Page 71 - DCOM510_FINANCIAL_DERIVATIVES

Financial Derivatives

Notes 17. Time value of an option: The time value of an option is the difference between option’s
time values, all else being equal. At expiration, an option should have no time value.

Self Assessment

Fill in the blanks:

4. .............................. is also referred to as the option premium.
5. .............................. options are options that can be exercised at any time up to the expiration
date.

6. .............................. options is options that can be exercised only on the expiration date itself.
7. The option premium can be broken down into two components - intrinsic value and
..............................

8. A call option on the index is out-of-the-money when the current index stands at a level
which is less than the ..............................

5.3 Types of Options

There are two basic types of options-call options and put options:

1. Call option: A call option gives the holder the right but not the obligation to buy an asset
by a certain date for a certain price.
2. Put option: A put option gives the holder the right but not the obligation to sell an asset
by a certain date for a certain price.

Did u know? The money made in an option is called as the option pay off. There can be two
pay off for options, for put and call option
The price of options is decided between the buyers and sellers on the trading screens of the
exchanges in a transparent manner. The investor can see the best five orders by price and
quantity. The investor can place a market limit order, stop loss order, etc. The investor can
modify or delete his pending orders. The whole process is similar to that of trading in shares.
In simple words, a call option gives the holder the right to buy an asset at a certain price within
or at the end of a specific period of time. Calls are similar to having a long position on a stock.
Buyers of calls hope that the stock will increase substantially before the option expires.
Similarly, a put option gives the holder the right to sell an asset at a certain price within or at the
end of a specific period of time. Puts are similar to having a short position on a stock. Buyers of
put options hope that the stock will decrease substantially before the option expires.

An investor with a long equity call or put position may exercise that contract at any time before
the contract expires, up to and including the Friday (in the Indian stock market) before its
expiration. To do so, the investor must notify his brokerage firm of intent to exercise in a
manner, and by the deadline specified by that particular firm.
Any investor with an open short position in a call or put option may nullify the obligations
inherent in that short (or written) contract by making an offsetting closing purchase transaction
of a similar option (same series) in the marketplace. This transaction must be made before the
assignment is received, regardless of whether you have been notified by your brokerage firm to
this effect or not.

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