Options

Option contracts
• Options contracts, their characteristics/features and types

• Factors affecting option prices

• Pay-offs from the options

• Pricing Conditions: Put-call parity and Put-call-futures parity

conditions.
Options contracts
• Options are the derivative contracts, which offer a right to the holder
to buy/sell the underlying asset at a price, agreed upon today (called
strike price), on or up to future date(s).
• Options are, in general, the Exchange-traded-derivatives (ETD);
however, they are traded equally in the over-the-counter (OTC)
market as well.
• Option holder (buyer): has the right, but no obligation, to buy/sell the
underlying asset at the specified date(s).
• Option writer (seller): is obliged to honour the position, in case
exercised by the option holder.
Options types
• Based on the characteristics/ specifications:
• European options
• American options
• Exotic options (e.g., Bermudan options, Asian options, among others)
• Based on the right they offer:
• Call options
• Put options
• Based on moneyness:
• In-the-money (ITM)
• At-the-money (ATM)
• Out-of-the-money (OTM)
Options types
• Based on maturity:
• Near-the-month (NTM)
• Next-the-month (NXTM)
• Far-the-month (FTM)
• Long-dated-options (LDOs)
• Based on the underlying:
• Equity options: Stock options and Index options
• Bond futures options
• Currency options
• Swaptions
Example
• Assume the index is trading at 11,445 today. You are given a right
today to buy the same one month later, at say 11,500.
• Assume the index is trading at 11,445 today. You are given a right
today to sell the same one month later, at say 11,500.
• In order to get this right you are required to pay a small amount
today, say Rs. 150/-.
• (Define: Spot Price, Strike Price/ Exercise price, Moneyness, Call and
Put option, Lot size,
Call Option

This is
denoted
as X or K
Put Option
Option Positions
• There are two sides to every option contract.
• On one side is the investor who has taken the long position (i.e., has bought
the option).
• On the other side is the investor who has taken a short position (i.e., has sold
or written the option).
• There are four types of option positions:
• A long position in a call option
• A long position in a put option
• A short position in a call option
• A short position in a put option.
Options Payoff
• A European call option on Nifty index, with strike of 10200, trades at a price of Rs. 70.
The contract is scheduled to expire on August 31, 2018. Assume that on August 31, 2018,
Nifty index may take any of the following prices:
• ce
• 10000
• 10100
• 10200
• 10300
• 10400
• 10500
• 10600
• 10700
• 10800

• Based on the above-mentioned data, draw the pay-offs at maturity for a long call and a
short call position.
Factors affecting option prices
Bound on Options Prices
• European Call option
• The value of a call option will be highest for an option with zero
exercise value and infinite time until expiration.
• Similarly, the value will be lower for an option with higher exercise
price and shortest time to expiry.
• The bound for call option is given by
and
Bound on Options Prices
• European put option
• Value of put at expiry 𝑀𝑎𝑥 0, 𝑋 − 𝑆𝑇
• Upon exercise, the owner of put receives the exercise price- the spot
price at the time of expiry.
• Therefore, the lower the stock price, the more valuable the put must
be.
• For a European put
and
Bound on American options
• American Call
• Is it optimal to exercise an American call option on a non-dividend-paying
stock before the expiration date?
• At expiry?
• Bound?
• American Put
• Is it optimal to exercise an American put option on a non-dividend-paying
stock before the expiration date?
• At expiry?
• Bound?