Introduction

To OPTIONS
By : DINESH KUMAR
B.COM (HONS)
III YEAR
Roll No.: 753

OPTIONS

Types

Working

Terminologies

Profits and payoffs

Options
An option is a derivative financial instrument
that specifies a contract between two parties
for a future transaction on an asset at a
reference price.
The buyer of the option gains the right, but
not the obligation, to engage in that
transaction, while the seller incurs the
corresponding obligation to fulfill the
transaction.

Option Classifications
Call Option : an option which gives a
right to buy the underlying asset at a
strike price.
Put Option : an option which gives a
right to sell the underlying asset at
strike price.

CALL AND PUT OPTIONS

A call option is a financial contract
between two parties, the buyer and
the seller of this type of option. It is
the option to buy shares of stock at a
specified time in the future. Often it is
simply labelled a "call". The buyer of
the option has the right, but not the
obligation to buy an agreed quantity
of a particular commodity The buyer
pays a fee (called a premium) for this
right.
Put Option is just opposite of the Call
Option which gives the holder the
right to buy shares. A put becomes

Some Terminologies
Call Option: Right but not the obligation to buy
Put Option: Right but not the obligation to sell
Option Price: The amount per share that an option
buyer pays to the seller
Expiration Date: The day on which an option is no
longer valid
Strike Price: The reference price at which the
underlying may be traded
Long Position: Buyer of an option assumes long
position
Short Position: Seller of an option assumes short
position

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.

 Both the Call and Put option buyers

are buying the rights, that is they are
transferring their risks to the sellers of
the option.
For this transfer of risk to the sellers,
buyers have to compensate by paying
Option Premium.
Option premium is also known as
Price of the option, Cost or Value of
the option.

Option Styles
European option an option that may only
be exercised on expiration.
American option an option that may be
exercised on any trading day on or before
expiry.
Bermudan option an option that may be
exercised only on specified dates on or
before expiration.

Option Selling: Motives for

selling options
The seller is ready to assume the risk in option
exercise. The incentives for the seller to
assume that risk are two :

Option Premium This is the actual

amount received by him for selling an
option to the buyer.
The possibility of non-exercise of
option In sellers view the possibility of
option being exercised by the buyer may
be low.

Factors influencing Option

Pricing
Time to expiration greater the time to
expiration, higher the value of the options.
Volatility higher the volatility, higher the
value of the options.
Risk free Rate of Interest If interest rate
goes up, calls gain in value while puts lose
value.

Exercise of calls

Exercise of Puts

Option Pay Off

Pay off from a Long Call

Payoff from Short Call

Summary of basic
option strategies

Merits of Options
Options protect downside risk to the buyer
The buyer of the option limits losses to
the premium paid on the purchase of the
options
Eg. If I buy a nifty 2900 put at Rs 34, my
loss is limited to Rs 34 while gain potential
is limitless
If the price goes above Rs 2900 I do not
exercise the option limiting my loss to the
premium paid.

Option Pricing
Black Scholes formula is the most widely used
for pricing options
The factors going into the pricing of options are
the share price(S), time to expiry (t), risk free
rate of interest r, and risk of underlying asset
measured by standard deviation or volatility
These are also called the greeks as changes in
any one of these variables affect the option price
Options contracts can be classified into out of
the money, at the money and in the money

The BSOPM Formula

The price of a corresponding put option based on put-call parity is:

For both, as above:
is the cumulative distribution function of the standard normal distribution
is the time to maturity
is the spot price of the underlying asset
is the strike price
is the risk free rate (annual rate, expressed in terms of continuous compounding)
is the volatility of returns of the underlying asset

Options A
Options or option
contracts are
review
instruments

Right, but not the obligation, is given

To buy or sell a specific asset
At a specific price
On or before a specified date
Options can be exchange traded
derivatives or even over the counter
derivatives.

Options A review
Options have a buyer and a writer
The option writer receives premium for giving the
buyer the right but not the obligation to sell an
asset at a future date
The option writer is not protected on the
downside risk
Option writers have to settle mark to market
profit or loss on a daily basis
Options can be cash settled or settled by
physical delivery
Options in India are cash settled

THANK YOU
By: DINESH
KUMAR