Introduction to Options
Options Terminology
Exercise
Invoke the rights approved to buyer of option
Assignment
When the buyer of an option exercises his right to buy / sell, a randomly selected option seller (at the client level) is assigned the obligation to honor the underlying contract
Introduction to Options
Options Terminology
Open Interest
The total number of outstanding contracts on a given series or for a given underlying at a particular point in time
Introduction to Options
Options Terminology
European Option
Can be exercised only on the expiration date
eg. Index Options
American Option
Can be exercised any time on or before the expiration date
eg. Stock Options
Introduction to Options
Options Terminology
In the money options
It is an option that will lead to a positive cash flow to buyer when exercised
Call option is in the money when CMP is higher than strike
Put option is in the money when CMP is lower than strike
Introduction to Options
Options Terminology
At the money options
It is an option that will lead to a zero cash flow to buyer when exercised
Options are at the money when CMP is equal to strike
Introduction to Options
Options Terminology
Out of the money options
It is an option that will lead to a negative cash flow to buyer when exercised, however OTM options can never be exercised / assigned
Call option is out of money when CMP is lower than strike
Put option is out of money when CMP is higher than strike
Introduction to Options
Options Terminology
Intrinsic value (IV)
Difference between spot and strike
ITM has IV, ATM and OTM have zero intrinsic value
Time value (TV)
Difference between the Premium and Intrinsic value
ITM have both IV and TV, ATM and OTM have only TV.
Longer the expiry more the TV, on expiry TV is zero
Introduction to Options
Options Pricing
Primarily two methods used:
Black Scholes method
Cox – Ross method
Find attached calculator
Introduction to Options
Options Pricing
Factors affecting options price:
Stock price
Call options more valuable with the rise in price and less valuable with the fall in price
Put options more valuable with the fall in price and less valuable with the rise in price
Introduction to Options
Options Pricing
Factors affecting options price:
Strike price
Call options more valuable at the lower strike and less valuable at the higher strike
Put options more valuable at the higher strike and less valuable at the lower strike
Introduction to Options
Options Pricing
Factors affecting options price:
Risk free Interest rate
Call option premium increases with rise in interest rates
Put option premium decreases with rise in interest rates
Introduction to Options
Options Pricing
Factors affecting options price:
Time to expiry
Options are more valuable when the time to expiration is more
Options Terminology
Exercise
Invoke the rights approved to buyer of option
Assignment
When the buyer of an option exercises his right to buy / sell, a randomly selected option seller (at the client level) is assigned the obligation to honor the underlying contract
Introduction to Options
Options Terminology
Open Interest
The total number of outstanding contracts on a given series or for a given underlying at a particular point in time
Introduction to Options
Options Terminology
European Option
Can be exercised only on the expiration date
eg. Index Options
American Option
Can be exercised any time on or before the expiration date
eg. Stock Options
Introduction to Options
Options Terminology
In the money options
It is an option that will lead to a positive cash flow to buyer when exercised
Call option is in the money when CMP is higher than strike
Put option is in the money when CMP is lower than strike
Introduction to Options
Options Terminology
At the money options
It is an option that will lead to a zero cash flow to buyer when exercised
Options are at the money when CMP is equal to strike
Introduction to Options
Options Terminology
Out of the money options
It is an option that will lead to a negative cash flow to buyer when exercised, however OTM options can never be exercised / assigned
Call option is out of money when CMP is lower than strike
Put option is out of money when CMP is higher than strike
Introduction to Options
Options Terminology
Intrinsic value (IV)
Difference between spot and strike
ITM has IV, ATM and OTM have zero intrinsic value
Time value (TV)
Difference between the Premium and Intrinsic value
ITM have both IV and TV, ATM and OTM have only TV.
Longer the expiry more the TV, on expiry TV is zero
Introduction to Options
Options Pricing
Primarily two methods used:
Black Scholes method
Cox – Ross method
Find attached calculator
Introduction to Options
Options Pricing
Factors affecting options price:
Stock price
Call options more valuable with the rise in price and less valuable with the fall in price
Put options more valuable with the fall in price and less valuable with the rise in price
Introduction to Options
Options Pricing
Factors affecting options price:
Strike price
Call options more valuable at the lower strike and less valuable at the higher strike
Put options more valuable at the higher strike and less valuable at the lower strike
Introduction to Options
Options Pricing
Factors affecting options price:
Risk free Interest rate
Call option premium increases with rise in interest rates
Put option premium decreases with rise in interest rates
Introduction to Options
Options Pricing
Factors affecting options price:
Time to expiry
Options are more valuable when the time to expiration is more