Calculate and identify option and forward contract payoffs
FRM AIM: Calculate and identify option and forward contract payoffs
Call Option Payoff:
Let,
CT = Payoff on call option
ST = Stock price at maturity
X = Strike price of option
C0 = Call Premium
Payoff on call option to option buyer:
CT = max (0, ST – X)
Profit to Option Buyer:
Profit = CT – C0
Payoff on call option to option seller:
CT = - max (0, ST – X)
Profit to option seller:
Profit = C0 – CT
American Payoff on call option to option buyer:
CT = max (0, St– X) where 0 < t < T
American Payoff on call option to option seller:
CT = - max (0, St– X) where 0 < t < T
Put Option Payoff:
Payoff on put option to option buyer:
Let,
PT = Payoff on put option
ST = Stock price at maturity
X = Strike price of option
P0 = Put Premium
PT = max (0, X- ST)
Profit to Option Buyer:
Profit = PT – P0
Payoff on put option to option seller:
PT = - max (0, X - ST )
Profit to option seller:
Profit = P0 – PT
American Payoff on put option to option buyer:
PT = max (0, X - St) where 0 < t < T
American Payoff on put option to option seller:
PT = - max (0, X – St) where 0 < t < T
Forward Contract Payoff:
Let,
ST = Spot price at maturity
K = delivery price
Payoff to a long position in a forward contract:
Payoff = ST – K
Payoff to a short position in a forward contract:
Payoff = K - ST
Differentiate between options, forwards and future contracts:
FRM AIM: Differentiate between options, forwards and future contracts
Properties Options Contract Forward Contract Futures Contract
Definition Gives option to the buyer to buy(sell) an asset at an agreed upon price in the future Specifies the price and quantity of an asset to be delivered sometime in the future Legalized binding agreement to buy/sell an asset as predetermined time in the future
Is it binding on the buyer to buy/sell the asset at agreed price/date time No No Yes
Where it is traded OTC and Exchange OTC and Exchange Exchange, Commodities market
Example Options contract used in securities Used in Foreign exchange situations to hedge currency risk Used in commodities market like plane fuel, cotton, rice etc.
