OPTIONS TERMINOLOGY USED IN OPTION

An option is a financial contract that gives an investor the right, but not
the obligation, to either BUY OR SELL an asset at a pre-determined price (known as
the strike price) by a specified date (known as the expiration date).

Option is one of risk management tools in investment:

-Investors have their expectation towards market price (will rise or decline) in
the future.
-Investors use/enter option contracts to secure their investment whether to get
profit or to reduce risk (by the function of Strike Price in option contract)

CALL OPTION PUT OPTION

- Right to BUY security at a specified price (Strike Price); SP < actual MP ◉-Right to SELL security at a specified price (Strike Price); SP > actual MP
- Expect stock price to rise – investors use option to buy at lower price since SP < actual MP - Expect stock price to drop or decline – investors used option to sell at higher price
since SP > actual MP

- Eg: An investor wants to buy stock and he expect the stock price will rise in one month (30 - Eg: An investor wants to sell stock and he expect the stock price will drop in one
days) month (30 days)
-Current price: RM10, Expected price to INCREASE -Current price: RM10, Expected price to DECREASE
-So, he bought/ entered a 30 days Call Option with the Strike Price of RM8 and cost -So, he bought a 30 days Put Option with the Strike Price of RM15 and cost
incurred was RM1 per incurred was RM1 per share
share (because he believed that the actual market price will be higher in the future)
◉ (because he believed that the actual market price will be lower than the Strike
-If what he expect comes true, on the expiration date (stock price at day 30th) becomes Price) (MP < SP)
RM15 (actual
-If what he expect comes true, on the expiration date (stock price at day 30th)
market price) becomes RM5 (actual market price)
-If he exercised/ used the option contract, he bought the stock at RM8 (strike price) -If he exercised/ used the option contract, he sold the stock at RM 15 (strike price)
instead of RM15. instead of RM5.
He also can make profit if he sell the stock at actual market price on the expiration ◉ (Profit = Strike price – Actual MP – Cost)
date.
(Profit = Actual MP – Strike price – Cost)
 CALL OPTION
Info:
• NOS Bought = 100 units
• Strike Price of Call Option = RM25
• Option Premium/Cost of Call Option
= RM150
EP - actual MP at the day contract was exercised x NOS bought • EP = MP on expiration date = RM35
SP - price of call option x NOS (bought in units)
OP - cost of buying the option x NOS (bought in units)

CALL OPTION CALL OPTION

Solution: Solution:
Profit/ Loss = [(RM30 x 300) – (RM30 x 300)] – (RM2 x 300) Profit/ Loss = [(RM40 x 300) – (RM30 x 300)] – (RM2 x 300)
= (RM 9,000 – RM 9,000) – RM 600 = (RM 12,000 – RM 9,000) – RM 600
= - RM600 (Loss) = RM 2,400 (Profit)
 CALL OPTION

PUT OPTION

EP - actual MP at the day contract was exercised x NOS bought

Solution: SP - price of put option x NOS (bought in units)
Profit/ Loss = [(RM25 x 300) – (RM30 x 300)] – (RM2 x 300) OP - cost of buying the option x NOS (bought in units)
= (RM 7,500 – RM 9,000) – RM 600
= - RM 2,100 (Loss)

PUT OPTION

Info:
• NOS Bought = 200 units
• Strike Price of Call Option = RM50
• Option Premium/Cost of Call Option
= RM4 per option
• EP = MP on expiration date = RM40
Solution:
Profit/ Loss = [(RM 7.50 x 100) – (RM 3 x 100)] – (RM 300)
= (RM 750 – RM 300) – RM 300
= RM 150 (Profit)
TUTORIAL QUESTIONS

Solution:

Profit/ Loss = [(RM40 x 500) – (RM20 x 500)] – (RM900)

= (RM 20,000 – RM 10,000) – RM 900
= RM 9,100 (Profit)