Page 70 - DMGT513_DERIVATIVES_AND_RISK_MANAGEMENT

Unit 6: Introduction to Options

quantity. The investor can place a market limit order, stop loss order, etc. The investor can Notes
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.

Notes Other Types of Options

Various other types of options are listed below:
1. Real options: A real option is a choice that an investor has when investing in the real
economy (i.e. in the production of goods or services, rather than in financial contracts).
This option may be something as simple as the opportunity to expand production,
or to change production inputs. Real options are an increasingly influential tool in
corporate finance. The liquidity of this kind of exchange-traded options is relatively
lower.

2. Traded options - (Exchange-Traded Options): Traded Options are, Exchange-traded
derivatives, as the name implies. As for other classes of exchange traded derivatives,
they have: standardized contracts; quick systematic pricing and are settled through
a clearing house (ensuring fulfillment).
3. Vanilla and exotic options: Generally speaking, a vanilla option is a 'simple' or
well understood option, whereas an exotic option is more complex, or less easily
understood (hybrid options). European options and American options on stock and
bonds are usually considered to be "plain vanilla". Asian options, lookback options,
barrier options are often considered to be exotic, especially if the underlying
instrument is more complex than simple equity or debt.

Self Assessment

State the following are true or false:
6. A put option gives the holder the right but not the obligation to buy an asset by a certain
date for a certain price.
7. A call option gives the holder the right but not the obligation to sell an asset by a certain
date for a certain price.

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