Project topic:-TYPES OF OPTION

Acknowledgement

I would like to thanks the Prof. for giving me a great opportunity to prepare a project report on Types of options a part of study. This was the excellent experience to be shared with in this project. This project helps me in increasing my knowledge about trading of share market which is very useful for me.

INDEX
Sr No. 1) 2) 3) 4) 5) 6) Particulars Introduction of option Types of option Benefits of option Disadvantages of option Option terminology Sums

Introduction of option:A financial derivatives that represent a contract sold by one party (option writer) to another party (option holder).the contract offers the buyers the right, but not the obligation, to buy (call) or sell (put) a security or other financial asset at an agreed upon price (the strike price) during a certain period of time or on a specific date (exercise date).call option give the option to buy at certain price, so the buyer would want the stock to go up. Put option give the option to sell at certain price, so the buyer would want the stock to go down. Options are extremely versatile securities that can be used in many different ways. Trader use option to speculative, which are a relatively risky practices, while hedgers use option to reduce the risk of holding an asset. Options involve risk and are not suitable for everyone .option trading can be speculative in nature and carry substantial risk of loss. Options involve risks and are not suitable for everyone. Option trading can be speculative in nature and carry substantial risk of loss. Only invest with risk capital.

Types of option:
1. Call option:A call option is a right to buy an underlying asset at a fixed on or before a particular day by paying premium. 2. Put option:Put option is a right to sell an underlying asset at a specified price on or before a particular day by paying a premium. 3. American option:American option can be exercised at any time before and on the expiry date.american option permits early exercise while a European option does not. 4. European option:European option can be exercised only on maturity date of the option which is known as expiry date. European options are easier to analysis than American option and properties of an American option are frequently deducted from those of its European counterpart. 5. over the counter:-

Otc option are private agreement between two parties and are tailor made to the requirement of the party buying the option.excange traded option are brought or sell on an organized exchange and re standardized conracts.most exchange traded option are same as American option.

Benefits of option:Option as a strategic investment is fast becoming the choice of many. The benefits that option trading offers are many and we shall discuss the same here. Option trading having many benefits it is actually a wonder as to why it was not a sought after means for investment for so long. 1. Option trading is not as risky as it seems if traded wisely. In case of option you do not require as much finance as you would do for stocks. As far as hedge is concerned, option trading seems to be the most reliable of them all. In case of option trading you have an insurance throughout the day, all seven days a week and not until the close of the market. 2. Option is very cost effective. You could be in a similar position as you would have stocks but by putting in much less as investment but the catch is that the investor needs to be careful and select the right call option so as to be in the same position as he would be with stocks. This stock replacement strategy is very cost effective. 3. Option as a strategic investment offers to its investors a high return on its investments. The return investors make on the right selection in option trading is far greater than any stock investment. Option can get you about 60-70% and even more on your investments and in the same scenario your stocks may give you a return of only about 10-15%. But there is a flipside to this. When option give you such high rate of return it is only when you have made the right choice but a wrong selection on the other hand can

get you back by the entire 100%. So the returns are good but only when you take calculated risks. 4. Option as a strategic investment provides the investor with multiple options so as to attain their aim. Option offers the investors various alternatives if planned and executed well. An example to quote here would be how a margin would have to be paid if short selling is to be done. At times the margin quoted by the brokers is so high that the investor finds it difficult to go ahead with his plans. Then there are those who do not allow short selling by the investor thus again the investor going back to square one as far as his investment plans are concerned. This puts the investor in the back seat as he is unable to execute his plans and here is where the option trading comes into play. You wouldn't find any broker who says that the investor cannot purchase puts when the market seems to be falling. This would give the option trader an advantage and he would be able to reap the benefits later. 5. An option trader can invest in the market not only when it moves up or down, when the prices are almost steady, a trader can also use the time factor where the prices are not moving significantly as a profit making opportunity. Thus it is only the option trader who gets a share in the pie in every kind of market.

Disadvantages of option:

Lower liquidity. Many individual stock options don't have much volume at all. The fact that each option able stock will have options trading at different strike prices and expirations means that the particular option you are treading will be very low volume unless it is one of the most popular stocks or stock indexes. This lower liquidity won't matter much to a small trader that is trading just 10 contracts though. Higher spreads. Options tend to have higher spreads because of the lack of liquidity. This means it will cost you more in indirect costs when doing an option trade because you will be giving up the spread when you trade. Higher commissions. Options trades will cost you more in commission per dollar invested. These commissions may be even higher for spreads where you have to pay commissions for both sides of the spread. Complicated. Options are very complicated to beginners. Most beginners, and even some advanced investors, think they understand them when they don't. Time Decay. When buying options you lose the time value of the options as you hold them. There are no exceptions to this rule. Less information. Options can be a pain when it is harder to get quotes or other standard analytical information like the implied volatility.

Options not available for all stocks. Although options are available on a good number of stocks, this still limits the number of possibilities available to you.

Option terminology: Call:An option contract giving the buyer the right but not the obligation to purchase the commodity or to enter into a long futures position. Covered Call:An option spread position where Calls are sold against a long position in the underlying instrument. In essence, the trader is limiting his profit on the long position in exchange for receiving the option premium. On option expiration day, the breakeven on the long futures is lower by the amount of option premium received, less commissions. Covered Option:A short call or put option position which is covered by the sale or purchase of the underlying futures contract or physical commodity. For example, in the case of options on futures contracts, a covered call is a short call position combined with a long futures position. A covered put is a short put position combined with a short futures position. Also called a Covered Write. See also Covered Call and Covered Put. Covered Put:An option spread position where Puts are sold against a short position in the underlying instrument. In essence, the trader is limiting his profit on the short position in exchange for receiving the option premium. On option expiration day, the breakeven on the short futures is raised by the amount of option premium received, less commissions.

 Delta:A measure of how much an option premium changes, given a unit change in the underlying futures price. Delta often is interpreted as the probability that the option will be in-themoney by expiration. Exercise:The action taken by the holder of a call option if he wishes to purchase the underlying futures contract or by the holder of a put option if he wishes to sell the underlying futures contract. Exercise Price:the price at which the futures contract underlying a call or put option can be purchased (if a call) or sold (if a put). Also referred to as Strike Price. Expiration Date:The last day that an option may be exercised into the underlying futures contract. Also, the last day of trading for a futures contract. Horizontal spread:The purchase of either a call or put option and the simultaneous sale of the same type of option with typically the same strike price but with a different expiration month. Also referred to as a calendar spread. In-the-money Option:An option with intrinsic value. A call option is in-the-money if its strike price is below the current price of the underlying futures contract. A put option is in-the-money if its strike price is above the current price of the underlying futures contract. See Intrinsic Value. Intrinsic Value:The amount by which an option is in-the-money. See In-theMoney Option. Long Options Value:It is the combined value of all options purchased. It is marked-to-market. Options marked to the last reported price. Net Options Value:the credit or debit value of all option positions combined. It is marked-to-market.

 Option:A contract giving the holder the right, but not the obligation, hence, "option," to buy (call option) or sell (put option) a futures contract in a given commodity at a specified price at any time between now and the expiration of the option contract. Option Buyer:The purchaser of either a call or put option. Option buyers receive the right, but not the obligation, to assume a futures position. Also referred to as the holder. Option Premium:The price of an option. The sum of money that the option buyer pays and the option seller receives for the rights granted by the option. Option Seller:The person who sells an option in return for a premium and is obligated to perform when the holder exercises his right under the option contract. Also referred to as the Writer or Grantor. Option spread:The simultaneous purchase and sale of one or more options contracts, futures, and/or cash positions. Out-of-the-Money Option:An option with no intrinsic value, i.e., a call whose strike price is above the current futures price or a put whose strike price is below the current futures price. Its value is solely time related. Put:An option to sell a commodity, security, or futures contract at a specified price at any time between now and the expiration of the option contract. In particular, a Put gives the option buyer the right but not the obligation to sell (go "short'') the underlying futures contract at the strike price on or before the expiration date. Hedge:The number of options compared to the number of futures contracts bought or sold in order to establish a hedge that is risk neutral.

 Spread:This strategy, which applies to both puts and calls, involves buying or selling options at one strike price in greater number than those bought or sold at another strike price. Strangle An option position consisting of the purchase (or sale) of both puts and calls having the same expiration but different Strike Prices.

Time Value:The amount of money option buyers are willing to pay, above the intrinsic value, for an option in the anticipation that, over time, a change in the underlying futures price will cause the option to increase in value. In general, an option premium is the sum of time value and intrinsic value. Any amount by which an option premium exceeds the option's intrinsic value can be considered time value. Also referred to as Extrinsic Val

Sums:Moneyness of option:1) In may2010 Mrs. Suresh purchased a July call option on stock of InfoTech ltd at exercised price of 1150 and July put option on biotech at an exercise price of 520. If the price of share of InfoTech and biotech in the month of July 2010 as under Possibility a b c InfoTech 1170 1150 1130 biotech 510 520 530

Show cash flow n suggests????

Ans:InfoTech: - spot price-exercise price A B C : - 1170- 1150=20(itm) : - 1150 - 1150=0(atm) :1130 -1150=-20(otm)

Biotech: - exercise price-spot price A : - 520- 510=10(itm)

B C

: - 520-520=0 (atm) :520-530=-10(otm)

Mrs.suresh should exercised option under possibility a since the option itm which would generate cash flow. He should not exercise at the level of atm and otm.

2. Miss Tejal get European call option on stock ABC ltd by paying option premium rs 3 have exercised price rs 50. Calculate intrinsic value or profit or loss of Miss Tejal for spot price at the expiry of rs 46 to 55. Ans:- A call option will have intersic value ,when spot price exceed exercise price than it will not favorable call option buyer to exercise the option so that it will laps. Call option buyer pay off Exercise price 50 50 50 50 50 50 50 50 50 50 Spot price Intersic value 0 0 0 0 0 1 2 3 4 5 Call premium paid -3 -3 -3 -3 -3 -3 -3 -3 -3 -3 Profit/loss

46 47 48 49 50 51 52 53 54 55

-3 -3 -3 -3 -3 -2 -1 0 +1 +2

2) Mr. Kumar writes European put option on stock of LMN ltd having stock price 50. Option premium 3.calculte internsic value and profit n loss of Mr. Kumar. Spot price 46 to55.

Ans:- A put option will have intersic value ,when exercise price exceed spot price than it will not favorable put option buyer to exercise the option so that it will laps.

Put option writer pay off Exercise price 50 50 50 50 50 50 50 50 50 50 Spot price Intersic value -4 -3 -2 -1 0 0 0 0 0 0 Call premium paid 3 3 3 3 3 3 3 3 3 3 Profit/loss

46 47 48 49 50 51 52 53 54 55

-1 0 1 2 3 3 3 3 3 3