Page 79 - DCOM510_FINANCIAL_DERIVATIVES

Financial Derivatives

Notes — ` 100,000 true value of property
` 45,000 profit from Put option
Had the government allowed them to build the hotel they would have let the option
expire worthless and lost ` 5,000 for the cost of the option. This is how money can be made
with Put options when an underlying asset falls in price.
Questions:

1. Analyse the case and find out the factors that affect the value of an option (premium)
of land?
2. Why it is not possible to exercise the option and buy the underlying commodity?

Source: www.apexfutures.com/trading-tools/options/what-are-puts/

5.6 Summary

An option is a contract that gives the buyer the right, but not the obligation, to buy or sell
an underlying asset at a specific price on or before a certain date.
An option, just like a stock or bond, is a security. There are two basic types of options – call
options and put options.
There are three main categories of options: European, American and Bermudan.
There are four types of participants in options markets namely, Buyers of calls, Sellers of
calls, Buyers of puts and Sellers of puts.
The Options Clearing Corporation is the sole issuer of all options listed at the Chicago
Board of Options Exchange (CBOE) and other U.S. options exchanges.

In India, NSE has an associated clearing house attached to it for futures and options trading.
Some of the important terms used in option trading are: Option Class, Option price, Strike
Price, Expiration date and others.
There are three positions in an option – In-the-money; At-the-money; and Out-of-the-
money.

The option premium can be broken down into two components – intrinsic value and time
value.

Index derivatives are derivative contracts which derive their value from an underlying
index. The two most popular index derivatives are index futures and index options.
Index derivatives are a powerful tool for risk management for anyone who has portfolios
composed of positions in equity.

5.7 Keywords

American Options: American options are options that can be exercised at any time up to the
expiration date. Most exchange-traded options are American.
At-the-money option: An at-the-money (ATM) option is an option that would lead to zero cash
flow if it were exercised immediately.

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.

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