For some reason (which was announced on the loud speaker and I couldn’t follow) the flight was delayed. The temperature within the airport seemed to have dropped suddenly or was it just my feeling? Felt chilly but tried my best to bare the cold – sometimes you just kind of challenge yourself to see the extreme limits and test yourself. Finally I had to give in and pull on my favourite red school sweater. I saw a few Indian faces near the boarding area – a couple of elderly ladies with their grandchildren; some single guys (probably traveling like me), a pretty north Indian couple buried reading books; there was a group of French people and the rest were either British or Americans.
Half an hour later we were on our way; thankfully this time my seat was on the aisle; yippee I needn’t depend on two other people for taking a walk! The flight was good but the veggie food was not good – I could hardly eat the main dish – was some form of mashed food which had a weird sweetish taste that tickled by vomit sensors. The good part of the meal was that there was a kitkat chocolate! The non veg chicken meal that my two neigbours were relishing on tempted me. The guy to my immediate right, a chap with signs on Chinese origin, enjoyed whatever food was given throughout the flight – he enjoyed every morsel of food and every drop of drink. I was quite amazed – very rarely can you find someone like that who enjoys all their meals on flight.
Though the flight departed 30 minutes late we reached Newark on time. We had a couple of forms to fill up during the flight – customs form and I94 card. The cards were relatively simple to complete; the only issue I had was that there was a severe constraint on length of name! It was around 10pm when we stepped out of the flight and on to US soil (or rather stepped on to the airport concrete). There was a long queue at the immigration counter. During the flight I had weird thoughts running in my mind – what if I didn’t have some document that they asked for? – would they send me back? Would they pay for my ticket? What would my company do then? It was interesting to conjecture some situations! After about 45 minutes in line I was just one person away from the immigration officer – but alas – the guy before me got into some problems; perhaps nonchalant way of answering the questions aroused suspicion – he wasn’t even able to say how long he would stay in the US; he was most likely a student but his interview went for 15 minutes. And then the officer took him to a backroom where he would probably be questioned by some other superior officer to ensure that he was no threat. The officer returned and called me over – fortunately or unfortunately nothing of what I imagined happened; things went straightforward and my I94 was stapled to the passport and returned back. My colleagues were kept waiting for an hour now! People had told me to check the date stamped on the I94 before leaving the immigration counter – oh; I almost forgot about that and started hunting for a date on the card but could find none. Just when I thought I’d go back and ask I found a hand scrawled date which suited me perfectly.
They charged $3 for a trolley – nice way to make money; I wonder why they didn’t start this policy in other airports as well. $3 per trolley was certainly a lot of money! It was optional to take a trolley but invariably everyone would need one. Since I was held up for an hour I didn’t have to wait for my check-in baggage to arrive – it was already there on the floor.
Customs didn’t take any time and in a couple of minutes I located my colleagues who were waiting for me. A gentle cool breeze welcomed me to the US.
Sunday, April 29, 2007
Friday, April 20, 2007
How did he make 15k in two days?
Puzzle we left off with in the last edition:
A colleague made a whopping Rs. 15,000 in one day by trading in options. He did so without exercising the option. Any guess as to how he did it?
Before answering that we missed one term in the last edition.
Strike price: In our example of land, the strike price was Rs. 5 lakhs - we told the seller that we are paying this premium to buy the land for Rs. 5 lakh at a later date.
So how did my colleague do it?
Let's say we have a stock which trades at Rs. 3800. My friend feels that this price is surely going to rise in a month - possibly to somwhere around Rs. 4100 and so he checks on what options are available for that stock.
He finds one with a 1 month duration with strike price of Rs.4000.
There are people who are willing to take a risk and sell options - they feel the opposite - that the stock price will go down further - so they want to make some money through premiums. Now there are a group of potential buyers - and they would kind of bid against one another to buy the option. It is all based on supply and demand - many people want to buy means that many feel the price will go up - and since demand is more the premium price will also go high.
Let's say the premium was Rs.50 per share (not many people expect that it will go up by 200).
Options are sold in lots (i.e. in bulk amounts of 100 or 200 shares). So my friend buys the option for 200 shares at a premium of Rs. 50 per share. Total money he pays is Rs. 10,000.
So he has bought options for a stock at a strike price of Rs. 4000 with a premium for Rs. 50 - which means he expects the stock price within one month to rise above Rs.4050 (only then will he make some profit).
On Monday due to some positive news in the market the stock price climbs up to Rs.3900 ?(up by Rs.100). Now more people start realizing that this stock could well cross the 4000 mark and so they scamper to buy the option at strike price of 4000. Since buyers are more the premium goes up. It might have gone up from 50 to 150 per stock since people now feel it might really shoot up.
My friend now has two options - wait till the price crosses the 4000 mark and then exercise the option. So if at the end of the option duration the stock price is 4001 then he makes a profit of Rs.1 per stock. Total profit = Rs.1 * 200 = Rs.200
Or he could square off his position - meaning that he now sells the option to someone else; since the premium is now 150 (while he gave a premium of only 50) he makes a profit of 100 per stock. Total money made = Rs.100 * 200 = Rs. 20,000.
Wow you say; that's a quick way to make huge amount of money. Everything is not rosy of course - on the downside; suppose my friend sells his option and at the end of the duration of the option the markey price might have become 4500.
Now the person who bought the option from my friend will think, "I paid 150 as premium for a strike price of Rs. 4000. So effectively I will make profit when the market price crosses 4150 mark. Now it is 4500 which meanuls I make a profit of 350 per option for a total of Rs.350 * 200 = Rs. 70,000". So the guy sees that he can make a huge profit and will enforce (exercise) the option. Since my friend was the seller of the option he has to either buy 200 stocks from the market and give it to the buyer at the rate of 4000 or he has to pay the Rs. 70,000 difference between current market price and strike price.
ERRATA (21 August 2007): There's a catch; in the above case my friend will not have to pay the other guy - instead it will be the first guy who sold the option who will be held liable. Whenever one does a buy and sell of an option (square off) then you are not considered as being the creator of the option. If you sell an option without having bought it then you are the initiator of the option - this is possible and this is how options originate. How can you sell without buying? An option just means that you are telling a person "give me an advance now and I shall guarantee to give you the stock in future at the strike price irrespective of the market price at that time". So you can sell an option without ever buying one but in this case you end up with unlimited liability. If my friend had sold the option without having bought it he would've been exposed to unlimited liability and will need to pay the 70k.
So you can see that the losses are unlimited for the seller of options but for the buyer the worst case would be losing his premium if he finds that the prices are going in an unfavourable direction.
And that is similar to what my friend did to earn a large sum in 2 days.
A colleague made a whopping Rs. 15,000 in one day by trading in options. He did so without exercising the option. Any guess as to how he did it?
Before answering that we missed one term in the last edition.
Strike price: In our example of land, the strike price was Rs. 5 lakhs - we told the seller that we are paying this premium to buy the land for Rs. 5 lakh at a later date.
So how did my colleague do it?
Let's say we have a stock which trades at Rs. 3800. My friend feels that this price is surely going to rise in a month - possibly to somwhere around Rs. 4100 and so he checks on what options are available for that stock.
He finds one with a 1 month duration with strike price of Rs.4000.
There are people who are willing to take a risk and sell options - they feel the opposite - that the stock price will go down further - so they want to make some money through premiums. Now there are a group of potential buyers - and they would kind of bid against one another to buy the option. It is all based on supply and demand - many people want to buy means that many feel the price will go up - and since demand is more the premium price will also go high.
Let's say the premium was Rs.50 per share (not many people expect that it will go up by 200).
Options are sold in lots (i.e. in bulk amounts of 100 or 200 shares). So my friend buys the option for 200 shares at a premium of Rs. 50 per share. Total money he pays is Rs. 10,000.
So he has bought options for a stock at a strike price of Rs. 4000 with a premium for Rs. 50 - which means he expects the stock price within one month to rise above Rs.4050 (only then will he make some profit).
On Monday due to some positive news in the market the stock price climbs up to Rs.3900 ?(up by Rs.100). Now more people start realizing that this stock could well cross the 4000 mark and so they scamper to buy the option at strike price of 4000. Since buyers are more the premium goes up. It might have gone up from 50 to 150 per stock since people now feel it might really shoot up.
My friend now has two options - wait till the price crosses the 4000 mark and then exercise the option. So if at the end of the option duration the stock price is 4001 then he makes a profit of Rs.1 per stock. Total profit = Rs.1 * 200 = Rs.200
Or he could square off his position - meaning that he now sells the option to someone else; since the premium is now 150 (while he gave a premium of only 50) he makes a profit of 100 per stock. Total money made = Rs.100 * 200 = Rs. 20,000.
Wow you say; that's a quick way to make huge amount of money. Everything is not rosy of course - on the downside; suppose my friend sells his option and at the end of the duration of the option the markey price might have become 4500.
Now the person who bought the option from my friend will think, "I paid 150 as premium for a strike price of Rs. 4000. So effectively I will make profit when the market price crosses 4150 mark. Now it is 4500 which meanuls I make a profit of 350 per option for a total of Rs.350 * 200 = Rs. 70,000". So the guy sees that he can make a huge profit and will enforce (exercise) the option. Since my friend was the seller of the option he has to either buy 200 stocks from the market and give it to the buyer at the rate of 4000 or he has to pay the Rs. 70,000 difference between current market price and strike price.
ERRATA (21 August 2007): There's a catch; in the above case my friend will not have to pay the other guy - instead it will be the first guy who sold the option who will be held liable. Whenever one does a buy and sell of an option (square off) then you are not considered as being the creator of the option. If you sell an option without having bought it then you are the initiator of the option - this is possible and this is how options originate. How can you sell without buying? An option just means that you are telling a person "give me an advance now and I shall guarantee to give you the stock in future at the strike price irrespective of the market price at that time". So you can sell an option without ever buying one but in this case you end up with unlimited liability. If my friend had sold the option without having bought it he would've been exposed to unlimited liability and will need to pay the 70k.
So you can see that the losses are unlimited for the seller of options but for the buyer the worst case would be losing his premium if he finds that the prices are going in an unfavourable direction.
And that is similar to what my friend did to earn a large sum in 2 days.
Wednesday, April 18, 2007
Day 1 contd - a few hours in one of the largest airports
At Heathrow:
People had forewarned me that the security check at Heathrow will be lengthy. The landing was just as smooth as the take off - felt just a very slight jerk and nothing else. People had forewarned me that the terminals very huge and traversing through them will be time consuming. But I was looking forward to it - stepping out in the open air felt great and I was eager to stretch my legs. The legroom in economy class was not good - my knees were brushing against the seat in front most of the time. And I thought "hey, I'm flying to a land of tall people - why is the legroom so less".
I soon reached the security check area where we had to remove our shoes and let that pass through the scanner in a separate tray (the security check turned out to be a refreshing time for me). I had three hours for my connecting flight and wouldn't know the boarding gate till one hour before departure. The main terminal area was huge - it resembled a shopping mall with a series of shops packed one beside the other. I wandered around in search of a cosy place to sit and write my diary - a board read "Quiet area" and I followed the directions which led me to the extreme end of the terminal where there were plenty of vacant seats and a couple of television sets - aptly named "quiet area"! Just as I was about to sit down near a table I noticed a man seated in a corner facing the window with his back towards me. He made surreptitious glances every minute after flipping through a few pages of a magazine he held. With my height advantage (and filled with curiosity) I managed to catch a glimpse of the magazine - it was an A-magazine. After a couple of minutes (after he had quickly flipped through all the pages), he left the place.
Window shopping:
Ten minutes later I strolled around window shopping - the terminal was huge - it was like a long corridor which didn't have an end in sight. The A-magazine guy was now lying stretched out on the empty seats with his briefcase as a pillow. The terminal was impressive - and this was just one of the many terminals in Heathrow - wow! There was a wide variety of shops selling just about anything you could think of - from napkins to laptops. And along the way I also saw an elegant looking Ferrari (prize for a lottery). I had lost my appetite towards the end of the journey but the fresh bakery smell and arousing smell of fish tempted me. My appetite was back but I didn't want to take a risk during travel - perhaps on my return I would indulge in a few of the restaurants there. There were sandwiches, lobsters, a range of wines, plenty of chocolates - oooh - so very tempting.
I noticed that 1 in every 20 was working on a laptop and probably 1 in every 15 carried one. Technology is certainly becoming cheaper aned more accessible to everyone now. Window shopping was fun and many of the shops were staffed by pretty and handsome Indians who by now were probably holding British passports.
People had forewarned me that the security check at Heathrow will be lengthy. The landing was just as smooth as the take off - felt just a very slight jerk and nothing else. People had forewarned me that the terminals very huge and traversing through them will be time consuming. But I was looking forward to it - stepping out in the open air felt great and I was eager to stretch my legs. The legroom in economy class was not good - my knees were brushing against the seat in front most of the time. And I thought "hey, I'm flying to a land of tall people - why is the legroom so less".
I soon reached the security check area where we had to remove our shoes and let that pass through the scanner in a separate tray (the security check turned out to be a refreshing time for me). I had three hours for my connecting flight and wouldn't know the boarding gate till one hour before departure. The main terminal area was huge - it resembled a shopping mall with a series of shops packed one beside the other. I wandered around in search of a cosy place to sit and write my diary - a board read "Quiet area" and I followed the directions which led me to the extreme end of the terminal where there were plenty of vacant seats and a couple of television sets - aptly named "quiet area"! Just as I was about to sit down near a table I noticed a man seated in a corner facing the window with his back towards me. He made surreptitious glances every minute after flipping through a few pages of a magazine he held. With my height advantage (and filled with curiosity) I managed to catch a glimpse of the magazine - it was an A-magazine. After a couple of minutes (after he had quickly flipped through all the pages), he left the place.
Window shopping:
Ten minutes later I strolled around window shopping - the terminal was huge - it was like a long corridor which didn't have an end in sight. The A-magazine guy was now lying stretched out on the empty seats with his briefcase as a pillow. The terminal was impressive - and this was just one of the many terminals in Heathrow - wow! There was a wide variety of shops selling just about anything you could think of - from napkins to laptops. And along the way I also saw an elegant looking Ferrari (prize for a lottery). I had lost my appetite towards the end of the journey but the fresh bakery smell and arousing smell of fish tempted me. My appetite was back but I didn't want to take a risk during travel - perhaps on my return I would indulge in a few of the restaurants there. There were sandwiches, lobsters, a range of wines, plenty of chocolates - oooh - so very tempting.
I noticed that 1 in every 20 was working on a laptop and probably 1 in every 15 carried one. Technology is certainly becoming cheaper aned more accessible to everyone now. Window shopping was fun and many of the shops were staffed by pretty and handsome Indians who by now were probably holding British passports.
Sunday, April 15, 2007
Day 1 - Fying overseas after 7 years...
11 April 2007
Pre flight:
Slept at 11pm and woke by 3am; cab was delayed - stuffed some things at the last minute into my two bags and in the pitch black darkness we were off to the airport.
7:10am IST:
Everything was smooth as of now - helpful British airways staff everywhere (helpful and pretty I might add!) who ensure that you can't take a wrong step or land up in the wrong queue. I also The only place there really was a queue was at the immigration area. It was nice to hear a couple of typical Engish voices behind me discussing a gamut of topics ranging from the Bush administration to Afghanistan to carrying vodka! After immigration was the security check and that was a snap - you look in awe at the cabin crew and pilots who walk past queues without any prompts.
There was a good amount of time for the flight - spent my time loitering around the departure area reading a John Grisham book "The Broker". Also overheard a couple of middle aged ladies chatting about their fights to the Gulf. Time sped quickly and soon there was a call "The BA flight is ready for boarding - passengers needing assistance on wheelchairs will board first followed by the elderly, passengers with infants and then passengers on rows 26-40 followed by rows 21-25. Exclusive club travellers can board at any time. Please remain seated till further notice".
No sooner had the announcement finished when a huge queue formed - actually a double queue and the people in the queue didn't seem to require any assistance or carrying infants. The next announcement came, "those needing wheelchair assitance can now start boarding. Other passengers are requested to remain seated till further notice". Not many were seated - the queue was there to stay and it appeared as if people were very enthusiastic to sit in the airplane than in the departure lounge. Everyone seemed to have the attitude of "early worm catches the bird" in situations where it didn't matter much. We are anyway going to get our seats and there will surely be space on board for everyone's cabin baggage - so why hurry; we could just follow the airline instructions rather than forming long queues and waiting for longer times.
8:00am
When I entered the flight I almost immediately realized the disadvantage of having a window seat (something that I had asked for while getting the boarding pass). Beside the window seat where two more seats - so to get to the aisle or to even get out from the seat I would have to disturb two fellow passengers to stand up as well; and my fellow passengers were a couple of elderly ladies - one English and one Indian. I struggled with finding overhead space for my cabin baggage - and realized that the smaller bag you carry the more easier it is to find space. Eventually just as they announce please take your seats I found a vacant overhead cabin.
And off we went in the morning; departing the shores of my homeland - first time in seven years. Was a nice feeling - the takeoff was really smooth and my ears didn't even get blocked during the takeoff. I kept the novel in hand thinking I would read it but for most of the time was engrossed with the inflight entertainment system (you have a mini TV on the back of every seat for which you have your own remote control and on each channel a specific movie is played). I saw the movie "Incredibles" completely and slept off for a couple of hours. I didn't want to disturb the two ladies to the right and timed my walking/toilet breaks such that I had only 3 during the 10 hour flight. I usually hate the food on flights when I was small but used to love them when I came home and ate it. This time the breakfast and lunch was pretty decent and I ate most of it. Towards the last couple of hours of the trip is started feeling miseable - flight sick I guess where that flight food smell was nauseating; mentally I probably felt tired due to lack of sleep (slept only 4 hours before the night of the travel and then during the flight only for a couple of hours), felt my head throbbing a litte and felt simply miserable. I wandered into philosophical mood and wondered "What are we doing in this world? Why are we here? How would it be if there were no earth at all - where would we be?" "Why are we so obsessed with money, matter and looks when everything is just temporary? Where is the world heading to? Does everyone know their purpose in life?"
The flight began its descent and somehow my philosophical mood kind of made me feel better.
Pre flight:
Slept at 11pm and woke by 3am; cab was delayed - stuffed some things at the last minute into my two bags and in the pitch black darkness we were off to the airport.
7:10am IST:
Everything was smooth as of now - helpful British airways staff everywhere (helpful and pretty I might add!) who ensure that you can't take a wrong step or land up in the wrong queue. I also The only place there really was a queue was at the immigration area. It was nice to hear a couple of typical Engish voices behind me discussing a gamut of topics ranging from the Bush administration to Afghanistan to carrying vodka! After immigration was the security check and that was a snap - you look in awe at the cabin crew and pilots who walk past queues without any prompts.
There was a good amount of time for the flight - spent my time loitering around the departure area reading a John Grisham book "The Broker". Also overheard a couple of middle aged ladies chatting about their fights to the Gulf. Time sped quickly and soon there was a call "The BA flight is ready for boarding - passengers needing assistance on wheelchairs will board first followed by the elderly, passengers with infants and then passengers on rows 26-40 followed by rows 21-25. Exclusive club travellers can board at any time. Please remain seated till further notice".
No sooner had the announcement finished when a huge queue formed - actually a double queue and the people in the queue didn't seem to require any assistance or carrying infants. The next announcement came, "those needing wheelchair assitance can now start boarding. Other passengers are requested to remain seated till further notice". Not many were seated - the queue was there to stay and it appeared as if people were very enthusiastic to sit in the airplane than in the departure lounge. Everyone seemed to have the attitude of "early worm catches the bird" in situations where it didn't matter much. We are anyway going to get our seats and there will surely be space on board for everyone's cabin baggage - so why hurry; we could just follow the airline instructions rather than forming long queues and waiting for longer times.
8:00am
When I entered the flight I almost immediately realized the disadvantage of having a window seat (something that I had asked for while getting the boarding pass). Beside the window seat where two more seats - so to get to the aisle or to even get out from the seat I would have to disturb two fellow passengers to stand up as well; and my fellow passengers were a couple of elderly ladies - one English and one Indian. I struggled with finding overhead space for my cabin baggage - and realized that the smaller bag you carry the more easier it is to find space. Eventually just as they announce please take your seats I found a vacant overhead cabin.
And off we went in the morning; departing the shores of my homeland - first time in seven years. Was a nice feeling - the takeoff was really smooth and my ears didn't even get blocked during the takeoff. I kept the novel in hand thinking I would read it but for most of the time was engrossed with the inflight entertainment system (you have a mini TV on the back of every seat for which you have your own remote control and on each channel a specific movie is played). I saw the movie "Incredibles" completely and slept off for a couple of hours. I didn't want to disturb the two ladies to the right and timed my walking/toilet breaks such that I had only 3 during the 10 hour flight. I usually hate the food on flights when I was small but used to love them when I came home and ate it. This time the breakfast and lunch was pretty decent and I ate most of it. Towards the last couple of hours of the trip is started feeling miseable - flight sick I guess where that flight food smell was nauseating; mentally I probably felt tired due to lack of sleep (slept only 4 hours before the night of the travel and then during the flight only for a couple of hours), felt my head throbbing a litte and felt simply miserable. I wandered into philosophical mood and wondered "What are we doing in this world? Why are we here? How would it be if there were no earth at all - where would we be?" "Why are we so obsessed with money, matter and looks when everything is just temporary? Where is the world heading to? Does everyone know their purpose in life?"
The flight began its descent and somehow my philosophical mood kind of made me feel better.
Sunday, April 08, 2007
Ramblings of 8th April...
I've been spending my time learning about semaphores and processes and threads - probably something that I should've learnt by now; but as they say 'better late than never'. It is quite a fascinating topic.
It was nice to watch a supposedly weak team topple the number one team in the cricket world cup. The passion and enthusiasm in the players is something that stirs even a passive spectator. Bangladesh batted beautifully in the last ten overs playing some cheeky shots and scoring runs at will. South Africa was at the receiving end and a total of 250 against any team isn't a cakewalk. And so Bangladesh have done their second killer act in this world cup; who knows, they might have more in store!
I read an interesting news article about a research being conducted somewhere in Europe regarding "what women want". The results are really depressing news for highly ambitious guys; it seems girls don't prefer the highly ambitious, high life bachelor since these hi fi guys might not spend enough time with family and won't help sustain the relationship. What a pity :-(
It was nice to watch a supposedly weak team topple the number one team in the cricket world cup. The passion and enthusiasm in the players is something that stirs even a passive spectator. Bangladesh batted beautifully in the last ten overs playing some cheeky shots and scoring runs at will. South Africa was at the receiving end and a total of 250 against any team isn't a cakewalk. And so Bangladesh have done their second killer act in this world cup; who knows, they might have more in store!
I read an interesting news article about a research being conducted somewhere in Europe regarding "what women want". The results are really depressing news for highly ambitious guys; it seems girls don't prefer the highly ambitious, high life bachelor since these hi fi guys might not spend enough time with family and won't help sustain the relationship. What a pity :-(
Wednesday, April 04, 2007
What is the option in options? How options work?
Just thought of writing a series on the stock markets, finance and related concepts - hope you enjoy the series...Stock market terminologies are bolded
What is the option in options? How options work?
You must've heard of derivatives with respect to te stock market; Futures and Options (F&O as they are called) are a form of derivative. We'll take a look at that later.
So let's say there is a piece of land up for sale. Owner demands 5 Lakhs. You really want to own that property but can't afford it right now. You want to buy it after a couple of months. But the owner is bound to sell it to someone else by then - after all, everyone is into real estate business now. So you talk to the owner and tell him, "I really want to buy this land in a couple of months".
Owner: I can't keep waiting for two months; what guarantee do I have that you will buy it after 2 months. Two months is a long way away.
After a long pause the owner says, "Ok, we'll do one thing. You pay me an advance amount now - like a reservation fee to block the land for you. If you don't buy it then at least I would get the reservation fee".
"And if you do buy the land, then I'll give it to you for the same price of Rs. 5 lakhs itself irrespective of the market price at the end of two months".
This sounds a fair enough deal. We pay a non-refundable advance to the owner and at the end of the second month we have the option to buy the land at the current price. We have a gut feeling that the price of the land will most likely shoot up by 2 months.
Note: It is an option given to us by the owner and not a compulsion for us to buy the land at the end of two months. Let's say the advance amount is 10% of the total value = Rs. 50,000
This amount is the the premium.
Now at the end of the second month two scenarios can arise because of various factors:
1.) Price of land shoots up (say to Rs. 6 lakhs).
2.) Price drops to Rs. 3 lakhs.
Case I: If case 1 happens, then we will gladly buy the land at the promised rate of Rs. 5 lakhs - we don't need to pay the current market price because the owner promised to give it to us at the old rate of Rs. 5 lakhs.
So now we can buy the land at the old rate and resell it to make a profit of Rs. 50,000.
Profit = Selling price - (premium paid + price of land)
= 6,00,000 - (50,000 + 5,00,000) = Rs. 50, 000
The owner who gave us the option has actually suffered a loss. If he hadn't sold us the option, or if he had charged a higher premium he could have made more money because the land price now has shot up.
Case II: Now if we buy the land then we stand to lose Rs. 2,50,000.
Loss = 3,00,000 - (50,000 + 5,00,000) = Rs. 2,50,000.
Here the owner actually make a good profit while we suffer a loss. But wait; we never promised the owner that we will surely buy the land after 2 months - it was just an option. So now we will decide not to enforce the option in which case we won't buy the land and we will lose the premium we paid for the option - a loss of Rs. 50,000 only. Land owner earns Rs. 50,000 because the land price went down.
So we were the buyer of the option and the land owner was the seller of the option (called the writer). The buyer of the option has limited liability (maximum loss is the premium paid) but the seller has unlimited liability (the higher the land price goes at the end of the second month the greater the loss the seller suffers).
At the end of the second month we had the choice to either enforce the option (called exercising the option - in which case we buy the land at the promised rate) or ignore the option (in which case we lose the premium).
Apply the same concept to stocks and you'll understand what are "options" in terms of stocks. Instead of the land here the underlying asset is the stock of a company. Typically stock options are traded in lots - one lot is usually 100 stocks but it could vary depending on the price of the stock (sometimes a lot is 3000 stocks).
Note: Seller of the option feels the price will go down while the buyer feels the price will go up.
We'll end with a puzzle:
A colleague made a whopping Rs. 15,000 in one day by trading in options. He did so without exercising the option. Any guess as to how he did it?
What is the option in options? How options work?
You must've heard of derivatives with respect to te stock market; Futures and Options (F&O as they are called) are a form of derivative. We'll take a look at that later.
So let's say there is a piece of land up for sale. Owner demands 5 Lakhs. You really want to own that property but can't afford it right now. You want to buy it after a couple of months. But the owner is bound to sell it to someone else by then - after all, everyone is into real estate business now. So you talk to the owner and tell him, "I really want to buy this land in a couple of months".
Owner: I can't keep waiting for two months; what guarantee do I have that you will buy it after 2 months. Two months is a long way away.
After a long pause the owner says, "Ok, we'll do one thing. You pay me an advance amount now - like a reservation fee to block the land for you. If you don't buy it then at least I would get the reservation fee".
"And if you do buy the land, then I'll give it to you for the same price of Rs. 5 lakhs itself irrespective of the market price at the end of two months".
This sounds a fair enough deal. We pay a non-refundable advance to the owner and at the end of the second month we have the option to buy the land at the current price. We have a gut feeling that the price of the land will most likely shoot up by 2 months.
Note: It is an option given to us by the owner and not a compulsion for us to buy the land at the end of two months. Let's say the advance amount is 10% of the total value = Rs. 50,000
This amount is the the premium.
Now at the end of the second month two scenarios can arise because of various factors:
1.) Price of land shoots up (say to Rs. 6 lakhs).
2.) Price drops to Rs. 3 lakhs.
Case I: If case 1 happens, then we will gladly buy the land at the promised rate of Rs. 5 lakhs - we don't need to pay the current market price because the owner promised to give it to us at the old rate of Rs. 5 lakhs.
So now we can buy the land at the old rate and resell it to make a profit of Rs. 50,000.
Profit = Selling price - (premium paid + price of land)
= 6,00,000 - (50,000 + 5,00,000) = Rs. 50, 000
The owner who gave us the option has actually suffered a loss. If he hadn't sold us the option, or if he had charged a higher premium he could have made more money because the land price now has shot up.
Case II: Now if we buy the land then we stand to lose Rs. 2,50,000.
Loss = 3,00,000 - (50,000 + 5,00,000) = Rs. 2,50,000.
Here the owner actually make a good profit while we suffer a loss. But wait; we never promised the owner that we will surely buy the land after 2 months - it was just an option. So now we will decide not to enforce the option in which case we won't buy the land and we will lose the premium we paid for the option - a loss of Rs. 50,000 only. Land owner earns Rs. 50,000 because the land price went down.
So we were the buyer of the option and the land owner was the seller of the option (called the writer). The buyer of the option has limited liability (maximum loss is the premium paid) but the seller has unlimited liability (the higher the land price goes at the end of the second month the greater the loss the seller suffers).
At the end of the second month we had the choice to either enforce the option (called exercising the option - in which case we buy the land at the promised rate) or ignore the option (in which case we lose the premium).
Apply the same concept to stocks and you'll understand what are "options" in terms of stocks. Instead of the land here the underlying asset is the stock of a company. Typically stock options are traded in lots - one lot is usually 100 stocks but it could vary depending on the price of the stock (sometimes a lot is 3000 stocks).
Note: Seller of the option feels the price will go down while the buyer feels the price will go up.
We'll end with a puzzle:
A colleague made a whopping Rs. 15,000 in one day by trading in options. He did so without exercising the option. Any guess as to how he did it?
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