1. Options – 1

2. Think of options as the right to buy (call) or sell (put) a specified lot size of an underlying asset at a specific price (strike price), on or before an expiration date.
-- They are called options since they offer several choices as the price of the underlying changes.
-- Underlying assets can be stocks, ETFs, indexes, currencies, etc. We only talk stocks for now.
-- Strike (or exercise) prices are trigger points, set by the exchange where the stock trades. (X)
-- Expiration dates are set by the exchanges too, and are when the option dies. Choice of
expirations vary widely. Depending on location, both shorter (weekly) and longer exist.
-- The lot size in US exchanges is typically set at a 100 shares (and will adjust if splits occur
before expiration). In India, the lot size varies as a function of the stock price.  

3. What are your choices?
If you originally did buy (sell) the option, you can later close the trade if you sell (buy) it and book profit or loss.
Can hold onto the option until expiration, Feb 23.
If call purchased, you can exercise the option and buy shares of HLL on Feb 23 (if European), or before Feb 23 (if American).
There are also Asian and Bermudean options (which have little
to do with geography!).

4. India specifics
Futures and options segment has about 175 optionable stocks.
For stocks, expirations are typically near-month, middle-month and a far-month. More (quarterly) expirations exist for index options.
Strikes prices seem to be 5 each ITM and OTM, and one ATM. Why limit them?
Lot sizes vary with the stock price, from 25 for Bosch (P = 22484) to for GMR (price = 14). Nifty is 75, Nifty mid-cap is 200. This is weird too, must be an attempt to “fix” the size of the bet.
Expiration day is the last Thursday of the expiration month. Settlement is T+1.
Margins are messy, there is a premium margin, a SPAN margin, a settlement margin, an assignment margin, depending on the type of transaction.

5. Strike Call Price Put Price SEE WHAT HAPPENED TO IT NOW?
An example (on Feb 12, 2017)
HUVR 23 Feb 17, Stock Price = 860.
Strike Call Price Put Price
For the 850 call, you pay for the right to purchase one share on 23-Feb-17 expiration (European).
SEE WHAT HAPPENED TO IT NOW?

6. Examine the call option.
Lower strike calls are more expensive- right to buy lower.
Likewise, longer expiration options are more expensive- more time.
Suppose the 850 call is priced at 8. There is an arbitrage, you buy the call and immediately exercise (cost 858), and sell the stock at 860. So the min. price must be 10.
With the stock at 860, the 850 (and lower strike) calls are said to be in-the-money,
i.e there is a positive cash flow (not necc profit) if exercised.
The 860 calls are said to be at-the-money.
The 870 calls (and higher strikes) are out-of-the-money.
Notion of moneyness relates directly to the option’s value. For the 850 call, 10 of the 17.2 is intrinsic value, the remaining 7.20 is time value. For the other two call options, all the premium is time value.

7. EXPIRATION DAY GRAPH (CALL)
WRITE CALL
+17.20
Stock Price
860
877.2
BUY CALL
-17.20
Hockey stick shape only at expiration, non-linear otherwise.

8. Moneyness and delta.
Options at different strikes respond differently to stock price moves. Think first derivative, dC/dS.
An 820 call is pretty much like owning the stock. A one point move in the stock moves the option by 1 point. Delta = 1.
An at the money (860 call) typically has a delta around 0.5
The price of a 900 call won’t budge if the stock moves from 860 to 861. Delta close to zero. (tie to delta hedging).

9. BUYING AND WRITING CALLS-1
Buy calls on the expectation of upward price movement.
Sell calls to collect premium on expectation of no upward price movement.
Own stock and sell calls: Covered Calls.
Popular strategy to generate revenue when a stock you own is not moving. Or to protect against downturn.
Graphically, a covered call looks like a Written Put !!!

10. Buying and selling calls-2
SHORT STOCK AND BUY CALLS
 The call purchase is like insurance, acts as a hedge against potential losses on a short position (if the stock price rises). In that case, gains on the call offset the loss on the short.
Graphically, looks like a purchased put option.
In many such combination strategies, the temptation to initiate or exit from the two trades at different times rather than simultaneously is often very strong.

11. EXAMINE THE PUT OPTIONS
S = 860, the 850 put at 4.95, the 860 put costs 8.65, dies today.
Lower strike puts cost less, the right to sell at 850 should be cheaper than the right to sell at 860.
Can be a bet on the downside (connect to short-sales).
Think in terms of a deductible on an insurance policy. The lower strike put is like a higher deductible. If you own the stock, more comes out of your pocket (loss of value till 850,which you bear), before the insurance kicks in.

12. CONNECT WITH SHORT SELLING
Buying puts limits downside loss- if stock price appreciates, the max you can lose is the premium.
The max you gain is the strike price.
With short selling, downside is unlimited (as stock goes up), but gains come earlier (no premium).

13. Protective Puts OWN STOCK AND BUY A PUT
Stock appreciates, put expires worthless, lose cost of the put.
Stock declines, put profits to offset the decline in the stock (like an insurance policy, hence the use of the word “premium”).
Graphically, a protective put looks like a purchased call.
Q: CHOOSE STRIKE PRICE FOR THE PROTECTIVE PUT ?
In the above example, the profits from the put purchase accrue to you only after the stock falls below 40. The loss in value from the current price of 42.5 to 40 is borne by you (in the sense that the put does not protect you from that $1 loss). This is the deductible feature.
If you select a lower strike put (say the 30 strike), then losses in stock value until 30 are borne by you (higher deductible) and after that the puts pays you back.

14. WHY BUY PUTS
Buying puts is like buying insurance to protect against losses on a position you own. As with homes/cars/life/stocks, we have an “insurable” interest -- when the underlying asset falls in value, the put seller helps to makes you (or your beneficiaries) somewhat whole.
By picking the level of insurance coverage (and the deductible) you choose the amount of protection you desire. This is essentially like choosing a strike price at which the put option can be exercised.
Buying puts without owning the underlying asset is like buying insurance on someone’s house (or life?). It is then a bet that the underlying asset will fall in value at which time you can buy it cheap (own it later) and exercise it to receive its strike value.
Or you can trade the puts directly without exercise, profiting from increases in its underlying value as the value of the underlying asset drops.
Going away from stocks, the CDS market, was an unregulated environment where default risk (death) of individual companies/mortgage pools/countries was traded in this manner.

15. WHO SELLS PUTS-1
Insurance companies. The bet is that they will take in more as premiums than they have to pay out if assets lose their value.
Regulations require them to set aside enough capital to ensure that such payments can actually be made if necessary. Concerns that they will not be able is a kind of counterparty risk. This is what happened to many insurance firms during GFC.
These capital requirements can be just a good faith deposit for a portion of it (collateral). For some “special” insurers, deals can be cut. With the Dow at in Fall 2007, Berkshire Hathaway sold 20 year puts on broad indexes (without collateral) and closed out most of it last year (I think).
Alternatively, these firms can “reinsure” against risks of catastrophes. This is Berkshire’s core business.  

16. WHO SELLS PUTS-2
Since stocks seem to trend upwards, selling puts to generate income during bull markets is appealing- you keep the premium. Often done with index options. Beware! Collateral! Margin!
For years, Microsoft had a strategy of writing puts around the time of a stock buyback. Why? The buyback keeps the stock from falling and MSFT uses the premium received to fund a portion of the buyback!
Think in terms of exercise. The put writer who is assigned has to purchase stock at the strike price from the put buyer. Exercise is likely as the stock drops below strike price. Of course the value of the put is increasing too, and the put writer would lose money if he/she has to close out the position at this time (by buying back the put at higher prices than where they had sold it).
A version of this can be used in falling markets where you don’t know how low the price will settle. Here the intent is to actually hope the option is exercised, so you get to buy the stock (from the put buyer) at the strike price (which is what you wanted in the first place).

17. MOTIVATING STRATEGIES
Q: GET MORE CREATIVE. ARRANGE FINANCING?
Also write a call in addition to the protective put. Effectively, the put protects you against declines in the stock price, while the written call implies that you surrender some of the upside potential !(COLLAR)
Q: WHAT IF YOU COULD DO THIS AT ZERO-COST?
I.E Pick strike prices on the call and the put so that the price paid for the purchased put is equal to (or close to) the price received from the written call !
Who would do this? Think Bill Gates or Michael Dell.
Q Go one better ? Now that the stock value is locked up within
a tight range, why not borrow against it !!(prepaid forward).