options and obligations options call options buyer right to buy no initial margin pays premium...
TRANSCRIPT
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Options and obligations
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Margining system for Seller of Options• Initial Margin- Risk margin• Premium margin• Assignment margin• Initial margin –According SPAN formula-
Historical 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
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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
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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
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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
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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
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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
Call option Put option
MP>SP I-T-M O-T-M
MP=SP A-T-M A-T-M
MP<SP O-T-M I-T-M
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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
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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
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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
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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 ?
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Valuation of Options B-S model• 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)
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B-S model
• 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
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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?
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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
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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
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Pay off diagrams
• + =
Buy Buy synthetic callStock Put
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Synthetic put /Protective Call /Synthetic Long put /Synthetic Short
• 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
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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
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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
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Synthetic put /Protective Call /Synthetic Long put /Synthetic Short
+ =
• Sell Stock Buy call Synthetic short
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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
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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