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Tuesday, June 28, 2016

Stock Options

 
 


To the lay stock investor, derivatives are an unfamiliar, and somewhat, forbidding universe. However, for a few uninitiates , the mystique of options, at some point, has an irresistible pull which compels them to dabble in the products without fully comprehending their structure.

1. What are the types of options?

Let us consider here options on Nifty , the knowl edge of which can be ex trapolated to stock and other types of options.

Those with a bullish view, but low-risk appe tite, prefer to buy a call option on Nifty , while the bearish among traders prefer buying a put on Nifty . A bull can also sell puts confident that the market won't fall in a cer tain time horizon.

Similarly a bear, with a converse view, can sell calls on the index. But here, we only will consid er option purchase.

2. When do call and put buyers gain ?

A call buyer gains when the Nifty breaks above the strike of the option purchased plus premium paid. A put buyer gains when the Nifty falls below a strike purchased plus premium paid. Premium refers to the price the buyers of options pay to sellers.

3. Is there anything more one needs keep in mind?

Yes, options are of three types: in the money , at the money and out of the money .An in the money call refers to an option whose strike price is lower than the current market price. For example, the 8100 call is in the money considering Nifty closed last week at 8220.8. An in the money put is an option whose strike is higher than CMP . For example, 8300 is an in the money put given Friday's closing. An at the money callput is an option whose strike is close to or at the CMP , for example 8200. An out of the money call is an option whose strike is higher than CMP , for example 8300 call given Friday's closing. An out of the money put is an option whose strike is below CMP , for example 8100.

4. What is intrinsic value of option?

Generally , only in the money op tions have inherent value. For example, given Friday's closing at appx 8221, the 8100 call has an intrinsic value of `121. Similarly , intrinsic value of the 8300 put is `79.

5. What is time value?

It is the premium minus intrinsic value. At Friday close, the premi um of 8100 call was `200. That means time value of the option equals 200-121, the intrinsic value, or `79.Similarly , 8300 put price was `151. So, time value will equal 151 minus 79.

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