Options: Basic Definitions

1
Options Basic Definitions

• Put option gives the buyer the right to a short
  position in the futures market. Seller or writer
  of the put is assigned a long position IF the
  option is exercised
• Call option give the buyer the right to a long
  position in the futures market. Seller or writer
  of the call is assigned a short position IF the
  option is exercised

2
Calls and Puts
Put
Sell (Writer)
Buy
Short
Long
Exercise
Call
Sell (Writer)
Buy
Short
Long
Exercise
3
Definitions

• Strike Price Specific price owner has right to
  buy or sell
• Premium Cost of buying an option at a
  particular strike price
• In the Money Putfutures is below strike price
• In the Money Callfutures is above strike price
• Intrinsic Value Difference between the
  underlying futures and an in the money put or
  call
• Time Value Difference between options premium
  and intrinsic value

4
Premiums Puts and Calls 10/30/01
Cotton Z01 Futures at 28.92 Cents Per Pound
Calls
Puts
24.00 4.93 25.00 3.97 30.00 .35 35.00
.05 40.00 . 01
24.00 0.02 25.00 0.06 30.00 1.43 35.00
6.12 40.00 11.09
5
Premiums Puts and Calls 10/31/01
Cotton Z01 Futures at 29.90 Cents Per Pound
Calls
Puts
24.00 5.91 25.00 4.93 30.00 .68 35.00
.05 40.00 . 01
24.00 0.02 25.00 0.04 30.00
.78 35.00 5.14 40.00 10.11
6
Change in Intrinsic and Time Value Question
Cotton Z01 Futures at 28.92 Cents Per Pound on
10/30 And 29.90 Cents Per Pound on 10/31
Calls Premium Intrinsic Time
Puts Premium Intrinsic Time
24.00 4.93 4.92 .01 25.00 3.97 3.92 .05 30.00
.35 .00 .35 35.00 .05 .00 .05 40.00 . 01
.00 .01 10/31 24.00 5.91 5.90 .01 25.00 4.93 4.90
.03 30.00 .68 .00 .68 35.00 .05
.00 .05 40.00 .01 .00 .01
24.00 .02 25.00 .06 30.00 1.43 35.00
6.12 40.00 11.09 10/31 24.00 .02 25.00
.04 30.00 .78 35.00 5.14 40.00 10.11

7
Change in Intrinsic and Time Value Answer
Cotton Z01 Futures at 28.92 Cents Per Pound on
10/30 And 29.90 Cents Per Pound on 10/31
Calls Premium Intrinsic Time
Puts Premium Intrinsic Time
24.00 .02 .00 .02 25.00 .06 .00 .06 30.00
1.43 1.08 .35 35.00 6.12 6.08 .06
40.00 11.09 11.08 .01 10/31 24.00
.02 .00 .02 25.00 .04 .00 .04 30.00 .78 .10
.68 35.00 5.14 5.10 .04 40.00 10.11
10.10 .09
24.00 4.93 4.92 .01 25.00 3.97 3.92 .05 30.00
.35 .00 .35 35.00 .05 .00 .05 40.00 . 01
.00 .01 10/31 24.00 5.91 5.90 .01 25.00 4.93 4.90
.03 30.00 .68 .00 .68 35.00 .05
.00 .05 40.00 .01 .00 .01
8
Intrinsic and Time ValueCall
Underlying Futures at 2.80
Strike Price (Call) Premium Intrinsic Value Time Value
2.60 .25 .20 .05
2.70 .16 .10 .06
2.80 .10 0 .10
2.90 .07 0 .07
3.00 .05 0 .05
9
Intrinsic and Time Value Put
Underlying Futures at 2.80
Strike Price (Put) Premium Intrinsic Value Time Value
2.60 .05 0 .05
2.70 .07 0 .06
2.80 .10 0 .10
2.90 .16 .10 .06
3.00 .25 .20 .05
10
Futures and Options Hedging Differences
Futures- Sell Short
Options - Buy Put
Price falls - Gain from futures, no
premium Price rises Gain from cash Price Locked
Price falls- Premium deducted from N.S.P. Price
rises Let put expire, collect price
differential over premium cost Price not locked
on upside
11
Price Falls Zero Basis
Futures
Sell 7.00 Futures and Price Falls to 6.50
Gain of .50 in Futures Loss .50 in Cash Net
selling price 7.00
Put
Buy 7.00 put for .15 premium and price falls
to 6.50. Offset put for .60 premium Loss of
.50 in cash, gain of .45 on options Net
selling price 6.95
12
Price Rise Zero Basis
Futures
Sell 7.00 Futures and Price Rises to 7.50
Gain of .50 in Cash Loss of .50 in Futures
Net selling price 7.00
Put
Buy 7.00 put for .15 premium and price rises
to 7.50. Let put expire Gain of .50 in cash
market Less .15 premium Net selling price 7.35
13
Short Hedging Futures vs. Options
14
Short Hedging Futures vs. Options
Price Rise Greater Than Premium
15
Long Hedging Futures vs. Options
16
Options Put Buyer-Seller Choices
17
Options Call Buyer-Seller Choices
18
Options Calls- Retrade
19
Options Calls-Exercising Option
20
Options Covered Options
21
Writing Covered Puts w/Price Increase
22
Writing Covered Puts w/Price Decrease
23
Writing Covered Calls w/ Price Increase
24
Writing Covered Calls w/Price Decrease
25
Writing Naked Puts w/ Price Increase
26
Writing Naked Puts w/Price Decrease
27
Writing Naked Calls w/Price Increase
28
Writing Naked Calls w/Price Decrease
29
Writing Options Summary