OPTIONS

Recap
• Derive value from the underlying equities.
• Exchange traded future contracts with
expiries of one, two and three months.
• Come in pre-determined lot sizes
• Only margin payments required
• Daily settlement and that too in cash in
India
 Options
• Two types: Call & Put
• Call option gives buyer a right to buy but
not the obligation to buy the underlying, at
a given, price on or before a given future
date.
• Put option gives the buyer a right to sell
but he is not obliged to sell the underlying.
 Understanding Options
• Index Options • European style
• Stock Options • American style
• Writer • In the money
• Option Premium • Out of the money
• Strike price • At the money
• Expiry • Intrinsic value
• Time value
• American options can be exercised
anytime i.e. on or before the expiry.
• Stock options are American options

• European options can only be exercised

on the expiry date
• Index options are European options.
Option premium can be broken down into two
components
Intrinsic value which is the value of an option that
is ITM. If it is OTM then it will zero as intrinsic
value cannot be negative
Time value is difference between premium and its
intrinsic value. Maximum time value exists when
the option is ATM. The longer the time to expiry
greater will be the time value and its zero on
expiry.
 Payoff for a buyer of the equity Vs
buyer of a CALL option

profit profit

3000
3000
nifty nifty

50

loss loss
 Payoff for a buyer of call option:
long call
• As long as the expiry close (spot) is below
3000 the buyer is at loss.
• When the expiry close crosses 3000 he
starts making profits.
• But it is to be noted that in options the
maximum loss of a buyer is CAPPED to
the premium that he pays.
 Payoff for a CALL Buyer and Writer

profit profit

50
3000 3000

50

loss
loss
 Payoff for a writer of call option:
Short Call
• Whatever is the buyer’s profit is the
seller’s loss since he has to oblige if the
buyer decides to exercise the option.
• Writer’s profit is limited to the up-front
premium paid by the buyer.
Payoff for a seller of the equity Vs
buyer of a PUT option

profit profit

3000
3000

50

loss loss
Payoff for the buyer of a put option:
long put
• If the spot closes above the strike then the
buyer is at a loss
• As soon as the spot goes below the strike
the option becomes ITM and the buyer
starts making profits
• Here again his loss is capped to the
premium paid.
 Payoff for a PUT Buyer and Writer

profit

3000

50 3000

loss
Payoff for the writer of a put option:
Short put
• Like a call writer, he makes losses if the
option becomes an ITM option.
• His profit is only limited to the premium he
receives up-front for writing the option.
 Exercise settlement value
• For a Call
Closing price of the underlying security –
Strike price

• For a Put
Strike price – Closing price of the
underlying security
 Option Settlement
• Daily premium settlement: Net premium payable
or receivable is computed on daily basis for
every buyer and writer
• Exercise settlement: When a buyer decides to
exercise the option the seller has to oblige him..
In Indian bourses all options are cashed settled
there is no delivery though we are looking
forward to making it delivery based.
• Interim exercise settlement: Possible only
in the case of American options. It takes
place when the buyer decides to settle the
option before it expires.
• Final exercise settlement: Done in case of
index options which are always European
in style. They are settled only on the expiry
date.
 Exercise process
• All options if not settled prior to the expiry
will be automatically exercised on the
expiry date subject to they being ITM.
• If intermediate exercise is to take place
then the Trading Member has to give a
notice to NSCCL and such a notice once
given cannot be revoked
 Advantages of options
• Derivatives – pay less and earn equally
• No margin requirements only premium to
be paid
• Loss for the buyer is capped to the
premium paid
Thank You