keep
in mind this alternative of liquidating his option position.
The holder of the stock index option is required to give the
Clearing House notice of his intention to exercise through his
broker. All writers who are registered as having open positions
in a particular series at the close of trading, are liable to be
selected to fulfil the obligation when served the exercise
notice.

Writing Put Options

Writing Put options offers an attractive investment opportunity
for investors who expect the underlying stock index to remain
at or slightly above the exercise price of the option.

U & V

There are two types of options that an investor can choose to

buy or sell, a Call Option or a Put Option. Both are listed on MDEX.
Anybody can be a holder (buyer) or writer (seller) of an option.

What is a Stock Index Option?

A contract which gives the holder the right, without the
obligation, to buy (Call) or sell (Put), a specific stock index, at
a specified price on or before a specific future date. In
Malaysia, this stock index would refer to the basket of 100 stocks
that make up the KLSE CI.

Call Option
A Call option gives the buyer the right, but not the obligation,
to purchase the underlying asset at a stipulated exercise price
and at a specified time before expiry, that is, during the life of
the option.

Example:
The KLSE CI September 600 Call gives the holder the option
to purchase the KLSE CI at 600 index points when the option
expires in September.

U!V

If the holder exercises the option, the writer is obliged to sell

the KLSE CI to the holder at 600 index points.

Writing Call Options

Put Option

While the option holder takes a limited risk and stands to

benefit substantially, the option writer is subject to unlimited
risk, with the prospect of known and limited rewards.

A Put option gives the buyer the right, but not the obligation,
to sell the underlying asset at the stipulated exercise price
and at a specified time during the life of the option.

If the underlying stock index moves upwards, the loss is

equivalent to the current price of the index less the amount
of premium received.

Example:
The KLSE CI October 700 Put gives the holder the option to sell
the KLSE CI at 700 index points when the option expires in October.

Since options are wasting assets, the option writer benefits as

the time value of the option decays.

If the holder exercises the option, the writer must purchase the
KLSE CI from the holder at 700 index points.
Hence, a Put option is the exact opposite of a Call option.
Where a Call gives the buyer the right to buy, a Put will give
the buyer the right to sell.

SUMMARY
RIGHTS

MARKET SENTIMENT

Neutral to Bearish

PLAN OF ACTION

Write Call Option

WRITERS POTENTIAL
OBLIGATION

To sell the underlying

index

WRITERS RIGHT

To liquidate position i.e.

buy back the Call Option

Date

Position

2 January

The underlying index is at 760

Sell January 760 call @ 17.0

31 January

The underlying index closes at 750

Out-of-the-money by 10 index points

OBLIGATIONS

Holder of a Call

Buy the underlying

Holder of a Put

Sell the underlying

Writer of a Call

Sell the underlying

Writer of a Put

Buy the underlying

Holder does not exercise, thus option expires worthless.

Profit for writer is limited to the premium received = RM1,700

U " V

U % V

A margin is required to write an option. Margins are funds which

must be deposited by the writer to guarantee his fulfilment of the
option contracts. Besides cash, other forms of collateral may also
be accepted and these are determined by the Malaysian
Derivatives Clearing House (MDCH).Margins are refundable upon
liquidation of written positions.
Basic FFacts
acts About Wr
iting Options
Writing
WRITTEN POSITIONS

- Similar to futures trading. (Writing

call options are similar to selling
futures and writing put options
are similar to buying futures)

REQUIREMENTS

- A margin deposit

DAILY MONITORING

- Marked-to-market. Additional
funds may be requested
depending on the daily closing
of the underlying index

IMPOR
IMPORTTANT POINTS TO REMEMBER WHEN TRADING
OPTIONS
Underlying Asset
An underlying asset is the instrument which is bought or sold
when an option is exercised. Hence, the KLSE CI would be the
underlying asset for options currently listed on MDEX.
Styles of Options
There are 2 option styles - American and European.
An American style option contract may be exercised at any time
up to, and including, the expiry date. A European style option
contract can only be exercised on the expiration date.The KLSE
CI Option contracts traded on MDEX are European style.
Exercise Price
The exercise or strike price of an option is the price which the
option holder pays or receives when the option is exercised.

All cash-covered written positions are marked-to-market at the

close of each days trading. This means that the investor has
to deposit additional funds to hold his written position if the
position is against him at the end of each trading day.
The additional fund requirement is termed a Margin Call.. These
Margin Calls must be fulfilled by the investor within the time
frame required by the broker. If the underlying moves positively
for the investor and his written stock option position shows a
positive balance, the additional funds will be credited into his
account at the close of the days trading.

Premium
The premium is the amount that the holder pays for the option;
it is therefore also the amount the option writer receives.
Premiums are established in a free and open market
environment at MDEX, through competitive bidding between
buyers and sellers.
Expiration Date
An option has a limited life span. The expiration date is the
last day on which the option may be exercised. The KLSE CI
Option contract is cash-settled upon expiration.
An option has no value after its expiration date.

U $ V

U#V

To allow options to be easily bought and sold on the Exchange,

all elements such as the underlying asset, exercise styles,
exercise price and expiration date, are standardised.

MARKET SENTIMENT

- Bearish

PLAN OF ACTION

- Buy Put Option

HOLDERS RIGHT

YV
ARIABLE ELEMENT OF AN OPTION IS ITS PREMIUM
ONLY
THE ONL
VARIABLE
(PRICE).
Pr
ofit
Profit

The theoretical or fair value of the premium is influenced by

the following factors:

Sell option (liquidate position)

OR
l Exercise option at expiration
l

1. Price of the Underlying Asset

The market price of the underlying asset has a significant
influence on the premium of the option. On expiration, the
value of the option is the positive difference between the
underlying asset price and the exercise price.
A Call option value increases as the underlying asset price
increases; whereas a Put option value increases as the
underlying asset price decreases.
2. The Option Exercise Price

Premium
paid

Underl
ying Inde
Underlying
Indexx
Breake
ven
Breakeven

Loss

As in the case of Call options, if the underlying index rises, the

holder of the Put option cannot lose more than the premium
paid. The alternative is to recover a portion of the premium by
selling the Put option before the expiration date, i.e., closing
out an open position.

IN, AT AND OUT-OF-THE-MONEY

In-the-money

At-the-money

U $ V

Call : when the exercise price is lower

than the underlying index
Put : when the exercise price is higher
than the underlying index
The exercise price is equal to or
approximately at the underlying index

Writing Options
Writing options involves risks and rewards that are exactly
opposite to the risks and rewards when buying options.
While the OPTION BUYER
assumes
limited risk
and the prospect of
unlimited rewards

The OPTION SELLER

assumes
unlimited risk
with the prospect of
limited rewards

U # V

Pr
ofit
Profit

Premium
paid

Out-of-the-money

Underl
ying Inde
Underlying
Indexx
Breake
ven
Breakeven

E = Ex
er
cise Price
Exer
ercise

KLSE COMPOSITE INDEX

EX. PRICE
JAN

Loss

In theory, when exercising a Call option on a stock index, the

option holder buys the basket of stocks which makes up the
underlying stock index at the option exercise price.

A Put option holder has the right to sell the underlying stock
index at the exercise price when he exercises the option.
Should the underlying stock index move upward and the
option expires worthless, he will lose no more than the premium
paid for the option.

In-the-mone
y
In-the-money
At-the-mone
y
At-the-money
Out-of-the-mone
y
Out-of-the-money

PUT
Out-of-the-mone
y
Out-of-the-money
At-the-mone
y
At-the-money
In-the-mone
y
In-the-money

A Put option is in-the-money if the market price of the

underlying asset is below the exercise price of the Put.
Therefore, at a given exercise price, the value of a Put
option decreases as the underlying asset price increases
and vice versa.

Buying Put Options

Almost any economic, financial, political or social factor may
affect the direction of the stock market. If the stock market is
expected to be adversely affected by current data, investors
may capitalise on this by purchasing Put options. This
opportunity is not available in the physical stock market.

740
760
780

CALL

760

A Call option is in-the-money if the market price of the

underlying asset is above the exercise price of the Call.
Using the above example, should the KLSE CI be at 760
and if you have purchased a 740 call, you can essentially
buy the index at a much lower price (740).Therefore, at a
given exercise price, the value of a Call option increases
as the underlying asset price increases and vice versa.

What happens if the underlying stock index drops

below the Call option exercise price :a) at expiry? Option expires worthless
b) before expiry? Investor may liquidate his position
in the option market to cut his losses; or hold on and
hope the underlying index price will rise

U " V

Call : when the exercise price is

above the underlying index
Put : when the exercise price is lower
than the underlying index

3.

Time Remaining To Expiration

Time value relates to the life span of an option.The longer
the time to expiration, the greater the probability of a
movement in the stock price which results in a positive
impact on the stock option premium. As an option
approaches expiration, its time value approaches zero.
This means that as the life span of the option shortens,
the time value decreases.

U %V

Time
Value

Time Remaining - month

4.

The rate at which an option decreases

in value is called the rate of decay. This
rate accelerates towards expiry. This is
because the further away an option is
from expiry, the greater the probability
of favourable price movements resulting
in the option being in-the-money.

Volatility of the Underlying Asset

All other factors remaining constant, the more volatile
the price of the underlying asset, the higher the premium
as there is a greater chance of the option remaining inthe-money.
More volatile underlying assets have higher option
prices. For example, if the index has the ability for a huge
upward swing, buyers of Calls are willing to pay higher
prices - and sellers demand them as well.

5.

Supply and Demand

Ultimately, the premium is determined by market supply
and demand. In general, the demand for Call options
rises in bullish market conditions, while the demand for
Put options rises in bearish market conditions.

BASIC TRADING STRA

TEGIES
STRATEGIES
Buying Options
This is the simplest way to participate in the options market. It
provides an attractive opportunity to profit from an expected
increase or decrease in the price of the underlying asset.
Its upside profit potential is unlimited with a known and limited
downside.

Buying Call Options

The holder of a Call option expects an increase in the
underlying index. Having bought the option, he may choose
to realise his gains by either closing out his position or holding
the option to expiration and exercising the option should it be
in-the-money.
In the event that he was wrong in his judgement, his risk is limited
to the amount paid for the option and no more. Option holders
usually choose to realise their profits by liquidating their options.
Generally, only a small percentage of investors proceed to
exercise their options.
MARKET SENTIMENT

- Bullish

PLAN OF ACTION

- Buy Call Option

HOLDERS RIGHT

l
l

U & V

Sell option (liquidate position)

OR
Exercise option at expiration

U ! V

THE POWER OF LEVERAGE

DATE
2 January
31 January

Cost of purchase
Proceeds from sale
Net Profit
Profit / Cost

A Fur
ther Note On Pr
emium
Further
Premium
OPTION
RM1,700
RM3,000
RM1,300
76.5%

PORTFOLIO
RM76,000
RM79,000
RM 3,000
3.95%

INTRINSIC VALUE

The total value for the option is obtained by multiplying the

premium with the contract multiplier of RM100.

CALLS

2 January
KLSE CI January 760 Calls premium
The cost of the KLSE CI January 760 Call

The intrinsic value of a Call option is the amount by which the

price of the underlying asset exceeds the exercise price.
17 index points
17 index points x RM100
= RM1,700

31 January
KLSE CI is trading at 790
KLSE CI January 760 call option is now in-the-money by 30 points and
exercised.
Final Settlement Value
790 index points
The profit realised when cash-settled at expiration (30 - 17 index points)
x 100 = RM1,300
(Please note that all transaction costs have been excluded)

3.

CALL OPTION INTRINSIC VALUE = Under

lying Inde
er
cise Pr
ice
Underlying
Indexx - Option Ex
Exer
ercise
Price

Example
KLSE CI (underlying) is at 780, therefore the intrinsic value of a
September 760 Call is 780 - 760 = 20 index points
This may be realisable into profit by exercising the option at
expiration

Example:
Holder exercises the KLSE CI September 760 Call 760 index points
Final Settlement Value at
780 index points
Profit
20 index points

Generating additional income

Writing options on a stock holding generates
additional income for the portfolio. This additional
income which is received in the form of premiums may
also be used to reduce the cost of stock purchase or
to enhance returns.

V

1. Intrinsic value
2. Time value

(Comparing holding options vs. actual stocks)

* Estimated portfolio value = KLSE CI Level x RM 100

Example:

U 

The premium may be assessed by breaking it into 2

components:

Based on the Final Settlement Value, an option tha

ya
thatt is in-the-mone
in-the-money
att the
y an amount deter
mined b
y the
close of trading on the Final Trading Day b
by
determined
by
Exchange with the agr
eement of the Malaysian Der
iv
ativ
es Clear
ing House
agreement
Deriv
iva
tives
Clearing
(MDCH) shall automa
tically be e
xer
cised
automatically
ex
ercised
* Assumption: Option pr
emium and transaction costs not tak
en into account
premium
taken

U 'V

BASIC APPLIC
ATIONS
APPLICA
APPLICATIONS

PUTS
The intrinsic value of a Put option is the amount by which the
price of the underlying asset is lower than the exercise price
of the option.
PUT OPTION INTRINSIC V
ALUE = Option Ex
er
cise Pr
ice - Under
lying Inde
Exer
ercise
Price
Underlying
Indexx
VALUE
Exercise

Stock index options offer investors the opportunity to profit from

bullish, bearish as well as neutral market conditions. For option
holders, the risk is limited to the premium paid. For writers, there is
the opportunity to earn additional investment income. However,
an option writer can have potentially unlimited losses.
In summary, options are typically used by investors for: -

Intr
insic V
alue can ne
ver be neg
ativ
e
Intrinsic
nev
nega
tive
Value
never
negative

1.

Risk management - Portfolio protection

The purchase of a Put can serve as an insurance against a
fall in the market price of the underlying stock index.

TIME VALUE
2.

Leverage

An option generally has both intrinsic and time value.. The time
value is the amount that investors are willing to pay with the
expectation that they will be able to make a profit when the
option is exercised or liquidated at some time before the
expiration date. The time value of an option is related to the
time to expiration of the option, the volatility of the underlying
asset and the risk-free interest rate.

Leverage is the fundamental factor that makes options

so attractive. It allows holders to participate in the market
without the need to put up a large sum of money. This
means that an investor can take positions in the market
while waiting for funds or alternatively, place the rest of
his available funds in other forms of investment.

Where the option has no intrinsic value, it is said to be out-ofthe-money and the premium will then consist entirely of time
value.

Leverage also allows for diversification at a low cost. A

large amount of capital would otherwise be required
to diversify a stock portfolio.

HOW LEVERAGE WORKS

U  V

2 January

The underlying index is at

Buy January 760 call for

760
17.0

31 January

The underlying index closes at

In-the-money by 30 index points

790

U  V