FINANCIAL DERIVATIVES AND

RISK MANAGEMENT
ASSIGNMENT 2

Mohd Aqil
2016008809  MBA 2nd year
Ans 1- An options contract is an agreement between a buyer and seller
that gives the purchaser of the option the right to buy or sell a
particular assets at a later date at an agreed upon price.  Options
contracts are often used in securities, commodities.
Features of an option-:
 The buyer has the right to buy or sell the asset.
 To acquire the right of an option, the buyer of the option must
pay a price to the seller. This is called the option price or the
premium.
 The exercise price is also called the fixed price, strike price or
just the strike and is determined at the beginning of the
transaction. It is the fixed price at which the holder of the call or
put can buy or sell the underlying asset.
 Exercising is using this right the option grants you to buy or sell
the underlying asset. The seller may have a potential
commitment to buy or sell the asset if the buyer exercises his
right on the option.
The expiration date is the final date that the option holder has to exercise
her right to buy or sell the underlying asset.

There are four key advantages of options may give an investor:

 They may provide increased cost efficiency;
 They may be less risky than equites;
 They have the potential to deliver higher percentage returns; and
 They offer a number of strategic alternatives.

Ans 2- A long position in an asset signifies that the investor owns the
asset. On the other hand, when an investor buys a call option, he does
not own the underlying asset. A call option derives its price from
multiple factors, such as the underlying asset price, implied volatility
and time decay.
A call option is a contract that gives the buyer, or holder, the right to
buy the underlying asset at a predetermined price by or on a certain
date. However, he is not obligated to purchase the underlying asset.
For example, suppose an investor buys one call option on stock XYZ
with a strike price of $50, expiring next month. If the stock price rises
above $50 before the call option's expiration date, the investor has the
right to purchase 100 shares of XYZ at $50. The buyer only owns a
contract that allows him to buy a stock if he chooses to. Unlike an
investor who has a long position in XYZ, he does not own any part of
the company.
key specification parameters of an option contract.
1) Index
2) Instrument
3) Expiration date
4) Option type
5) Strike price
6) Trading cycle
7) Permitted lot size
Ans 3- How would the call price change with change in
 Spot Price - the most influential factor on an option premium is the
current market price of the underlying asset. In general, as the spot price of
the underlying increases, call prices increase and put prices decrease.
Conversely, as the spot price of the underlying decreases, call
prices decrease and put prices increase
 Volatility- The greater the expected volatility, the higher the option value.
 Interest rate - Interest rates have small, but measurable, effects on option
prices. In general, as interest rates rise, call premiums increase and put
 premiums decrease. This is because of the costs associated with owning the
underlying.
 Exercise price - The exercise price determines if the option has any intrinsic
value. intrinsic value is the difference between the strike price of the option
and the current price of the underlying asset. The premium typically
increases as the option becomes further in-the-money (where the strike
price becomes more favorable in relation to the current underlying price).
The premium generally decreases as the option becomes more out-of-the-
money (when the strike price is less favorable in relation to the underlying
security).

Ans 4- call seller’s or call writer’s profit would be different from the call buyer’s
because call seller had writes the option to call buyer and its profit would be
limited but the loss of call seller can be unlimited and call buyer’s profit would be
unlimited because call option can increase at any limit but the loss of call buyer
will be limited by its premium paid.

Ans 5- bullish strategy

1) Long call
2) Short naked put
3) Covered call
4) Bull call spread
5) Bull put spread
Baelish strategy
1) Long put
2) Short call
3) Covered put
4) Bear put spread
Ans 6- a market neutral strategy is a type of investment strategy undertaken by an
investor or an investment manager that seeks to profit from both increasing or
decreasing price in one or more market, with attend to completely avoid some
specific of market risk. Market neutral strategy are of the attained by taking
matching long and short position in different stock to increase the return from
making good stock selection and decreasing the return from broad market
movement.

Ans 7 – short notes –

 Intrinsic value- the intrinsic value is the actual value of a company or an
asset based on underlying perception of its true value building all the aspect
of the business in the terms of both tangible and intangible factors. This
value may or may not be the value. As the additionally intrinsic value is
primarily used in option pricing to indicate the amount an option is in the
money.
 Time Value Of Option- An option's time value is equal to its premium (the
cost of the option) minus its intrinsic value (the difference between the strike
price and the price of the underlying). As a general rule, the more time that
remains until expiration, the greater the time value of the option.
 Put Call Parity - call parity defines a relationship between the price of
a European call option and European put option, both with the
identical strike price and expiry, namely that a portfolio of a long call option
and a short put option is equivalent to (and hence has the same value as) a
single forward contract at this strike price and expiry. This is because if the
price at expiry is above the strike price, the call will be exercised, while if it
is below, the put will be exercised, and thus in either case one unit of the
asset will be purchased for the strike price, exactly as in a forward contract.
 Butterfly Spread- The butterfly spread is a neutral strategy that is a
combination of a bull spread and a bear spread. It is a limited profit, limited
risk options strategy. There are 3 striking prices involved in a butterfly
 spread and it can be constructed using calls or puts. Butterfly Spread
Construction. Buy 1 ITM Call.
 Protective Put- A protective put strategy is usually employed when the
options trader is still bullish on a stock he already owns but wary of
uncertainties in the near term. It is used as a means to protect unrealized
gains on shares from a previous purchase.
 Straddle - An options strategy where the investor holds a position in both a
call and put with the same strike price and expiration date, but with different
exercise prices. Straddles are a good strategy to pursue if an investor
believes that a stock's price will move significantly, but is unsure as to which
direction. The stock price must move significantly if the investor is to make
a profit.
 Strangle- 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.
The strategy involves buying an out-of-the-money call and an out-of-the-
money put option. A strangle is generally less expensive than a straddle as
the contracts are purchased out of the money.