OPTIONS: MEANING

An option is a legal contract which gives the holder the

right to buy or sell a specific amount of underlying asset

at a fixed price within a specified period of time.

For Example:

Foreign currency options

Interest rate options

Futures options

POINTS TO REMEMBER
1.

2.
3. 4.

5.

6. 7.

Legal Contract Buyer and Seller of the option contract Option Exchange OTC Buyer/Holder of option has a right to buy / sell the asset Seller/Writer of the option has the obligation to buy / sell Buyer must pay the premium to the seller Contract should be completed within or on expiry of the term of contract

PARTIES TO THE OPTIONS CONTRACT

BUYER Long Position

Option Exchange -----------------------OTC

SELLER Short Position

OPTIONS : TYPES
Right to buy Buyer Pays premium Call Option Obligation to sell Seller Receives the premium Options Right to sell Buyer Pays premium Put Option Obligation to buy Seller Receives the premium

OPTION POSITIONS

Buy call

Buy put

Write call

Write put

EXERCISE PRICE

It is the price at which the parties with long and short position buy and sell the underlying asset.

ATTITUDES OF BUYERS & SELLERS

1.

Call Option Buyer Bullish Call Option Seller Bearish

2.

3.

Put Option Buyer Bearish

Put Option Seller Bullish

4.

PROFITABILITY OF OPTIONS
Price Call Option Put Option

S>X
S=X

In the Money
At the Money Out of the Money

Out of the Money

At the Money In the Money

S<X

EXERCISE FOR OTM, ITM & ATM

Stock Price (S) Strike Price (X) Condition Status for Status for s call put

270 300

360 360

360
400

360
360

450
500

360
360

EXERCISE FOR OTM, ITM & ATM

Stock Price (S) Strike Price (X) Condition Status for Status for call put

270 300 360 400 450

360 360 360 360 360

S<X S<X S=X S>X S>X

OTM OTM ATM ITM ITM

ITM ITM ATM OTM OTM

500

360

S>X

ITM

OTM

WHY TO BUY OPTIONS

1.

2.

3.

4. 5.

Bull buys the call option to take advantage of rise in price Bear buys the put option to take advantage of a fall in price One can buy the option at lower premium and sell it at a higher premium Buyer can limit the loss to the option premium Call and put option can be used for hedging

WHY TO SELL OPTIONS

1.

Call option can be sold to earn option premium Put option can be sold to earn premium To reduce cost of acquisition of asset (When the asset is overpriced)

2.

3.

OPTIONS PAYOFF
CALL OPTION BUYER (LONG CALL) (IN RS.)
Stock Price Strike Price Premium 500 525 600 600 25 25 P/L to the buyer

550 575 600 625 650 675 700

600 600 600 600 600 600 600

25 25 25 25 25 25 25

OPTIONS PAYOFF
CALL OPTION BUYER (LONG CALL) (IN RS.)
Stock Price Strike Price Premium 500 525 600 600 25 25 P/L to the buyer -25 -25

550 575 600 625 650 675 700

600 600 600 600 600 600 600

25 25 25 25 25 25 25

-25 -25 -25 00 25 50 75

OPTIONS PAYOFF
CALL OPTION SELLER (SHORT CALL)
Stock Price Strike Price 500 525 600 600 Premium 25 25 P/L to the seller

550 575 600 625 650 675 700

600 600 600 600 600 600 600

25 25 25 25 25 25 25

OPTIONS PAYOFF
CALL OPTION SELLER (SHORT CALL)
Stock Price Strike Price 500 525 600 600 Premium 25 25

(RS.)
P/L to the seller 25 25

550 575 600 625 650 675 700

600 600 600 600 600 600 600

25 25 25 25 25 25 25

25 25 25 00 -25 -50 -75

OPTIONS PAYOFF
PUT OPTION BUYER (LONG PUT) (IN RS.)
Stock Price Strike Price Premium 500 525 600 600 25 25 P/L to the buyer

550 575 600 625 650 675 700

600 600 600 600 600 600 600

25 25 25 25 25 25 25

OPTIONS PAYOFF
PUT OPTION BUYER (LONG PUT)
Stock Price Strike Price Premium 500 525 600 600 25 25 P/L to the buyer 75 50

550 575 600 625 650 675 700

600 600 600 600 600 600 600

25 25 25 25 25 25 25

25 00 -25 -25 -25 -25 -25

OPTIONS PAYOFF
PUT OPTION WRITER (SHORT PUT)
Stock Price Strike Price Premium 500 525 600 600 25 25 P/L to the buyer

550 575 600 625 650 675 700

600 600 600 600 600 600 600

25 25 25 25 25 25 25

OPTIONS PAYOFF
PUT OPTION WRITER (SHORT PUT)
Stock Price Strike Price Premium 500 525 600 600 25 25 P/L to the buyer -75 -50

550 575 600 625 650 675 700

600 600 600 600 600 600 600

25 25 25 25 25 25 25

-25 00 25 25 25 25 25

AMERICAN V/S EUROPEAN OPTIONS

American option can be exercised by its owner at any time on or before its expiry date European option can be exercised by its owner only on the date of expiry

AMERICAN OPTION CALL OPTION BUYER (LONG CALL) (IN RS.)

Date

March1 5 7 9 11

13
15 17

20

Stock Price 500 525 550 575 600 700 675 650 550

Strike Price 600 600 600 600 600 600 600 600 600

Premium
25 25 25 25 25

25 25 25 25

P/L to the buyer -25 -25 -25 -25 -25 75 50 25 -25

EUROPEAN OPTION CALL OPTION BUYER (LONG CALL) (IN RS.)

Date

Stock Price
March1 5 7 9 11 13 15 17

Strike Price 600 600 600 600 600 600 600 600

500 525 550 575 600 700 675 650

Premium P/L to the buyer 25 -25 25 -25 25 25 25 25 25 25 -25 -25 -25 75 50 25

20

550

600

25

-25