Trading Hedging With Options Ppt

7/30/2019 Trading Hedging With Options Ppt

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*Options are contracts that give the buyers the right butnot the obligation to buy or sell a specified quantity of

certain underlying asset at a specified price on or before

a specified date

*The seller is under obligation to perform the contract (i.e.

buy or sell the underlying as per the wish of the buyer of

the option)

*The underlying asset can be share, index, interest rate,

bond, commodities, etc.


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OPTIONS

DERIVATIVES

PUTCALL

RIGHT BUT NOT OBLIGATIONTO BUY

RIGHT BUT NOT THE OBLIGATIONTO SELL


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*AMERICAN OPTIONS:It can be exercised any time up to expiration

Premium charged are high

These are flexible in nature

Options traded on NSE for securities are Americanstyle of options

*EUROPEAN OPTIONS:

It can be exercised only at the time of expiration

Premium charged are low

Easier to analyze

Example: S&P CNX IT options at NSE


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CALL OPTION BUYER*PAYS PREMIUM

*RIGHT TO EXERCISE &

BUY

*PROFIT FROM RISING

PRICES

*UNLIMITED GAINS,

LIMITED LOSSES

CALL OPTION WRITER*RECEIVES PREMIUM

*OBLIGATION TO SELL IF

BUYER EXERCISES RIGHT

*PROFIT FROM FALLING

PRICES OR REMAINING

NEUTRAL

*LIMITED GAIN, UNLIMITED

LOSSES


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*MEANING: BUYING A CALL-RIGHT TO BUY

*PREMIUM PAID, THUS STARTS WITH LOSS

*PROFIT FROM RISING PRICES

*LIMITED LOSS, UNLIMITED PROFIT

*TO BREAK-EVEN, RECOVER STRIKE PRICE(K)+PREMIUM

*SPOT>STRIKE, PROFIT FOR LONG CALL


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BREAK-EVEN

PROFIT

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0

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LOSS

LOSS

PROFITSTRIKE PRICE

SPOT PRICE


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*MEANING: TAKING OBLIGATION TO SELL A CALL

*SELLING A CALL WITHOUT OWNING AN ASSET

*RECEIVES PREMIUM, THUS STARTS WITH PROFIT

*PROFIT FROM FALLING PRICES

*UNLIMITED LOSS, LIMITED PROFIT

*TO EARN PROFIT, STRIKE PRICE< SPOT


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PROFIT

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LOSS BREAK-EVEN

STRIKE PRICE

SPOT PRICELOSS

PROFIT


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*MEANING: BUYING THE RIGHT TO SELL SHARE

*PAYS PREMIUM, THUS STARTS WITH LOSS

*PROFIT FROM FALLING PRICES

*LIMITED LOSS, UNLIMITED PROFIT

*TO EARN PROFIT, SPOT PRICE < STRIKE PRICE


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PROFIT

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LOSS

LOSS

STRIKE PRICE

SPOT PRICE

BREAK-EVEN

PROFIT


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*MEANING: TAKES THE OBLIGATION TO BUY

WHAT LONG PUT HOLDER SELLS

*RECEIVES PREMIUM, THUS STARTS WITH PROFIT

*LIMITED PROFIT, UNLIMITED LOSS

*LOSS FROM FALLING PRICES

*TO EARN PROFIT, SPOT PRICE > STRIKE PRICE


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PROFIT

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LOSS

PROFIT

SPOT PRICE

STRIKE PRICE

BREAK-EVEN

LOSS


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*STRIKE PRICE: The price specified in the options contractis known as the strike price or the exercise price

The price at which the buyer of an option can buy the

stock (in the case of a call option) or sell the stock (in the

case of a put option) on or before the expiry date of

option contracts is called strike price

*EXPIRATION DATE: The date specified in the options

contract is known as the expiration date, the exercise

date, the strike date or the maturity.

It is also called the final settlement date


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*OPTION PRICE/PREMIUM: Option price is the price which the optionbuyer pays to the option seller

It is also referred to as the option premium

Comprises of Intrinsic Value and Time Value

* INTRINSIC VALUE OF AN OPTION: STRIKE PRICE-SPOT PRICE

The intrinsic value of an option is defined as the amount by which anoption is in-the-money or the immediate exercise value of the optionwhen the underlying position is marked-to-market

For CA: Intrinsic Value= MAX(spot-strike, 0)

For PA: Intrinsic Value= MAX(strike-spot, 0)

*TIME VALUE OF AN OPTION: PREMIUM-INTRINSIC VALUE

Both calls and puts have time value.

An option that is OTM or ATM has only time value. Usually, themaximum time value exists when the option is ATM.

The longer the time to expiration, the greater is an option's timevalue, all else equal.

At expiration, an option should have no time value


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*CALL OPTION:

In-the-money = strike price less than stock price.

At-the-money = strike price same as stock price.

Out-of-the-money = strike price greater than stock price

*PUT OPTION:

In-the-money = strike price greater than stock price

At-the-money = strike price same as stock price

Out-of-the-money = strike price less than stock price


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*IN-THE-MONEY OPTION:An in-the-money (ITM) option is an

option that would lead to a positive cash flow to the holder ifit were exercised immediately

*AT-THE-MONEY OPTION:An at-the-money (ATM) option is anoption that would lead to zero cash flow if it were exercisedimmediately. An option on the index is at-the-money whenthe current index equals the strike price (i.e. spot price =strike price)

*OUT-OF-THE-MONEY OPTION:An out-of-the-money (OTM)option is an option that would lead to a negative cash flow if

it were exercised immediately


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*Greeks help us to measure the risk associated with

derivative positions

*Greeks also come in handy when we do local valuation of

instruments.

*This is useful when we calculate value at risk

*DELTA

*GAMMA

*THETA

*VEGA

*RHO


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POSITION DELTA GAMMA VEGA THETA RHO

LONG CALL POSITIVE POSITIVE POSITIVE NEGATIVE POSITIVE

SHORT CALL NEGATIVE NEGATIVE NEGATIVE POSITIVE NEGATIVE

LONG PUT NEGATIVE POSITIVE POSITIVE NEGATIVE NEGATIVE

SHORT PUT POSITIVE NEGATIVE NEGATIVE POSITIVE POSITIVE


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*Option Pricing Model assists the trader in keeping theprices of calls and puts in proper numerical relationshipto each other and helps the trader make BIDS & OFFERquickly

PRICING OF OPTIONS

Black-ScholesOption PricingModel (BSOPM)

Binomial Option

Pricing Model(BOPM)


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*The Black Scholes Model is one of the most importantconcepts in modern financial theory

*The BlackScholes model is a mathematical descriptionof financial markets and derivative investmentinstruments. The model develops partial differentialequations whose solution, the BlackScholes formula, iswidely used in the pricing of European-style options

*The BlackScholes model is a tool for equity optionspricing

*Black Scholes Model which assumes that percentagechange in the prices of underlying follows normaldistribution


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Base price of the options contracts, on introduction of new contracts,would be the theoretical value of the options contract arrived at basedon Black- Scholes model of calculation of options premiums.

C = price of a call optionP = price of a put optionS = price of the underlying asset

X = Strike price of the optionr = rate of interestt = time to expiration = volatility of the underlyingN represents a standard normal distribution with mean = 0 and

standard deviation = 1It represents the natural logarithm of a number. Natural logarithms arebased on the constant e (2.71828182845904).Rate of interest may be the relevant MIBOR rateor such other rate asmay be specified
http://www.nseindia.com/content/debt/debt_mibidborday.htmhttp://www.nseindia.com/content/debt/debt_mibidborday.htm


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*The options price for a CALL, computed as per

the following Black Scholes formula:

C = S * N (d1) - X * e- rt * N (d2)

and the price for a PUT is :P = X * e- rt * N (-d2) - S * N (-d1)

where :

d1 = [ln (S / X) + (r + 2/ 2) * t] / * sqrt(t)

d2 = [ln (S / X) + (r - 2/ 2) * t] / * sqrt(t)

= d1 - * sqrt(t)


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*BOPM was invented to explain the Black Scholes Model.

*The Binomial Model is named so, as it returns two possibilities atany given time

*Due to its simple and iterative structure, the model presents

certain unique advantages. For example, since it provides astream of valuations for a derivative for each node in a span oftime, it is useful for valuing derivatives such as American optionswhich allow the owner to exercise the option at any point intime until expiration (unlike European options which are

exercisable only at expiration).

*The model is also somewhat simple mathematicallywhen compared to counterparts such as the Black-Scholesmodel, and is therefore relatively easy to build and implement

with a computer spreadsheet


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*A stock is currently priced at $40 per share.

*In 1 month, the stock price may

*go up by 25%, or

*go down by 12.5%.

*Stock price dynamics:

t = now t = now + 1 month

$40

$40x(1+.25) = $50

$40x(1-.125) = $35

UP STATE

DOWN STATE


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*A call option on this stock has a strike price of

$45t=0 t=1

Stock Price=$40;

Call Value=$c

Stock Price=$50;

Call Value=$5

Stock Price=$35;

Call Value=$0


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*A ratio of the trading volume of put options to call options

*The put-call ratio has long been viewed as an indicator ofinvestor sentiment in the markets

*The put-call ratio is a popular tool specifically designed to helpindividual investors gauge the overall sentiment (mood) of the

market*The ratio is calculated by dividing the number of open interest

put options by the number of open interest call options

*As this ratio increases, it can be interpreted to mean thatinvestors are putting their money into put options rather thancall options

*An increase in traded put options signals that investors areeither starting to speculate that the market will move lower, orstarting to hedge their portfolios in case of a sell-off


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*Options are instruments that can be used to hedge aswell as to speculate

*Different options can be combined to create differentsynthetic instruments, which will match the risk andreturn profile of the option user

*Covered option strategies: Covered call and put

*Synthetic options: Synthetic call and put

*Straddles: long and short

*Strangles: long and short*Butterfly spread: long and short


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*The covered call is a strategy in which an investor Sells a Calloption on a stock he owns.

*The Call would not get exercised unless the stock price increasesabove the strike price. Till then the investor in the stock (Callseller) can retain the Premium with him. This becomes hisincome from the stock.

*WHEN TO USE: This strategy is usually adopted by a stock ownerwho is Neutral to moderately Bullish about the stock.

*RISK: If the stock price falls to zero, the investor loses the entirevalue of the stock but retains the premium, since the call willnot be exercised against him.

*So MAXIMUM RISK= STOCK PRICE PAID-CALL PREMIUM

*REWARD: Limited to (CALL STRIKE PRICE-STOCK PRICE PAID) +PREMIUM RECEIVED

*BREAKEVEN: STOCK PRICE PAID-PREMIUM RECEIVED


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PROFIT

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LOSS

K

SHORT CALL

LONG ASSET

COVERED CALL

STRIKE PRICE

SPOT PRICE


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*This strategy is opposite to a Covered Call. A Covered Call is a

neutral to bullish strategy, whereas a Covered Put is a neutralto Bearish strategy

*This strategy is done when the price of a stock / index is goingto remain range bound or move down

*Covered Put writing involves a short in a stock / indexalongwith a short Put on the options on the stock/ index

*WHEN TO USE: If the investor is of the view that the marketsare moderately bearish

*RISK: Unlimited if the price of the stock rises substantially

*REWARD: Maximum is (SALE PRICE OF THE STOCK STRIKEPRICE) + PUT PREMIUM

*BREAKEVEN: SALE PRICE OF STOCK + PUT PREMIUM


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PROFIT

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LOSS

SHORT PUT

SHORT ASSET

COVERED PUT

K


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*In this strategy, we purchase a stock since we feel bullish about

it. But what if the price of the stock went down. You wish youhad some insurance against the price fall. So buy a Put on thestock. This gives you the right to sell the stock at a certain pricewhich is the strike price. The strike price can be the price atwhich you bought the stock or slightly below

*SYNTHETIC CALL: LONG PUT + LONG ON UNDERLYING ASSET*WHEN TO USE: When ownership is desired of stock yet investor is

concerned about near-term downside risk. The outlook isconservatively bullish

*RISK: Losses limited to Stock price + Put Premium Put Strikeprice

*REWARD: Profit potential is unlimited

*BREAK-EVEN POINT: Put Strike Price + Put Premium + Stock Price

Put Strike Price


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PROFIT

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LOSS

LONG PUT

LONG ASSET

K

PROTECTIVE PUT


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*This is a strategy wherein an investor has gone short on a stockand buys a call to hedge

*This is an opposite of Synthetic Call. The net effect of this isthat the investor creates a pay-off like a Long Put, but insteadof having a net debit (paying premium) for a Long Put, hecreates a net credit (receives money on shorting the stock)

*This strategy hedges the upside in the stock position whileretaining downside profit potential

*SYNTHETIC CALL: LONG CALL + SHORT ON UNDERLYING ASSET

*When to Use: If the investor is of the view that the markets willgo down (bearish) but wants to protect against any unexpected

rise in the price of the stock*Risk: Limited. Maximum Risk is Call Strike Price Stock Price +

Premium

*Reward: Maximum is Stock Price Call Premium

*Breakeven: Stock Price Call Premium


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PROFIT

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LOSS

K

LONG CALL

SHORT ASSET

PROTECTIVE CALL


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*A Straddle is a volatility strategy and is used when the stock

price / index is expected to show large movements*LONG STRADDLE:

*This strategy involves buying a call as well as put on the samestock / index for the same maturity and strike price, to take

advantage of a movement in either direction*WHEN TO USE: The investor thinks that the underlying stock /

index will experience significant volatility in the near term

*RISK: Limited to the initial premium paid

*REWARD: Unlimited

*BREAKEVEN: Upper Breakeven Point = Strike Price of Long Call+ Net Premium Paid

* Lower Breakeven Point = Strike Price of Long Put - Net Premium

Paid


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PROFIT

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LOSS

LONGCALLLONG

PUT

K

LONG STRADDLE

*SHORT STRADDLE:


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SHORT STRADDLE:

*A Short Straddle is the opposite of Long Straddle

*It is a strategy to be adopted when the investor feels themarket will not show much movement

*He sells a Call and a Put on the same stock / index for the samematurity and strike price. It creates a net income for theinvestor. If the stock / index does not move much in eitherdirection, the investor retains the Premium as neither the Callnor the Put will be exercised

*WHEN TO USE: The investor thinks that the underlying stock /index will experience very little volatility in the near term

*RISK: Unlimited

*REWARD: Limited to the premium received

*BREAKEVEN:

* Upper Breakeven Point = Strike Price of Short Call + NetPremium Received

* Lower Breakeven Point = Strike Price of Short Put - Net

Premium Received


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PROFIT

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LOSS

K

SHORTCALL

SHORTPUT

SHORT STRADDLE


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*A Strangle is a slight modification to the Straddle to make it cheaper to

execute. This strategy involves the simultaneous buying of a slightly out-of-the-money (OTM) put and a slightly out-of-the-money (OTM) call ofthe same underlying stock / index and expiration date.

*The initial cost of a Strangle is cheaper than a Straddle, the returns couldpotentially be higher for a Strangle to make money, it would require

greater movement on the upside or downside for the stock / index thanit would for a Straddle

*WHEN TO USE: The investor thinks that the underlying stock / index willexperience very high levels of volatility in the near term.

*RISK: Limited to the initial premium paid

*REWARD: Unlimited

*BREAKEVEN:

* Upper Breakeven Point = Strike Price of Long Call + Net Premium Paid

* Lower Breakeven Point = Strike Price of Long Put - Net Premium Paid


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100 150

PROFIT

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0

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LOSS

LONGCALL

SHORTCALL

K

*


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*SHORT STRANGLE:

*A Short Strangle is a slight modification to the Short Straddle. Ittries to improve the profitability of the trade for the Seller of

the options by widening the breakeven points so that there is amuch greater movement required in the underlying stock /index, for the Call and Put option to be worth exercising

*WHEN TO USE: This options trading strategy is taken when theoptions investor thinks that the underlying stock willexperience little volatility in the near term.

*RISK: Unlimited

*REWARD: Limited to the premium received

*BREAKEVEN:

* Upper Breakeven Point = Strike Price of Short Call + NetPremium Received

* Lower Breakeven Point = Strike Price of Short Put NePremium Received


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PROFIT

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0

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LOSS

100 150

SHORT

CALL

SHORTPUT


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LONG CALL BUTTERFLY: SELL 2 ATM CALL OPTIONS, BUY 1 ITMCALL OPTION AND BUY 1 OTM CALL OPTION

*A Long Call Butterfly is to be adopted when the investor isexpecting very little movement in the stock price / index. Theinvestor is looking to gain from low volatility at a low cost. Thestrategy offers a good risk / reward ratio, together with low cost.A long butterfly is similar to a Short Straddle except your losses

are limited.*WHEN TO USE: When the investor is neutral on market direction

and bearish on volatility.

*RISK: Net debit paid.

*REWARD: Difference between adjacent strikes minus net debit

*BREAK EVEN POINT:

*Upper Breakeven Point = Strike Price of Higher Strike Long Call Net Premium Paid

*Lower Breakeven Point = Strike Price of Lower Strike Long Call +

Net Premium Paid


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*BUY 2 ATM CALL OPTIONS, SELL 1 ITM CALL OPTION AND SELL 1 OTMCALL OPTION.

*A Short Call Butterfly is a strategy for volatile markets

* It is the opposite of Long Call Butterfly, which is a range bound strategy

*WHEN TO USE: You are neutral on market direction and bullish onvolatility. Neutral means that you expect the market to move in either

direction - i.e. bullish and bearish*RISK: Limited to the net difference between the adjacent strikes less the

premium received for the position

*REWARD: Limited to the net premium received for the option spread.

*BREAK EVEN POINT:

*Upper Breakeven Point = Strike Price of Highest Strike Short Call - NetPremium Received

*Lower Breakeven Point = Strike Price of Lowest Strike Short Call + NetPremium Received


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K

PROFIT

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0

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LOSS

LOWER STRIKE PRICE

MIDDLE STRIKE PRICE

HIGHER STRIKE PRICE

SELL ITM SHORT CALL

BUY 2 ATM LONG CALL

BUY OTMCALL OPTION

SHORT CALL BUTTERFLY


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Trading Hedging With Options Ppt