Options Trading: Bullish vs Bearish, Buying a Call vs Writing a Put, Option Premium, Intrinsic Value, and Interest Rates

Answer to Question 7
Bullish vs Bearish:
Bullish ("Bullish | Definition Of Bullish In English By Oxford Dictionaries") in context
of stock market means characterized by rising share prices and in context of the
behavior of investor means – inclined to buy because of an anticipated rise in
prices.
It refers to being optimistic about the prospects of the asset under consideration. If
you say that you are bullish in respect to an asset, it means that you are
anticipating that the price of the asset will rise.
Bearish ("Bearish | Definition Of Bearish In English By Oxford Dictionaries") in the
context of stock market means characterized by or associated with falling share
prices.
It is being pessimistic about the prospects of the asset under consideration and
implies that you are anticipating a decline in the market price of the asset.
Buying a Call vs writing a Put:
Buying a call refers to buying a right (without any obligation attached) to acquire
the underlying asset at a predetermined price (called Strike Price) on a
predetermined date. The holder of the call (buyer) exercises his right to buy only
when the price on the date of exercise is more than the strike price.
Writing a put refers to selling a right (without any obligation attached) to sell the
underlying asset at a predetermined strike price on or before a predetermined date.
The buyer of put option exercises his right to sell only when the price on the date of
exercise is less than the strike price.
Advantage or disadvantage of
Buying a call when you are bullish on a stock:
If the prediction goes right, the price of the stock increases above the strike price
and the holder (buyer) of the call exercise his right to buy and gets a profit of
(Market price on the date of exercise – Strike Price) – Premium paid for buying the
call.
Writing a put when bullish on a stock:
If the prediction goes right, the price of the stock increases above the strike price
and the holder (buyer) of the call will not exercise his right and the writer of the
option will get a profit to the extent of premium received for selling the put

Answer to Question 12
The Option Premium:
Option Premium is the amount paid by the buyer of the option to the seller of the
option at the beginning of the contract.
Components of Option Premium:
The option premium consists of an intrinsic value and time value. Where,
• Intrinsic value = Stock Price – Strike Price and
• Time Value = Premium – Stock Price.
The statement is correct. As per the definition, only in-the-money options will have
intrinsic value and since out-of-money options cannot have any intrinsic value, the
entire premium consists of time value alone. Therefore it can be said that the option
which is out-of-the-money must have time value
Answer to Question 13
In-the-money Option:
The Option is said to be in-the-money if:
• Strike Price is less than Underlying Price in case of a Call Option, and
• Underlying Price is less than Strike Price in case of Put Option
Intrinsic Value:
The intrinsic value of an option is computed as follows:
• Intrinsic Value = Underlying Asset Price – Strike Price (in case of Call)
• Intrinsic Value = Strike Price – Underlying Asset Price (in case of Put)
By comparing the description about both ‘in-the-money’ option and ‘intrinsic value’
it can be understood that only ‘in-the-money’ options can have intrinsic value and
hence it can be said that the option which is in-the-money must have intrinsic value.
Answer to Question 14:
The statement is squarely correct.
A typical transaction of an option contract involves two persons. A buyer of option
and a seller (or) writer of the option. Let us consider an example of a call option.
While the buyer is optimistic that the price of the stock will incline, the writer of the

option expects the price of the stock to decline. The buyer, with his confidence,
pays a premium with an anticipation that he will get more profit than the amount of
premium paid. Indirectly we can say that the buyer is betting his stake (premium)
on an anticipated increase of stock. Conversely, the seller with an anticipation of
the decline in price is getting premium and is acquiring an obligation to sell the
stock in potentially unfavorable conditions. This can be seen as seller betting on the
decline of the price of the stock. Usually, the bet has the following characteristics.
1. The persons involving in betting should have something to gain or lose. In
case of the option, the writer may either gain premium or lose the capital
appreciation of underlying. On the other hand, the buyer may either gain the
benefits of capital appreciation of the underlying or lose the premium paid.
2. The outcome of the bet should be contingent upon future uncertain events
not in the control of parties to the bet. In the case of options, the outcome of
the transaction is dependent upon the increase or decrease of the price of
the underlying which is not under the control of the parties to the transaction.
Therefore it can be said that options are nothing more than side bet on the direction
stock prices are going to take.
Answer to Question 24:
A rise in the interest rate of the economy as a whole and its impact on
option premium:
The Call Premium rises with a given rise in risk-free interest rate (other factors
remaining constant) since the call premium is directly related to the interest rate
prevalent in the economy.
The relevance of Interest rates in Option Pricing: