Call option and buy option of sharemarket.pptx

Stock market

1. Options Meaning - Option is an agreement which gives buyer right but not obligation to buy or sell a specific quantity of underlying asset on a future at a predetermined prices. Options are of two type call and put .call option gives buyer right but not obligation to buy underlying asset on a future date at predetermined prices. Put option gives right but not obligation to sell underlying asset on a a a future date at a predetermined prices.

2. Terminology Buyer of option: Buyer also known as holder is the person who pays premium to seller and buys right but not obligation to sell or buy. Seller of option: Seller also known as writer is the person who receives premium. Call Option: Call option gives buyer or holder right but not obligation to buy underlying asset on a future date at a predetermined prices. Put option: Put option gives right but not obligation to sell underlying asset on a future date at predetermined prices Option price: Option price is amount paid by option buyerbro option seller to buy the option. Expiration date: It is last date on which options will be traded.

3. European option : this option can be exercised only on expiration date . American option: American option is one which can be exercised on any day up to maturity. Strike price: It is price specified in option contract and is also known as exercise price. In- the –Money: At the call option spot price is higher than strike price. In put option spot price lower than the strike price. At- the -Money: In both call and put option the spot price equals strike price. If immediately exercise the contract leads zero cash flow. Out-of-Money: in call option as for prices lower than strike price. In put option an spot price higher than strike price.If exercise immediately it give negative cash flow

4. CALL OPTION A call option is a financial contract that gives the buyer the right, but not the obligation, to buy a specified quantity of an asset (such as stocks) at a specified price (the strike price) within a specified period of time. EXAMPLE: Suppose you purchase a call option on the stock of ABC Ltd. with a strike price of ₹100 per share. The option premium (the cost to buy the option) is ₹10 per share, and the option expires in one month.

5. Scenario 1: Stock price rises to ₹120 at expiration. You can buy the stock at the strike price of ₹100. You can then sell the stock at the market price of ₹120. Profit per share = (Market price - Strike price) - Option premium = (₹120 - ₹100) - ₹10 = ₹10. Total profit if you bought 100 shares = 100 shares * ₹10 = ₹1000. Scenario 2: Stock price remains at ₹90 at expiration. You will not exercise the option since the market price is lower than the strike price. Your loss is limited to the option premium paid = ₹10 per share. Total loss if you bought 100 shares = 100 shares * ₹10 = ₹1000.

6. PUT OPTION A put option is a financial contract that gives the buyer the right, but not the obligation, to sell a specified quantity of an asset at a specified price (the strike price) within a specified period of time. EXAMPLE: Suppose you purchase a put option on the stock of XYZ Ltd. with a strike price of ₹150 per share. The option premium is ₹15 per share, and the option expires in one month.

7. Scenario 1: Stock price falls to ₹120 at expiration. You can sell the stock at the strike price of ₹150. You can then buy the stock at the market price of ₹120. Profit per share = (Strike price - Market price) - Option premium = (₹150 - ₹120) - ₹15 = ₹15. Total profit if you bought 100 shares = 100 shares * ₹15 = ₹1500. Scenario 2: Stock price remains at ₹170 at expiration. You will not exercise the option since the market price is higher than the strike price. Your loss is limited to the option premium paid = ₹15 per share. Total loss if you bought 100 shares = 100 shares * ₹15 = ₹1500.

8. In Call Option Buyer Seller 1 = Holder going long 1 = He goes short 2 = Pays total premium 2 = Receives premium 3 = He has the right but not the obligation to buy 100 shares of underlying stock at strike price 4 = right to buy the underlying at a specific price on or before a specific date 3 = He is obligated to sell on demad when buyee exercise call option 4 = obligation to sell the underlying at a specific price on or before a specific date Pay off charts and diagram for option contract

9. In Put Option Buyer Seller 1 = Holder goes long 1 = Going short 2 = Pays premium 2 = Receives premium 3 = Right s not obligation to buy 4 = right to sell the underlying at a specific price on or before a specific date 3 = Obligated to buy on demand if buyer exercise put option 4 = obligation to buy the underlying at a specific price on or before a specific date

10. Futures Options Future contract is an agreement made through an organised exchange to buy or sell a fixed amount of a commodity on a future date at an agreed Price It is a contract which gives right but no obligation to buyer. It is buying & selling of financial Instrument at a predetermined price at a future specific Date 2. It gives right to buy or sell the instrument on or before a certain date but the investor is not obligated to do so. 3. Buyer is having obligation to execute the contract 3. Buyer is having no obligation to execute the contract 4. In future execution done on agreed date 4. Execution can be done at any time before expiry date 5. High risk 5. Limited risk 6. No need of advance payment 6. Premium is paid in advance 7. Profit & loss is unlimited 7. Unlimited profit with limited loss It gives right & obligation to both the parties 8. It gives right but no obligation to the holder 9. Less flexibility 9. Higher flexibility

11. Futures Options 10. Contract is started with initial margin. 10. Premium is paid 11. Linear pay off diagram 11. Non- linear pay off diagram 12. Time value of money is not considered 12. Time value of money is considered 13. Strike price fluctuates in the future contract 13. Strike price fixed in nature 14. Execution on the pre-decided date as per contract 14. Execution on any point of time before the date of expiry

12. FACTORS AFFECTING OPTION PREMIUM

13. BASIC UNDERSTANDING OF OPTION STRATEGIES 1. SPREAD : Under the strategy , we either buy and sell, only call or put at different strike prices, but we don’t buy our sell combination of call and put. Spread can be divided into. (A) vertical, (B) horizontal/calendar, and(C) diagonal. A) Vertical spread : Here we buy and sell options with different price, but with same expiration date. This can be further divided into. (a) Bull Spread, (b) Bear Spread and (c) Butterfly.

14. B) Horizontal Or Calendar Spread : Here all options are with different expiration, but same strike prices. This strategy is used when the investor feels.(based on some specific news about the company or some tip) that the share price will be behaving is some specific manner. This strategy can be further divided into: normal calendar & b) reverse calendar.

15. C) Diagonal Spread : this spread is a mixture of vertical and horizontal spread, which means that options have different strike price(which is what happens vertical spread) with different expiration (which is what happens under calendar spread) 2. COMBINATION : Under this strategy we have a combination of call and put, but either only buying or only selling. This strategy can be divided into following four different strategies. a) Straddle : Under the strategy we buy (or sell) one call and one put with same strike price and expiration. This strategy is used when there is equal expectation of both falling and rising situation. b) Strip : Under this strategy we buy (or sell) one call and two put with same strike price and expiration. This strategy is used when the market is most likely to fall. c) Strap : Under this strategy we buy (or sell) two call & one put with same strike price, and expiration. This strategy is used when the market is most likely to rise.

16. d) Strangle : Under this strategy, we buy (or sell) one call & one put with different strike price and expiration. Selling combination involves high degree of risk and therefore it should be used when the fluctuation expected is minor . Buying combination involves low degree of risk and therefore it should be used when the fluctuation expected is major . 3. SYNTHETIC : This strategy involves combining futures and options. This strategy is used by arbitrageurs in their portfolio. a) Synthetic Long : Under this strategy the arbitrageurs buys one call, Sell one put and sell one futures. b) Synthetic Short : under this strategy the arbitrageurs sell one call, buys one put and buys one futures.

17. MEANING OF THE BINOMIAL OPTION PRICING MODEL The Binomial Option Pricing Model is a popular method for valuing options. It uses a discrete-time approach to model the possible future price movements of an asset (like a stock) over multiple time periods. The basic idea is that in each period, the asset price can either move up or down by certain factors, thus creating a “binomial tree” of possible asset prices at each step.The model works by simulating possible price paths for the underlying asset, calculating the option’s value at each final node of the tree, and then working backward to determine the value at earlier nodes, including the current time. This backward induction process considers the risk-neutral probabilities of the up and down moves.

18. ADVANTAGES & DISADVANTAGES OF THE BINOMIAL OPTION PRICING MODEL ADVANTAGES: Flexibility Intuitive Framework American Options Numerical Stability Convergence Risk-Neutral Valuation Adaptability to Stochastic Processes DISADVANTAGES: Computational Intensity Approximation Errors Difficulties with Path-Dependent Options Assumption of Constant Volatility and Interest Rates Limited Accuracy for Complex Options Over fitting to Specific Scenarios Cumbersome for Large-Scale Problems