Assignment No.

In The Money-1. For a call option, when the option's strike price is below the market price of the underlying asset. 2. For a put option, when the strike price is above the market price of the underlying asset. Being in the money does not mean you will profit, it just means the option is worth exercising. This is because the option costs money to buy For Example-If John buys a call option on ABC stock with a strike price of $12, and the price of the stock is sitting at $15, the option is considered to be in the money. This is because the option gives John the right to buy the stock for $12 but he could immediately sell the stock for $15, a gain of $3. If John paid $3.50 for the call, then he wouldn't actually profit from the total trade, but it is still considered in the money.

At The Money-1. At-the-money Forward: An Option whose strike is set at the same level as the prevailing market price of the Underlying Forwardcontract. With a Black-Scholes model, the Delta of a European-style, at-themoney Forward Option Will be close to 50%. 2. At-the-money Spot: An Option whose strike is set the same as the prevailing market price of the Underlying. Because forwards commonly trade at a Premium or Discount to the Spot, the Delta may not be close to 50%.

Example: If the stock of XYZ is trading at $50, the $50 strike price for both puts and calls would be considered to be the atthe-money option strike price. An at-the-money option has little to no intrinsic value

Out of the Money - An option is said to be out-of-the-money if exercising the option will result will result in loss.For a call, when an option's strike price is higher than the market price of the underlying asset. For a put, when the strike price is below the market price of the underlying asset. Example: If the stock of XYZ is trading at $50, the $55 strike price would be considered to be an out-of-the-money call option. An out-of-the-money call option is made up of entirely extrinsic value.
The various situations for an option buyer are as follows:

If Exercise price > Market Price Exercise price = Market Price Exercise price < Market Price

Call buyer Out of the money

Put buyer In the money

At the money

At the money

In the money

Out of the money

The position is automatically reversed for options are essentially a zero sum game. If buyer its out of the money to the writer; if the buyer its in the money to the writer; if buyer its at the money to the writer as well.

the writer the deal is the deal is the deal is

of the option since in the money to the out of the money to at the money to the

For buyer Out of the money At the money In the money

For Writer In the money At the money Out of the money

Q 2. You bought a one-month call option at a premium pf Rs. 6 with an exercise price of Rs. 40.What is the position if the current market price ( CMP ) is (a) Rs 45 (b) Rs 40 or (c) Rs 35. Will the position change if you had been a put buyer? What is the corresponding position for the call seller and the put seller?
EP Vs. MP Situation Call buyer Put buyer

40 < 45

EP < MP money EP = MP

In the money

Out of the

40 = 40

At the money

At the money

40 > 35

EP > MP

Out of the money

In the money

The option buyer premium of Rs.6 is irrelevant being a sunk cost. For the call seller, the position is the reverse of what it is for the call buyer. For the put seller, the position is the reverse of what it is for the put buyer.

Q 3. How is Break-Even price determined in option contracts? Illustrate with suitable examples for both buyer and seller for call and put options. A3.Breakeven price is determined in options as follows, if we equate the
profit equation to zero and solve for the value of market price we would be sitting on the breakeven price. Breakeven price is therefore the market price at which the call buyer or the put buyer neither makes a profit nor incurs a loss. Identification of this price is crucial to take investment decision. Call Put

Buyer

MP-EP-P=0

EP-MP-p=0

Seller

EP-MP+P=0

MP-EP+P=0

Examples: 1. An investor buys a put option with an exercise price of Rs. 200 for Rs. 15. What is the breakeven stock price? Thus Breakeven equation is EP-MP-p=0 200 MP 15 = 0 MP = 185, Hence BEP is Rs. 185

2. An Investor buys a call option with an exercise price of Rs. 100 for Rs. 10. What is the breakeven stock price? Thus Breakeven equation is MP-EP-P=0 MP 100 10 = 0 MP = 110, Hence BEP is Rs. 110