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Webinar - 5
Options 360

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Content

• Basic knowledge of call and put options.

• Basic Terminology related to options
• How to calculate premium in option
• Risk and rewards in buy and selling options.
• Long and short straddle strategy.
• Long and short strangle strategy.
• Covered call and covered put.
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What is Option
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An Option is a contract that gives the right, but not an obligation, to buy or sell the
underlying asset on or before a stated date/day, at a stated price, for a price. The party
taking a long position i.e. buying the option is called buyer/ holder of the option and the
party taking a short position i.e. selling the option is called the seller/ writer of the
option.

The option buyer has the right but no obligation with regards to buying or selling the
underlying asset, while the option writer has the obligation in the contract. Therefore,
option buyer/ holder will exercise his option only when the situation is favourable to
him, but, when he decides to exercise, option writer would be legally bound to honour
the contract.

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Basic Terminology
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Index option: These options have index as the American option: The owner of such option
underlying asset. For example options on Nifty, can exercise his right at any time on or before
Bank Nifty, etc. the expiry date/day of the contract.
Stock option: These options have individual European option: The owner of such option
stocks as the underlying asset. For example, can exercise his right only on the expiry
option on ONGC, NTPC etc. date/day of the contract. In India, Index options
are European.
Buyer of an option: The buyer of an option is
one who has a right but not the obligation in the Option price/Premium: It is the price which
contract. For owning this right, he pays a price to the option buyer pays to the option seller.
the seller of this right called ‘option premium’ to Lot size: Lot size is the number of units of
the option seller. underlying asset in a contract. Lot size of Nifty
Writer of an option: The writer of an option is option contracts is 75. Accordingly, in our
one who receives the option premium and is examples, total premium for call option
thereby obliged to sell/buy the asset if the buyer
of option exercises his right.
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Basic Terminology
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Expiration Day: The day on which a In the money (ITM) option: This option
derivative contract ceases to exist. It is the would give holder a positive cash flow, if it
last trading date/day of the contract. Like in were exercised immediately. A call option is
case of option contracts also expire on said to be ITM, when spot price is higher
every Thursday of the week (or, on the than strike price. And, a put option is said to
previous trading day, if the Thursday is a be ITM when spot price is lower than strike
trading holiday). price.
Spot price (S): It is the price at which the At the money (ATM) option: At the money
underlying asset trades in the spot market. option would lead to zero cash flow if it were
exercised immediately. Therefore, for both
Strike price or Exercise price (X): Strike
call and put ATM options, strike price is
price is the price per share for which the
equal to spot price.
underlying security may be purchased or
sold by the option holder.

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Basic Terminology
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Out of the money (OTM) option: Out of the Intrinsic value: Option premium, defined
money option is one with strike price worse than above, consists of two components‐ intrinsic
the spot price for the holder of option. In other value and time value.
words, this option would give the holder a
negative cash flow if it were exercised For an option, intrinsic value refers to the
immediately. A call option is said to be OTM, amount by which option is in the money i.e. the
when spot price is lower than strike price. And a amount an option buyer will realize, before
put option is said to be OTM when spot price is adjusting for premium paid, if he exercises the
higher than strike price. option instantly. Therefore, only in‐the‐money
Time value: It is the difference between options have intrinsic value
premium and intrinsic value, if any, of an option.
ATM and OTM options will have only time value whereas at‐the‐money and out‐of‐the‐money
because the intrinsic value of such options is options have zero intrinsic value. The intrinsic
zero. value of an option can never be negative.
Open Interest: open interest is the total number
of option contracts outstanding for an underlying
asset.

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Premium Calculation
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Analysis edit
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Trading from Buyer’s Perspective
The spot price of Nifty on March 20, 2020, was 8745. Let us consider call options with strike prices of 8600,
8700, 8800 and 8900. A call option buyer will buy the option and pay the premium upfront. The premiums
for various strike prices are as follows:
Strike Price Premium
8600 450
8700 391
8800 346
8900 290

The 8600 strike call option is deep in the money and has an intrinsic value of 8745 –8600 = 145. Hence the
option premium will be at least equal to this value. The remaining portion of the premium is the time value
(450 – 145 = 301) The 8800 strike call option is out of the money option. There is no intrinsic value here.
The entire option premium is attributed to risk associated with time, i.e. time value.

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options title strikes
with different styleand premiums Nifty Closing
Strike 8600 8700 8800 8900
Nifty
Premium 450 391 346 290
Expiry
BEP 9050 9091 9146 9190
8500 -450 -391 -346 -290
8600 -450 -391 -346 -290
8700 -350 -391 -346 -290
8800 -250 -291 -346 -290
8900 -150 -191 -246 -290
9000 -50 -91 -146 -190
9100 50 9 -46 -90
9200 150 109 54 10
9300 250 209 154 110
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rewards
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buy and
styleselling options

Buyer of an Option Seller of an Option

• Low premium. • Huge Margin Money
• Limited Risk. • Limited Profit.
• Unlimited Reward. • Unlimited Risk.

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Straddle

• The strategy is profitable only when the stock either rises or falls
from the strike price by more than the total premium paid.
• A straddle implies what the expected volatility and trading range of a
security may be by the expiration date.
• A straddle is a strategy accomplished by holding an equal number
of puts and calls with the same strike price and expiration dates. The
following are the two types of straddle positions.

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Long Straddle - The long straddle is designed around the purchase of a put and a call at the exact
same strike price and expiration date. The long straddle is meant to take advantage of the market
price change by exploiting increased volatility. Regardless of which direction the market's price
moves, a long straddle position will have you positioned to take advantage of it.

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Short Straddle
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Short Straddle - The short straddle requires the trader to sell both a put and a call option at the
same strike price and expiration date. By selling the options, a trader is able to collect the premium
as a profit. A trader only thrives when a short straddle is in a market with little or no volatility. The
opportunity to profit will be based 100% on the market's lack of ability to move up or down

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Strangle

• A strangle is similar to a straddle, but uses options at different strike

prices, while a straddle uses a call and put at the same strike price.
• A strangle is an options strategy where the investor holds a position
in both a call and a put option with different strike prices, but with the
same expiration date and underlying asset. A strangle is a good
strategy if you think the underlying security will experience a large
price movement in the near future but are unsure of the direction.
• A strangle is profitable only if the underlying asset does swing
sharply in price.

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The long strangle, also known as buy strangle or simply "strangle", is a neutral strategy in options
trading that involve the simultaneous buying of a slightly out-of-the-money put and a slightly out-of-
the-money call of same underlying stock and expiration date.
Buy 1 OTM Call
Buy 1 OTM Put

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Short Strangle
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The short strangle, also known as sell strangle, is a neutral strategy in options trading that involve
the simultaneous selling of a slightly out-of-the-money put and a slightly out-of-the-money call of
same underlying stock and expiration date.
Sell 1 OTM Call
Sell 1 OTM Put

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Covered call Master title style

• A covered call is a popular options strategy used to generate income

in the form of options premiums.
• To execute a covered call, an investor holding a long position in an
asset then writes (sells) call options on that same asset.
• It is often employed by those who intends to hold the underlying
stock for a long time but does not expect an appreciable price
increase in the near term.
• This strategy is ideal for an investor who believes the underlying
price will not move much over the near-term.

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Suppose edit Master
an investor buys SBI intitle style
the cash market at Rs. 200 and also sells a call option with a
strike price of 250, thereby earning Rs. 10 as premium. If the stock price moves up from 250
level, he makes profit in the cash market but starts losing in the option trade. For example,
if Stock goes to 290,
Long Cash: Profit of 290 – 200 = 90
Short Call: – 290 + 240 + 10 = ‐30
Net Position: 90 – 30 = 60

If the stock moves below 200 level, he loses in the cash market, but gets to keep the
premium as income. For example, if Stock goes to 150,
Long Cash: 200 – 150 = ‐50
Short Call: + 10 (Long call holder will not exercise his right as he can buy the stock
from the market at a price lower than strike, so he will let the option expire and the
seller gets to keep the premium)
Net Position: ‐50 + 10 = ‐40
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Protective Master title style

• A protective put is a risk-management strategy using options

contracts that investors employ to guard against a loss in a stock or
other asset.
• For the cost of the premium, protective puts act as an insurance
policy by providing downside protection from an asset's price
declines.
• Protective puts offer unlimited potential for gains since the put buyer
also owns shares of the underlying asset.
• When a protective put covers the entire long position of the
underlying, it is called a married put.
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an investor buys atitle
SBI in style
the cash market at 200 and at the same time buys a
put option with strike of 200 by paying a premium of Rs 20. Now, if prices fall to 150 from
here:
Long Cash: Loss of 200 – 150 = ‐ 50
Long Put: Profit of – 20 – 150 + 200 = 30
Net Position: ‐20

For all falls in the market, the long put will turn profitable and the long cash will turn
loss making, thereby reducing the overall losses only to the extent of premium paid (if
strikes are different, losses will be different from premium paid)

In case prices rise to 250

Long Cash: Profit of 250 – 200 = 50
Long Put: Loss of 20
Net Position: 50 – 20 = 30
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Thank You
Options 360

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