Friday, February 22, 2013

Excellent Trading School - 9 - Options Basics

Options Contracts: Options give the buyer (holder) a right but not an obligation to buy or sell an asset in future. Options are of two types - calls and puts.

Calls give the buyer the right but not the obligation to buy a given quantity of the underlying asset, at a given price on or before a given future date.

 Puts give the buyer the right, but not the obligation to sell a given quantity of the underlying asset at a given price on or before a given date. One can buy and sell each of the contracts.

When one buys an option he is said to be having a long position and when one sells he is said to be having a short position.

The margining system for F&O segment is explained below:
• Initial margin: Margin in the F&O segment is computed by NSCCL (National Securities Clearing Corporation Ltd) upto client level for open positions of Clearing Members/Trading Members. These are required to be paid up-front on gross basis at individual client level for client positions and on net basis for proprietary positions.

NSCCL collects initial margin for all the open positions of a Clearing Member based on the margins
computed by NSE-SPAN. A Clearing Member is required to ensure collection of adequate initial margin from his Trading Member and his respective clients. The Trading Member is required to collect adequate initial margins up-front from his clients.

• Premium margin: In addition to initial margin, premium margin is charged at client level. This margin is required to be paid by a buyer of an option till the premium settlement is complete.

• Assignment margin: Assignment margin is levied in addition to initial margin and premium margin. It is required to be paid on assigned positions of Clearing Member towards exercisesettlement obligations for option contracts, till such obligations are fulfilled. The margin is charged on the net exercise settlement value payable by a Clearing Member.

SPAN approach of computing initial margins: The objective of SPAN is to identify overall risk in a portfolio of futures and options contracts for each member. The system treats futures and options contracts uniformly, while at the same time recognizing the unique exposures associated with options portfolios like extremely deep out-of-the-money short positions, inter-month risk and inter-commodity risk.

Because SPAN is used to determine performance bond requirements (margin requirements), its overriding objective is to determine the largest loss that a portfolio might reasonably be expected to suffer from one day to the next day.

In standard pricing models, three factors most directly affect the value of an option at a given point in time:
1. Underlying market price
2. Volatility (variability) of underlying instrument
3. Time to expiration
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