Options Payoff

Presented By

Prantika HalderMBA-BT-II yr.

Options Definition

• The right, but not the obligation, to enter into a transaction [buy or sell] at a pre-agreed price, quantity, time [by a specified date in the future], and terms.

• The option buyer typically pays the seller an upfront free (the premium) for the option rights.

Options Markets

• Over-The-Counter (OTC)– Physicals Market

• Exchange Traded– Standardized Terms– Style– Expiry Dates– Strike Levels

Basic Options Structures

• Calls – Options acquired by a buyer (holder) and granted by a seller (writer) to buy at a fixed price

• Puts – Options acquired by a buyer and granted by a seller to sell at a fixed price

Basic Options Structures

• All option products & strategies are some combination of buying or selling of calls or puts

Basic Options Provisions• Buy or Sell (Write)

– Long or Short

• Call or Put

• Underlying Asset– Product, Security / Instrument

• Strike (Exercise) Price

• Premium

• Exercise Date

Basic Options Provisions - Strike

• Strike Price – Fixed price to be paid if option exercised, as specified in the options agreement

• Set in intervals on exchange traded options

• At any preferred level OTC

Basic Options Provisions - Premium

• Premium – Price of the option that buyer pays and seller receives at the time of option transaction.

• Consideration paid for rights

• Non-Refundable

Option Exercise Provisions or “Style”

• American – Style

• European - Style

American-style Exercise Provision

• Buyer (Holder) may exercise at any time prior to expiry

• Value factor related to dividends on equity options

European-style Exercise Provision

• Buyer (Holder) may exercise only on expiry date

• Valuation difference

Payoff profile of buyer of asset:Long Asset

• When an investor buys the underlying asset sells it back at a future date at an unknown price; once it is purchased the investor called long asset.

Payoff profile for seller of asset:Short Asset

• When an investor shorts the underlying asset and buys it back at a future date at an unknown price; once it is sold the investor called short asset.

Payoff profile for buyer of call options:Long Call

• A trader who believes that a stock's price will increase might buy the right to purchase the stock (a call option) rather than just buy the stock.

Payoff profile for seller of call options:Short Call

A trader who believes that a stock price will decrease, can sell the stock short or instead sell, or "write," a call.

Payoff profile for buyer for put options:Long put

A trader who believes that a stock's price will decrease can buy the right to sell the stock at a fixed price (a put option).

Payoff profile for seller for put options:short put

A trader who believes that a stock price will increase can buy the stock or instead sell a put. The trader selling a put has an obligation to buy the stock from the put buyer at the put buyer's option.

When Do Traders Typically Use Options In Their Portfolios• When Pricing Is Viewed As Attractive

• When Seeking To Enhance Portfolio Income– To Play The Market With Limited Risk (No

More Than Premium Paid.

• Secondary Trading In Options– Rights Sold And Re-Sold

• Typically Not Just “Buy And Hold”– Frequently Traders Will

Exit Or Roll Positions Before Nearing Expiry

Options Trading Strategies

Options Pricing SampleBrent Crude Oil OptionsCalls: With Underlying @ $28.99

Exercise

Price

Current Settlement

PriceImplied

VolatilityOpen

Interest

$28.50 85¢ 32.52% 440

$29.00 57¢ 31.93% 993

$29.50 37¢ 32.49% 201

Options Pricing

• Theoretically The Net Present Value Of All Potential Outcomes For The Option

For Determining pricing option Black Scholes Model is applicable.

Likely Factors Influencing Pricing Of Options

• Price Volatility Of Underlying Asset

• Duration Of The Option – Time To Expiration

• Strike Price Of The Option

• Value Of The Underlying Commodity [Or Financial Instrument]

• Risk Free Interest Rate

Returns On Basic OptionsPayoff Diagram

-60

-40

-20

0

20

40

60

1 2 3 4 5 6 7 8 9 10 11

Spot Price

Pay

off

Long UnderlyingAsset

Short Put Option

Long Call Option

Option Value

• At-The-Money

• In-The-Money

• Out-Of-The-Money

• Option Price Can Be Viewed As Comprised Of Two Components– Intrinsic Value– Extrinsic Value

Option Value - Intrinsic

• Intrinsic Value Of An Option Is Simply The Amount, If Any, By Which The Option Is In-The-Money

• Profit That Could Be Realized If Option Were Exercised Immediately

• Easy Valuation

Option Value - Extrinsic

• Extrinsic Value Reflects The Potential Future Value Of The Option, Influenced Primarily By The Time Remaining To Expiry And The Price Volatility Of The Underlying Asset

• The Hard Part To Value

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