Prof. Pankaj K.

Gupta
Options
An option agreement is a contract in which the writer of the
option grants the buyer of the option the right to purchase
from or sell to the writer a designated instrument at a
specific price (or receive a cash settlement) within a
specified period of time
 Options vs. Futures
Points of difference Options Futures

Performance Only seller Both

Premium to writer No Premium

Risk Buyer  premium and  potential  and 

Settlement on or before expiry date at settlement date

Options Terminology
Call Option - An option that grants the buyer the right to buy a
designated instrument . (Pc ; Call Option Price)

Put Option - An option that grants the buyer the right to sell a
designated instrument . (Pp ; Put Option Price)

Expiration Date - The date on which the contract expires- the last
day on which the option can be exercised.
Options Terminology contd..
Exercise Price/ Strike Price

The price at which the buyer of a call can purchase the

underlying asset (stock/currency/commodity etc.) during the life
of the option(X).

Spot Rate Current Stock price/currency rate (S).

Options Terminology contd..
Premium
The Price which the buyer pays to the seller/writer for an option contract
Intrinsic Value
0
American Option
An option, call or put , which can be exercised on any business day from
initiation to maturity.
European Option
An option which can be exercised only on maturity date.
Money ness
In-the-money S>X
Out-of-money S<X
At -the-money S=X
Call Options or Put Options?
 Option Example{Call}
 Type - Call
 Month = September
 S0 = 1512
 X = 1400
 Premium = 121
Payoff Schedule{Call}
Closing Option Whether Gain from
Net Payoff
Price Premium Exercised? exercising
1200 -121 No 0 -121
1250 -121 No 0 -121
1300 -121 No 0 -121
1350 -121 No 0 -121
1400 -121 * 0 -121
1450 -121 Yes 50 -71
1500 -121 Yes 100 -21
1521 -121 Yes 121 0
1550 -121 Yes 150 29
1600 -121 Yes 200 79
1650 -121 Yes 250 129
Payoff Behavior{Call}
150

100

50

0
1200 1250 1300 1350 1400 1450 1500 1521 1550 1600
-50

-100

-150
 Option Example{Put}
 Type - Put
 Month = September
 S0 = 1512
 X = 1400
 Premium = 9
Payoff Schedule{Put}
Closing Option Whether Gain from
Net Payoff
Price Premium Exercised? exercising
1200 -9 Yes 200 191
1250 -9 Yes 150 141
1300 -9 Yes 100 91
1350 -9 Yes 50 41
1391 -9 Yes 9 0
1400 -9 * 0 -9
1500 -9 No 0 -9
1521 -9 No 0 -9
1550 -9 No 0 -9
1600 -9 No 0 -9
1650 -9 No 0 -9
Payoff Behavior{Put}
250

200

150

100

50

0
1200 1250 1300 1350 1391 1400 1500 1521 1550 1600
-50
Types of Strategies
 Simple - Position in the option and the underlying

 Spread - Position in two or more options of the same type

 Combination - Position in a mixture of calls & puts (A

combination)
 Option Strategy{Simple}
 Type – Put and Buy Underlying Asset(stock)
 Month = September
 S0 = 1512
 X = 1400
 Premium = 9
 Option Strategy{Simple}
Gain
Outflow Gain/Los
Closing Option Whether from
on the s from Net Payoff
Price Premium Exercised? exercisin
Position Position
g
1200 1512 -9 Yes 200 -312 -121
1250 1512 -9 Yes 150 -262 -121
1300 1512 -9 Yes 100 -212 -121
1350 1512 -9 Yes 50 -162 -121
1391 1512 -9 Yes 9 -121 -121
1400 1512 -9 * 0 -112 -121
1512 1512 -9 No 0 0 -9
1521 1512 -9 No 0 9 0
1550 1512 -9 No 0 38 29
1600 1512 -9 No 0 88 79
1650 1512 -9 No 0 138 129
Payoff Behavior{Simple Strategy}
150

100

50

0
1200 1250 1300 1350 1370 1430 1450 1550 1580 1600
-50

-100

-150
Spreads
Spread consists of a put and a call option
on the same security for the same time
period at different prices.
Spread Types
Bullish- selling the call with higher strike price and buying the call with

lower strike price.(for call options) and vice-versa for put options on
expectation of increase in stock price/ currency rate.

Bear - selling the call with lower strike price and buying the call with
higher strike price.(for call options) and vice-versa for put options on
expectation of decline in stock price/ currency rate.
 Option Strategy{Bullish}
 Sell Call(X=1550) for Premium = 24
 Buy Call(X=1300) for Premium = 154
 Month = September
 S0 = 1512
 Payoff
Premium Gain Gain
Premiu Whether Whether
Closing (Call from from
m(Call X1 X2 Net Payoff
Price Bought;X2 exercisin exercisin
Sold;X1) Exercised? Exercised?
) g (X1) g (X2)
1200 24 -154 No No 0 0 -130
1250 24 -154 No No 0 0 -130
1300 24 -154 No No 0 0 -130
1350 24 -154 No Yes 0 50 -80
1370 24 -154 No Yes 0 70 -60
1430 24 -154 No Yes 0 130 0
1450 24 -154 No Yes 0 150 20
1550 24 -154 No Yes 0 250 120
1580 24 -154 Yes Yes -30 280 120
1600 24 -154 Yes Yes -50 300 120
1650 24 -154 Yes Yes -100 350 120
 150

100

50

0
1200 1250 1300 1350 1370 1430 1450 1550 1580 1600
-50

-100

-150
Spread Types contd..
Butterfly- Buying Two calls with middle strike price
and writing one each on either side.

Time - Both options having same exercise price but

different maturity.

Price- Both options having same maturity but

different exercise price.
 Option Strategy{Butterfly}
 Call1(X=1450) Premium = 104
 Call2(X=1500) for Premium = 24
 Call3(X=1600) for Premium = 14
 Month = September
 Whethe Whethe Whethe
Premiu r r r Gain Gain Gain
Premiu m (Call Premiu X1=1450 X2=1500 X3=1600 from from from
Closing m(Call Bought; m (Call Exercise Exercise Exercise exercisi exercisi exercisi Net
Price Sold;X1) X2) Sold;X3) d? d? d? ng (X1) ng (X2) ng (X3) Payoff

1200 104 -48 14 No No No 0 0 0 70

1250 104 -48 14 No No No 0 0 0 70

1300 104 -48 14 No No No 0 0 0 70

1350 104 -48 14 No No No 0 0 0 70

1370 104 -48 14 No No No 0 0 0 70

1430 104 -48 14 No No No 0 0 0 70

1450 104 -48 14 No No No 0 0 0 70

1500 104 -48 14 Yes No No -50 0 0 20

1550 104 -48 14 Yes Yes No -100 100 0 70

1600 104 -48 14 Yes Yes No -150 200 0 120

1650 104 -48 14 Yes Yes Yes -200 300 -50 120

1700 104 -48 14 Yes Yes Yes -250 400 -100 120

1750 104 -48 14 Yes Yes Yes -300 500 -150 120
 Payoff
140

120

100

80

60

40

20

0
1200 1250 1300 1350 1370 1430 1450 1500 1550 1600 1650 1700 1750
Combinations
Strap - two calls and one put at the same contracted
exercise price and for the same period.

Strip - two puts and one call at the same contracted

exercise price and for the same period.
 Combinations contd..
Ratio Call Spread
 Purchasing a certain amount of calls at one strike and
simultaneously selling more calls than purchased at a
higher strike. It is generally a neutral options strategy.
 Maximum profit = the initial credit + difference between the two
strikes (or)
 Maximum profit = difference between the two strikes - the initial
debit
 Upside break even point = higher strike price + the points of
maximum profit
 Combinations contd..
 Straddle is an options strategy, which involves the purchase of a call
and a put with the same strike price, the same expiration date, and the
same underlying security.
 A strangle is an options strategy where the investor holds a position in
both a call and put with different strike prices but with the same
maturity and underlying asset. This option strategy is profitable only if
there are large movements in the price of the underlying asset.
 Assets Underlying Exchange-Traded Options
 Stocks
 Foreign Currency
 Stock Indices
 Futures
 Warrants
 Warrants are options that are issued by a corporation or a
financial institution
 The number of warrants outstanding is determined by the
size of the original issue and changes only when they are
exercised or when they expire
Positions in an Option & the Underlying

Profit Profit

K ST ST

(a)
(b)
Profit Profit

K
ST K ST

(c) (d)
Bull Spread Using Calls

Profit

ST
K1 K2
Bull Spread Using Puts

Profit

K1 K2 ST
Bear Spread Using Puts

Profit

K1 K2 ST
Bear Spread Using Calls

Profi
t

K1 K2 ST
 Box Spread
 A combination of a bull call spread and a bear put spread
 If all options are European a box spread is worth the
present value of the difference between the strike prices
 If they are American this is not necessarily so.
Butterfly Spread Using Calls

Profit

K1 K2 K3 ST
Butterfly Spread Using Puts

Profit

K1 K2 K3 ST
Calendar Spread Using Calls

Profit

ST
K
Calendar Spread Using Puts

Profit

ST
K
A Straddle Combination

Profit

K ST
Strip & Strap

Profit Profit

K ST K ST

Strip Strap
A Strangle Combination

Profit

K1 K2
ST
Thank You