Options

OPTIONSPROF. MALLIKARJUN BALIBLDEA’S VP DR. P. G. H . CETMBA DEPARTMENTBIJAPUR

Introduction

Options, like futures, are also speculative financial instruments. An option is a legal contract which gives the holder the right to buy or sell a specified amount of underlying asset at a fixed price within a specified period of time. It gives the holder the right to buy (or sell) a designated asset. The holder is, however, not obliged to sell (or buy) the same.

Option is the right to either buy or sell something, at a specified price within a specified period of time.

Types of Options

Call Options It gives the right to buy underlying asset,

but not obligation to buy. Put Options

It gives the right to sell underlying asset, but not obligation to sell.

Call Option Buying

A Call option buyer basically is bullish about the underlying stock.

Put Option buying

• A buyer of put option is bearish on underlying stock.

Terminologies used in Options

Call options and Put options American options and European options Physical delivery v/s cash- settled options Expiration date Exercise price Option premium Long Call & Long Put Shot Call & Short Put Covered and Uncovered (Naked) Call

Return and risk of Buyer and seller of Option contract

• Seller has an obligation and buyer has a right in option agreement

• Buyer• Limited amount of risk (max loss is premium

paid)• Return (profit) potential in unlimited

• Seller• Unlimited risk• Limited return potential

Options Terminology

At any time, option maybe: Call

Put At the money (ATM) : ExP = MP ExP =

MP In the money (ITM) : ExP < MP

ExP > MP Out of the money (OTM): ExP > MP

ExP < MP

Call Option at Expiration

Call optionStrike price : 100; Premium : Rs 10/share;No of shares – 100; Expiration : 31.03.2012

On 31.03.2012, Market price of share

Profit (Loss) for buyer

80 (1000)

90 (1000)

100 (1000)

110 0

120 1000

130 2000

140 3000

Put optionStrike price : 100; Premium : Rs 10/share;No of shares – 100; Expiration : 31.03.2012

On 31.03.2012, Market price of share

Profit (Loss) for buyer

70 2000

80 1000

90 0

100 (1000)

110 (1000)

120 (1000)

Exercise of Puts

Pay off from a Long Call

Payoff from Short Call

Options Trading Strategies

Hedging a Long position in stock Hedging a short position in stock Hedging with writing call and put options Spreads and Combinations

Bull spreads Bear spreads

Butterfly spreads Straddle Strips and straps strangles

Option Valuation Modules

The Binomial model Black and Scholes model

Thank You!