FARMERS PROTEST 2020

■ What is the reason?

OPTIONS
■ An options contract offers the buyer the opportunity/option to buy or sell (Not obligation like
futures) the underlying asset.
 CALL OPTION
■ A call option gives the holder of the option/ the right to buy an asset on a certain date for a certain
price. Investor may or may not choose to exercise this right/option.
– Strike price: Price at which you can purchase the asset
– Example: Strike price = $100
– Number of share=100
– Let current stock price = $98 (Spot)
– On expiry the investor will have the option/ opportunity to purchase 100 share at strike price
i.e. $100 per share.
– Expiration: After 4 months
– Option price/premium per share =$5 .
■ Therefore, total initial payment to buy this option = 5* 100 =$500
 Exercising CALL OPTION

■ Effective Cost of per share (if option exercised) = 100 (Purchase price) + 5(cost) =$105
– Lets take 3 cases:

– 1) If Spot = $90 after 4 months

■ Then it is not logical to exercise the option i.e. to buy shares at $100 because current
price $90
■ Option is left unexercised
■ Hence, Loss = $5 Per share (initial payment for option)
■ OR Loss = $500 for 100 share
Exercising CALL OPTION

■ Effective Cost of per share (if option exercised) = 100 (Purchase price) + 5(cost) =$105

– 2) If Spot = $103 after 4 months

■ Then it is logical to exercise the option i.e. to buy shares at $100
– As total cost is 100 + 5=$105

■ Hence, Loss = 105-103 Per share= $2 per share

■ If left unexercised loss will be $5 per share (initial payment)

– Loss of $2 is better than loss of $5
Exercising CALL OPTION

■ Effective Cost of per share (if option exercised) = 100 (Purchase price) + 5(cost) =$105

– 3) If Spot = $107 after 4 months

■ Then it is logical to exercise the option i.e. to buy shares at $100
■ Hence, profit = $107-105= $2 Per share
Payoff/Profit from Call Option

Profit > 0 , when Spot > 105

PUT OPTION
■ A put option gives the holder of the option/ the right to sell an asset on a certain date for a
certain price. Investor may or may not choose to exercise this right/option.
– Strike price: Price at which you can sell the asset
– Example: Strike price = $70
– Number of share=100
– Let current stock price = $65 (Spot)
– On expiry, the investor will have the option/ opportunity to sell 100 share at strike price
i.e. $70 per share.
– Expiration: After 3 months
– Option price/premium per share =$7 .
■ Therefore, total initial payment to buy this option = 7* 100 =$700
 Exercising PUT OPTION
– Effective Sell price (If option exercised) = $70 – cost = 70-7 =$63 per share
– Lets take 3 cases:

– 1) If Spot = $75 after 3 months

■ Then it is not logical to exercise the option i.e. to sell shares at $70 because
current price $75
■ Option is left unexercised
■ Hence, Loss = $7 Per share (initial payment for option)
■ OR Loss = $700 for 100 share
Exercising PUT OPTION

– Effective Sell price (If option exercised) = $70 – cost = 70-7 =$63 per share

– 2) If Spot = $65 after 3 months

■ Then it is logical to exercise the option i.e. to sell shares at $70
– As Effective Sell price =70-7 = $63 per share
– Loss = 65-63 = $2
■ If left unexercised loss will be $7 per share (initial payment)
– Loss of $2 is better than loss of $7
Exercising PUT OPTION

– Effective Sell price (If option exercised) = $70 – cost = 70-7 =$63 per share

– 3) If Spot = $50 after 3 months

■ Then it is logical to exercise the option i.e. to sell shares at $70 per share
■ Hence, profit = $(70-50) - cost = 20-7= $13 Per share
Payoff/Profit from PUT Option

Profit > 0 , when Spot < 63

Arbitrage in options
PUT CALL PARITY EQUATION (Relation between prices of PUT, CALL, and Underlying asset)
Spot Price

C + PV(X) = P + S

Price/premium of Call Price/Premium of Put

Present Value of strike price X

■ Assume Call and put have same strike price.

■ If left hand side is not equal to right hand side, then there will be arbitrage opportunity (Market is
inefficient)
■ When, Left hand side = Right hand side, we may say that call and put prices are correct/efficient.
C + PV(X) = P + S

■ A one-year put option on Sony with an exercise price of $50 is trading for $8. The current
stock price is $52. The risk free rate is 4%. Calculate the price of the call option implied by
put-call parity.
■ X =50
■ PV(X) = 50/1.04= 48.07
■ P=8
■ S= 52
■ C=?
■ C= 8+ 52 -48.07 = 11.93

■ Hence, if price of call option is 11.93, then there is no arbitrage opportunity.

■ Quiz on 16th Jan
– Syllabus Session 15 to 21

■ Assignment Due on 14th Jan

■ Any Questions Regarding End Term?

– Syllabus Session 11 to 21
– All formulas will be provided

■ Best of luck for end term