AMITY GLOBAL

BUSINESS SCHOOL Noida

MBA
Options
Mr. Sachin Rohatgi

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AMITY GLOBAL
BUSINESS SCHOOL Noida
Options

Option is a derivative instrument ,which gives

the right ,but not the obligation ,to buy an
underlying at a given price.

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BUSINESS SCHOOL Noida
Types of Options

1) Call option ( Buy an underlying)

2) Put Option (Sell an underlying)

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BUSINESS SCHOOL Noida
Call Option
1) European Call option:
It gives the owner a right ,but not the obligation ,to buy
an underlying at a given price and at a given date.

For E.g.
On 25 October you pay Rs.100 as a premium for a
contract which states that you have a right to purchase
1 share of reliance industries at a strike price /exercise
price of Rs.900 on 31st December.

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BUSINESS SCHOOL Noida
Call Option

Suppose on the exercise date the price of an underlying

comes to 1000 ,then you will exercise your right to buy
one share of Reliance Industries and your pay off will
be Rs.100
Here you are the option owner and the counter party is
called the option writer.
Here you have this right because you have paid a
premium to the option writer and if you exercise you
right he has to obliged your right.

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BUSINESS SCHOOL Noida
Call Option
2) American Call option:
It gives the owner a right ,but not the obligation ,to buy
an underlying at a given price by a given date.
For E.g.
On 25 October you pay Rs.100 as a premium for a
contract which states that you have a right to purchase
1 share of reliance industries at a strike price /exercise
price of Rs.900 on 31st December.
Here you can exercise our right any time between 25th
October and 31st December.
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BUSINESS SCHOOL Noida
Put Option
1) European Put Option:
European put option give the owner a right ,but not
obligation ,to sell an underlying at a given price and at a
given date.
Put option will be purchase when as an investor you
feel that the value of underlying will come down in
near future.
For E.g. On 25 October you pay Rs.50 as a premium for a
contract which states that you have a right to sell 1
share of reliance industries at a strike price /exercise
price of Rs.900 on 31st December.
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AMITY GLOBAL
BUSINESS SCHOOL Noida
Put Option
1) European Put Option:
European put option give the owner a right ,but not
obligation ,to sell an underlying at a given price and at a
given date.

For E.g. On 25 October you pay Rs.50 as a premium for a

contract which states that you have a right to sell 1
share of reliance industries at a strike price /exercise
price of Rs.900 on 31st December.

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AMITY GLOBAL
BUSINESS SCHOOL Noida
Put Option
Put option will be purchase when as an investor you
feel that the value of underlying will come down in
near future.

In case of put option the pay off increases as the price

of an underlying comes down and vice versa.

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BUSINESS SCHOOL Noida
Put Option
2) American Put Option:
American put option give the owner a right ,but not
obligation ,to sell an underlying at a given price by a
given date.

For E.g. On 25 October you pay Rs.50 as a premium for a

contract which states that you have a right to sell 1
share of reliance industries at a strike price /exercise
price of Rs.900 on 31st December.
Here you can exercise our right any time between 25th
October and 31st December.
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MONEYNESS

In the Money:

a) It means that the owner of an option have a pay off.

b) Let us assume that the share price is Rs.26 (S) and the
exercise price (X) is Rs.25. So for
Call option : S > X
Put Option : S< X

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AMITY GLOBAL
BUSINESS SCHOOL Noida
MONEYNESS

Out of the Money:

a)It means that the owner of an option have a loss pay

off.
b) Let us assume that the share price is Rs.24 (S) and the
exercise price (X) is Rs.25. So for
Call option : S < X
Put Option : S > X

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AMITY GLOBAL
BUSINESS SCHOOL Noida
MONEYNESS

At the Money:

a)It means that the owner of an option have no pay off.

b) Let us assume that the share price is Rs.24 (S) and the
exercise price (X) is Rs.24. So for
Call option : S = X
Put Option : S = X

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BUSINESS SCHOOL Noida
Types of Options

Financial Options:
a) Stock options
b) Index Options
c) Bond options
d) Interest rate options
e) Currency options
Options on Futures
Commodity Options

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Interest Rate Option

1) Interest Rate Call Option

2) Interest Rate Pull Option

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BUSINESS SCHOOL Noida
Interest Rate Call Option
1) In European Interest Rate Call option the owner of the
call option has a right to borrow certain amount of
money at a given Interest rate and at a given date.
2) Here the strike price is interest rate.
For E.g.
On 25th March you have an interest rate call option which
matures on 30th June with a strike rate of 5%. In this
case we assume a notional principal. Assume here it is
to be Rs.10,00,000.

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Interest Rate Call Option
1) Now Suppose on 30th June the market rate is 4% , then
in this case the interest rate call option is out of the
money as (S< X).
2) Where as if market rate (S) on 30th June is 6% ,then in
this case the owner of interest rate call option will
exercise the option and it is called is in the money as
(S>X).

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BUSINESS SCHOOL Noida
Interest Rate Put Option
1) In European Interest Rate put option the owner of the
put option has a right to lend certain amount of money
at a given Interest rate and at a given date.
2) Here the strike price is interest rate.
For E.g.
On 25th March you have an interest rate put option which
matures on 30th June with a strike rate of 5%. In this
case we assume a notional principal. Assume here it is
to be Rs.10,00,000.

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BUSINESS SCHOOL Noida
Interest Rate Put Option
1) Now Suppose on 30th June the market rate is 4% , then
in this case the interest rate put option is in the money
as (S< X).
2) Where as if market rate (S) on 30th June is 6% ,then in
this case the owner of interest rate put option will not
exercise the option and it is called out of the money as
(S>X).

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Interest Rate Option
Capping on Interest Rate Payment = Series of Calls

An interest rate cap is actually a series of European

interest call options (called caplets), with a particular
interest rate, each of which expire on the date the
floating loan rate will be reset.
At each interest payment date the holder decides
whether to exercise or let that particular option expire.
Interest rate caps are used often by borrowers in order
to hedge against floating rate risk
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Interest Rate Option
Capping on Interest Rate Payment = Series of Calls
For e.g.
ABC Ltd. has issued FRB for a period of 3 years @ 10%
Interest. Now as the company has an exposure of interest
rate risk( High Interest rate) , company is going to take a
series of call options, to eliminate this risk.
Now assume the interest rate at the beginning of 1st
year is 11% and the beginning of 2nd year is 12%.
Now company has decided to cap an interest payment at 10%.
It means irrespective of Interest rate company wants to pay only 10%

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Interest Rate Option
Now in this case company will take an IRCO at the
starting of the FRB( 0 year) for the period of 1year &
take an IRCO at the starting of 1st year for the period
of 1 year.
In this case as the FRB has a maturity of 3 years
therefore only 3 call options are taken.

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Interest Rate Option
Floor on Interest Rate Payment = Series of Puts
Floors are similar to caps in that they consist of a series
of European interest put options (called caplets) with a
particular interest rate, each of which expire on the date
the floating loan rate will be reset.
In an interest rate floor, the seller agrees to compensate
the buyer for a rate falling below the specified rate
during the contract period.
Lenders often use this method to hedge against falling
interest rates.
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BUSINESS SCHOOL Noida
Interest Rate Option
Floor on Interest Rate Payment = Series of Puts
This is taken by the investor to safeguard against the
decrease in the fall of an interest rate.

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Interest Rate Option
Interest Rate Collar = Long Cap + Short Floor

Suppose you are a Issuer of Floating rate bond and as

fluctuation in Interest rate you have taken a long on
Interest Rate call option (Long Cap.)
Now you are also concerned about the cost (premium)
paid on long cap , so to offset the cost of buying call
option you go short by selling put option .
In this case the Interest rate collar is created by taking
long in Cap and going short in Floor.
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AMITY GLOBAL
BUSINESS SCHOOL Noida
Currency Option

A currency option is a contract between a buyer and

a seller.
The buyer of the option gets the right to buy or sell a
fixed amount of the underlying currency at a
predetermined price on( European) or before
expiration( American).
The buyer of the option is not obligated to buy or sell
the underlying currency.

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Elements of Currency Option

The premium
The Strike price/ Exercise price (X)
The spot rate (S) of the currency
The expiration date of the contract.

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Basic Types of Currency Option

A call option allows the buyer to buy the underlying

currency at the strike price.
The buyer is expecting the spot price to rise: the
seller is expecting the opposite.
The buyer will exercise the call option when S >X.

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BUSINESS SCHOOL Noida
Basic Types of Currency Option

A Put option allows the buyer to sell the underlying

currency at the strike price.
The buyer is expecting the spot price to fall: the seller
is expecting the opposite.
The buyer will exercise the put option when S < X.

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AMITY GLOBAL
BUSINESS SCHOOL Noida
Currency Option

Let us assume there is a call option USDINR

strike price Rs.20 and premium Rs.3
If Spot rate is 20 that means S=X, this situation is at
the money and as a buyer no one will purchase this
option and loss of Rs.3 of a premium is occurred.
If Spot rate is less than 20 , means S< X, this
situation is called out of the money and as a buyer
there is loss of Rs.3 is occurred.

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AMITY GLOBAL
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Currency Option

Let us assume there is a call option USDINR strike

price Rs.20 and premium Rs.3
Now if spot rate (S) is Rs.23 the buyer will exercise
his option and this situation is called In the money.
However at Rs.23 payout is Rs. 3 but this will be
adjusted against the premium paid .
This is a case of Breakeven point.

Call option break even point =Strike price + Premium

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Currency Option

In case of Call option buyer :

Maximum Possible Gain = Unlimited

Maximum Possible Loss = Limited to Rs.3( Premium)
Draw a payoff diagram

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Currency Option

Let us assume there is a put option USDINR strike

price Rs.20 and premium Rs.3
Now if spot rate (S) is Rs.23 the buyer will exercise
his option and this situation is called out of the
money.
Now is spot rate is Rs.17,the buyer will exercise his
option and this situation is called In the money .
However at Ts.17 the pay off is rs.3 which will be
adjusted against the premium of Rs.3

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BUSINESS SCHOOL Noida
Currency Option

This is a case of breakeven point.

Maximum possible gain = Strike price premium
Maximum possible loss= premium

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Covered Call
Stock + Short Call

As a stock owner, you are entitled to several rights.

One of these is the right to sell your stock at any time
for the market price.
Covered call writing is simply the selling of this right
to someone else in exchange for cash paid today.

This means that you give the buyer of the option the
right to buy your shares before the option expires, and
at a predetermined price, called the strike price.
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Covered Call Example

S= Rs.20, X = Rs. 25, Premium =Rs.3

Calculate:
a) Profit/Loss on Stock
b) Profit on Put
c) Total Profit if:
Stock price comes to Rs.0,10,17,20,25,30
Formula for :
a) Maximum loss = S - P
b) Breakeven = S - P
c) Maximum Profit = X-S + P
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Protective Put
Stock + Long Put
S= Rs.30, X = Rs. 25, Premium =Rs.3
Calculate Profit/Loss on Stock
Profit on Put
Total Profit if:
Stock price comes to Rs.0,20,25,28,33,35
Formula for:
a) Maximum loss = S + P -X
b) Breakeven = S + P (premium)
c) Maximum Profit :
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