KNOWLEDGE POINT.........................09 APRIL 2011.

UNDERSTANDING THE CONCEPT OF "IN -THE- MONEY OPTION", "OUT OF -THE- MONEY OPTION" & AT -THE- MONEY OPTION" IN OPTION TRADING :-


IN -THE- MONEY OPTION :- IT IS THE OPTION IN WHICH THERE IS POSITIVE CASH FLOW TO THE OPTION HOLDER MEANS THERE WOULD BE PROFIT IN EXERCISING OR SQUARING OFF THE OPTION.


FOR CALL OPTION IS SAID TO BE IN -THE- MONEY OPTION WHEN SPOT PRICE > STRIKE PRICE MEANS,


POSITIVE CASH FLOW TO THE OPTION HOLDER IN CALL OPTION = SPOT PRICE - STRIKE PRICE


FOR PUT OPTION IS SAID TO BE IN -THE- MONEY OPTION WHEN STRIKE PRICE > SPOT PRICE MEANS,


POSITIVE CASH FLOW TO THE OPTION HOLDER IN PUT OPTION = STRIKE PRICE - SPOT PRICE

EXAMPLE :-


IN CASE OF CALL OPTION : SUPPOSE YOU BUY NIFTY 6000 CALL APRIL EXPIRY @ RS. 43 AND ON THE EXPIRY NIFTY SPOT IS CLOSED AT 6175. IN THIS CASE :-

SPOT PRICE = 6175 ON THE EXPIRY
STRIKE PRICE = 6000

SO "FOR CALL OPTION IS SAID TO BE IN -THE- MONEY OPTION WHEN SPOT PRICE > STRIKE PRICE" AND IN THIS CASE THIS OPTION WILL BE IN -THE- MONEY CALL OPTION BECAUSE HERE SPOT PRICE IS GRATER THAN STRIKE PRICE, SO



POSITIVE CASH FLOW TO THE OPTION HOLDER IN CALL OPTION = SPOT PRICE - STRIKE PRICE MEANS, 6175 - 6000 = +175(PROFIT)


IN CASE OF PUT OPTION :- SUPPOSE YOU BUY NIFTY 5800 PUT APRIL EXPIRY @ RS.35 AND ON THE EXPIRY NIFTY SPOT IS CLOSED AT 5715, IN THIS CASE:-


SPOT PRICE = 5715 ON THE EXPIRY
STRIKE PRICE = 5800


SO "FOR PUT OPTION IS SAID TO BE IN -THE- MONEY OPTION WHEN STRIKE PRICE > SPOT PRICE" AND IN THIS CASE THIS OPTION WILL BE IN -THE- MONEY PUT OPTION BECAUSE HERE STRIKE PRICE IS GRATER THAN SPOT PRICE, SO 

POSITIVE CASH FLOW TO THE OPTION HOLDER IN PUT OPTION = STRIKE PRICE - SPOT PRICE MEANS, 5800 - 5715 = +85(PROFIT)


OUT OF -THE- MONEY OPTION :- IT IS THE OPTION IN WHICH THERE IS NEGATIVE CASH FLOW TO THE OPTION HOLDER MEANS THERE WOULD BE LOSS IN EXERCISING OR SQUARING OFF THE OPTION.


FOR CALL OPTION IS SAID TO BE OUT OF -THE- MONEY OPTION WHEN SPOT PRICE < STRIKE PRICE MEANS,

NEGATIVE CASH FLOW TO THE OPTION HOLDER IN CALL OPTION = SPOT PRICE - STRIKE PRICE


FOR PUT OPTION IS SAID TO BE OUT OF -THE- MONEY OPTION WHEN STRIKE PRICE < SPOT PRICE MEANS,


NEGATIVE CASH FLOW TO THE OPTION HOLDER IN PUT OPTION = STRIKE PRICE - SPOT PRICE

EXAMPLE :-


IN CASE OF CALL OPTION : SUPPOSE YOU BUY NIFTY 6000 CALL APRIL EXPIRY @ RS. 43 AND ON THE EXPIRY NIFTY SPOT IS CLOSED AT 5910. IN THIS CASE :-

SPOT PRICE = 5910 ON THE EXPIRY
STRIKE PRICE = 6000

SO "FOR CALL OPTION IS SAID TO BE OUT OF -THE- MONEY OPTION WHEN SPOT PRICE < STRIKE PRICE" AND IN THIS CASE THIS OPTION WILL BE OUT OF -THE- MONEY CALL OPTION BECAUSE HERE SPOT PRICE IS LESS THAN STRIKE PRICE, SO


NEGATIVE CASH FLOW TO THE OPTION HOLDER IN CALL OPTION = SPOT PRICE - STRIKE PRICE MEANS, 5910 - 6000 = -90(LOSS), BUT REAL LOSS IS -43 BECAUSE "IN CASE OF BUYING THE OPTION LOSS IS LIMITED TO THE PREMIUM PAID" AND HERE THE PREMIUM IS PAID RS. 43/-. SO LOSS WILL BE ONLY RS. 43/- ONLY.


IN CASE OF PUT OPTION :- SUPPOSE YOU BUY NIFTY 5800 PUT APRIL EXPIRY @ RS.35 AND ON THE EXPIRY NIFTY SPOT IS CLOSED AT 5850 IN THIS CASE:-


SPOT PRICE = 5850 ON THE EXPIRY
STRIKE PRICE = 5800


SO "FOR PUT OPTION IS SAID TO BE OUT OF -THE- MONEY OPTION WHEN STRIKE PRICE < SPOT PRICE" AND IN THIS CASE THIS OPTION WILL BE OUT OF -THE- MONEY PUT OPTION BECAUSE HERE STRIKE PRICE IS LESS THAN SPOT PRICE, SO 

NEGATIVE CASH FLOW TO THE OPTION HOLDER IN PUT OPTION = STRIKE PRICE - SPOT PRICE MEANS, 5800 - 5850 = -50(LOSS) BUT REAL LOSS IS -35 BECAUSE "IN CASE OF BUYING THE OPTION LOSS IS LIMITED TO THE PREMIUM PAID" AND HERE THE PREMIUM IS PAID RS. 35/-. SO LOSS WILL BE ONLY RS. 35/- ONLY.


AT -THE- MONEY OPTION :- IT IS THE OPTION IN WHICH THERE IS NO CASH FLOW TO THE OPTION HOLDER MEANS ZERO CASH FLOW WILL BE THERE MEANS NO PROFIT AND LOSS WILL BE THERE, YOU WILL LOSE ONLY YOUR BUYING COST.


FOR CALL OPTION / PUT OPTION ARE SAID TO BE AT -THE- MONEY OPTION WHEN SPOT PRICE = STRIKE PRICE.


EXAMPLE :- 


IN CASE OF CALL OPTION : SUPPOSE YOU BUY NIFTY 6000 CALL APRIL EXPIRY @ RS. 43 AND ON THE EXPIRY NIFTY SPOT IS CLOSED AT 6000. IN THIS CASE :-

SPOT PRICE = 6000 ON THE EXPIRY
STRIKE PRICE = 6000

SO "FOR CALL OPTION IS SAID TO AT -THE- MONEY OPTION WHEN SPOT PRICE = STRIKE PRICE" AND IN THIS CASE THIS OPTION WILL BE AT -THE- MONEY CALL OPTION BECAUSE HERE SPOT PRICE IS EQUAL TO THE STRIKE PRICE, SO


ZERO CASH FLOW TO THE OPTION HOLDER IN CALL OPTION = SPOT PRICE - STRIKE PRICE MEANS, 6000 - 6000 = 0(ZERO), BUT YOU WILL LOSE YOUR WHOLE BUYING COST WHICH IS RS. 43/-. ONLY.


IN CASE OF PUT OPTION :- SUPPOSE YOU BUY NIFTY 5800 PUT APRIL EXPIRY @ RS.35 AND ON THE EXPIRY NIFTY SPOT IS CLOSED AT 5800, IN THIS CASE:-


SPOT PRICE = 5800 ON THE EXPIRY
STRIKE PRICE = 5800


SO "FOR PUT OPTION IS SAID TO BE AT -THE- MONEY OPTION WHEN STRIKE PRICE = SPOT PRICE" AND IN THIS CASE THIS OPTION WILL BE AT -THE- MONEY PUT OPTION BECAUSE HERE STRIKE PRICE IS EQUAL TO THE SPOT PRICE, SO 


ZERO CASH FLOW TO THE OPTION HOLDER IN PUT OPTION = STRIKE PRICE - SPOT PRICE MEANS, 5800 - 5800 = 0(ZERO), BUT YOU WILL LOSE YOUR WHOLE BUYING COST WHICH IS RS. 35/- ONLY.