Question

QUESTION 5
5.1 An options contract is an agreement between a buyer and seller that gives the purchaser of the option the
right to buy or sell a particular asset at a later date at an agreed upon price. Options contracts are often used
in securities, commodities, and real estate transactions. There are several reasons an investor would use
options.
Explain in detail how each of the following factors attract the use of option contracts:
5.1.1 Speculation
5.1.2 Hedging
5.1.3 Spreading
5.1.4 Creating synthetic positions.
5.2 Explain FOUR (4) differences between a forward contract and a future contract.

Answer 1

5.1.1 SPECULATION:-​​​​​​Option Contract can be used to earn money by speculation. Speculation consist of a trader who keep on eye on the market and assest whether there is chnage in the price on the stock market

Potion contract could he purchased which allow to buy a stock at the price of future. By this means , you could make money on the price difference less than what you paid for the option

5.1.2 Hedging:- It helps to eliminate any kind of rise in the stock market. It focus6 more protecting the money than making profit.

Option contact can be user to hedge agaist risk on the stock market. For making this work, two investment are made where when one investment falls in value, the other investments must rise.

5.1.3 Spreading :- Spreading is an strategy which helps to purchase one option and the sell of another option with different strike prices. It basically helps to lower the risk and the cost .

​​​​​ 5.1.4 Creating Synthetic position :- it is created to stimulate reward and risk as that of comparable position. Synthetic position could be created in option contact to swap position when there is change in expectations. In synthetic position, frequent transaction is not necessary as the existing position changes inti synthetic form as per the expectations.