Risk Management

Risk Management : 

Submitted to: Sir Imtiaz askari By: MUHAMMED NISAR(3105) TARIQ ANIS( ) Risk Management

WHAT IS AN OPTION? : 

An option gives the holder the right to do something. The holder does not have to exercise this right. The purchase of an option requires an up-front payment, unlike forward or futures contracts. WHAT IS AN OPTION?

TYPES OF OPTIONS : 

THERE ARE TWO BASIC TYPES OF OPTIONS: Call Option Put Option CALL OPTION A call option gives the holder the right to buy an asset by a certain date for a certain price. PUT OPTION A put option gives the holder the right to sell an asset by a certain date for a certain price. TYPES OF OPTIONS

EXAMPLE OF A CALL OPTION : 

An investor buys a call option to purchase 100 IBM shares Strike price: $40 Current stock price: $38 Price of an option to buy one share = $5 Initial investment is 100 x $5 = $500 The outcome: At the expiration of the option, IBM’s stock price is $55. At this time, the option is exercised for a gain of ($55 - $40) x 100 = $1,500 EXAMPLE OF A CALL OPTION

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When the initial cost of the option is taken into account, the net gain is $1,500 - $500 = $1,000 If the stock price is less than $40 the holder will not exercise the right to buy. In this circumstance the investor loses the whole initial investment of $500.

EXAMPLE OF A PUT OPTION : 

An investor buys a put option to sell 100 Exxon shares Strike price: $70 Current stock price: $65 Price of an option to buy one share = $7 Initial investment is 100 x $7 = $700 The outcome: At the expiration of the option, Exxon’s stock price is $55. At this time the, the investor buys 100 Exxon shares and, under the terms of the put option, sells them for $70 per share to realize a gain of $15 per share or $1500 in total. EXAMPLE OF A PUT OPTION

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When the initial cost of the option is taken into account, the net gain is $1500 - $700 = $800 There’s no guarantee that the investor will make a gain. If the final stock price is above $70, the put option expires worthless and the investor loses $700.

OPTIONS CAN BE EITHER : 

American European American options: are options that can be exercised at any time up to expiration date. European options: are options that can only be exercised on the expiration date itself. OPTIONS CAN BE EITHER

THE INPUTS : 

Stock Price Exercise Price Time to Exercise Risk-free rate Dividends Volatility Time to Dividends Steps THE INPUTS

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THE INPUTS Foreign Risk Free Rate Dividend Yield THE OUTPUTS Option Price Implied Volatility Delta Gamma Theta Vega Rho