Description
options in other financial instruments like convertible bonds, warrants, employee stock options.
Options
Option to buy or sell the underlying asset Right, not obligation Call option: right to buy the U/L asset Put option: right to sell the U/L asset Buyer = holder = long position (option to exercise) Seller = writer = short position
Mechanics of Options Markets
Options Terminology
Exercise price = strike price = price at which the holder of the option can exercise the option (and thus buy or sell the underlying asset) Expiration date Premium = amount paid for the option American option: can exercise any time up to and including expiration date European option: can exercise only on expiration date
Long Call on Unitech
Profit from buying one Unitech European call option: option price = 5, strike price = 100, option life = 2 months 30 Profit 20 10 70 0 -5 80 90 100 Terminal stock price 110 120 130
Short Call on Unitech
Profit from writing one Unitech European call option: option price = 5, strike price = 100 Profit 5 0 -10 -20 -30 110 120 130 70 80 90 100 Terminal stock price
Long Put on NTPC
Profit from buying a NTPC European put option: option price = 7, strike price = 200 30 Profit 20 10 0 -7
170 180 190 200
Terminal stock price
210 220 230
Short Put on NTPC
Profit from writing a NTPC European put option: option price = 7, strike price = 200 Profit 7 0 -10 -20 -30
170 180 190 200 210
Terminology
Moneyness :
At-the-money option In-the-money option Out-of-the-money option
Terminal stock price
220 230
Option Value
Intrinsic Value Time Value
Intrinsic Value and Time Value
An option premium, before expiration, can be split into two parts: intrinsic value and time value Intrinsic value of a call = max(0, S-K)
(You read this as: “The maximum of: zero OR the stock price minus the strike price.”)
Margins
Margins are required when options are sold 3% of the notional value of short open positions in index options The higher of 5% or 1.5 standard deviation of the notional value of gross short open positions in options on individual securities in a particular underlying. For other trading strategies there are special rules
Time value = C - intrinsic value Time value declines as the expiration date approaches. At expiration, time value = 0.
Options Contract Specifications
Options in Other Financial Instruments
Convertible Bonds Warrants Employee stock Options
Example 1
An investor buys a call option contract on Tata Motors @ Rs.16 on a share for strike price Rs.1020. The underlying price is Rs.1010. Under what circumstances will the option be exercised? Under what circumstances does the investor make a profit? A Tata Motors option contract size is 500 shares.
Example 2
An investor buys a European put on a share for Rs.10. The stock price is Rs.105 and the strike price is Rs.100. Under what circumstances will the option be exercised? Under what circumstances does the investor make profit?
Dividends & Stock Splits
Consider a call option to buy 100 shares for $30/share How should terms be adjusted: for a 2-for-1 stock split? for a 50% stock dividend? for cash dividend of 25% on market price of the stock?
Factors Impacting Option Prices
Pause for Thought
“American option is always worth at least as mush as a European option on the same asset with the same strike price and exercise date”. “An American option is always worth at least as much as its intrinsic value” “An investor is bullish on the market whether he buys call option or writes a put option”
Thank you!!!
doc_898622062.pdf
options in other financial instruments like convertible bonds, warrants, employee stock options.
Options
Option to buy or sell the underlying asset Right, not obligation Call option: right to buy the U/L asset Put option: right to sell the U/L asset Buyer = holder = long position (option to exercise) Seller = writer = short position
Mechanics of Options Markets
Options Terminology
Exercise price = strike price = price at which the holder of the option can exercise the option (and thus buy or sell the underlying asset) Expiration date Premium = amount paid for the option American option: can exercise any time up to and including expiration date European option: can exercise only on expiration date
Long Call on Unitech
Profit from buying one Unitech European call option: option price = 5, strike price = 100, option life = 2 months 30 Profit 20 10 70 0 -5 80 90 100 Terminal stock price 110 120 130
Short Call on Unitech
Profit from writing one Unitech European call option: option price = 5, strike price = 100 Profit 5 0 -10 -20 -30 110 120 130 70 80 90 100 Terminal stock price
Long Put on NTPC
Profit from buying a NTPC European put option: option price = 7, strike price = 200 30 Profit 20 10 0 -7
170 180 190 200
Terminal stock price
210 220 230
Short Put on NTPC
Profit from writing a NTPC European put option: option price = 7, strike price = 200 Profit 7 0 -10 -20 -30
170 180 190 200 210
Terminology
Moneyness :
At-the-money option In-the-money option Out-of-the-money option
Terminal stock price
220 230
Option Value
Intrinsic Value Time Value
Intrinsic Value and Time Value
An option premium, before expiration, can be split into two parts: intrinsic value and time value Intrinsic value of a call = max(0, S-K)
(You read this as: “The maximum of: zero OR the stock price minus the strike price.”)
Margins
Margins are required when options are sold 3% of the notional value of short open positions in index options The higher of 5% or 1.5 standard deviation of the notional value of gross short open positions in options on individual securities in a particular underlying. For other trading strategies there are special rules
Time value = C - intrinsic value Time value declines as the expiration date approaches. At expiration, time value = 0.
Options Contract Specifications
Options in Other Financial Instruments
Convertible Bonds Warrants Employee stock Options
Example 1
An investor buys a call option contract on Tata Motors @ Rs.16 on a share for strike price Rs.1020. The underlying price is Rs.1010. Under what circumstances will the option be exercised? Under what circumstances does the investor make a profit? A Tata Motors option contract size is 500 shares.
Example 2
An investor buys a European put on a share for Rs.10. The stock price is Rs.105 and the strike price is Rs.100. Under what circumstances will the option be exercised? Under what circumstances does the investor make profit?
Dividends & Stock Splits
Consider a call option to buy 100 shares for $30/share How should terms be adjusted: for a 2-for-1 stock split? for a 50% stock dividend? for cash dividend of 25% on market price of the stock?
Factors Impacting Option Prices
Pause for Thought
“American option is always worth at least as mush as a European option on the same asset with the same strike price and exercise date”. “An American option is always worth at least as much as its intrinsic value” “An investor is bullish on the market whether he buys call option or writes a put option”
Thank you!!!
doc_898622062.pdf