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A contract between seller & buyer. An option gives its owner the right to buy or sell an underlying asset on or before a given date at a fixed price. Eg- Mr.X may enjoy the option to buy a certain apartment on or any time before Dec 31 of the current year at a price of Rs.5 millions.

Call option. Put option. Covered option. Naked option.

Simple option. Compound option. Synthetic options. Stock index options. Interest options. Currency options. Range Forward options. Ratio Range forward options. Swaps options.

Capital gain. Tax advantage for holder. Knowing maximum loss in advance. Protects investors portfolio against market movements. Creates new investment opportunities to investors.

Exercise price. Expiration date. Stock price. Stock price variability. Interest rates.

Black-Scholes Option Pricing Model (BSOPM):

Assumptions of the Black-Scholes Option Pricing Model (BSOPM):

No taxes No transactions costs Unrestricted short-selling of stock, with full use of shortsale proceeds Shares are infinitely divisible Constant riskless interest rate for borrowing/lending No dividends European options (or American calls on non-dividend paying stocks) Continuous trading The stock price evolves via a specific process through time (more on this later.)

The BSOPM Formula

C SNd1 Ke rTNd2
where N(di) = the cumulative standard normal distribution function, evaluated at di, and:


ln(S/K) (r 2 /2)T T

d2 d1 T
N(-di) = 1-N(di)

Example Calculation of the BSOPM Value

S = $92 K = $95 T = 50 days (50/365 year = 0.137 year) r = 7% (per annum) s = 35% (per annum)

What is the value of the call?

Solving for the Call Price, I.

Calculate the PV of the Strike Price:

Ke-rT = 95e(-0.07)(50/365) = (95)(0.9905) = $94.093.

Calculate d1 and d2:

d1 ln(S/K) (r 2 /2)T T ln(92/95) (0.07 0.1225/2)0 .137 0.35 0.137

ln(0.96842) 0.01798 0.03209 0.01798 0.1089 (0.35)(0.3 701) 0.12955

d2 = d1 T.5 = -0.1089 (0.35)(0.137).5 = -0.2385

Solving for the Call Value

C = S N(d1) Ke-rT N(d2) = (92)(0.4566) (94.0934)(0.4058) = $3.8307. Applying Put-Call Parity, the put price is: P = C S + Ke-rT = 3.8307 92 + 94.0934 = $5.92.

A warrant is a security that entitles the holder to buy the underlying stock of the issuing company at a fixed exercise price until the expiry date. Warrants are frequently attached to bonds or preferred stock as a sweetener, allowing the issuer to pay lower interest rates or dividends. Warrants are actively traded in some financial markets such as Deutsche Brse and Hong Kong

Comparison with call options

Warrants are very similar to call options. For instance, many warrants confer the same rights as equity options, and warrants often can be traded in secondary markets like options. However, there also are several key differences between warrants and equity options:

Warrants are issued by private parties, typically the corporation on which a warrant is based, rather than a public options exchange. Warrants issued by the company itself are dilutive. When the warrant issued by the company is exercised, the company issues new shares of stock, so the number of outstanding shares increases. When a call option is exercised, the owner of the call option receives an existing share from an assigned call writer. Unlike common stock shares outstanding, warrants do not have voting rights. Warrants are considered over the counter instruments, and thus are usually only traded by financial institutions with the capacity to settle and clear these types of transactions. A warrant's lifetime is measured in years (as long as 15 years), while options are typically measured in months.

Portfolio protection: Put warrants allow the owner to protect the value of the owner's portfolio against falls in the market or in particular shares. Low cost Leverage