Page 69 - DCOM510_FINANCIAL_DERIVATIVES

Financial Derivatives

Notes 8. Expiration date: The date specified in the options contract is known as the expiration date,
the exercise date, the strike date or the maturity.
9. Strike Price (K): Also known as the “exercise price,” this is the stated price at which the
buyer of a call has the right to purchase a specific futures contract or at which the buyer of
a put has the right to sell a specific futures contract. The exchanges decide the strike price
at which call and put options are traded. Generally, to simplify matters, the exchanges
specify the strike price interval for different levels of underlying prices, meaning the
difference between one strike price and the next strike price over and below it.
Illustration: The strike price interval for Bharat Heavy Electricals is ` 10. This means that
there would be strike prices available with an interval of ` 10. Typically, the investor can
see options on Bharat Heavy Electricals with strike prices of ` 150, ` 160, ` 170, ` 180, ` 190
etc.
As the price of underlying moves up or down, the exchanges introduce more strike prices
in keeping with the strike price interval rules. At any point in time, there are at least five
strike prices (one near the stock price, two above the stock price and two below the stock
price) available for trading in one-, two- and three-month contracts.

Following (Table 5.1) are the strike price intervals specified by exchanges:
Table 5.1: Strike Price Intervals for Options

Price level of Underlying Strike Price Interval (In `)
Less than or equal to 50 2.5

Above 50 to 250 5.0
Above 250 to 500 10.0
Above 500 to 1000 20.0
Above 1000 to 2500 30.0
Above 2500 50.0

10. American options: American options are options that can be exercised at any time up to
the expiration date. Most exchange-traded options are American.
11. European options: European options are options that can be exercised only on the expiration
date itself. European options are easier to analyse than American options, and properties
of an American option are frequently deduced from those of its European counterpart.
12. Index options: These options have the index as the underlying. Some options are European
while others are American. Like index futures contracts, index options contracts are also
cash settled.

13. Stock options: Stock options are options on individual stocks. Options currently trade on
over 500 stocks in the United States. A contract gives the holder the right to buy or sell
shares at the specified price.
14. Option Premium: The “price” an option buyer pays and an option writer receives is
known as the premium. Premiums are arrived at through open competition between
buyers and sellers according to the rules of the exchange where the options are traded. A
basic knowledge of the factors that influence option premiums is important for anyone
considering options trading. The premium cost can significantly affect whether the investor
realise a profit or incur a loss.

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