FMI - Module IV On Derivatives (Options)

Financial
Markets &
Institutions
Module IV: Introduction to Derivatives
(Options)
Options vs Futures
• Options
o Option Buyer has the RIGHT (to purchase, in case of call
options). Option Seller has the OBLIGATION to settle the
contract
o No need for margin deposit from the buyer. Seller deposits
margin
o Involves a payment of option premium by buyer
• Futures
o Both Futures buyer and seller have the OBLIGATION
o Both parties have to deposit a margin
o No premium payable by either party
Teminologies used in Options
• Long
• Short
• Call option
• Put option
• Strike price
• Maturity
Teminologies used in Options
• Long:
o Buyer of the option contract. Also called option holder
o He has the rights in the contract to exercise or not on maturity
• Short
o Seller of the option contract. Also called option writer
o He has the obligations in the contract, if the buyer exercises his right
• Call option
o Option to buy the underlying
• Put option
• Option to sell the underlying
• Strike price
• Also referred to as the Exercise price
• Maturity
• Last date of the option, on which it expires
Call Option contracts
• CALL OPTIONS
o Buyer has
• the right
• to purchase
• specified quantity of the underlying asset
• at pre-agreed price ( called “ strike” price)
• on pre-defined date ( called expiry date)
o Seller has
• the obligation
• to sell
o For getting the right, buyer pays option premium
o For taking on the obligation, seller receives option premium
Call options - example
• On day 0
o “B” buys call option on stock X
• Quantity – 1000 units
• Strike price 100
• Expiry date – day 30
• Premium of Rs 4 per unit
o B pays Rs 4000 to buy this call option
o “S” sells call option on stock X
o S receives Rs 4000 by selling this call option
Call options – PAYOFFS
Payoff to buyer on
expiry day =
MAX ( 0, Stock price –
exercise price)
Seller = Min [0, (Strike
Price – Stock Price)]
Call options – Net Gain / Loss
Net Gain / Loss to

buyer on expiry day =
Payoff – Premium Paid
Seller = Payoff +
Premium Received
to buyer on expiry
• B holds the call option till expiry ie till day 30
• On day 30, the settlement price is the closing
price of the underlying
o If the closing price of the underlying on the expiry date is Rs 105
• Payoff to the buyer on the expiry day = max ( 0, settlement
price – exercise price)
• = max(0, Rs 105 – Rs 100)
• = Rs 5 per unit
• Net gain to the buyer = payoff on the expiry day – option
premium
• =Rs 5 per unit – Rs 4 per unit
• =Re 1 per unit
Call options – payoffs to
buyer on expiry
• B holds the call option till expiry ie till day 30
• Payoff to the buyer on the expiry day = max ( 0,settlement
price – exercise price)
• = max(0, Rs 95 – Rs 100)
• = Re 0 per unit
premium
• =Re 0 per unit – Rs 4 per unit
• = -Rs 4 per unit
Worst case for the buyer – net loss of Rs 4 per unit
Charting net gain for the call option buyer on
expiry
Rs per unit
Settlement price --- >

to Seller on expiry
• Payoff to the seller on the expiry day = min ( 0, exercise
price – settlement price)
• = min (0, Rs 100 – Rs 105)
• = Rs - 5 per unit
• Net loss to the seller = payoff on the expiry day + option
premium
• =Rs -5 per unit + Rs 4 per unit
• =Re -1 per unit
Seller has no limit on the loss, but the maximum gain is Rs 4 per unit
net gain for call option seller on expiry
6
0
91 93 95 97 99 101 103 105 107 109
-2
-4
-6
-8
Two styles of options
• European options can be exercised only on the
expiration date
• American options can be exercised on or before
expiration date
• All options traded on NSE and BSE are European
style
• All illustrations in the slides use European options
Examples of call options
• “A” buys 1000 units of call option on stock X at
exercise price of Rs 102 and pays premium of Rs
2 per unit. What is the net gain/ loss to “A” , if
the stock closes @ Rs 108 on the day of expiry ?
o 1000 *{ max ( 108 -102, 0) – 2} = 1000 * {6 – 2} = Rs 4000
• “B” sells 100 units of call option on stock Y at

exercise price of Rs 103 and receives premium
of Rs 4 per unit. If the stock closes@ Rs 110 on
the day of expiry, what is the net gain / loss to
“B” ?
o 100 * { min (0, 103 – 110) + 4} = 100 *{-7+4} = net loss of Rs 300
• “A” buys
o 10 lots of (25 units)
o NIFTY24SEP17 call option with strike of Rs 7900
o By paying option premium of Rs 210 per unit
o If Nifty closes @ 8000 on 24th Sep, what is the net gain / loss
to “A” ?
• 10 * 25 * {max(0, 8000 – 7900) – 210}= 10*25*{100-

210}=net loss of Rs 27,500.
• “B” sells 20 lots of NIFTY24SEP17 call options
with strike price 8200 @ 74 per unit. If nifty
closes @ 8150 on 24th Sep , what is the net
gain / loss to B?
o 20 * 25 * {min(0, 8200 -8150) + 74} = net gain of Rs 37,000

SNAP SHOT OF OPTION CHAIN ON BANK NIFTY AS ON 8 SEPT 2017
As strike price increases, call premium reduces

Bull Call Spread
• A bull call spread is a type of vertical spread.
• It contains two calls with the same expiration but
different strikes.
• The strike price of the short call is higher than the strike of
the long call, which means this strategy will always
require an initial outlay (debit).
• The short call's main purpose is to help pay for the long
call's upfront cost.
• Up to a certain stock price, the bull call spread works a
lot like its long call component would as a standalone
strategy. However, unlike with a plain long call, the
upside potential is capped. That is part of the trade off;
the short call premium mitigates the overall cost of the
strategy but also sets a ceiling on the profits.
Example of bull spread
• Buy 95 call @ 7 and sell 105 call @ 2
• Prepare the payoff and the gain/loss table on a
spreadsheet
• Chart the gain/loss vs market price on the expiry.
-Higher gain at higher prices, hence called Bull spread
-Cap on the gain
-Floor on the loss
-Such a trade is entered into when there is a bullish view on the underlying
-Max loss is restricted to the floor value even if the underlying moves down significantly
Gain/loss diagram bull spread

6
0
90 95 100 105 110
-2
-4
-6
Bear Call Spread
• A bear call spread is a type of vertical spread.
• It contains two calls with the same expiration but different
strikes.
• The strike price of the short call is below the strike of the long
call, which means this strategy will always generate a net
cash inflow (net credit) at the outset.
• The short call's main purpose is to generate income, whereas
the long call simply helps limit the upside risk.
• As the strategy's name suggests, it does best if the stock stays
below the lower strike price for the duration of the options.
• The profitability of the strategy depends on how much of the
initial premium revenue is retained before the strategy is
closed out or expires.
• Still, an unexpected rally should not provoke a crisis: though
the maximum gain of this strategy is very limited, so are
potential losses.
Example of bear spread
• Buy 104 call @ 3 and sell 97 call @ 6
spreadsheet
gain/loss diagram bear spread
4
0
90 95 100 105 110
-1
-2
-3
-4
-5
Examples of call options -
set II
1. If current month Nifty 7700 call was bought @ 177 and
current month Nifty 7650 call was sold @ 203;
o what is the cap on the gain per unit ?
• Cap on the gain : - 203 – 177 = Rs 26 per unit
o In which situations would the maximum possible gain ( ie the cap) would be
realized ?
• When settlement price is equal to or below 7650 ( ie lower of the two strike
prices) in case of a bear spread using call options
o If Nifty on the expiry day was 7950, what was the gain/loss per unit on the
expiry ?
• On 7700 call : - max (0, 7950 – 7700) – 177 = 73
• On 7650 call : - min( 7650 – 7950 , 0) + 203 = - 97
• Net = 73 – 97 = -24, loss of Rs 24 per unit
• Bear spread, market went up , resulted in loss
o Is this the maximum possible gain/loss ?
• Yes, it is the maximum possible loss; as the settlement price was greater
than 7700 ( the higher of the two strike prices) in a bear spread using call
options
set II
2. If 1 lot of current month Nifty call 7700 is
purchased @162 , 2 lots of current month Nifty
call 7800 are sold at 114 and 1 lot of Nifty Sep
Future is bought @7662; what would be the
net gain on the expiry day if Nifty closes at
7785 ? (lot size - 25 units)
o Nifty 7700 call : - 25 * {max( 0, 7785 – 7700) – 162} = - 1925
o Nifty 7800 call : - 2 * 25 *{min(0, 7800 – 7785) + 114} = 5700
o Nifty future : - 1 * 25 * (7785 – 7662) = 3075
o Net gain = -1925 + 5700 + 3075 = Rs 6850
set II
3. The following were purchased on 1st Sep : -
o 250 shares of Infosys @ 1075
o 1 lot ( lot size 250 units) of Infosys Sep future @ 1080. Assume average margin
blocked at 25%.
o 1 lot ( 250 units) of Infosys 1080 Sep call @ 35
o Infosys closes at 1125 on 24th Sep ( ie the day of the expiry)
o Compute funds blocked in all 3 cases
• Stock : 250 * 1075 = Rs 2,68,750
• Future : 250 * 1080 * 0.25 = Rs 67,500
• Call option : 250 * 35 = Rs 8750 ( note – buyer pays only the call premium)
o Compute the returns on stock, future and call option per unit
• Stock : (1125 – 1075)/1075 = 4.65% for 23 days ie 73.8% p.a.
• Future : (1125 – 1080) / (1080 *.25) = 16.67% for 23 days ie 264.5% p.a.
• Call option : (1125 – 1080 – 35)/35 = 28.57% for 23 days ie 453.4% p.a.
o Compute the gain in INR for all the three cases
• Stock : 250 * (1125 – 1075) = Rs 12500
• Future : 250 * ( 1125 – 1080) = Rs 11250
• Call option : 250 * ( 1125 – 1080 – 35) = Rs 2500
IN THE MONEY”, “OUT OF THE MONEY”, “AT
THE MONEY” CALL OPTIONS
• “in the money” : market price of

underlying > strike price of the call option
o Strike price Rs 100, market price Rs 102
In the money means that your stock option is worth money and
you can turn around and sell or exercise it.
For example, if John buys a call option on ABC stock with a strike
price of $12, and the price of the stock is sitting at $15, the option
is considered to be in the money. This is because the option gives
John the right to buy the stock for $12 but he could immediately
sell the stock for $15, a gain of $3. If John paid $3.50 for the call,
then he wouldn't actually profit from the total trade, but it is still
considered in the money.
• “out of the money” : market price of

underlying < strike price of the call option
Out of the money (OTM) is term used to describe a call

option with a strike price that is higher than the market price of
the underlying asset, or a put option with a strike price that is
lower than the market price of the underlying asset.
An out of the money option has no intrinsic value, but only
possesses extrinsic or time value.
• “at the money” : market price of

underlying = strike price of the call option
At the money is a situation where an option's strike price is
identical to the price of the underlying security. Both call and put
options are simultaneously at the money.
For example, if XYZ stock is trading at 75, then the XYZ 75 call
option is at the money and so is the XYZ 75 put option. An at-the-
money option has no intrinsic value, but it may still have time
value. Options trading activity tends to be high when options are
at the money
Intrinsic value and time value of call options
• Intrinsic value of a call option = max ( market

price of the underlying – strike price, 0)
• Time value of a call option = call option

premium – intrinsic value
• Time value
o is a payment for the possibility that the price of the underlying may
increase prior to the expiry date
o reduces as expiry day gets closer.
o is zero at the close of the expiry day
• “in the money” : market price of underlying >
strike price of the call option
o Strike price Rs 100, market price Rs 102. Call Premium Rs. 3
o If call premium is Rs 3 then it consists of intrinsic value of Rs 2 (ie 102
– 100) and time value of Re 1

underlying < strike price of the call option
o Strike price Rs 100, market price Rs 98. call Premium is Re 1
o If call premium is Re 1, it is entirely time value. Intrinsic value is zero.
• “at the money” : market price of underlying =

strike price of the call option
o Strike price Rs 100, market price Rs 100. Call Premium Rs. 1.5
o If call premium is Rs 1.5, it would entirely be time value. Intrinsic
value is zero.
Covered Call Strategy
A covered call is an investment strategy involving two
transactions.
1. You buy stock (or use stock you already own).

2. You sell a call option against that stock.
The combination of being long the stock and short a call option
is called "covered call." It is also known as a "buy-write"
transaction (because you buy the stock and write (sell) the
option).
A covered call is a call option that is sold against stock an

investor already owns.
Covered call (Option strategy)
• “A” is holding 1,00,000 shares of Infosys.
• Current market price of Infosys stock is 1070
• Selling Infy1280 Sep call @ Rs 2 per unit would
give premium income of Rs 2,00,000 to “A”
• 18 days left for expiry of the call option
• Assumption is that
o Infosys price is unlikely to go higher than 1280 ( ie almost 20% jump)
over next 18 days
o In case the price goes higher than 1280; the shares held will also
increase in value.
o A part of the share holding can be liquidated to cover the loss on
the call option in case price goes above 1280.
o Hence this is called covered call.
PUT OPTIONS
Put Option contracts
• Put options
o Buyer has
• the right
• to sell
o Seller has
• the obligation
• to buy
o For getting the right, buyer pays option premium
o For taking on the obligation, seller receives option premium
Call v/s Put
Put Option Call Option
o Buyer has o Buyer has
• the right • the right
• to sell • to purchase
• specified quantity of the • specified quantity of the
underlying asset underlying asset
• at pre-agreed price ( called “ • at pre-agreed price ( called
strike” price) “ strike” price)
• on pre-defined date ( called • on pre-defined date ( called
expiry date) expiry date)
o Seller has o Seller has
• the obligation • the obligation
• to buy • to sell
• specified quantity of the • specified quantity of the
underlying asset underlying asset
• at pre-agreed price ( called “ • at pre-agreed price ( called
strike” price) “ strike” price)
• on pre-defined date ( called • on pre-defined date ( called
expiry date) expiry date)
Put options - example
• On day 0
o “B” buys put option on stock X
o B pays Rs 4000 to buy this put option
o “S” sells put option on stock X
o S receives Rs 4000 by selling this put option
Put options – PAYOFFS
Payoff to buyer on
expiry day =
MAX ( 0, Exercise price –
Stock price)
Payoff to Seller on expiry
day = Min (0, Stock price
– Exercise Price)
Put options – Net gain /
Loss
Net Gain / Loss to
buyer on expiry day =
Payoff – Premium Paid
Seller on expiry day =
Payoff +Premium
Received
Put options – payoffs to
buyer on expiry
• B holds the put option till expiry ie till day 30
• On day 30, the settlement price is the closing price of
the underlying
• Payoff to the buyer on the expiry day = max ( 0,Exercise price –
Stock price)
• = max(0, Rs 100 – Rs 95)
• = Rs 5 per unit
premium
• =Rs 5 per unit – Rs 4 per unit
• =Re 1 per unit
Put options – payoffs to
buyer on expiry
• B holds the put option till expiry ie till day 30
• On day 30, the settlement price is the closing price of
the underlying
o If the closing price of the underlying on the expiry
date is Rs 105
• Payoff to the buyer on the expiry day = max ( 0, Exercise price –
settlement price)
• =max(0, Rs 100 – Rs 105)
• = Re 0 per unit
premium
• =Re 0 per unit – Rs 4 per unit
• = - Rs 4 per unit
Worst case for the buyer – net loss of Rs 4 per unit
Charting net gain for the put option buyer
8
6
Rs per unit
4
0
90 92 94 96 98 100 102 104 106 108 110
Settlement price --- >
-2
-4
-6
Seller has no limit on the loss, but the maximum gain is Rs 4 per unit
Charting net gain for the put option seller
6
0
90 92 94 96 98 100 102 104 106 108 110
-2
-4
-6
-8
Examples of put options -
Set I
• “A” buys 1000 units of put option on stock X
at exercise price of Rs 102 and pays premium
of Rs 2 per unit. What is the net gain/ loss to
“A” , if the stock closes @ Rs 96 on the day of
expiry ?
o 1000 *{ max ( 102 -96, 0) – 2} = 1000 * {6 – 2} = Rs 4000
• “B” sells 100 units of put option on stock Y at

exercise price of Rs 103 and receives
premium of Rs 4 per unit. If the stock closes@
Rs 98 on the day of expiry, what is the net
gain / loss to “B” ?
o 100 * { min (0, 98 – 103) + 4} = 100 *{-5+4} = net loss of Rs 100
Set I
• “A” buys
o 10 lots of (1 lot = 25 units)
o NIFTY24SEP17 put option with strike of Rs 7500
o By paying option premium of Rs 95 per unit
o If Nifty closes @ 7300 on 24th Sep, what is the net gain / loss
to “A” ?
• 10 * 25 * {max(0, 7500 - 7300) – 95}= 10*25*{200-95}=net

gain of Rs 26,250.
Set I
• “B” sells 20 lots of NIFTY24SEP17 put
options with strike price 7400 @ 70 per
unit. If nifty closes @ 8150 on 24th Sep ,
what is the net gain / loss to B?
• (1 lot = 25 units)
o 20 * 25 * {min(0, 8150 - 7400) + 70} = 20 * 25 * 70 = net gain

of Rs 35,000
SNAP SHOT OF OPTION CHAIN ON BANK NIFTY AS ON 8 SEPT 2017
As strike price increases, put premium increases

Bull Put Spread
• A bull put spread involves being short a put option and long
another put option with the same expiration but with a lower
strike.
• The short put generates income, whereas the long put's main
purpose is to offset assignment risk and protect the investor in
case of a sharp move downward. Because of the relationship
between the two strike prices, the investor will always receive
a premium (credit) when initiating this position.
• This strategy entails precisely limited risk and reward potential.
The most this spread can earn is the net premium received at
the outset, which is likeliest if the stock price stays steady or
rises.
• If the forecast is wrong and the stock declines instead, the
strategy leaves the investor with either a lower profit or a loss.
The maximum loss is capped by the long put.
• Buy 96 put @ 3 and sell 106 put @ 7
spreadsheet
using put options
Gain/loss diagram bull spread using put options
0
90 95 100 105 110
-2
-4
-6
-8
Bear Put Spread
• A bear put spread is a type of vertical spread.
• It consists of buying one put in hopes of profiting from a
decline in the underlying stock, and writing another put
with the same expiration, but with a lower strike price, as
a way to offset some of the cost. Because of the way
the strike prices are selected, this strategy requires a net
cash outlay (net debit) at the outset.
• Assuming the stock moves down toward the lower strike
price, the bear put spread works a lot like its long put
component would as a standalone strategy. However, in
contrast to a plain long put, the possibility of greater
profits stops there. This is part of the tradeoff; the short
put premium mitigates the cost of the strategy but also
sets a ceiling on the profits.
• Buy 106 put call @ 7 and sell 96 put@ 3
spreadsheet
using put options
Gain/loss diagram bear spread using put options
0
90 95 100 105 110
-2
-4
-6
set II
1. If current month Nifty 7600 put was bought @
177 and current month Nifty 7650 put was sold
@ 203;
o what is the cap on the gain per unit ?
• Cap on the gain : 203 – 177 = Rs 26 per unit
o In which situations would the maximum possible gain ( ie the cap)
would be realized ?
• When settlement price is equal to or above 7650 ( ie higher of the
two strike prices)
o If Nifty on the expiry day was 7400, what was the gain/loss per unit on
the expiry ?
• On 7600 put : - max (0, 7600 – 7400) – 177 = 23
• On 7650 put : - min( 7400 – 7650 , 0) + 203 = - 47
• Net = 23 – 47 = -24, loss of Rs 24 per unit
• Is this the maximum possible gain/loss ?
• Yes, it is the maximum possible loss
set II
2. If 1 lot of current month Nifty put 7700 is
purchased @168 , 2 lots of current month
Nifty call 7800 are sold at 114 and 1 lot of
Nifty Sep Future is bought @7662; what
would be the net gain/loss on the expiry day
if Nifty closes at 7785 ? (lot size - 25 units)
o Nifty 7700 put : 25 * {max( 0, 7700 – 7785) – 168} = - 4200
o Nifty 7800 call : 2 * 25 *{min(0, 7800 – 7785) + 114} = 5700
o Nifty future : 1 * 25 * (7785 – 7662) = 3075
o Net gain = -4200 + 5700 + 3075 = Rs 4575
“IN THE MONEY”, “OUT OF THE MONEY”, “AT
THE MONEY” PUT OPTIONS

• “in the money” : market price of underlying
< strike price of the put option

underlying > strike price of the put option
• “at the money” : market price of underlying

= strike price of the put option
• Intrinsic value of a put option = max ( strike

price - market price of the underlying , 0)
• Time value of a put option = put option

premium – intrinsic value
• Time value
o is a payment for the possibility that the price of the underlying may
decrease prior to the expiry date
o reduces as expiry day gets closer.
o is zero at the close of the expiry day
Intrinsic value and time value of put options
• “in the money” : market price of underlying < strike

price of the put option
o If put premium is Rs 3 then it consists of intrinsic value of Rs 2 (ie 100 – 98)
and time value of Re 1
• “out of the money” : market price of underlying >

strike price of the put option
o If put premium is Re 1, it is entirely time value. Intrinsic value is zero.
• “at the money” : market price of underlying = strike

price of the put option
o If put premium is Rs 1.5, it would entirely be time value. Intrinsic value is
zero.
Protective Put
• A protective put position is created by buying (or owning) stock and
buying put options.
• Potential profit is unlimited, because the underlying stock price can
rise indefinitely. However, the profit is reduced by the cost of the put
• Risk is limited to an amount equal to put option premium
Example:
Buy 100 shares XYZ Stock at 100
Buy 1 XYZ 100 put at 3.25
Breakeven stock price at Expiration

Stock price + put premium
Prepare Payoff stock price range from 88 - 108

Protective Put (option strategy)
• “A” is holding 1,00,000 shares of Infosys.
• Current market price of Infosys stock is 1095
• Buying Infy1060 Sep put @ Rs 20 per unit
• This would protect loss below 1040
o @ 1040 downwards , the net profit on the put position would be positive
and match the loss on the value of the shares
o This is alternative to putting a stop loss order @ 1040
Combinations of Equity
call and PUT options
Long Straddle
• A long straddle is a combination of buying a call and buying a put, both with the
same strike price and expiration.
• Together, they produce a position that should profit if the stock makes a big move
either up or down.
• Typically, investors buy the straddle because they predict a big price move and/or
a great deal of volatility in the near future.
• The maximum loss is limited to the two premiums paid. The worst that can happen is
for the stock price to hold steady and implied volatility to decline. If at expiration
the stock's price is exactly at-the-money, both options will expire worthless, and the
entire premium paid to put on the position will be lost.
• The maximum gain is unlimited. The best that can happen is for the stock to make a
big move in either direction. The profit at expiration will be the difference between
the stock's price and the strike price, less the premium paid for both options. There
is no limit to profit potential on the upside, and the downside profit potential is
limited only because the stock price cannot go below zero.
• Upside breakeven = strike + premiums paid
• Downside breakeven = strike - premiums paid
Example
Long 1 XYZ 100 Call at 3.30
Long 1 XYZ 100 Put at 3.20
Total Cost 6.50
Long Straddle
Long straddle = long call 100 @ 2 + long put 100 @ 3
Purchase of 1:1 call and put at the same strike price and same expiration
date
Such positions are usually taken prior to an event after which market
may move strongly in either direction
Short Straddle
• A short straddle consists of one short call and one short put.
• Both options have the same underlying stock, the same strike price and the same expiration date.
• A short straddle is established for a net credit (or net receipt) and profits if the underlying stock trades in
a narrow range between the break-even points.
• Profit potential is limited to the total premiums received.
• Potential loss is unlimited if the stock price rises and substantial if the stock price falls.
• Goal is to profit from little or no price movement in the underlying stock.
Example of short straddle

Sell 1 XYZ 100 Call at 3.30
Sell 1 XYZ 100 Put at 3.20
Net Credit 6.50
Breakeven stock price at expiration

There are two potential break-even points:
Strike price plus total premium: 100.00 + 6.50 = 106.50
Strike price minus total premium: 100.00 – 6.50 = 93.50
Stock price at expiration

90-110
Short straddle
Short straddle = short call 100 @ 2 + short put 100 @ 3
Sale of 1:1 call and put at the same strike price and same expiration date
may not move strongly in either direction, in view of the seller
Long Strangle
• A long strangle consists of one long call with a higher strike price and one long put with a lower strike.
• Both options have the same underlying stock and the same expiration date, but they have different
strike prices.
• A long strangle is established for a net debit (or net cost) and profits if the underlying stock rises above
the upper break-even point or falls below the lower break-even point.
• Profit potential is unlimited on the upside and substantial on the downside.
• Potential loss is limited to the total cost of the strangle .
• Both options will expire worthless if the stock price is equal to or between the strike prices at expiration.
Goal: To profit from a big price change – either up or down – in the underlying stock.
Example
Buy 1 XYZ 105 Call at 1.50
Buy 1 XYZ 95 Put at 1.30
Net Cost 2.80

• Higher strike price plus total premium: 105.00 + 2.80 = 107.80
• Lower strike price minus total premium: 95.00 – 2.80 = 92.20

90-110
Strangle
Long Strangle = long call 102 @ 1 + long put 98 @ 2
Purchase of 1:1 call and put at the different strike price and same
expiration date, put at a lower strike than call
may move strongly in either direction
Short Strangle
• A short strangle consists of one short call with a higher strike price and one short put with a lower strike.
• Both options have the same underlying stock and the same expiration date, but they have different
strike prices.
• A short strangle is established for a net credit (or net receipt) and profits if the underlying stock trades in
a narrow range between the break-even points.
• Profit potential is limited to the total premiums received less commissions.
• Potential loss is unlimited if the stock price rises and substantial if the stock price falls.
Goal: To profit from little or no price movement in the underlying stock.
Example
Short 1 XYZ 105 Call at 1.50
Short 1 XYZ 95 Put at 1.30
Net Credit 2.80

Higher strike price plus total premium: 105.00 + 2.80 = 107.80
Lower strike price minus total premium: 95.00 – 2.80 = 92.20

90-110
Stock Price at Short 105 Call Short 95 Put Short Strangle Profit /
Expiration Profit/(Loss) at Profit/(Loss) at (Loss) at Expiration
Expiration Expiration
110 (3.50) +1.30 (2.20)
109 (2.50) +1.30 (1.20)
108 (1.50) +1.30 (0.20)
107 (0.50) +1.30 +0.80
106 +0.50 +1.30 +1.80
105 +1.50 +1.30 +2.80
104 +1.50 +1.30 +2.80
103 +1.50 +1.30 +2.80
102 +1.50 +1.30 +2.80
101 +1.50 +1.30 +2.80
100 +1.50 +1.30 +2.80
99 +1.50 +1.30 +2.80
98 +1.50 +1.30 +2.80
97 +1.50 +1.30 +2.80
96 +1.50 +1.30 +2.80
95 +1.50 +1.30 +2.80
94 +1.50 +0.30 +1.80
93 +1.50 (0.70) +0.80
92 +1.50 (1.70) (0.20)
91 +1.50 (2.70) (1.20)
90 +1.50 (3.70) (2.20)
Strangle
Short Strangle = Short call 105 @ 1.50 + Short put 95 @ 1.30
Sale of 1:1 call and put at the different strike price and same expiration
date, put at a lower strike than call
A short strangle profits when the price of the underlying stock trades in
a narrow range between the breakeven points. The ideal forecast,
therefore, is “neutral or sideways.” In the language of options, this is
known as “low volatility.”
American vs European
options
• European options can be exercised only on the
expiration date
• American options can be exercised on or before
expiration date
Note:
• It is advantageous to exercise American put prior to
expiration date, for a non-dividend paying stock
• It is never optimal to exercise American call prior to
expiry for a non-dividend paying stock

FMI - Module IV On Derivatives (Options)

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Financial

Net Gain / Loss to

Settlement price --- >

• “B” sells 100 units of call option on stock Y at

• 10 * 25 * {max(0, 8000 – 7900) – 210}= 10*25*{100-

o 20 * 25 * {min(0, 8200 -8150) + 74} = net gain of Rs 37,000

As strike price increases, call premium reduces

Gain/loss diagram bull spread

THE MONEY” CALL OPTIONS

• “in the money” : market price of

THE MONEY” CALL OPTIONS

• “out of the money” : market price of

Out of the money (OTM) is term used to describe a call

THE MONEY” CALL OPTIONS

• “at the money” : market price of

• Intrinsic value of a call option = max ( market

• Time value of a call option = call option

• “out of the money” : market price of

• “at the money” : market price of underlying =

1. You buy stock (or use stock you already own).

A covered call is a call option that is sold against stock an

• “B” sells 100 units of put option on stock Y at

• 10 * 25 * {max(0, 7500 - 7300) – 95}= 10*25*{200-95}=net

o 20 * 25 * {min(0, 8150 - 7400) + 70} = 20 * 25 * 70 = net gain

As strike price increases, put premium increases

THE MONEY” PUT OPTIONS

• “out of the money” : market price of

• “at the money” : market price of underlying

• Intrinsic value of a put option = max ( strike

• Time value of a put option = put option

• “in the money” : market price of underlying < strike

• “out of the money” : market price of underlying >

• “at the money” : market price of underlying = strike

Breakeven stock price at Expiration

Prepare Payoff stock price range from 88 - 108

Example of short straddle

Breakeven stock price at expiration

Stock price at expiration

Breakeven stock price at expiration

Stock price at expiration

Goal: To profit from little or no price movement in the underlying stock.

Breakeven stock price at expiration

Higher strike price plus total premium: 105.00 + 2.80 = 107.80

Lower strike price minus total premium: 95.00 – 2.80 = 92.20

Stock price at expiration

S-ar putea să vă placă și

• 10 * 25 * {max(0, 8000 – 7900) – 210}= 1025{100-

• 10 * 25 * {max(0, 7500 - 7300) – 95}= 1025{200-95}=net