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Security Analysis and Portfolio Management




                    Notes

















                                                 Net Profit - Payoff minus ‘c’




                                                 Option Position and Strategies
                                     Notes

                                     The Call option gives the buyer a right to buy the requisite shares on a specific date at a
                                     specific price. This puts the seller under the obligation to sell the shares on that specific
                                     date and specific price. The Call buyer exercises his option only when he/she feels it is
                                     profitable. This process is called “exercising the option.” This leads us to the fact that if the
                                     spot price is lower than the strike price then it might be profitable for the investor to buy
                                     the share in the open market and forgo the premium paid.
                                     The implications for a buyer are that it is his/her decision whether to exercise the option
                                     or not. In case the investor expects prices to rise far above the strike price in the future then
                                     he/she would surely be interested in buying call options. On the other hand, if the seller
                                     feels that his shares are not giving the desired returns and they are not going to perform
                                     any better in the future, a premium can be charged and returns from selling the call option
                                     can be used to make up for the desired returns. At the end of the options contract there is
                                     an exchange of the underlying asset. In the real world, most of the deals are closed with
                                     another counter or reverse deal. There  is no  requirement to exchange the underlying
                                     assets then as the investor gets out of the contract just before its expiry.

                                   Put Options

                                   The European Put Option is the reverse of the call option deal. Here, there is a contract to sell a
                                   particular number of underlying assets on a particular date at a specific price. An example would
                                   help understand the situation a little better:


                                          Example: An investor buys one European Put Option on one share of Reliance Petroleum
                                   at a premium of  2 per share on July 31. The strike price is   60 and the contract matures on
                                   September 30. The pay-off table shows the fluctuations of net profit with a change in the spot
                                   price.












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