1. Fintech Chapter 12: Options

2. Derivatives Linear- Futures, Forwards, Swaps
Non-linear- Insurance aspect: CDS, Options

3. Options
Options grant the buyer or long, the right but not the obligation
to own the underlying asset at a specified or “strike” price
For this right, the buyer pays a fee or “premium”
The seller or short is under the obligation to sell the underlying
asset at the strike price if the buyer so desires.
In return for being required to sell at what might be a below current market price, the seller of the option collects a fee or “premium

4. Options Options are traded on many financial assets: Equities
Equity indexes
Bonds
Currencies
Commodities
Futures

5. Options
Call option: gives the buyer the right to own or go long the underlying asset
Put option: gives the buyer the right to sell or go short the underlying asset

6. Options Four basic option strategies: Long call Short call Long put
Short put
More complex option strategies are a result of combining two or more of these four basic positions.

7. Options Option name: Underlying issue Expiry Date Put or Call
Strike Price
Example: SQ September 2018 Call $0.95

8. Options Exchange traded options: terms specified by the Exchange
Equity options on CBOE, NYSE, Nasdaq
Monthly, quarterly and longer dated
Energy options on NYMEX and ICE
OTC: customized terms

9. Options When can buyer exercise their option rights?
American options: at any time during the life of the options
European options: exercisable only at expiry

10. Options
Options are “in the money”, “at the money”, or “out of the money”.
At-the-money options have a strike price equal to the current underlying asset price.
A call option is in-the-money if the strike price is below the current asset price
A put option is in-the-money if the strike price is above the current asset price.
A call option is out-of-the-money if the strike price is above the current asset price;
A put option is out-of-the-money if the strike price is below the current asset price.

11. Options Risks in trading options:
Option buyers risk losing the amount of premium paid
Call sellers risk being short in a rising market, theoretically unlimited
Put sellers risk being long in a falling market. Their risk would be the total of the strike price minus the premium received.

12. Options Figure 12.1 Long Call
Net Position at Expiry Long XYZ 60 call Maximum Gain: Unlimited
Maximum Loss: Premium paid

13. Options Figure 12.2 Long Put Net Position at Expiry Long XYZ 60 put
Maximum Gain: Strike price – premium paid Maximum Loss: Premium paid

14. Options Figure 12.3 Short Call
Net Position at Expiry Short XYZ 60 call
Maximum Gain: Premium received Maximum Loss: Unlimited

15. Options Figure 12.4 Short Put Net Position at Expiry Short XYZ 60 put
Maximum Gain: Premium received
Maximum Loss: Strike price – premium received (substantial)

16. Options Advanced option strategies:
Covered call: own a stock, sell a call.
Investor owns stock, collects any dividend, and collects option premium.
The covered call doesn’t have the same unlimited risk as the short call alone. The investor can deliver the underlying stock if call is exercised.
Investor still has risk to the downside on the original equity position, but call premium provides a (modest) cushion

17. Options Advanced option strategies:
Vertical call spread (also called a “bull” or “debit” call spread). Here, the
investor buys a lower strike call and sells a second higher strike call.
For example, the investor might buy XYZ 60 call and sell XYZ 65 call. If the price of XYZ at expiry is above 60, the investor exercises the long 60 call and is increasingly profitable until XYZ is valued at 65.
The investor’s risk is limited to loss of the net premium paid for the
strategy.

18. Options Advanced option strategies:
Vertical put spread. This is the mirror image of the vertical call spread. In this strategy, the investor wants some coverage to the bearish side of the market. In our example, the investor might buy the XYZ 60 put and sell the XYZ 55 put.
As the market trades lower, at expiry, the 60 put goes in the money and the strategy begins to be profitable. At 55, the investor can be expected to be assigned a long position which would offset the short acquired at 60.

19. Options Advanced option strategies:
Collar (or Cap and Floor). In this strategy, options are used to protect a range. An investor long an equity might wish to buy a put to protect against the downside. They might also wish to offset some of the cost of the put by being willing to sell the equity at a price above the current market price. This can be accomplished by selling a call.
The combination of the long put and short call establishes a floor and cap, or collar on the position. In our example, with XYZ currently trading at 60, the investor could buy the 55 put and sell the 65 call.

20. Options Advanced option strategies: View of market direction:
Going higher:
Long call
Short put
Long call spread
Short put spread
Going lower:
Short call
Long put
Short call spreads
Long put spreads

21. Options Advanced option strategies:
Increased volatility, but not sure of market direction
Greater volatility
Buy straddle
Buy strangle
Lesser volatility
Sell straddle
Sell strangle
Long Straddle. The long straddle consists of both a long call
and a long put, at the same strike price.
Long Strangle. Similar to straddle, but the put strike is lower than the call strike.

22. Options Figure 12.5 Long Straddle Net Position at Expiry
Long 1 XYZ 60 call
Long 1 XYZ 60 put
Maximum Gain: Unlimited to the upside. Strike price – total premia to the downside Maximum Loss: Total premia paid

23. Options Option Pricing
There are six factors that influence the pricing of options. They are:
Strike price of the option
Price of the underlying asset at the current time
Interest rate
Time to expiry of the option
Volatility in the price of the underlying asset
Dividend that might be expected from the underlying asset

24. Options
The Black-Scholes-Merton and other models are used to develop theoretical option prices. Changes in the above factors are seen to each have an impact on option pricing, and a convention has been developed of referring to some of these incremental impacts by the following Greek letters:
Delta refers to the sensitivity of an option’s theoretical value to a
change in the price of the underlying asset
Gamma refers to the change in delta for a change in the underlying price
Vega is a measure of the sensitivity of the option value to changes in volatility
Theta is a measure of time decay, the change in the option’s
value over time
Rho is a measure of the sensitivity of the option value to changes in interest rates

25. Options Fintech Applications in Options
AI for pricing and trading of options
Blockchain in post-trade processing