SFM Options — Complete Notes

Options in CA Final SFM — Overview

The options chapter in SFM is one of the highest-weightage and most conceptually dense portions of the paper. Every attempt in recent years has had at least 14-16 marks from this chapter. Understanding it conceptually — not just formula-wise — is what separates 60+ scorers from the rest.

Key Concepts to Master

1. Option Basics

An option is a contract that gives the buyer the right, but not the obligation, to buy (call) or sell (put) an underlying asset at a predetermined price (strike price) on or before a specified date (expiry).

Key terminology:

• Premium — the price paid for the option
• In the Money (ITM) — option has intrinsic value
• At the Money (ATM) — strike equals current market price
• Out of the Money (OTM) — option has no intrinsic value

2. Black-Scholes Model

The BSM formula is frequently tested in numerical problems. Key inputs:

• S = Current stock price
• K = Strike price
• r = Risk-free rate
• T = Time to expiry (in years)
• σ = Volatility (standard deviation of returns)

The formula: C = S·N(d₁) − K·e^(−rT)·N(d₂)

Where:

• d₁ = [ln(S/K) + (r + σ²/2)T] / (σ√T)
• d₂ = d₁ − σ√T

Exam tip: ICAI consistently provides N(d) values in the question. Focus on clean substitution and correct identification of d₁ and d₂.

3. The Greeks

| Greek | Measures | Direction | |-------|----------|-----------| | Delta | Price sensitivity | Call: 0 to 1, Put: -1 to 0 | | Gamma | Rate of change of Delta | Always positive | | Theta | Time decay | Always negative | | Vega | Volatility sensitivity | Always positive |

4. Option Strategies

The most commonly tested strategies:

Straddle — buy a call and put at the same strike. Profits from large moves in either direction.

Bull Call Spread — buy lower strike call, sell higher strike call. Reduces cost, caps upside.

Protective Put — long stock + long put. Insurance against downside.

Exam Strategy

For numerical questions, always:

1. Identify the option type (call/put, American/European)
2. Write down all given values clearly
3. Identify the model required (BSM, Binomial, or Put-Call Parity)
4. Show all intermediate steps — ICAI awards step marks generously

For theory questions, definitions with examples score full marks. Memorize the BSM assumptions and limitations — they appear as 4-5 mark theory questions regularly.