Question

Explain the relationship of time value and options, how does it affect pricing of options, how it is looked at in business etc. Make sure to discuss the time value of money and its mathematical calculations.

Explain how options prices are derived? What are ALL the factors that affect options prices?

What are the advantages and disadvantages of trading options instead of equities? be detailed and include them all.

Describe in detail the two kinds of options contracts that exist, also describe the advantages and disadvantages of each?

Answer 1

Value of option comprise of two part 1) Intrinsic value and 2) Time value of money. Time value of money is the portion that indicates the period of expiry, further the expiry more the portion of time value of money. Thus as expiry approaches this time value portion declines and ultimately become 0

Intrinsic value is nothing but difference between stock price and strike price, For call option it is stock price less strike price and for put option it is strike price less stock price

Thus option prices = Intrinsic value + time value of money

Advantages of trading in option : Only premium is required to be paid upfront, Hence whole of capital is not needed to be blocked

Disadvantage of trading in options: If market do not move in either direction the premium paid will become zero, hence incurring huge loss. It is considered tobe very risky

There are two king of options available

1) Call option : it gives right to the buyer of the option to buy security at specified price at maturity

2) Put option :.it gives right to the buyer of the option to sell security at specified price at maturity