Chapter 8: Summary

Let's recap some key points in this section:

• An option is a contract for the right to determine whether to enforce a purchase/sales agreement for an underlying asset.
• Call option holder has the right to buy the underlying asset at the strike price on expiry date (i.e. European Option) / at any time before expiry (i.e. American Option).
• Call option writer has the obligation to sell the underlying asset at the strike price whenever the call is exercised.
• Put option holder has the right to sell the underlying asset at the strike price on expiry date (i.e. European Option) / at any time before expiry (i.e. American Option).
• Put option writer has the obligation to buy the underlying asset at the strike price whenever the put is exercised.
• Basic option strategies: 1) long call, 2) short call, 3) long put, 4) short put.
• The upside potential of long call (put) can be theoretically unlimited (substantial). The associated risk is limited (i.e. losing the premium invested).
• The upside potential of short call (put) is limited (i.e. maximum profit is the premium received). The associated risk can be theoretically unlimited (substantial).
• The most important elements of an option contract are 1) Underlying Asset, 2) Type, 3) Strike Price (Exercise Price), 4) Expiry Date, 5) Exercise Style, 6) Contract Size, and 7) Settlement Style.
• Two main reasons to use options: 1) to profit from a market view, 2) to hedge underlying stocks against downside.
• Option premium is the price of the option trade at. It has two components: Intrinsic Value and Time Value.
• Intrinsic value is affected by underlying price, while time value is affected by time to maturity and volatility of the underlying asset.
• There are six factors which affects the value of option premium. The effect of each factor, keeping other factors constant, is summarised below:

  Factor	Change in Factor	Change in Call Premium	Change in Put Premium
  Underlying Price
  Strike Price
  Time to Expiry*
  Volatility
  Dividend
  Interest Rate

  *Not necessarily true for deep in-the-money or deep out-of-the-money options

• Counterparty risks of exchange-traded options are minimised as the options contracts are cleared by clearing houses.
• At Hong Kong Exchanges and Clearing Limited (HKEX), The SEHK Options Clearing House (SEOCH) is responsible for clearing stock options while HKFE Clearing Corporation Limited (HKCC) is responsible for clearing index options.
• Margin deposits are required for all short option positions.