1. UNIT 3
OPTIONS

2. Introduction…

3. Recap

4. Stock Option
An index option is a financial derivative that gives the holder the right, but not the obligation, to buy or sell the value of an underlying index, such as the Standard and Poor's (S&P) 500, at the stated exercise price on or before the expiration date of the option.
No actual stocks are bought or sold; index options are always cash-settled.

5. Index call and put options are simple and popular tools used by investors, traders and speculators to profit on the general direction of an underlying index while putting very little capital at risk.
The profit potential for long index call options is unlimited, while the risk is limited to the premium amount paid for the option, regardless of the index level at expiration.
For long index put options, the risk is also limited to premium paid, and the potential profit is capped at the index level, less the premium paid, as the index can never go below zero.
Beyond potentially profiting from general index level movements, index options can be used to diversify a portfolio when an investor is unwilling to invest directly in the index's underlying stocks.
Index options can also be used in multiple ways to hedge specific risks in a portfolio.
American style index options can be exercised at any time before the expiration date, while European style index options can only be exercised on the expiration date.

6. Problem
An investor buys call contract on the S&P Nifty for 100 times with a strike price of Rs.980. If it is exercised when the value of the index is 992. How much writer of the option contract pays to the buyer?

7. THE UNDERLYING ASSETS IN EXCHANGE TRADED OPTIONS
STOCK OPTION
A privilege, sold by one party to another, that gives the buyer the right, but not the obligation, to buy (call) or sell (put) a stock at an agreed-upon price within a certain period or on a specific date.
In the U.K., it is known as a "share option".
Most exchange-traded stock options are American.
While strike prices are not because of cash dividend paid to common stockholders, the strike price is adjusted for stock splits, stock dividend, reorganization, recapitalization, etc which affect the value of the underlying stock.

8. Problem
An investor buys call option on SBI shares with a strike price of Rs.280. If it is exercised when the value of the is stock is 312 and the premium per share is Rs.2. How much writer of the option contract pays to the buyer?

9. THE UNDERLYING ASSETS IN EXCHANGE TRADED OPTIONS
FOREIGN CURRENCY OPTION
A foreign-exchange option (commonly shortened to just FX option or currency option) is a derivative financial instrument that gives the owner the right but not the obligation to exchange money denominated in one currency into another currency at a pre-agreed exchange rate on a specified date.
Major currencies which are traded in the option markets are USD, AUD, CAD, CHF,GBP, YEN, EURO.

10. THE UNDERLYING ASSETS IN EXCHANGE TRADED OPTIONS
INDEX OPTION:
A financial derivative that gives the holder the right, but not the obligation, to buy or sell a basket of stocks, such as the S&P 500, at an agreed-upon price and before a certain date.
An index option is similar to other options contracts, the difference being the underlying instruments are indexes.
Options contracts, including index options, allow investors to profit from an expected market move or to reduce the risk of holding the underlying instrument.
Popular index options include S&P 500 Index Options (SPX), Dow Jones Industrial Average Index Options (DJX) and Nasdaq-100 Index Options (NDX).

11. THE UNDERLYING ASSETS IN EXCHANGE TRADED OPTIONS
FUTURES OPTION:
In a futures option, the underlying asset is a futures contract.
An option contract on futures contract gives the buyer the rights to buy from or sell to the writer a specified future contract at designated price at a time during the life of the options.
If the futures options is a call option, the buyer has the right to acquire along futures position.
Similarly, a put option on a futures contract grants the buyer the right to sell one particular futures contracts to writer at the exercise price.
It is observed that the futures contract normally matures shortly after the expiration of the option.

12. THE UNDERLYING ASSETS IN EXCHANGE TRADED OPTIONS
INTEREST RATE OPTIONS:
It is popular in the international financial markets.
Interest rate options can be written on cash instruments or futures.
There are various debt instruments, which are used as underlying instruments for interest rate options on different exchanges.
These contracts are referred to as options on physical.

13. THE UNDERLYING ASSETS IN EXCHANGE TRADED OPTIONS
LEAPS OPTIONS:
These options are created for a longer period.
The longest time before expiration for standard exchange traded option is six-months.
Long Term Equity Anticipated Securities (LEAPS) are option contracts designated to offer with longer period maturities even up to 39 months.
These leaps options are available on individual stocks and some indexes.

14. THE UNDERLYING ASSETS IN EXCHANGE TRADED OPTIONS
FLEX OPTION:
It is specific type of option where some terms of the option have been customized.
It can be created for individual stocks, stock indexes, treasury securities etc.
They are traded on an option exchange and cleared and guaranteed by the clearing house of that exchange.

15. THE UNDERLYING ASSETS IN EXCHANGE TRADED OPTIONS
EXOTIC OPTIONS:
The option contracts though the OTC market can be customized in any manner desired by an institutional investor.
For eg. If a dealer can reasonably hedge the risk associated with opposite side of the option sought, it will design an option as desired by the customer.
OTC options are not limited to only European or American type of options, rather a particular option can be created with different exercise dates as well as the expiration date of the option.
Such options are also referred to as limited exercise options, Bermuda options, Atlantic option, etc.
More complex options created as per the needs of the customers are called exotic options.