Options

OUTLINE PRESENTATION Options

I. DEFINITIONS
I.1 Derivatives: A financial instrument whose value depends on underlying

variables Example: Futures, Options and Swaps.

I.2 Options: Contracts that give the owner the right, not the obligation, to buy

(in the case of a call option) or sell (in the case of a put option) an asset Strike price: The price at which the sale takes place I.3 Benefits of options Not as risky as trading normally Cost effective High returns on investments Multiple options to attain aims

I.4 Style of options

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European option American option Bermudan option

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Barrier option Exotic option Vanilla option

II. USE OF OPTIONS II.1 II.2 II.3 Long call: A trader buys the right to purchase stock at a fixed price Long put: A trader buys the right to sell stock at a fixed price Short call: The trader selling a call has an obligation to sell the stock

to the call buyer at the buyer's option II.4 Short put: The trader selling a put has an obligation to buy the stock

from the put buyer at the put buyer's option III. RISK IN OPTIONS -

Options holder: risk the entire amount of the premium pay Options writer: take on a much higher level of risk, unlimited losses

IV.CONCLUSION V. GAMES

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TECHNICAL TERM
1. Holder 2. Underlying stock The purchaser of an option The stock subjects to being purchased or sold upon exercise of the contract 3. Exercise To implement the right under which the holder of an option is entitled to buy or sell the underlying stock 4. Writer 5. Bearish The seller of an option contract An opinion that expects a decline in price, either by the general market or by an underlying stock, or both 6. Bullish An opinion in which one expects a rise in price, either by the general market or by an individual security. 7. Bid Price The price at which a potential buyer is willing to buy from you. This means that you sell at the
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Bid Price 8. Early exercise The exercise or assignment of an option contract before its expiration date. 9. Uncovered option A written option is considered to be uncovered if the investor does not have a corresponding position in the underlying security 10. Topping out A peak point where the sellers begin to outnumber the buyers. 11. Hedge A conservative strategy used to limit investment loss by effecting a transaction that offsets the existing one 12. In the money A call option is in-the-money if the strike price is less than the market price of the underlying security. A put option is in-the-money if the strike price is greater than the market price of the underlying security. 13. Strike price The price at which the buyer of a call can purchase the stock during the life of the option or the price at which the buyer of a put can sell the stock during the life of the option. 14. Premium The price of an option contract, determined in the competitive marketplace, which the buyer of the option pays to the option writer for the rights conveyed by the options contract. 15. Volatility A measure of the fluctuation in the market
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price of the underlying security. Mathematically, volatility is the annualized standard deviation of returns. 16. Take Delivery To fulfill the obligation of buying stocks when put options that you sold becomes exercised. 17. Secondary market A market in which holders and writers may be able to close existing options positions by offsetting sales and purchases.
18. Open interest

The number of outstanding option contracts in the exchange market or in a particular class or series.

19. Class of options

Option contracts of the same type (call or put) and style (American or European) that cover the same underlying security.

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OPTIONS
I. DEFINITIONS 1.1 Definition of Derivatives A derivative is a financial instrument whose value depends on underlying variables. The most common derivatives are futures, options, and swaps but may also include other trade-able assets such as a stock or commodity or non-tradeable items such as the temperature (in the case of weather derivatives), the unemployment rate, or any kind of (economic) index. A derivative is essentially a contract whose payoff depends on the behavior of a benchmark. 1.2 Definition of Options Options are contracts that give the owner the right, not the obligation, to buy (in the case of a call option) or sell (in the case of a put option) an asset. The price at which the sale takes place is known as the Strike price, and is specified at the time the parties enter into the option. The option contract also specifies a maturity date. In the case of a European option, the owner has the right to require the sale to take place on (but not before) the maturity date; in the case of an American option, the owner can require the
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sale to take place at any time up to the maturity date. If the owner of the contract exercises this right, the counter-party has the obligation to carry out the transaction. 1.3 Benefits of Options Options as a strategic investment is fast becoming the choice of many. The benefits that options trading offers are many and we shall discuss the same here. Options trading having many benefits it is actually a wonder as to why it was not a sought after means for investment for so long.
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Options trading is not as risky as it seems if traded wisely. In case of options you do not require as much finance as you would do for stocks. As far as hedge is concerned, options trading seems to be the most reliable of them all. In case of options trading you have an insurance throughout the day, all seven days a week and not until the close of the market.

Options is very cost effective. You could be in a similar position as you would have stocks but by putting in much less as investment but the catch is that the investor needs to be careful and select the right call options so as to be in the same position as he would be with stocks. This stock replacement strategy is very cost effective.

Options as a strategic investment offers to its investors a high return on its investments. The return investors make on the right selection in option trading is far greater than any stock investment. Options can get you about 60-70% and even more on your investments and in the same scenario your stocks may give you a return of only about 10-15%. But there is a flipside to this. When options give you such high rate of return it is only when you have made the right choice but a wrong selection on the other hand can get you back by the entire 100%. So the returns are good but only when you take calculated risks.

Options as a strategic investment provides the investor with multiple options so as to attain their aim. Options offers the investors various alternatives if planned and
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executed well. An example to quote here would be how a margin would have to be paid if short selling is to be done. At times the margin quoted by the brokers is so high that the investor finds it difficult to go ahead with his plans. Then there are those who do not allow short selling by the investor thus again the investor going back to square one as far as his investment plans are concerned. This puts the investor in the back seat as he is unable to execute his plans and here is where the options trading comes into play. You wouldn't find any broker who says that the investor cannot purchase puts when the market seems to be falling. This would give the options trader an advantage and he would be able to reap the benefits later. An options trader can invest in the market not only when it moves up or down, when the prices are almost steady, a trader can also use the time factor where the prices are not moving significantly as a profit making opportunity. Thus it is only the options trader who gets a share in the pie in every kind of market. 1.4 Style of Options
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European option: an option that may only be exercised on expiration. American option: an option that may be exercised on any trading day on or before expiry.

Bermudan option: an option that may be exercised only on specified dates on or before expiration.

Barrier option: any option with the general characteristic that the underlying security's price must pass a certain level or "barrier" before it can be exercised.

Exotic option: any of a broad category of options that may include complex financial structures.
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Vanilla option: any option that is not exotic

II. USE OF OPTIONS 2.1 Long call A trader who believes that a stock's price will increase might buy the right to purchase the stock (a call option) rather than just purchase the stock itself. He would have no obligation to buy the stock, only the right to do so until the expiration date. If the stock price at expiration is above the exercise price by more than the premium (price) paid, he will profit. If the stock price at expiration is lower than the exercise price, he will let the call contract expire worthless, and only lose the amount of the premium. A trader might buy the option instead of shares, because for the same amount of money, he can control (leverage) a much larger number of shares.

2.2 Long put A trader who believes that a stock's price will decrease can buy the right to sell the stock at a fixed price (a put option). He will be under no obligation to sell the stock, but has the right to do so until the expiration date. If the stock price at expiration is below the exercise price by more than the premium paid, he will profit. If the stock price at

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expiration is above the exercise price, he will let the put contract expire worthless and only lose the premium paid.

2.3 Short call A trader who believes that a stock price will decrease, can sell the stock short or instead sell, or "write," a call. The trader selling a call has an obligation to sell the stock to the call buyer at the buyer's option. If the stock price decreases, the short call position will make a profit in the amount of the premium. If the stock price increases over the exercise price by more than the amount of the premium, the short will lose money, with the potential loss unlimited.

2.4 Short put

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A trader who believes that a stock price will increase can buy the stock or instead sell, or "write", a put. The trader selling a put has an obligation to buy the stock from the put buyer at the put buyer's option. If the stock price at expiration is above the exercise price, the short put position will make a profit in the amount of the premium. If the stock price at expiration is below the exercise price by more than the amount of the premium, the trader will lose money, with the potential loss being up to the full value of the stock. A benchmark index for the performance of a cash-secured short put option position is the CBOE S&P 500 PutWrite Index (ticker PUT)

Summary of Breakeven, Gains and Losses Position Long call Short call Long put Short put Break - even point Strike price + Premium Strike price + Premium Strike price Premium Strike price Premium
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Maximum gains Unlimited Premium Strike price Premium Premium

Minimum losses Premium Unlimited Premium Strike price - Premium

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III.

RISKS IN OPTIONS Like other securities - including stocks, bonds, and mutual funds - options carry

no guarantees, and you must be aware that it's possible to lose all of the principal you invest, and sometimes more. As an options holder, you risk the entire amount of the premium you pay. But as an options writer, you take on a much higher level of risk. For example, if you write an uncovered call, you face unlimited potential loss, since there is no cap on how high a stock price can rise. However, since initial options investments usually requires less capital than equivalent stock positions, your potential cash losses as an options investor are usually smaller than if you'd bought the underlying stock or sold the stock short. The exception to this general rule occurs when you use options to provide leverage. Percentage returns are often high, but it's important to remember that percentage losses can be high as well.
IV.

CONCLUSION The intended purpose of our presentation today is to provide an introduction to

the fundamentals of options, and to illustrate some of the basic strategies available. You have been shown that options may have many benefits including flexibility, leverage, and limited risk for buyers employing these strategies. Despite their many benefits, options involve risk and are not suitable for everyone. An investor who desires to utilize options should have welldefined investment objectives suited to his particular financial situation and a plan for achieving these objectives. The successful use of options requires a willingness to learn what they are, how they work, and what risks are associated with particular options strategies.

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