options-understanding the financial derivative

24
Options Basics of the option derivatives

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Page 1: Options-Understanding the Financial Derivative

Options

Basics of the option derivatives

Page 2: Options-Understanding the Financial Derivative
Page 3: Options-Understanding the Financial Derivative

Option

Exchange OTC

Page 4: Options-Understanding the Financial Derivative

Option

Buyer Seller

Option Price

Long Short

Page 5: Options-Understanding the Financial Derivative

Basic types of options

Call option

Put Option

•A call option is the right to buy•A put option is the right to sell

Strike Price

Page 6: Options-Understanding the Financial Derivative

Option type- based on the style of exercising

European style options

American style options

Page 7: Options-Understanding the Financial Derivative

A quick revision

Page 8: Options-Understanding the Financial Derivative

Why trade options ?

Page 9: Options-Understanding the Financial Derivative

Limited Risk

Portfolio 11 option =1000 XYZ sharesCurrent price of XYZ=$100Option price=$200

Price of XYZ = $90 Maximum loss=$200

Portfolio 2Buy 100 shares of XYZCurrent price of XYZ=$100Investment=$10000

Price of XYZ=$90Maximum loss=$1000

After 3 months

Page 10: Options-Understanding the Financial Derivative

Unlimited profit potential

Portfolio 11 option =1000 XYZ sharesCurrent price of XYZ=$100Option price=$200

Portfolio 1Buy 100 shares of XYZCurrent price of XYZ=$100Investment=$10000

Price of XYZ = $110 Maximum gain=$10000

Price of XYZ = $110 Maximum gain=$1000

After 3 months

Page 11: Options-Understanding the Financial Derivative

Insurance

Do you own a stock ?

Are you bearish about the market ?

Buy a put option on the stock !

Page 12: Options-Understanding the Financial Derivative

Profits from buying the options

Page 13: Options-Understanding the Financial Derivative

Option positions

Long Call Long Put Short Call Short Put

Page 14: Options-Understanding the Financial Derivative

Option contract - example

Option profit (Call Option)

Stock price Strike price+ option price

Case 1 :The option profit = 120-(105+10)=$5 .

Case 2 :The option profit= 0

Page 15: Options-Understanding the Financial Derivative

Option contract - example

Option profit (Put Option)

Strike price Stock price+ option price

Case 1 :The option profit= 0.

Case 2 :The option profit = 100-(85+10)=$5

Page 16: Options-Understanding the Financial Derivative

Buying a call option

Stock : XYZOption price=$5Strike price=$100

Page 17: Options-Understanding the Financial Derivative

30

20

10

0-5

70 80 90 100

110 120 130

Profit ($)

Terminalstock price ($)

Page 18: Options-Understanding the Financial Derivative

-30

-20

-10

05

70 80 90 100

110 120 130

Profit ($)

Terminalstock price ($)

Page 19: Options-Understanding the Financial Derivative

Stock : XYZOption price=$7Strike price=$70

Buying a put option

Page 20: Options-Understanding the Financial Derivative

30

20

10

0

-770605040 80 90 100

Profit ($)

Terminalstock price ($)

Page 21: Options-Understanding the Financial Derivative

-30

-20

-10

7

070

605040

80 90 100

Profit ($)Terminal

stock price ($)

Page 22: Options-Understanding the Financial Derivative

Moneyness of an option

In the money

At the money

Out of the money

Page 23: Options-Understanding the Financial Derivative

Moneyness of a call option

In the money

Out of the money

At the money

S – K > 0

S – K < 0

S – K = 0

S= stock priceK=strike price

Page 24: Options-Understanding the Financial Derivative

Moneyness of a put option

In the money

Out of the money

At the money

K – S > 0

K– S < 0

K – S = 0

S= stock priceK=strike price