Options
1. Agreement - option holder and writer
2.Right , but not an obligation - holder has right but not the obligation to exercise if CM - 100 and i feel it will fall at 80 , the price till 29 december is 98 so you will not exercise the option , what is my loss is premium which i paid .
4.Non linear payoffs -options are limited and profits are unlimited
5.Exchange traded and OTC- OTC is broker (banks ) and exchange traded is BSE and NSE, exchange trade is done by people and not OTC.
6.Settlement depends on type - American and european .
Let us take an example of an investor who is interested in stock market and got a news reliance is 500 and will go up to 600 . He wants to purchase reliance but do not have capital , there is option contract in derivative market where one receipt is given which is charged at premium say rs 10 after 10 days the price is 550 now the investor sell the receipt but at 50 not at 10 now stock reaches 600 so he will charge 30 , so 20 rs he is earning, invest less and earn good amount of profit.
Stock is going up , premium go up and receipt go up.
Its an agreement between 2 parties ie buyer (Holder) and seller (Writer)
, buyer has right but not obligation , now reliance price was 500 now is 450 , the buyer will now in this case wont exercise. and the premium because will go from 10 to 0 .He is not under obligation to exercise .
No options trading in commodities but now it is allowed
Non linear payoffs - when loss is limited then the profit is unlimited.
Exchange traded and OTC (over the counter)- there is broker or dealer (bank) , i am entering into a contact which is OTC (offline) but exchange traded is online .
Settlement depends on type - whether to take put or call option.
If market is going to fall you will go for put (PE) buy
If market is going up you will call (CE) sell
Call has American and European put or call option.
Example - Contract of 29 december - american call option is anytime you can exercise util the exercise date .Whereas european can sell only on date of expiry .
OPTIONS TERMINOLOGY
Holder - buyer
Writer - seller
Strike price - expected price or exercise price
Exercise date - when we will exercise the option can be before or after.
ITM- (In the Money)- Current price is 1550, strike price, 1600 now current price is 1700, if cm is more than sp (CM>SP) (sp=strike price)
OTM-(Out the Money)-if cm is less than sp (strike price)(CM<SP)
ATM- (At the money option)- if cm = sp
IV- (Intrinsic Value) -Intrinsic value is what a stock value should be? The real price of the asset. (difference between strike price and current market is intrinsic value)
for example - now , cm = 1555 , my contact is 1600 on 12 december to 29 december but the value is1670 , now 70 is intrinsic value . It is the true value of derivative .
Open Interest- number of contract outstanding on date .
Naked call- writer do not have any delivery still I am entering to it .(risky)
Covered call- writer have the delivery of shares.(less risky)
Time value - the duration of the contract and money given in the contract to get profit.
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