Options

Elements of an Options Contract

Fundamentals

  • Amount
    The contract will specify a notional principal amount, which represents the face value of the Option.
  • Premium
    To obtain the benefits of holding an Option, the buyer pays a premium to the writer or seller of the Option.
  • Call Option
    A Call Option gives the buyer the right to purchase the underlying asset.
  • Put Option
    A Put Option grants the buyer the right to sell the underlying asset.
Amount

Strike or Exercise Price

  • The strike price is the predetermined price at which the Option can be exercised. For instance, the strike price on an Option on a futures contract might be 92.50 (equivalent to a yield of 7.5% per annum) or an exchange rate of 0.8500 USD per EVR. An Option with a strike price equal to the underlying asset's current cash or spot price is known as an 'at-the-money' Spot Option. If the strike price matches the forward price of the underlying asset, it is referred to as an 'at-the-money-forward' Option. A holder will exercise the Option only if it is profitable, meaning the strike price is more favourable than the cash or spot price. This situation is described as 'in-the-money'. Conversely, if it is not profitable, the Option is 'out-of-the-money'.
Strike or Exercise Price

Exercise Date

The exercise date is when the Option can be exercised. There are three standard types of Option contracts that treat the exercise date differently:

  • American Option: Allows the buyer to exercise the Option at any time, including the expiry date.
  • European Option: Permits the buyer to exercise the Option only on the expiry date.
  • Bermudian Option: A hybrid, allowing exercise on specific dates or during specified periods within the contract term.
Exercise Date

Interest Rate Options

  • You can engage in various Options, including interest rate and Currency Options.
  • Interest Rate Options
  • An interest rate Option gives the buyer the right, but not the obligation, to set the interest rate on a notional deposit or loan or fix the price of an instrument such as a futures contract or security at a future date. This protects the buyer from adverse interest rate movements while allowing them to benefit from favourable changes.
  • Bond Options
  • A bond Option grants the buyer the right to buy or sell a specific fixed or floating interest rate security at a set rate on or before a future date.
  • Caps
  • An interest rate cap agreement allows borrowers with floating-rate debt to limit their interest rate exposure. The seller compensates the borrower for interest costs exceeding the cap level based on a stated notional principal amount. The buyer pays a premium, which may be a percentage of the principal value or a fixed amount.
  • Floors
  • An interest rate floor agreement operates similarly to a cap but in reverse. It is an Option where the seller receives a premium in exchange for surrendering the right to borrow at a lower rate if market interest rates fall below a certain level.
  • Collars
  • A collar combines a purchased cap and a written floor agreement (or vice versa). A borrower who purchases a cap and simultaneously writes a floor with the same party is protected against rising interest rates while preceding the benefits of rates falling below the floor level. The cost of a collar is typically lower than a standalone cap, as the premium paid for the cap is offset by the premium received for the floor.

Currency Options

  • A Currency Option allows the buyer to exchange two currencies at a fixed rate on a future date. Currency Options are used for:
  • Import or Export Cover: Protects against uncertain foreign exchange cashflows by hedging against downside risk.
  • Contingent Currency Exposures: Cover potential exposures, such as foreign currency tenders. If the exposure does not materialise, the loss is limited to the premium paid. The Option can also be resold for its residual value.
  • Balance Sheet Protection: Shields against adverse currency movements affecting the balance sheet's value of assets and liabilities.

Currency Options Vs Forward Foreign Exchange Contracts

  • Currency Options
  • A currency option grants the holder (buyer) the right, but not the obligation, to buy or sell a currency within an agreed period. The loss for the holder of a currency option is limited to the premium paid for the option. This financial instrument enables the holder to benefit from favorable currency movements while providing protection against adverse movements.
  • Forward Exchange Contracts
  • In contrast, a forward exchange contract obligates the holder to buy or sell a currency at a specified future date. This type of contract offers protection only from unfavorable currency fluctuations.

Other types of Options

Swaptions

  • A Swaption is an option on a swap, giving the buyer the right to enter into a swap at a future date without obligation. This financial derivative allows the buyer to hedge against interest rate fluctuations or to speculate on future interest rate movements. Swaptions can be categorised as either payer swaptions, which give the right to enter a swap as a fixed-rate payer, or receiver swaptions, which grant the right to enter a swap as a fixed-rate receiver.
Import or Export Cover

Barrier Options

  • Barrier Options have a payout dependent not just on the final price of the underlying asset but also on whether the asset trades at or beyond a specific barrier price during the option’s life. They can be classified as knock-in options, which activate upon reaching the barrier, or knock-out options, which become void if the barrier is breached.
Contingent Currency Exposures

Average Price Options

  • Average Price Options have a settlement value based on the difference between the strike price and the average price of the underlying asset (such as a stock, index, interest rate, or exchange rate) on specified dates or periods during the Option’s term.

For more details, please get in touch with us at derivatives@hdfc.bank.in

Balance Sheet Protection

More About Options Trading

The type of risk generated by options differs from most other financial instruments. The market risk for a holder of an option is limited to the amount of premium paid. Once that cost has been met, the buyer of an option has no further obligations. The exposure that remains for the buyer is the credit risk that the writer of that option will not meet his or her obligations upon exercise of the option. In contrast, the writer of an option gains the amount of premium received but bears an unlimited exposure to market risk, since there is an obligation to fulfil the option contract at the exercise price regardless of market price. The writer is not, however, exposed to credit risk once the premium has been received.

The following are the key features of Option Trading

Wide Range of Options: Access to Index, Stock, And Currency Options contracts.

Advanced Trading Platforms: Real-time data, analytics, and trading tools.

Leverage: Maximise returns with greater exposure and smaller capital outlay.

Risk Management Tools: Includes stop-loss orders, margin trading, and automated alerts.

Competitive Pricing: Conduct cost-effective trading with competitive brokerage fees.

Expert Research and Insights: Access to expert reports, market insights, and trading strategies.

Educational Resources: Webinars, tutorials, and seminars for enhanced understanding.

Dedicated Support: Assistance from HDFC Bank’s trading experts.

Flexibility: Implement various trading strategies like hedging and speculation.

Seamless Integration: Easy fund transfers and account management with HDFC Bank accounts.

Real-Time Market Data: Live streaming quotes and market data updates.

Customisable Interface: User-friendly and customisable trading interface.

HDFC Bank’s Option trading platform provides a comprehensive and efficient trading experience, catering to both novice and experienced traders.

Options offer flexibility in investment strategies, allowing for potential profit in rising and falling markets. They provide leverage, enabling significant exposure with a small investment. Additionally, Options can be used to hedge against market volatility, protecting other investments.

To apply for Options trading, you can follow these general steps

Open a Brokerage Account: Choose a reputable broker and open an account. Ensure the broker offers Options trading facilities.

Complete the Application: Fill out the Options agreement form, which assesses your trading experience and financial capability.

Approval: Wait for the broker to review and approve your application based on your qualifications for Options trading.

Start Trading: Once approved, you can begin trading Options by placing orders through your brokerage’s platform.

Frequently Asked Questions

An Option is a financial contract that grants the buyer (or holder) the right, but not the obligation, to buy or sell a specified amount of an underlying asset at a predetermined price on or before a specified future date.

In contrast, the seller of the Option is obligated to fulfill the terms of the contract if the buyer decides to exercise their right. For this privilege, the buyer pays the seller (or writer) a premium, which represents the Option's price. Unlike Futures or Forward contracts, where the holder is required to complete the transaction, exercising an Option is entirely at the holder's discretion.

Options trading entails financial derivatives that give buyers the right, but not the obligation, to buy or sell an asset at a set price on or before a certain date. They’re used for hedging or speculation in markets.

Options are contracts that give the Option holder the right to trade an asset at a predetermined price within a specific timeframe. The holder can exercise this right depending on market conditions and investment strategy. Options are often used to hedge against potential losses in other investments or to speculate on future price movements of assets.

The three main types of Options trading instruments are:

  • Call Options - Gives the holder the right to buy an asset.
  • Put Options - Allows the holder to sell an asset.
  • Binary Options - Offers a fixed payout based on a yes/no proposition.