OPTIONS –
An option is a contract that gives the holder of the option the right, but not an
obligation, to buy or sell the underlying asset on or before a stated date/day, at a
predetermined price.
The buyer of an option is one who has a right but not the obligation in the contract.
For owning this right, he pays a price called ‘option premium’ to the seller of this
right.
The writer of an option is one who receives the option premium and is thereby
obliged to sell/buy the asset if the buyer of option exercises his right.
European option: The owner (buyer/holder) of a European option can exercise his
right only on the expiry date/day of the contract. In India, all index and stock options
are European style options.
An option, which gives the buyer/holder a right to buy the underlying asset, is called
a çall option; and an option which gives the buyer/holder a right to sell the
underlying asset, is called a ’put option’.
Option contracts on individual stocks traded on the NSE follow a three-month
trading cycle.
Unlike the NSE, the BSE offers trading in weekly as well as monthly stock options
contracts.
Index option contracts on the NSE and BSE are available for trading with weekly as
well as monthly maturities
The Nifty and Bank Nifty option contracts expire on the last Thursday of the expiry
month
Unlike the futures contracts, there is no daily settlement of options contracts.
A put option is said to be In-the-money (ITM) option when spot price is lower than
strike price.
for both call and put At-the-money (ATM) option, strike price is equal to spot price.
An out-of-the-money option is one with a strike price worse than the spot price for
the holder of option.
The intrinsic value of an option refers to the amount by which the option is in-the-
money i.e., the amount an option buyer will realize, before adjusting for premium
paid, if he exercises the option instantly. Therefore, only in-the-money options have
intrinsic value whereas at-the-money and out-of-the-money options have zero
intrinsic value. The intrinsic value of an option can never be negative because an
option holder is not bound to exercise an option if such exercise will result in a loss to
him.
Time value: It is the difference between the premium and intrinsic value,
Long Call – Purchased a deal of buying the asset. Thus will execute the deal only if
spot price is higher than strike price + premium. [ a call option gives the buyer the
right, but not the obligation to buy the underlying at the strike price. ]
Max loss = Premium paid. Max profit = Unlimited
Short call – SELLER OF LONG CALL.
Max loss = unlimited. Max gain = Premium received
Long Put – Purchased a deal of selling the asset at strike price. Thus will execute the
deal only when spot price i.e. the selling price is lower than the deal price i.e. strike
price.
Max loss = premium paid Max gain = when spot price is zero
[A put option gives the buyer of the option the right, but not the obligation, to sell
the underlying at the strike price.]
Short put – BUYER OF LONG PUT
Max loss = when spot price is zero
Max profit = premium received
Risk Return
Long Premium paid Unlimited
Short Unlimited Premium received
there are five fundamental parameters on which the option price depends upon: 1)
Spot price of the underlying asset 2) Strike price of the option 3) Volatility of the
underlying asset’s price 4) Time to expiration 5) Interest rates
Delta = Change in option premium/ Unit change in price of the underlying asset.
Gamma = Change in an option delta / Unit change in price of underlying asset
Theta = Change in an option premium / Change in time to expiry
Vega = Change in an option premium / Change in volatility
Rho = Change in an option premium / Change in cost of funding the underlying
