Essay on Options strategies for financial transactions Cambodian Economist Journal, Vol.

1, Issue: 004 LONG KimKhorn, PUC, MA.IRs, ID: 61283 January 18th, 2013 We cant define and discuss options strategies for financial transactions without understanding the terminologies which introduced here. First and foremost, there are many definitions of strategy by many scholars through out different fields, study and scientific subjects. According to California Management Review, 2001, by scholars - to Drucker, Strategy is purposeful action; to Moore design for action, in essence, conception preceding action.Strategy defined by fields in the military: strategy is concerned with draft the plan of war to shape individual campaigns and within these, decide on individual engagement. In the game theory: Strategy is complete plan: a plan which specifics what choices [the player] will make in every possible situation. In management: Strategy is a unified, comprehensive, and integrated plan design to ensure that the basic objectives of the enterprises are achieved. And in the dictionary: strategy is (among other things) a plan, method or series of maneuvers or stratagem for obtaining a specific goal or result. As for strategic options are creative alternative action-oriented responses to the external situation that an organization (or group of organizations) faces. Strategic options take advantage of facts and actors, trends, opportunities and threat of the outside world. Strategic options can be identified after an institutional assessment, keeping in mind the aspirations (basic question) of an organization. The tool Strategic options helps to identify and make a preliminary screening of alternative strategic options or perspectives (MDF, 2005). According to Bussinessdictionary.com, financial transaction: Event which involves money or payment, such as the act of depositing money into a bankaccount, borrowing money from a lender, or buying or sellinggoods or property. The question here, how the options strategies play its roles and impact the financial transaction. Well, according to Options Industry Council, they classified thirteen different options and nine strategies in financial transaction. First of all, Long: (a) You have the right

to exercise that option at any time prior to its expiration, (b) Your potential loss is limited to the amount you paid for the option contract; Short: when we are short, it means (a)We can be assigned an exercise notice at any time during the life of the option contract, (b)Our potential loss on a short call is theoretically unlimited. For a short put, the risk of loss is limited by the fact that the stock cannot fall below zero in price; Open: An opening transaction is to create a new trading position either a purchase or a sale - (a) Opening purchase a transaction in which the purchasers intention is to create or increase a long position in a given series of options, (b) Opening sale a transaction in which the sellers intention is to create or increase a short position in a given series of options; Close: A closing transaction is to reduce or eliminate an existing position - (a) Closing purchase a transaction in which the purchasers intention is to reduce or eliminate a short position in a given series of options. This transaction is frequently referred to as covering a short position, (b) Closing sale a transaction in which the sellers intention is to reduce or eliminate a long position in a given series of options; Leverage and Risk: Options can provide leverage. This means an option buyer can pay a relatively small premium for market exposure in relation to the contract value (usually 100 shares of underlying stock). Leverage also has downside implications. In-the-money, Atthe-money, Out-of-the-money: The strike price, or exercise price, of an option determines whether that contract is in-the-money, at-the-money, or out-of-the-money. If the strike price of a call option is less than the current market price of the underlying security, the call is said to be in-the-money. Likewise, if a put option has a strike price that is greater than the current market price of the underlying security, it is also said to be out-of-the-money. If the strike price equals the current market price, the option is said to be at-the-money. Time Decay: Generally, the longer the time remaining until an options expiration, the higher its premium will be. This is because the longer an options lifetime, greater is the possibility that the underlying stock might make a favorable price move.Expiration Day: The expiration date is the last day an option exists. For listed equity options, this is the Saturday following the third Friday of the expiration month.Exercise: If the holder of an American-style option decides to exercise his right to buy (in the case of a call) or to sell (in the case of a put) the underlying shares of stock, the holder must direct his brokerage firm

must submit his exercise notice.Assignment: The holder of a long American-style option contract can exercise the option at any time until the option expires. Whats the Net: When an investor exercises a call option, the net price paid for the underlying stock on a per share basis will be the sum of the calls strike price plus the premium paid for the call. Early Exercise / Assignment: For call contracts, holders might exercise early so that they can take possession of the underlying stock in order to receive a dividend. Volatility: Volatility is the tendency of the underlying securitys marketprice to fluctuate either up or down. It reflects the magnitude of price fluctuation; it does not imply a bias toward price movement in one direction or the other. All above mentioned options cant work alone to gain its ultimatum unless it used strategically. These nine strategies to be used to adjust/regulate those options and depends on the financial markets situation. Those strategies are (1)Long Call:Purchasing calls has remained the most popular strategy with investors since listed options were first introduced; (2) Long Put: A long put can be an ideal tool for an investor who wishes to participate profitably from a downward price move in the underlying stock; (3) Married Put: An investor purchasing a put while at the same time purchasing an equivalent number of shares of the underlying stock is establishing a married put position; (4) Protective Put:An investor who purchases a put option while holding shares of the underlying stock from a previous purchase is employing a protective put.; (5)Covered Call: The covered call is a strategy in which an investor writes a call option contract while at the same time owning an equivalent number of shares of the underlying stock; (6) Cash-Secured Put: According to the terms of a put contract, a put writer is obligated to purchase an equivalent number of underlying shares at the puts strike price if assigned an exercise notice on the written contract; (7) Bull Call Spread: Establishing a bull call spread involves the purchase of a call option on a particular underlying stock, while simultaneously writing a call option on the same underlying stockwith the same expiration month, at a higher strike price; (8) Bear Put Spread: Establishing a bear put spread involves the purchase of a putoption on a particular underlying stock, while simultaneously writing a put option on the same underlying stock with the same expiration month, but with a lower strike price; (9) Collar: A collar (which may be referred to as a "combination") can be established by holding

shares of an underlying stock, as well as purchasing a protective put and writing a covered callon that stock. Generally, the put and the call are both out-of-the-money when this collar is established, and have the same expiration month. Description on option pricing, we can not understand the option pricing by over-looking the theory of option pricing. The text publishedin the Bell Journal and Economics and Management Science of Massachusetts Information Technology (MIT) in 2002 by Robert C. Merton stated that the theory of option pricing began in 1900 when the French mathematician Louis Bachelier deduced an option pricing formula based on the assumption that stock prices follow a Brownian motion with zero drift. An option is a security that gives its owner the right to trade in a fixed number of shares of a specified common stock at a fixed price at any time on or before a given date. Options have been traded for centuries, but they remained relatively obscure financial instruments until the introduction of a listed options exchange in 1973. At that time, Fischer Black and Myron Scholes presented the first completely satisfactory equilibrium option pricing model (John, Stephen, Mark, 1979). According to Montreal Exchange in 2009 on Equity Option,there are two main approaches that used to replicate the option position and price an option. The most common use is an analytical formula known as the Black-Scholes model. Second widely a use approach is a methodology known as the Binomial model from Ross, Cox and Rubinstein. Binomial option pricing model is more like a process than a formula, in that it is a series of steps that can be used to price an option. The Black-Scholes option pricing model has been one of the most influential formulas in finance since its initial publication in 1973. The original Black-Scholes model is based on the following assumptions: (1) The option is European style; (2) The evolution of share prices follows a continuous random process; (3) The model is based on the lognormal of distribution of stock prices; (4) No commissions or taxes are charged; (5) Short-selling is permitted and the process of such a sale are immediately available for use; (6) Stock prices move in smooth increments (there are no stock market crashes or bubbles); (7) We can borrow or rent at the risk-free interest rate and this rate is constant; (8) Markets are efficient and there is no arbitrage possibilities; (9) The stock pays no dividends during the life of the option. Furthermore, the formula based on a

simplistic representation of the real world, the model only applied for European-style options and we can not calculate Black-Scholes model value of an option using a simple calculator. As for Binomial option pricing model (Ross, Cox and Rubinstein) is an easy-to-understand pricing methodology that closely emulates the actions that an option trader takes to create options. This model breaks down the time to expiration into a potentially very large number of steps. The greater the number of steps, the more accurate the option price estimation. The binomial models name is derived from the underlying assumption that the stock price can only take on one of two values in the next period. In other word, in each step, the stock price can rise from a current price (denoted by S) to an up-price (Su)or fall to a downprice (Sd)by an amount that depends on it anticipated future volatility. The different between the two princes (up and down) represents the future stock price volatility. The tree shows all the possible prices that the stock could take during the life of the option. At the end of the tree upon expiration of the option, the final option price is simply its intrinsic value. Next, the initial option value is estimated by back calculation of its intermediate values. Again, Binomial option pricing model is very flexible, and can price many different types of options, including options that can not be priced using the better-known BlackScholes option pricing formula. Furthermore, the procedure for pricing put options is the exactly same as for call options, except that the terminal values for the payout of the option differ. With minor change, the model can also be used to be used to price American-style option, and can be modified to allow for dividends as well.