Q1: What is an option?
Q2: What are call options?
Q3: What are put options?
Q4: What is an underlying?
Q5: What is an option premium?
Q6: What is an expiration date?
Q7: What is a strike price or an exercise price?
Q8: What is an option holder?
Q9: What is an option seller or option writer?
Q10: What is the intrinsic value of an option?
Q11: Explain Time Value with reference to Options.
Q12: What does it mean when an option is in-the-money?
Q13: What does it mean when an option is out-of-the-money?
Q14: What does it mean when an option is at-the-money?
Q15: What are European & American Style of options?
Q16: Explain the options Greeks.
Q17: What is SPAN?
Q18: What is PC SPAN?
Q19: What the different types of margins?
Q20: What is an Initial Margin?
Q21: What is a Maintenance Margin?
Q22: What is a long straddle?

Q1: What is an option?

A: An option is a contract, which gives the buyer (holder) the right, but not the obligation, to buy or sell a specified quantity of the underlying assets, at a specific (strike) price on or before a specified time (expiration date). The underlying may be physical commodities such as wheat/ rice/ cotton/ gold/ oil or financial instruments like equity stocks/ stock index/ futures etc. An example of an option contract is the Hang Seng Index option.

Q2: What are call options?

A: A call option gives the holder, the right to buy specified quantity of the underlying asset at the strike price on or before expiration date. The seller however, has the obligation to sell the underlying asset if the buyer of the call option decides to exercise his option to buy. The buyer of a call option pays a premium to the seller of a call option to have this right. For example, a buyer purchases a Hang Seng Index September call option at the strike price of 20000. The buyer pays a premium of HKD300. Upon expiry, if the Hang Seng Index price reaches 21000, the buyer can exercise his right to buy the underlying at 20000 and profit from this trade.

Q3: What are put options?

A: A Put option gives the holder the right to sell a specified quantity of the underlying asset at the strike price on or before the expiry date. The seller of the put option however, has the obligation to buy the underlying asset at the strike price if the buyer decides to exercise his option to sell. Say for example a buyer purchases a Hang Seng Index September put option at the strike price of 20000. The buyer pays a premium of HKD900. Upon expiry, if the Hang Seng Index price falls to 19000, the buyer can exercise his right to sell the underlying at 20000 and profit from this trade.

Q4: What is an underlying?

A: An underlying is the specific security or asset on which an options contract is based.

Q5: What is an option premium?

A: An option premium is the price paid by the buyer to the seller to acquire the right to buy or sell. It's basically the sum of the option's intrinsic and time value. However, part of the option's premium is a function of how volatile the option is.

Q6: What is an expiration date?

A: The expiration date is the date the option expires. Functionally, expiration dates are always the third Friday of the month.

Q7: What is a strike price or an exercise price?

A: The strike or exercise price of an option is the specified or pre-determined price of the underlying asset at which the same can be bought or sold if the option buyer exercises his right to buy/ sell on or before the expiration day.

Q8: What is an option holder?

A: An option holder is the one who buys an option which can be a call or a put option. He enjoys the right to buy or sell the underlying asset at a specified price on or before specified time. His upside potential is unlimited while losses are limited to the Premium paid by him to the option writer.

Q9: What is an option seller or option writer?

A: An option seller or option writer is one who is obligated to buy (in case of Put option) or to sell (in case of call option), the underlying asset in case the buyer of the option decides to exercise his option. His profits are limited to the premium received from the buyer while his downside is unlimited.

Q10: What is the intrinsic value of an option?

A: The intrinsic value is the in-money portion of an option's premium. A call option has intrinsic value if the underlying price of the underlying security is ABOVE the option's strike price. A put option has intrinsic value if the underlying price is BELOW the strike price.

Q11: Explain Time Value with reference to Options.

A: Time value is the amount option buyers are willing to pay for the possibility that the option may become profitable prior to expiration due to favourable change in the price of the underlying. An option loses its time value as its expiration date nears. At expiration an option is worth only its intrinsic value. Time value cannot be negative.

Q12: What does it mean when an option is in-the-money?

A: A call option is in-the-money if the share price of the stock underlying the option is ABOVE the strike price. A put option is in-the-money if the share price of the stock underlying the option is BELOW the strike price.

Q13: What does it mean when an option is out-of-the-money?

A: A call option is out-of-the-money if the share price of the stock underlying the option is BELOW the strike price. A put option is out-of-the-money if the share price of the stock underlying the option is ABOVE the strike price.

Q14: What does it mean when an option is at-the-money?

A: An option is at-the-money when the underlying price is equal to that of the option’s exercise price.

Q15: What are European & American Style of options?

A: An American style option is the one which can be exercised by the buyer on or before the expiration date, i.e. anytime between the day of purchase of the option and the day of its expiry. The European kind of option is the one which can be exercised by the buyer on the expiration day only & not anytime before that. Majority of the index options are European Style options.

Q16: Explain the options Greeks.

A: The price of an Option depends on certain factors like price and volatility of the underlying, time to expiry etc. The option Greeks are tools that measure the sensitivity of the option price to the above mentioned factors. These Option Greeks include the delta, gamma, vega, theta and rho.

• Delta: measures the estimated change in option premium/price for a change in the price of the underlying.
• Gamma: measures the estimated change in the Delta of an option for a change in the price of the underlying.
• Vega: measures the estimated change in the option price for a change in the volatility of the underlying.
• Theta: measures the estimated change in the option price for a change in the time to option expiry.
• Rho: measures the estimated change in the option price for a change in the risk free interest rates.

Q17: What is SPAN?

A: Standard Portfolio Analysis of Risk (SPAN) is a worldwide acknowledged risk management system developed by Chicago Mercantile Exchange (CME). It is a portfolio-based margin calculating system adopted by all major Derivatives Exchanges. The objective of SPAN is to identify overall risk in a complete portfolio of futures and options at the same time recognising the unique exposures associated with both inter-month and inter-commodity risk relationships. It determines the largest loss that a portfolio might suffer with in the period specified by the exchange i.e may be a day (or) two. At the same time members can also calculate margin requirements of their clients by using PC SPAN.

Q18: What is PC SPAN?

A: PC-SPAN is an easy to use program for PC's which calculates SPAN margin requirements at the members' end. How PC SPAN works: Each business day the exchange generates risk parameter file (parameters set by the exchange) which can be down loaded by the member. The position file consisting of members' trades (own + clients) and the risk parameter file has to be fed into PC-SPAN for calculation of Margins payable for the trades executed.

Q19: What the different types of margins?

There are two types of margins, namely the Maintenance Margin and Initial Margin. The margin for options is calculated using PC-SPAN.

Q20: What is an Initial Margin?

The initial margin or original deposits are fund required to be placed by the customer with the Corporate Member at the initiation of the trade. This is required under the Rules to secure customers’ obligations arising from positions held. This margin may be in the form of cash or other assets that are prescribed by SGX-DT.

Upon liquidation of the position by offsetting it with an opposite trade, the margin will be returned to the customer after considering the profits or losses incurred for the trade.

Q21: What is a Maintenance Margin?

Maintenance margin is the minimum required level of margin the customer must maintain in his account at all times in order to support the trade.

Q22: What is a long straddle?

A: A Long Straddle is a combination of buying a Call and buying a Put on the same underlying, both with the same strike price and expiration. Together, they produce a position that should profit if the underlying makes a big move either up or down. Typically, investors buy the straddle because they predict a big price move and/or a great deal of volatility in the foreseeable future.