m An option is a contract that gives the

holder a right, without any obligation, to

buy or sell an asset at an agreed price
on or before a specified period of time.

m Options can be for short term(less than a

year to expiration) or long term.

m Examples of long term options are can

be rights, warrants, LEAPS (long term
equity anticipation securities) etc.
’
m
hey provide 
 to the holder instead
of an obligation.

m
he option writer (seller) charges a price
for granting the right from the option
holder (buyer).

m It can be used for hedging.

m Option writer or holder can limit the

amount of risk or loss.
’ ’
’
 
{
he option to buy an asset is known as a Ê




{
he option to sell an asset is called a  
.

{ x
 an option if covered/ written
against the assets owned by the option writer
is called a covered option

{ ¦   if the option is not covered

bye the physical asset, it is known as naked
option.
’ ’
’
 
÷ iʏ In which underlying assets
are individual stocks.

÷ ©  In which underlying asset

is the index of securities.

÷ © ©
      
  




   

 
  



 
 
  
  




’ ’
’
 
 { @   ½hen an option is allowed
to be exercised only on the maturity date, it
is called a @

 
 .

{ 6 Ê  ½hen the option can be

exercised any time before its maturity, it is
called an 6 
 
 .

m © ©
   

  
 6 


    
 
  

@

 
 

’ ’
’
 
m
he futures involve obligation while the
options involve right.

m No premium is to be paid in futures while

it·s the price to be while buying an
option.

m In futures, both the parties are exposed

to unlimited profit or loss.

m Generally, the maturity period of futures is

longer than that of options.
’ ’
’
 
m u   it is the price; the
option holder pays to the option writer
for availing the right.

m iʏ it is the specified price at

which the option can be exercised

m @   It is the last date when

the option can be exercised.

’ ’
’
 
m ©

  A put or a call option is said
to     when it is advantageous
for the investor to exercise it.

m u 


  A put or a call option is

   if it is not advantageous
for the investor to exercise it.

m 6

  ½hen the holder of a put or

a call option does not lose or gain whether
or not he exercises his option.

’ ’
’

 ^
 x



Actual price > Selling Price In-

he-Money

Actual price = Selling Price At-

he-Money

Actual price < Selling Price Out-

he-Money

’ ’
’
 

m
he Security Exchange Board of India
(SEBI) has announced a list of 31
shares for the stock-based option
trading from July 2002. SEBI selected
these shares for option trading on the
basis of the following criteria

{ Shares must be among the top 200 in

terms of market capitalisation and trading
volume.

{ Shares must be traded in at least 90 per

cent of the trading days.

’ ’
’
 
m
he non-promoter holding should be at
least 30 per cent and the market
capitalisation of free-float shares should
be Rs 750 crore.

m
he six-month average trading volume in
the share in the underlying cash market
should be a minimum of Rs 5 crore.

m
he ratio of daily volatility of the share vis-
à-vis the daily volatility of the index
should not be more than four times at
any time during the previous six months.

’ ’
’
 ’
m
he minimum size of the contract is Rs
2 lakh. For the first six months, there
would be cash settlement in options
contracts and afterwards, there would
be physical settlement.

he option sellers will have to pay the
margin, but the buyers will have to
only pay the premium in advance.

he stock exchanges can set limits on
exercise price.

’ ’
’
 
m Œ  Ê

buying a right from the
option writer to buy a specified quantity
on a specified date for a specified price

m i

 Ê


  

Ê

 selling a right to
someone to allow him to buy from us, a
specified quantity of security on a
specified date at a specified price.
’ ’
’
 
m Simple binomial tree approach to
option valuation.

m Black-Scholes option valuation model.

’ ’
’
 
 [ Ê x





1.increase in value of increases

underlying asset
2.extent of volatility in increases
value of asset
3.increase in the strike rate decreases

4.longer expiration time increases

5.increase in rate of increases

interest ’ ’
’
 

he value of option will always be positive because it
provides us with a right and not an obligation.

÷ ©Ê

 It is the difference
between the spot price and the strike price

÷
 

 
he time value or the time
premium of an option is the amount by which
the option price exceeds the intrinsic value

÷ Option premium = Ê


 



’ ’
’
 
m If the annual volatility is ǔ, then ;

½e can estimate the up price

movement, , and down price
movement,
by using

      

’ ’
’
 
For example, assume a current stock price of Rs.75,
a volatility of .50 and time as 1 month. And we
have to calculate 2 weeks prices.

hen ǔ =0.50

t=2 weeks i.e. .04167 years

On substituting the values, we get,

u=e 0.50 ¥.04167 = 1.10745

and d=e- 0.50 ¥.04167 = .90297

’ ’
’
 

ÊÊ




"

Π !

u3.06*1.0745=91.9u
75*1.0745=u3.05u
u3.06*0.9029=75

Rs. 75

67.72*1.10745=75
75*0.90297=67.72
67.72*0.9029=61.15

Œ©¦u!©6

^@@

’ ’
’
 ’