Transcript III Day Presentation-II

Options and obligations
Options
Call options
Buyer
Put options
Buyer
Seller
Right to buy
Obligation to selll
Seller
Right to sell
Obligation to buy
No initial margin
Initial margin to be paid
No initial margin
Initial margin to be
paid
Pays premium
Receives premium
Pays premium
Receives premium
Margining system for Seller of Options
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Initial Margin- Risk margin
Premium margin
Assignment margin
Initial margin –According SPAN formulaHistorical volatility of asset in the past
• If price of the asset increases- Call Writer’s
financial loss increases
• If price of the asset decreases- Put Writers’
financial loss increases
Margining-Continuing
• Premium margin- Deposit of collected
premiums by the Seller of options with the
clearing house
• Increase in the premium- result additional
margin to be brought than at the premium
when they sold options and vice versa
Long call and short call -example
• Assume that Mr.ABC has purchased a call
option on stock X at Rs.100 by paying a
premium of Re1 to the seller of a call option
Mr.PQR .Let us see the range of prices above
and below the exercise price and observe the
profit trend of both the buyer and the seller
Long put and Short put –example
• Assume that Mr.ABC has purchased a put
option on stock X at Rs.100 by paying a
premium of Re1 to the seller of a put option
Mr.PQR . Let us see the range of prices above
and below the exercise price and observe the
profit trend of both buyer and seller
In the money-At the money
• Call option: when stock price raises than the
strike price and brings money to the buyer
• Put option :when stock price declines than the
strike price and brings money to the buyer
• When the strike and stock prices are the same
– no advantage position to exercise
Out of the money
• There is no definitive advantage in exercising an
option in situation –Out of the money – no need to
abandon .
• Example
Market
scenario
MP>SP
Call option
Put option
I-T-M
O-T-M
MP=SP
A-T-M
A-T-M
MP<SP
O-T-M
I-T-M
Intrinsic value and Time value of the option
• Option premium-Option price
• =Intrinsic value + Time value or Extrinsic value
• Intrinsic value of the option : the part of
premium which represents to the extent to
which the option is I-T-M;Intrinsic value of the
option – never be negative : A-T-M and O-T-M
=> intrinsic value is zero
Intrinsic value of the option
• Consider a share currently trading at Rs.235.
Assume you hold a Rs.200 call and a Rs.260
call . At the same time you also hold a Rs.200
put and a Rs.260
Time value of the option
• Quantification of the probability of the change
in the underlying price to become in the
money during the remaining period of option
• Time value= Option premium-Intrinsic value
• Value of option-Intirnsic value= Time value of
the option
• If the option is A-T-M and O-T-M the entire
premium is time value of option
Effect of time decay
• Assume that we bought a call option with
exercise price of Rs235 and the share price in
the market is Rs 240 . It is also known that we
paid a premium of Rs.32 for this 60 day
contract How much of this 2 month option’s
premium is time value ?
Valuation of Options B-S model
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Black and Scholes -1973
Direct work of Rober merton , Black and Scholes
1997-Nobel winners Robert merton and Scholes
1995- Black died
“The pricing of options and corporate liabilities “
Stock price , strike price , expiration date , risk free
rate of return and the standard deviation of stock
return (volatility)
B-S model
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C=SN(d1)-Xe-rt N(d2)
C= price of the call option
S= price of the underlying stock
X=options exercise price
R=risk free interest
T=current time until expiration
N=area under the normal curve
D1=[ln(S/X)+(r+σ2/2)T]/ σ T1/2
D2 = d1- σ T1/2
Option Problems-Call and Put
• Tata Motors stock is currently selling for
Rs.750 . There is call option on Tata motors
with a maturity of 90 days and an exercise
price of Rs.800 .The volatility in the stock price
is estimated to be 22% The risk free rate is 8%
What will be the price of call option?
Synthetic Long call strategy –Buy Stock
and Buy Put
• Buy the stock – anticipating the price rise
• Instead – If price comes down –to have insurance –
Put option
• The strike price either equals the stock bought or
below i-e A-T-M or O-T-M
• Strategy is resembling like a call option but not real
call option
• Risk (Maximum losses)Stock price +put premium
–put strike price
• Break even : Stock price+ Put premium
• Investor- conservatively bullish
Synthetic call –Buy stock and Buy put
• Holding the stock for reaping the benefits ,dividends ,rights
and so on but at the same time insuring against an adverse
price movement
• Simple buy call- no underlying
• Example
• ABC ltd is trading at Rs.4000 on 4th July
• Buy 100 shares of the stock at Rs4000
• Buy 100 July put options with a strike price of Rs.3900 at a
premium of Rs143.80 per put
• Pay off the synthetic call: Payoff from the stock+ Pay off from
the put option
Pay off diagrams
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Buy
Stock
+
=
Buy
Put
synthetic call
Synthetic put /Protective Call /Synthetic
Long put /Synthetic Short
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Short on a stock
Buy the call either A-T-M or O-T-M
In case the price falls he will gain out of the price fall
If any unexpected price –loss is limited
Pay off the long call compensates the loss out of the
stock short position
• Bearish and to protect from the unexpected price
increase
Synthetic put /Protective Call /Synthetic
Long put /Synthetic Short
• The expectation of the investor is – prices will go
down but against the price rise
• Risk: call strike price –stock price +premium
• Reward : Maximum stock price-call option pay off
• Maximum is Comparision of Stock price and
Stock sold at
• Breakeven Stock price –call premium
Synthetic put /Protective Call /Synthetic
Long put /Synthetic Short
• Example ABC ltd is trading at Rs.4457 in June .
An investor Mr.A buys a Rs.4500 call for Rs100
while shorting the stock at Rs.4457
Synthetic put /Protective Call /Synthetic
Long put /Synthetic Short
+
• Sell Stock
=
Buy call
Synthetic short
Covered call –owning the stock and sell
call
• When to use:usually adopted by the investor
owns who is neutral to moderately bullish
about the stock
• But bearish in the near term
• The target price at which he wants exit- strike
price and should O-T-M
• Investor earns premium from the buyer of call
option –at or below the strike price
Covered call –buy stock + Sell call
• Example :Mr A bought XYZ Ltd for Rs.3850 and
simultaneously sells a call at a strike price of Rs.4000.
The price of XYZ ltd stays at or below Rs.4000 . The
call buyer will not exercise the call option Mr.A will
keep the premium of Rs.80 . Mr A bought XYZ ltd for
Rs.3850 and the call option .If the stock moved
between Rs.3850 to 3950 Profit is ?
• The price of stock moves to Rs.4100