What is an option?

 It is an intangible right bought or sold by a trader to

control shares of a security; it expires on a specific
date in the future.
 Every option has four specific features:

a. 1. It relates to a specific stock or other security,

called the “underlying” security.”
b. 2. It is a right to buy (call) or sell (put), and every
option controls 100 shares of stock.
c. 3. A specific “strike” price is the fixed price at
which the option can be exercised.
d. 4. Every option has a fixed expiration date. After
that date, the option is worthless.
 The Standardized Terms
They cannot be changed. Every option is unique
in its combination of these terms

Underlying Security
Strike Price
Expiration Date
Types Of Options
 Underlying Security
An underlying security is the stock or other security on
which the option is written.

For example, an option on Caterpillar controls 100 shares

of Caterpillar stock.

This option cannot be transferred to a different

underlying stock. It exists only on that one underlying.
 The Strike Price
The option’s strike is the fixed amount
per share at which the option can be
exercised. “Exercise” means buying 100 shares (with a
call) or selling 100 shares (with a put) at the fixed
strike price.

A call owner may exercise a call when the current market

price is higher than the fixed strike.

A put owner may exercise a put when the current market

price is lower than the fixed strike.
 Expiration
Every option expires on a specific date, called the
“expiration date.”

This is the third Saturday of the expiration month; the

last trading day is the third Friday of expiration
month.

After expiration, every option that was not closed or

exercised becomes worthless.
 Types of Options
There are two basic kinds of options:
 Call Option
 Put Option
 Call Option
Call options are an agreement that give the option buyer the
right, but not the obligation, to buy a stock,
bond, commodity or other instrument at a specified price
within a specific time period.
The market price of the call option is called the premium. It
is the price paid for the rights that the call option provides.
If at expiry the underlying asset is below the strike price,
the call buyer loses the premium paid. This is the
maximum loss.
If the underlying's price is above the strike price at expiry, the
profit is the current stock price, minus the strike price and
the premium. This is then multiplied by how many shares
the option buyer controls.
 Properties Of Stock Option Prices

 Time to expiration
 Volatility
 Risk-Free Interest Rate
 Underlying Price
 Strike Price
 Dividends
 Options Models
 The Black-Scholes Model

 The Binomial Model

 The Black-Scholes Model
 The Black-Scholes model is used to calculate a
theoretical call price (ignoring dividends paid during
the life of the option) using the five key determinants
of an option's price: stock price, strike price, volatility,
time to expiration, and short-term (risk free) interest
rate.
 Advantage: It lets you calculate a very large number of
option prices in a very short time.
 Limitation: It cannot be used to accurately price
options with an American-style exercise as it only
calculates the option price at one point in time -- at
expiration. It does not consider the steps along the way
where there could be the possibility of early exercise of
an American option.
 The Binomial Model
 The binomial model breaks down the time to expiration into
potentially a very large number of time intervals, or steps. A tree
of stock prices is initially produced working forward from the
present to expiration.
 At each step it is assumed that the stock price will move up or
down by an amount calculated using volatility and time to
expiration.
 This produces a binomial distribution, or recombining tree, of
underlying stock prices.
 The tree represents all the possible paths that the stock price
could take during the life of the option.
 At the end of the tree -- ie at expiration of the option -- all the
terminal option prices for each of the final possible stock prices
are known as they simply equal their intrinsic values.
 Advantage: The big advantage the binomial model has
over the Black-Scholes model is that it can be used to
accurately price American options.
 The binomial model basically solves the same equation,
using a computational procedure that the Black-Scholes
model solves using an analytic approach and in doing so
provides opportunities along the way to check for early
exercise for American options.
 Limitation: The main limitation of the binomial model is
its relatively slow speed. It's great for half a dozen
calculations at a time only.
 Options Strategies
1 • Caps

2 • Floors

3 • Collars

4 • Captions

5 • Swaptions

6 • Compound
Cross-Currency Futures & Options
 A cash-settled option that entails the exchange of one
currency into another with the premium usually paid
in a third currency. In other words, the currency of
the strike price of this option is different from the
currency used to denominate the underlying asset.

 This option is particularly used by firms which have

cash flows denominated in two different currencies,
neither of which is the domestic currency.
 In cross-currency futures, a pair of currencies traded in
for-ex the excludes the U.S. dollar. One currency is
traded for a different currency without exchanging the
currencies into American dollars.
 When trading currencies, it is import an (as always
with futures) to keep in mind the notional value. If the
futures of two different currencies represent
significantly different amounts of currency, they need
to be balanced out. To do this, we need to find the
spread ratio for the currencies.
 Top 5 Investment Options in
India
1. Direct mutual fund plans.
2. Employee Stock Options.
3. Growing annuities.
4. Gold bonds.
5. Focussed portfolios.
THANK YOU!