Yanuar Dananjaya, Bsc.

, MM

Option
Option (Opsi): Right (but not obligation) to buy or sell
an asset (commodity, foreign exchange, stock, etc) in
a specific time in the future in a pre-determined price
Difference with future:

Option Market

In future there is no premium paid between two parties. In option,

owner of option pays premium to the seller of the option.

In future both parties have obligation to fulfill the contract. In option,

owner of the option has the choice to exercise the option or not.
Seller of the option must fulfill his/her obligation if the option owner
choose to exercise his/her option

Hedging using future locks the price in both directions. Hedging

with option locks the price only in one direction, thus can gain profit if
price moves in other direction. But is not free, must pay premium

In future both parties lock the price. In option, only owner of option
hedges. Seller of option does not hedge, he/she even add risk

Yanuar Dananjaya, Bsc., MM

Option Market

Option
Terms on option:
Call option: option that grants right to the owner to buy underlying
asset.
Put option: option that grants right to the owner to sell underlying
asset.
Exercise price/strike price: price that will be used in case option is
exercised
Expiration date: date in which the option expires
In the money: situation where owner of option gains, thus will
exercise his option. Ex: call option where asset market price is higher
than exercise price, put option where asset market price is lower than
exercise price
At the money: Asset market price is the same as exercise price
Out the money: situation where owner of option does not gain, thus
will not exercise his option
American style: Owner can exercise anytime until expiration date
European style: Owner can exercise only at expiration date

Yanuar Dananjaya, Bsc., MM

Option Market

Option

Yanuar Dananjaya, Bsc., MM

Option
Speculating with call option: see p397
Speculating with put option: see p400
Hedging with call option: see p407
Hedging with put option: see p408

Option Market

Determinant of Premiums:

Premiums is mostly depends on supply and demand. Supply and

demand depends on the following factors

Current market price of the underlying asset relative to exercise

price higher current price relative to exercise price, the higher

premium for call option. Lower current price relative to exercise price,
the higher premium for put option.

Underlying asset price volatility higher volatility, the higher the

premium. Because more chance for option owner to gain

Time to expiration date longer time to expiration date, the higher

the premium. Because more chance for option owner to gain

Yanuar Dananjaya, Bsc., MM

Option
Other underlying assets for option:

Stock index option right to buy/sell index point. Payment is

specified amount of money multiplied by difference between index

level and exercise price (exercise price in point). To hedge/speculate
on general movement of stock market in a country

Option Market

Option on futures contract right to buy/sell future contract.

Stock call option as compensation:

Given by company to employee as compensation

To stimulate employee to increase company stock price
agency problem

Distortion between performance and market condition

Manipulation of stock price by managers
Problem with expense reporting

solve