E-CONTENT –

INTERNATIONAL
FINANCE
Asst. Prof. Dayanand Vishwanath Thakur
Sant Rawool Maharaj Mahavidayalaya, Kudal
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OPTIONS

 Option: Option may be defined as a contract, between

two parties whereby one party obtains the right, but not
the obligations, to buy or sell a particular asset, at a
specified price, on or before a specified date
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OPTIONS

 There are two parties involved Option Holder and Option Writer

 The person who get right is known as the Option Buyer or

Option Holder

 While the other person who confers/given the right is known as

Option seller or Option writer
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OPTIONS

 Options can be divided into two types:

 Call Options

 Put Options
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OPTIONS
 A Call Option gives the holder the right to buy an asset at
a specified date for a specified price whereas

 In put option the holder gets the right to sell an asset at

the specified price and time
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OPTIONS
 The specified price in such contract is known as the
exercise price or the strike price and the date in the
contract is known as the expiration date or the exercise
date or the maturity date
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OPTIONS
Participant Call Option Put Option
Buyers (Long Right to buy stock, Right to sell stock
Position) if exercised if exercised
Sellers (Short Obligation to sell Obligation to buy
Position) stock if exercised stock if exercised
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OPTIONS
 Basic Terminologies:
1. Call Option
2. Put Option
3. Option Buyer/Holder
4. Option seller/Writer
5. Spot price: The price at which the underlying assets
trades in the spot market
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OPTIONS
 Basic Terminologies:

6. Exercise/Strike Price: The fixed price, at which, the

buyer of option contract can exercise his option to buy/sell
the underlying asset
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OPTIONS
 Basic Terminologies:

7. Expiration/Maturity Date: The last day on which option

can be either exercised or lapsed

8. Exercise Date: The date on which the option is actually

exercised, It can be on or before maturity date
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OPTIONS
 Basic Terminologies:

9. Option Premium/Price: Price paid by option buyer to the

option seller to acquire the right to buy or sell the underlying
asset at a specified exercise price
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OPTIONS
 Basic Terminologies:

10. Lot Size: The number of units of an underlying asset in a

contract is called as Lot, Lot size of Nifty option contracts is
75
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OPTIONS
 Basic Terminologies:

11. European Option: An option which can be exercised

only on the specified date is called as European Option can
only be exercised at the maturity of option
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OPTIONS
 Basic Terminologies:

12. American Option: An option which can be exercised on

any date up to expiry date is called as American Option
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OPTIONS
 Basic Terminologies:

13. Bermuda Option: Bermuda option is a combination of

American and European option

It can be exercised at the date of expiration and on certain

specified date between purchase date and date of expiration
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OPTIONS
 Basic Terminologies:

14. Intrinsic Value: It s the amount by which the option is

In the Money

It is the portion of an options price that is not lost due to

passage of time
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OPTIONS
 Basic Terminologies:

14. Intrinsic Value: At the Money and Out the Money Intrinsic Value
always Zero

Intrinsic Value of Call Option = Underlying assets current price – Strike

Price 100 -110 = -10 (Buyer)

Intrinsic Value of Put Option =Strike Price - Underlying assets current

price 110 -100 = 10 (Seller)
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OPTIONS
 Basic Terminologies:

15. Time Value: The price that the buyers pay for the
expectation that price will move in his favour

It is the amount by which price of an option exceeds its

intrinsic value
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OPTIONS
 Basic Terminologies:

15. Naked Call and Covered Call: In options covered are

the contracts sold by traders who actually own the
underlying assets whereas naked are those contracts where
the writer does not own the underlying assets
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OPTIONS

 CALL – (Buy) --- Long ( right to buy) ---- Short

(Obligation to Sell)

 Put – (Sell) ----- Long (right to Sell) ---- Short ----

(Obligation to buy)
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OPTIONS
 CALL – Long/Short, Put-Long/Short:

Long Call: means to purchase one or more call options on a

stock or index

The term “going long” refers to buying a security

Long call option strategy is one of the most basic options strategy
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OPTIONS
 CALL – Long/Short, Put-Long/Short:

Long Call: In this trader buys call options with a hope that
price of underlying asset will goes up

As he is buying the call, he gets a right and not obligation

to buy the underlying asset in the contract
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OPTIONS
 CALL – Long/Short, Put-Long/Short:

Long Call: A person who has “Long Call Option”

Has got the right to exercise the call option

Has potential loss limited to the premium amount paid

Has profit dependent on price of the underlying asset at the time

of exercise/expiry of the contract
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OPTIONS
 CALL – Long/Short, Put-Long/Short:

Short Call : Short call means to sell one or more call

options on a stock or index

The term “going short” is person has to sell a security

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OPTIONS
 CALL – Long/Short, Put-Long/Short:

Short Call : Seller of a call said to be “short on option”

As he is selling the call, he has the obligation and no right

to sell the underlying asset in the contract
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OPTIONS
 CALL – Long/Short, Put-Long/Short:

Short Call : A person who has “Put the call”

Has the obligation to exercise the call option

Has unlimited potential loss

Has maximum profit as the amount of premium received

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OPTIONS
 Example: 1
 E-CONTENT – UNIT II- DERIVATIVES -
OPTIONS
 CALL – Long/Short, Put-Long/Short:

Long Put: means to purchase one or more call options on a

stock or index

The term “going long” refers to buying a security

Long Put option strategy is one of the most basic options strategy
 E-CONTENT – UNIT II- DERIVATIVES -
OPTIONS
 CALL – Long/Short, Put-Long/Short:

Short Put : Short put means to sell one or more call options
on a stock or index

The term “going short” is person has to sell a security

 E-CONTENT – UNIT II- DERIVATIVES -
OPTIONS
 Option V/S Futures
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OPTIONS
 At The Money, In the Money and Out the Money

Moneyness describes he relationship between the spot

price of the underlying asset and the strike/ exercise price
of an option
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OPTIONS

 In the Money: AN ITM option results in positive cash flow to

the holder of an option, when exercised

An ITM option has positive intrinsic value

ITM options are comparatively more expensive as their

premium consist of significant intrinsic value on top of their time
value
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OPTIONS

 AT the Money: AN ATM Option results in nil cash

Flow to the holder of an option, when exercised

An ATM option has no intrinsic value

In ATM option, strike price is equal to the spot price of

underlying asset
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OPTIONS

 Out the Money: AN OTM Option results in negative cash

flow to the holder of an option, when exercised

 An OTM option has zero intrinsic value

 OTM options are comparatively cheaper as they may

expire worthless
E-CONTENT – UNIT II- DERIVATIVES -
OPTIONS
Moneyness Call Option Put Option Cash Flow IV

ITM S>X S<X Positive Yes

ATM S=X S=X Zero No

OTM S<X S>X Negative No

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OPTIONS

 Intrinsic Value: I V is also termed as Monetary value

 The value of an option determined through fundamental

analysis without reference to its market value
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OPTIONS

 Intrinsic Value: I V represents the profit that the holder

would have if the exercises the options

 In option value of “out the Money and At the Money

options is always zero
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OPTIONS

 Intrinsic value of Call Options = Underlying assets

current /price – Strike price

 Intrinsic value of Put Options = Strike price -

Underlying assets current price
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OPTIONS

 Time Value: Time value is also referred to as the Extrinsic value

 Time value of an option is the total value of the option minus the
Intrinsic Value

 As the option moves towards expiration date, the time value

decrease to zero
E-CONTENT – UNIT II- DERIVATIVES -
OPTIONS
Component ITM ATM OTM

Intrinsic Value YES No Yes

Time Value Yes Yes Yes

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OPTIONS
 Option Spreads:

In simple terms “Spreads” in options means combination of two leg

one short and one long

A spread position is entered by buying as well as selling equal number

of option of the same class with the same underlying asset but
different strike prices and expiration dates
 E-CONTENT – UNIT II- DERIVATIVES -
OPTIONS
 Option Spreads:

This includes buying a call and simultaneously selling call, buying a

put and simultaneously selling a put etc.

On the basis of relationships between Strike price and expiration dates

three main classes of spreads are
 E-CONTENT – UNIT II- DERIVATIVES -
OPTIONS
 Option Spreads:

1. Vertical Spreads: are spreads involving options of the same

underlying asset with same expiration but different strike prices

A vertical spread includes buying and selling a call or buying and

selling a put of the same expiration but different strike prices
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OPTIONS
 Option Spreads:

1. Vertical Spreads: Mr. A buys a Spet. Call at a strike price of Rs.

200 and also sells a sept. call at a strike price of Rs. 220
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OPTIONS
 Option Spreads:

2. Horizontal Spreads: are spreads using options of the same

underlying asset, same strike prices but different expiration

Mr. A buy a sept call at a strike price of Rs. 200 and also sell an Oct
call at a strike price Rs. 200
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OPTIONS
 Option Spreads:

3. Diagonal Spreads: are spreads of same underlying asset but

different strike prices and different expiration

They are combination of vertical and horizontal spreads

Example Mr. A buys a Sept call at a Strike price of Rs. 200 and also
sell on Oct call at strike price of Rs. 220
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OPTIONS
 Option Spreads:

In a snapshot, Vertical, Horizontal and Diagonal Spreads

Features Vertical Spread Horizontal Spread Diagonal Spread
Underlying Asset Same Same Same
Strike/ Exercise Different Same Different
Price
Expiration / Same Different Different
Maturity
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OPTIONS
 Option Spreads Strategies:

A) Bullish Strategies: Bullish option strategies are used when an

investor expects the underlying asset price to move upward
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OPTIONS
 Option Spreads Strategies:

Long Call:
Meaning Buying a call option at strike price closer to spot price
(ATM)
Purpose It is popular among new investors in options, in this strategy,
there is limit to downwards risk, if stock price goes up Long
call enters into profit
Investor View Bullish on index/stock
Risk Limited to the amount of premium paid
Reward Unlimited
Breakeven Strike price + Premium Paid
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OPTIONS
 Option Spreads Strategies:

Short Put:
Meaning Writing a put option at strike price closer to spot price
(ATM)
Purpose For making short term profit/Income
Investor View Bullish on index/stock
Risk Unlimited
Reward Limited to the amount of premium received
Breakeven Strike price + Premium Paid
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OPTIONS
 Option Spreads Strategies: Bull Call Spread:
Meaning Buying one ITM call and Selling one OTM Call
Purpose Making profit only when the stock price goes up. If the stock falls to the
lower strike, the investor makes maximum loss and if stock goes upwards to
higher strike, the investor makes maximum profit. It limits the investors
upside and downside risk
Investor View Moderate Bullish
Risk Limited to any initial premium paid is establishing the position

Reward Limited to the difference between the two strikes minus net premium cost

Breakeven Strike price of Purchase Call + Net Premium Paid

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OPTIONS
 Option Spreads Strategies: Bull Put Spread:
Meaning Buying one OTM Put and Selling one ITM Put
Purpose Earns net income for investor as well as limits the
downside risk of a put sold

Investor View Moderately Bullish

Risk Limited maximum loss occurs where the underlying falls to the level of the
lower strike or below
Reward Limited to the net premium received

Breakeven Strike price of short put - Net Premium received

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OPTIONS
 Option Spreads Strategies:

A) Bearish Strategies: Bearish option strategies are used when an

investor expects the underlying asset price to move downward
 E-CONTENT – UNIT II- DERIVATIVES -
OPTIONS
 Option Spreads Strategies:

Long Put:
Meaning Buying a Put Option
Purpose An investor can profit from reducing stock price by buying
puts
Investor View Bearish on index/stock
Risk Limited to the amount of premium paid
Reward Unlimited
Breakeven Strike price - Premium Paid
 E-CONTENT – UNIT II- DERIVATIVES -
OPTIONS
 Option Spreads Strategies:

Short Call:
Meaning Writing a call option
Purpose For making short term profits/income
Investor View Bearish on index/stock
Risk Unlimited
Reward Limited to the amount of premium received
Breakeven Strike price + Premium Paid
 E-CONTENT – UNIT II- DERIVATIVES -
OPTIONS
 Option Spreads Strategies:

Bear Call Spread:

Meaning Selling one ITM Call and buying one OTM Call
Purpose Earns a net income for the investor as well as limits the
downside risk of a call sold
Investor View Middly Bearish
Risk Limited to the difference between the two strikes minus the net
premium
Reward Limited to the net premium received for the position
Breakeven Strike price of sold call + Net premium paid
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OPTIONS
 Option Spreads Strategies:

Bear Put Spread:

Meaning Buying one ITM Put and Selling one OTM put
Purpose The effects of the strategy is to bring down the cost and raise
the breakeven on buying a put
Investor View Moderately Bearish
Risk Limited to the net amount paid for the spread
Reward Limited to the difference between the two strike prices minus
the net premium paid for the position
Breakeven Strike price of Long Put - Net premium paid
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OPTIONS
 PUT CALL PARITY THEOREM:

 The term parity means similarity, Both put and call value in options
are closely related to each other

 Put Call parity is a relationship that exists between prices of put and
call options
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OPTIONS
 PUT CALL PARITY THEOREM:

Put parity was initially introduced by Hans Stoll in his paper,

“The relation Between Put and Call Prices”, in 1969
It explains that the call option premium implies a certain fair
price for the corresponding put option
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OPTIONS
 PUT CALL PARITY THEOREM:
 In case there is a difference in the value of call and put
option there would be some arbitrage opportunity
 It means trader can earn risk free profit
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OPTIONS
 PUT CALL PARITY THEOREM:
 Put call parity can be explained as follows

C + PV(x) = P + S
Where,

C = Call premium of European Option

PV = Present value of strike price discounted from the value on the expiration date at the
risk free rate
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OPTIONS

 PUT CALL PARITY THEOREM:

Where,

X = Strike price

P = Put of European option

S = Spot price/Current price market value of underlying asset

E-CONTENT – UNIT II- DERIVATIVES -
OPTIONS

 PUT CALL PARITY

THEOREM:
PV (x) can be calculated as follow:

PV(x) = X / (1+r)t
E-CONTENT – UNIT II- DERIVATIVES -
OPTIONS

 PUT CALL PARITY

THEOREM:
C + X (1+r)t = P + S