www.a2zmba.

com

Meaning
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 with in or a specified period of time.

www.a2zmba.com

Features:
Legal contract
Buyers & seller of the options contract Options exchange or over the counter exchange Buyer will have a right to buy / sell the underlying

asset Buyer will have to pay a price called option premium to buy the right Contract should be completed on or within a specified time.
www.a2zmba.com

Parties to the option contract

Option Exchange OTC Buyer Seller

Holder Long Position

Writer Short position

www.a2zmba.com

Options Types
Option Buyer Types (Long position) Call Seller (Short position)

Right to buy asset Obligation to sell asset

Put

Right to sell asset Obligation to buy asset

Double Options : Call cum Put option, whereby the option buyer acquires the right (but not obligation) to buy or sell the underlying commodity.
www.a2zmba.com

Exchange Traded Vs Options

Standardized contract Organized exchanges Uniform underlying Limited strike prices Limited expiration dates Contract performance

OTC Options

* Tailor made options * Sold by dealers (banks & FIs)

guarantee by clearing house

www.a2zmba.com

Specifications of options
Assets underlying options:
- Agricultural commodities - Foreign currencies - Interest rates - Stock indices

www.a2zmba.com

Specifications of options
Exercise Style:
(a) American options: It can be exercised at any time on

or before expiration
(a) European options: It can be exercised on the

expiration date only

www.a2zmba.com

* Expiration Date: (a) Date on which option expires (b) Expiration dates are in cycles
Strike price

(a) Price at which options are written (b) Strike prices are specified by the exchange (c ) Strike prices differ with expiration period.

www.a2zmba.com

 Options contracts cash flows

(a) In-the-money. +ve cash flow (b) At-the-money . 0 cash flow (a) Out-of-the-money... -ve cash flow

www.a2zmba.com

Option Types
Stock Option Foreign currency option Index option Future options Interest rate options

www.a2zmba.com

 Stock Option contract gives the holder a right to buy

or sell stocks at a specified strike price.

Foreign currency option gives the holder a right to

exchange one currency with another currency at a specified strike price.

Buy or sell index option at a predetermined price.

www.a2zmba.com

Eg: NSE Nifty index is 3400 you purchase 100 June option at 3700 A. On delivery date, if the index value is 4000 (i) you will exercise your call option & get (4000-3700) x 100 = Rs.30,000/(ii) If you had a put option, you will not exercise this right. B. If the index falls to 3500 in June (i) If you had a call option, you will not exercise (ii) if you had a put option, you will exercise your right and receive (3700 3500) x 100 = Rs.20,000/www.a2zmba.com

Profitability of Options:
Call Option Put Options
S > X In the money S=X At the money Out of the money At the money

S < X Out of the money In the money

www.a2zmba.com

Options Positions & Pay-off

An investor buy 3 months call option. spot price = Rs.300 ; Strike price = Rs.350 premium = Rs.10 per share ; No.of shares =100 Maturity date: If spot price = Rs.355, he can exercise option; Profit / Loss = (355 350) x 100 1000 profit = Rs.500 Net position = 500 1000 = Rs. 500 Net Loss

www.a2zmba.com

* If ST= Rs.360 , Profit / Loss = (360 350) x 100 1000 profit = Rs.1,000 Net position = 1000 1000 = Break Even Beyond this price, he will get actual profit * If spot price = Rs.340, he will not exercise option; Net position = Rs. 1000 Net Loss

www.a2zmba.com

 Currency Option:

Ex: Buy in September dollar at exchange rate of 1 = 1.9000 $ maturing November. Spot rate : 1 = 1.875$ ; Premium = 0.704 As long as price of pound in the market below 1.900$, option will not exercised.
If Spot rate 1.920$ per 1 -- Exercise option

Profit /Loss = 0.0200 - 0.0704 = .0504 $ Loss

If spot = 1.9704 --- Break even If spot > 1.9704 .> Profit

www.a2zmba.com