Question

1.                  Assume that you have a LONG position in 25 call options with the following characteristics:

                                    Underlying stock        Lionsgate (100 shares)

                                    Exercise price (X)       5.00 ($ per share)

                                    Expiration date           June, 2018.

At the time you purchased the call options, you paid a premium of C_t = $1.00 ($ per share).

A.        Given the opening trade described above, what are the three possible closing trades for your call option position?

B.        Assume that you have decided that your closing trade will be to offset the options. Describe what action you must take to offset the options. Be thorough.

C.        Assume that, at the time of the closing trade (offset), the premium is C_t+n = $1.57 per share. What is the profit or loss per share? What is the total profit or loss?

D.            Now, assume that the premium is C_t+n = $ .76 per share at the time you offset your position. What is the profit or loss per share? What is the total profit or loss?

Answer 1

A). Given the opening trade described above, what are the three possible closing trades for your call option position?

Answer:-A)The confusing terminology mentioned in the question deals with entering and exiting option orders. In review, there are two main ways in which you can participate in options: You can either buy an option or write an option also called selling an option). When you buy an option you are purchasing the right to either buy or sell (put option) the underlying asset at a set price before a set date. Three possible opening trade has been described.If you write an option, you are selling this right for a premium.

When you enter a trade, you are essentially opening a position, hence the phrases "sell to open" and "buy to open." If you are buying an option, either a put or a call, you must enter a "buy to open" order. If you are writing an option, you must enter a "sell to open" order.

B). Assume that you have decided that your closing trade will be to offset the options. Describe what action you must take to offset the options. Be thorough.

Answer)Offsetting is the primary way that most traders close a position. Offsetting is simply a method of reversing your original transaction to exit the trade. You can always sell an option that you previously bought, or buy an option that you previously sold, at any time before the end of the last trading day. The last trading day is usually the first business day prior to the option’s expiration date (the third Friday of the month for stock options).If you own (bought) a call, you have to “sell to close" exactly the same call (with the same strike price and expiration) to close your position. Closing trade will be to offset the option If you own a put, I must take the option “sell to close" exactly the same put. And if you sold a put, you have to “buy to close" the put with the same strike price and expiration of closing trade will be to offset the options.

If you do not offset your position, then you have not officially exited the trade. If you are a long a call and you sell another call (with a different strike price or expiration month) you may have reduced your risk, but you have not closed your position. Instead, you would now have two positions (although you may think of it as a single combinational position). Doing an offsetting transaction is usually the best way to close out a position if there is still time remaining before expiration.

C). Assume that, at the time of the closing trade (offset), the premium is C_t+n = $1.57 per share. What is the profit or loss per share? What is the total profit or loss

As you can see, at the breakeven point we neither make money nor lose money. In other words, if the call option has to be profitable it not only has to move above the strike price but it has to move above the breakeven point.

Over the last few chapters we have looked at two basic option type’s i.e. the ‘Call Option’ and the ‘Put Option’. Further we looked at four different variants originating from these 2 options –

1. Buying a Call Option
2. Selling a Call Option
3. Buying a Put Option
4. Selling a Put Option

With these 4 variants, a trader can create numerous different combinations and venture into some really efficient strategies generally referred to as ‘Option Strategies’. Think of it this way – if you give a good artist a color palette and canvas he can create some really interesting paintings, similarly a good trader can use these four option variants to create some really good trades. Imagination and intellect is the only requirement for creating these option trades. Hence before we get deeper into options, it is important to have a strong foundation on these four variants of options. For this reason, we will quickly summarize what we have learnt so far in this module.

Please find below the pay off diagrams for the four different option variants –

Arranging the Payoff diagrams in the above fashion helps us understand a few things better. Let me list them for you –

1. Let us start from the left side – if you notice we have stacked the pay off diagram of Call Option (buy) and Call option (sell) one below the other. If you look at the payoff diagram carefully, they both look like a mirror image. The mirror image of the payoff emphasis the fact that the risk-reward characteristics of an option buyer and seller are opposite. The maximum loss of the call option buyer is the maximum profit of the call option seller. Likewise the call option buyer has unlimited profit potential, mirroring this the call option seller has maximum loss potential
2. We have placed the payoff of Call Option (buy) and Put Option (sell) next to each other. This is to emphasize that both these option variants make money only when the market is expected to go higher. In other words, do not buy a call option or do not sell a put option when you sense there is a chance for the markets to go down. You will not make money doing so, or in other words you will certainly lose money in such circumstances. Of course there is an angle of volatility here which we have not discussed yet; we will discuss the same going forward. The reason why I’m talking about volatility is because volatility has an impact on option premiums

D.            Now, assume that the premium is C_t+n = $ .76 per share at the time you offset your position. What is the profit or loss per share? What is the total profit or loss?

Whether the losses are for the current year or brought forward, you need to declare all of the information on the same page, known as the Trading Losses record. To do this you can use SimpleStep or HMRC Forms mode.

SimpleStep mode

HMRC Forms mode

Go to: CT600 > Computations > Trading losses record

Current year losses for the year

To offset current year losses, enter values in the following boxes:

• Trade loss this year (Box $7.6 CT 2008 / Box 780 CT 2015).
• New losses this year available for relief against other income.
• New losses set off against other profits or chargeable gains of this year.

Losses brought forward total profit or loss

     To offset losses brought forward, enter values in:

• Losses brought forward (total losses brought forward).
• Less: Relieved against trade profits of this year (total amount you wish to offset).

Future year losses

To offset losses for a future year, follow these below:

In the current year return

1. Go to the trading losses record.
2. Enter data for:
   • trade loss this year (Box 7.6 CT 2008/ Box 780 CT 2015)
3. Go to Finalising the return (SimpleStep mode) or CT600 Page 1 (HMRC Forms mode).
4. Go to the trading losses record.
5. Enter data for trading losses of a later accounting period utilised.
6. An automatic row should appear for Trading losses of a later accounting period utilised with the same figure entered.