Options and obligations Options Call options Buyer Right to buy No initial margin Pays premium Seller Obligation to selll Initial margin to be paid Receives.

Slides:



Advertisements
Similar presentations
© 2002 South-Western Publishing 1 Chapter 6 The Black-Scholes Option Pricing Model.
Advertisements

Session 3. Learning objectives After completing this you will have an understanding of 1. Financial derivatives 2. Foreign currency futures 3. Foreign.
“ Calls and Puts ” presented by Welcome to. What is an option? Derivative product Contract between two parties Terms of contract Buyers rights Sellers.
CHAPTER NINETEEN OPTIONS. TYPES OF OPTION CONTRACTS n WHAT IS AN OPTION? Definition: a type of contract between two investors where one grants the other.
Options on Stocks Buying Options offers Profit Potential with Limited Risk A good way to economically place your bet or a good way to lose your shirt?
Vicentiu Covrig 1 Options Options (Chapter 19 Jones)
Chapter 22 - Options. 2 Options §If you have an option, then you have the right to do something. I.e., you can make a decision or take some action.
1 Chapter 15 Options 2 Learning Objectives & Agenda  Understand what are call and put options.  Understand what are options contracts and how they.
FINANCE IN A CANADIAN SETTING Sixth Canadian Edition Lusztig, Cleary, Schwab.
Intermediate Investments F3031 Derivatives You and your bookie! A simple example of a derivative Derivatives Gone Wild! –Barings Bank –Metallgesellschaft.
Options Chapter 2.5 Chapter 15.
Spreads  A spread is a combination of a put and a call with different exercise prices.  Suppose that an investor buys simultaneously a 3-month put option.
CHAPTER 18 Derivatives and Risk Management
Financial options1 From financial options to real options 2. Financial options Prof. André Farber Solvay Business School ESCP March 10,2000.
Options Basics January 26, Option  A contract sold to one party (holder) by another party (writer).  The contract offers the right, but not the.
Chapter 19 Options. Define options and discuss why they are used. Describe how options work and give some basic strategies. Explain the valuation of options.
Option Strategies. Definitions In the money An option is in-the-money when there would be profit in exercising it immediately Out of the money Out-of-the-money.
TO PUT OR NOT TO PUT… THAT IS THE QUESTION WHETHER ‘TIS NOBLER IN THE MIND TO PUT THE PHONE DOWN, OR JUST KEEP CALLING… McKinney, Texas M-STREETBOYS.
Vicentiu Covrig 1 Options Options (Chapter 18 Hirschey and Nofsinger)
VALUING STOCK OPTIONS HAKAN BASTURK Capital Markets Board of Turkey April 22, 2003.
© 2002 South-Western Publishing 1 Chapter 2 Review Basic Puts and Calls.
Vicentiu Covrig 1 Options and Futures Options and Futures (Chapter 18 and 19 Hirschey and Nofsinger)
Understanding Agricultural Options John Hobert Farm Business Management Program Riverland Community College.
OPTIONS AND THEIR VALUATION CHAPTER 7. LEARNING OBJECTIVES  Explain the meaning of the term option  Describe the types of options  Discuss the implications.
Options Topic 9. I. Options n A. Definition: The right to buy or sell a specific issue at a specified price (the exercise price) on or before a specified.
Options: Introduction. Derivatives are securities that get their value from the price of other securities. Derivatives are contingent claims because their.
8 - 1 Financial options Black-Scholes Option Pricing Model CHAPTER 8 Financial Options and Their Valuation.
Put-Call Parity Portfolio 1 Put option, U Share of stock, P
1 Financial Options Ch 9. What is a financial option?  An option is a contract which gives its holder the right, but not the obligation, to buy (or sell)
Financial Options: Introduction. Option Basics A stock option is a derivative security, because the value of the option is “derived” from the value of.
I Investment Analysis and Portfolio Management First Canadian Edition By Reilly, Brown, Hedges, Chang 13.
Professor XXXXX Course Name / # © 2007 Thomson South-Western Chapter 18 Options Basics.
INVESTMENTS: Analysis and Management Second Canadian Edition INVESTMENTS: Analysis and Management Second Canadian Edition W. Sean Cleary Charles P. Jones.
1 Chapter 6 : Options Markets and Option Pricing Options contracts are a form of derivative securities, or simply derivatives. These are securities whose.
2007 Page 1 F. MICHAUX CORPORATE FINANCE Financial and Real Options.
Understanding options
Investment and portfolio management MGT 531.  Lecture #31.
Chapter 10: Options Markets Tuesday March 22, 2011 By Josh Pickrell.
Derivative securities Fundamentals of risk management Using derivatives to reduce interest rate risk CHAPTER 18 Derivatives and Risk Management.
Becoming Familiar With Options Becoming Familiar With Options Objectives: Define options Understand puts and calls Define strike price and premiums and.
INVESTMENTS | BODIE, KANE, MARCUS Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin CHAPTER 18 Option Valuation.
1 Chapter 11 Options – Derivative Securities. 2 Copyright © 1998 by Harcourt Brace & Company Student Learning Objectives Basic Option Terminology Characteristics.
Computational Finance Lecture 2 Markets and Products.
Bear Put Spread 碩財二甲 MA 陳俊諺. When to Use a Bear Put Spread Moderately Bearish An investor often employs the bear put spread in moderately bearish.
1 CHAPTER 8: Financial Options and Their Valuation Financial options Black-Scholes Option Pricing Model.
Using Stock Options Hedging: Have stock buy puts Assume that Mr. X holds 1000 shares of HLL. He plans to sell the shares three months later as he would.
© 2010 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible Web site, in whole or in part.
Chapter 18 Derivatives and Risk Management. Options A right to buy or sell stock –at a specified price (exercise price or "strike" price) –within a specified.
CHAPTER NINETEEN Options CHAPTER NINETEEN Options Cleary / Jones Investments: Analysis and Management.
Options Payoff Presented By Prantika Halder MBA-BT-II yr.
Salaar - Finance Capital Markets Spring Semester 2010 Lahore School of Economics Salaar farooq – Assistant Professor.
Option Valuation.
1 Agribusiness Library Lesson : Options. 2 Objectives 1.Describe the process of using options on futures contracts, and define terms associated.
Chapter 19 An Introduction to Options. Define the Following Terms n Call Option n Put Option n Intrinsic Value n Exercise (Strike) Price n Premium n Time.
© 2003 The McGraw-Hill Companies, Inc. All rights reserved. Basics of Financial Options.
Options Trading Strategies. BullishBullish StrategiesStrategies.
CHAPTER NINETEEN OPTIONS. TYPES OF OPTION CONTRACTS n WHAT IS AN OPTION? Definition: a type of contract between two investors where one grants the other.
 Options are binding contracts that involve risk, and are time bound  You buy an option when you want to protect a “position” (long or short on a stock)
Options Chapter 17 Jones, Investments: Analysis and Management.
Copyright © 2003 South-Western/Thomson Learning. All rights reserved. Chapter 19 An Introduction to Options.
Equity Derivatives Yield Enhancement and Hedging Strategies August 2003.
Introduction to Options Mario Cerrato. Option Basics Definition A call or put option gives the holder of the option the right but not the obligation to.
Chapter 3 Insurance, Collars, and Other Strategies.
Agricultural Commodity Marketing and Risk Management
CHAPTER 18 Derivatives and Risk Management
FINANCIAL OPTIONS AND APPLICATIONS IN CORPORATE FINANCE
Options Cliff Trent September 17, 2010.
CHAPTER 18 Derivatives and Risk Management
Options (Chapter 19).
CHAPTER 18 Derivatives and Risk Management
Presentation transcript:

Options and obligations Options Call options Buyer Right to buy No initial margin Pays premium Seller Obligation to selll Initial margin to be paid Receives premium Put options Buyer Right to sell No initial margin Pays premium Seller Obligation to buy Initial margin to be paid Receives premium

Margining system for Seller of Options Initial Margin- Risk margin Premium margin Assignment margin Initial margin –According SPAN formula- Historical volatility of asset in the past If price of the asset increases- Call Writer’s financial loss increases If price of the asset decreases- Put Writers’ financial loss increases

Margining-Continuing Premium margin- Deposit of collected premiums by the Seller of options with the clearing house Increase in the premium- result additional margin to be brought than at the premium when they sold options and vice versa

Long call and short call -example Assume that Mr.ABC has purchased a call option on stock X at Rs.100 by paying a premium of Re1 to the seller of a call option Mr.PQR.Let us see the range of prices above and below the exercise price and observe the profit trend of both the buyer and the seller

Long put and Short put –example Assume that Mr.ABC has purchased a put option on stock X at Rs.100 by paying a premium of Re1 to the seller of a put option Mr.PQR. Let us see the range of prices above and below the exercise price and observe the profit trend of both buyer and seller

In the money-At the money Call option: when stock price raises than the strike price and brings money to the buyer Put option :when stock price declines than the strike price and brings money to the buyer When the strike and stock prices are the same – no advantage position to exercise

Out of the money There is no definitive advantage in exercising an option in situation –Out of the money – no need to abandon. Example Market scenario Call optionPut option MP>SPI-T-MO-T-M MP=SPA-T-M MP<SPO-T-MI-T-M

Intrinsic value and Time value of the option Option premium-Option price =Intrinsic value + Time value or Extrinsic value Intrinsic value of the option : the part of premium which represents to the extent to which the option is I-T-M;Intrinsic value of the option – never be negative : A-T-M and O-T-M => intrinsic value is zero

Intrinsic value of the option Consider a share currently trading at Rs.235. Assume you hold a Rs.200 call and a Rs.260 call. At the same time you also hold a Rs.200 put and a Rs.260

Time value of the option Quantification of the probability of the change in the underlying price to become in the money during the remaining period of option Time value= Option premium-Intrinsic value Value of option-Intirnsic value= Time value of the option If the option is A-T-M and O-T-M the entire premium is time value of option

Effect of time decay Assume that we bought a call option with exercise price of Rs235 and the share price in the market is Rs 240. It is also known that we paid a premium of Rs.32 for this 60 day contract How much of this 2 month option’s premium is time value ?

Valuation of Options B-S model Black and Scholes Direct work of Rober merton, Black and Scholes 1997-Nobel winners Robert merton and Scholes Black died “The pricing of options and corporate liabilities “ Stock price, strike price, expiration date, risk free rate of return and the standard deviation of stock return (volatility)

B-S model C=SN(d 1 )-Xe -rt N(d 2 ) C= price of the call option S= price of the underlying stock X=options exercise price R=risk free interest T=current time until expiration N=area under the normal curve D 1 =[ln(S/X)+(r+σ 2 /2)T]/ σ T 1/2 D 2 = d 1 - σ T 1/2

Option Problems-Call and Put Tata Motors stock is currently selling for Rs.750. There is call option on Tata motors with a maturity of 90 days and an exercise price of Rs.800.The volatility in the stock price is estimated to be 22% The risk free rate is 8% What will be the price of call option?

Synthetic Long call strategy –Buy Stock and Buy Put Buy the stock – anticipating the price rise Instead – If price comes down –to have insurance – Put option The strike price either equals the stock bought or below i-e A-T-M or O-T-M Strategy is resembling like a call option but not real call option Risk (Maximum losses)Stock price +put premium –put strike price Break even : Stock price+ Put premium Investor- conservatively bullish

Synthetic call –Buy stock and Buy put Holding the stock for reaping the benefits,dividends,rights and so on but at the same time insuring against an adverse price movement Simple buy call- no underlying Example ABC ltd is trading at Rs.4000 on 4 th July Buy 100 shares of the stock at Rs4000 Buy 100 July put options with a strike price of Rs.3900 at a premium of Rs per put Pay off the synthetic call: Payoff from the stock+ Pay off from the put option

Pay off diagrams += BuyBuy synthetic call Stock Put

Synthetic put /Protective Call /Synthetic Long put /Synthetic Short Short on a stock Buy the call either A-T-M or O-T-M In case the price falls he will gain out of the price fall If any unexpected price –loss is limited Pay off the long call compensates the loss out of the stock short position Bearish and to protect from the unexpected price increase

Synthetic put /Protective Call /Synthetic Long put /Synthetic Short The expectation of the investor is – prices will go down but against the price rise Risk: call strike price –stock price +premium Reward : Maximum stock price-call option pay off Maximum is Comparision of Stock price and Stock sold at Breakeven Stock price –call premium

Synthetic put /Protective Call /Synthetic Long put /Synthetic Short Example ABC ltd is trading at Rs.4457 in June. An investor Mr.A buys a Rs.4500 call for Rs100 while shorting the stock at Rs.4457

Synthetic put /Protective Call /Synthetic Long put /Synthetic Short += Sell StockBuy call Synthetic short

Covered call –owning the stock and sell call When to use:usually adopted by the investor owns who is neutral to moderately bullish about the stock But bearish in the near term The target price at which he wants exit- strike price and should O-T-M Investor earns premium from the buyer of call option –at or below the strike price

Covered call –buy stock + Sell call Example :Mr A bought XYZ Ltd for Rs.3850 and simultaneously sells a call at a strike price of Rs The price of XYZ ltd stays at or below Rs The call buyer will not exercise the call option Mr.A will keep the premium of Rs.80. Mr A bought XYZ ltd for Rs.3850 and the call option.If the stock moved between Rs.3850 to 3950 Profit is ? The price of stock moves to Rs.4100