Documente Academic
Documente Profesional
Documente Cultură
Presented by
Vishakh S
Vishnu Sankar S
Neethu Satheesh
A call option is a financial contract between two parties, the buyer and the
seller of this type of option. It is the option to buy shares of stock at a specified
time in the future. Often it is simply labelled a "call". The buyer of the option
has the right, but not the obligation to buy an agreed quantity of a particular
commodity The buyer pays a fee (called a premium) for this right.
Put Option is just opposite of the Call Option which gives the holder the right
to sell shares. A put becomes more valuable as the price of the underlying
stock depreciates relative to the strike price.
Merits Of Option
Options protect downside risk to the
buyer
The buyer of the option limits losses
to the premium paid on the purchase
of the options
Eg. If I buy a nifty 2900 put at Rs 34,
my loss is limited to Rs 34 while gain
potential is limitless
If the price goes above Rs 2900 I do
not exercise the option limiting my
loss to the premium paid.
Option Terminology
Call option: An option to buy a
specified number of shares of a
security within some future period.
Put option: An option to sell a
specified number of shares of a
security within some future period.
Exercise (or strike) price: The price
stated in the option contract at which
the security can be bought or sold.
Strike
price (b)
Exercise value
of option (a)(b)
$25.00
30.00
35.00
40.00
45.00
50.00
$25.00
25.00
25.00
25.00
25.00
25.00
$0.00
5.00
10.00
15.00
20.00
25.00
Time
value
(d) (c)
$3.00
2.50
2.00
1.50
1.00
0.50
Value of
upside potential
Opportunity cost
of invested funds
X
C S N (d1 ) rt N (d 2 )
e
Where C: current price of a call option
S: current market price of the underlying stock
X: exercise price
r: risk free rate
t: time until expiration
N(d1) and N (d2) : cumulative density functions for d1 and d2
Example
Current stock price: 50
Risk free rate: 6.25%
months
Volatility: 40%
exercise price : 55
time to expiration: 6
What is the call price?
Solution
d1
0.4 0.5
0.0953 0.0713
0.0851
0.2828
N(d1) = 0.4661
d 2 0.0851 0.4
0.3679
N(d2) = 0.3564
X
N ( d 2 )
e rt
55
50[0.4661] ( 0.0625)( 0.5) [0.3564] $4.30
e
Call price S N ( d1 )
0.5
Covered call.
Ratio write.
Variable ratio write.
Insurance put.
Collar.
Synthetic stock.
Covered call
A covered call has two parts:
- ownership of 100 shares of stock
- 1 short call
A short call is created by selling it. When you
sell a call you receive cash.
A short transaction is sequenced as sell-holdbuy instead of the more familiar long
position, buy-hold-sell.
Covered call
A covered call becomes profitable if the underlying security
remains at or below the strike.
In that case, the call will expire worthless, or it can be closed
(bought) at a lower price.
If the underlying security moves above the strike, the call
will be exercised and your stock will be called away.
Being exercised is profitable as long as your original cost of
the stock was lower than the strike. In that case, you earn a
capital gain, the option premium, and any dividends during
your holding period.
Ratio write
The ratio write is an expansion of the
covered
call. Instead of 1 call per 100 shares, you
write
more calls than you can cover.
For example, if you own 200 shares and sell 3 calls, you
create a 3:2 ratio write. If you own 300 shares and sell 4
calls, you create a 4:3 ratio write.
Although this strategy is higher-risk than a covered call,
some or all of the exposed calls can be closed to avoid
exercise.
Insurance put
This strategy protects your stock position against the risk of
loss. A put is the right to sell stock at a fixed price.
For example, you bought stock at $45 and it is now worth $49.
You sell a 50 put and pay 2 ($200).
If the stock falls below 50, you can exercise the put and sell it
at the fixed strike of 50. However, because the put cost you
$200, your breakeven is $48 per share.
In this example, the insurance put locks in profits of at
least $300 the strike less cost of the put, minus your
original basis: $50 - $2 - $45 = $300
Collar
A collar is a three-part strategy that
combines the covered call with the
insurance put. It consists of:
100 shares of stock
1 short call
1 long put
Collar
A collar costs little or nothing to open. The
short call should be higher than the current
price, and the long put should be lower.
The cost of the long put is all or mostly
paid for by the short put.
The collar is a smart strategy when you want
to protect paper profits, and you are willing
to have shares called away at the calls
strike.
Synthetic stock
This is a strategy similar to the collar. But both options
are opened at the same strike price.
When you open a long call and a short put, it creates a
synthetic long stock position, because the options grow
in value as the stock rises, mirroring price changes
point for point.
When you open a short call and a long put,
it creates a synthetic short stock position,
because the options grow in value as the
stock falls, mirroring price changes point for point.