Advantages of Investing in Options
- It provides the opportunity to profit from the rise and fall in the stock price without buying stocks.
- Since options contract is leveraged instrument, it offers the opportunity to earn much higher profits with low investments compared to the spot market.
- Standardized options contracts are highly liquid.
- Options contracts offer protection opportunities that are not available in the spot market, through strategies to be applied correctly for investors.
Disadvantages of Investing in Options
- Since options contract is leveraged instrument, it is more likely to incur losses from investments much faster than in the spot market.
- For long position holder, the risk of the option is limited with premium paid. However, the risk can be unlimited for short position holder.
- If there are many contracts for strike prices in option contracts, liquidity problem arises except for commonly used contracts and the difference between bid/ask spreads (bid/ask spread) also grows. This situation makes closing position and profit realization difficult.
- Considering the differences between commission paid and the buy-sell price offers, it can be said that trading in the options market is more costly than the spot market.
An option premium consists of two components, namely, intrinsic value and time value:
Intrinsic value is equal to the difference between the spot market price of the underlying asset and the strike price of the option. Time value is essentially the price that the option buyer has determined for the uncertainty of the underlying asset’s (equity’s) price. Assuming that the investor pays a premium of TL 0.8 for an option contract written on an underlying asset (equity) with a spot price of TL 10, and strike price of TL 9.5; TL 0.5 (=10-9.5) is the intrinsic value, and the remaining TL 0.3 is the time value of the option. Pricing of option contracts changes depending on the type and kind of the option, and the model used.
Factors Influencing Option Prices
Price of the Underlying Asset There is a positive correlation between the price of the underlying asset and the price of a call option, whereas the correlation between the price of the underlying asset and the price of a put option is negative. As the price of the underlying asset rises, the price of a call option increases, and that of a put option decreases.
Strike Price
There is a negative correlation between the strike price of an option and the price of a call option, whereas the correlation between the strike price of an option and the price of a put option is positive. As the strike price increases, a call option will buy the underlying asset at a higher price, and therefore, a call option depreciates, whereas a put option will sell the underlying asset at a higher price, so a put option appreciates.
Days to Expiry
For American options, there is a positive correlation between the days to expiry and both call and put options. As the days to expiry increases, the price of both call and put options increases. The closer an American option gets to the end of expiry, the cheaper it gets. In the case of European options, on the other hand, the effect of days to expiry on the option price may be in the opposite direction.
Volatility
There is a positive correlation between the volatility of an underlying asset and the value of both call and put options. As the volatility of the underlying asset increases, both call and put options appreciate.
Market Interest Rate
There is a positive correlation between the interest rate and the value of a call option, and a negative correlation between the interest rate and the value of a put option. As the interest rate increases, call options appreciate, whereas put options depreciate.
Dividend
If the underlying asset is an equity, there is a negative correlation between the dividend of such equity and the price of call options, and a positive correlation between the dividend of such equity and the price of put options. As the dividend payable until expiry increases, a call option depreciates, and a put option appreciates.
Factors Influencing Option Price
| Call Option’s Value (American) | Put Option’s Value (American) | Call Option’s Value (European) | Put Option’s Value (European) | |
|---|---|---|---|---|
|
Underlying Asset’s Price |
+ |
- |
+ |
- |
|
Strike Price |
- |
+ |
- |
+ |
|
Days to Expiry |
+ |
+ |
+ |
+ |
|
Volatility |
+ |
+ |
+ |
+ |
|
Market Interest Rate |
+ |
- |
+ |
- |
|
Dividend |
- |
+ |
- |
+ |
The investor who buys the option contract does not buy the underlying stock, but acquires the right to buy or sell the stock. Therefore investor cannot entitle the followings;
- The dividend right provided by the shares
- The right to buy new shares (preemptive right)
- The right to participate in the liquidation balance
- The right to participate in company management
- The right to vote and access information
The shares are theoretically considered to last indefinitely. Option contracts, on the other hand, are valid for much shorter periods.
Stocks can be issued in a limited amount while options can be issued many times depending on supply and demand.
Options may not be a suitable investment instruments for all types of investors due to the leverage effect. Although this investment instrument which is time sensitive can be risky, it is a very flexible financial instrument that can provide risk control.
Legal Warning: "The Option Calculator was created by utilizing a calculation method that is widely used today in pricing American type options. The values to be calculated are purely theoretical and are based on the assumptions of the model and the values entered by the investors. Although utmost care has been taken in the creation of the calculator, Borsa İstanbul cannot be held legally responsible for the errors that may occur in the calculation results or the investment decisions to be taken based on the results obtained using the calculator, and the results thereof."
