FASB Updates Standards for Put and Call Options

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A call option is the right, but not an obligation to buy something at a fixed price — the strike price at anytime within the specified time period. The underlying is usually either an exchange traded stock or a commodity.

Note that an option gives the buyer the right to buy or sell the underlying contract at a predetermined price. The specific price at which the underlying can be bought or sold is referred to as the strike price or exercise price of the option. Options only have a limited life-span. In the above definition of an option the buyer of an option can exercise the right within a specified time period.

The exercise period of the option specifies when the option expires and can no longer be traded. The exact date in which the option expires is set by the exchanges and differs from one exchange to another. Different month options are entirely different instruments, so a June option is a separate and distinct contract from a July option. Investors buy call options if they think that the price of the underlying will go up and buy put options if they think the price of the underlying will go down.

The price paid for acquiring the right to buy is called the call option premium. Whether the investor has the right to buy or to sell depends on which type of option the investor buys. The purchaser of a call option has the right to buy the underlying asset.

The purchaser of a put option has the right to sell the underlying asset. Note that puts and calls are mutually exclusive. A call option does not offset a put option and vice versa. In the National Stock Exchange, India, the quotes are available for the current month, near month and far month.

For example, when investors trade in early May, they get quotes for May, June and July. The settlement period is the last Thursday of the relevant month. So, if an investor buys 1 lot of May-X1 — Rs. A put option is the right, but not an obligation to sell something at a fixed price — the strike price at anytime within the specified time period. The price paid for acquiring the right to sell is called the put option premium.

When the investor buys a put, then the investor has the right to sell the underlying. Note that the investor is dealing with different instruments here. The investor is buying a put instrument that gives the right to sell a different and distinct instrument which is the underlying asset. Components of an Equity Options Contract. This site rocks the Classic Responsive Skin for Thesis.

Call and Put Options by R. Venkata Subramani on March 5, Call Option A call option is the right, but not an obligation to buy something at a fixed price — the strike price at anytime within the specified time period.

Put Option A put option is the right, but not an obligation to sell something at a fixed price — the strike price at anytime within the specified time period. Components of an Equity Options Contract Previous post:

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FASB noted that the existing standards for derivatives and hedging require embedded derivatives to be separated from a host contract and accounted for separately as derivatives if certain criteria are met. One of those criteria is if the economic characteristics and risks of the embedded derivatives are not clearly and closely related to the economic characteristics and risks of the host contract. The guidance says that for contingent call put options to be considered clearly and closely related, they can be indexed only to interest rates or credit risk.

The sequence requires an entity to consider whether 1 the payoff is adjusted based on changes in an index, 2 the payoff is indexed to an underlying other than interest rates or credit risk, 3 the debt involves a substantial premium or discount, and 4 the call put option is contingently exercisable. However, new questions have emerged about how the four-step decision sequence interacts with the original guidance for assessing embedded contingent call put options in debt instruments.

Two different approaches have developed in practice, FASB noted. Under the first approach, the assessment of whether contingent call put options are clearly and closely related to the debt host only requires an analysis of the four-step decision sequence.

Under the second approach, an assessment of whether the event that triggers the ability to exercise the call put option is indexed only to interest rates or credit risk is required in addition to the four-step decision sequence. The problem is those two approaches could result in different conclusions about whether the embedded call put option is clearly and closely related to its debt host, and could even lead to different conclusions about which call put options should be bifurcated and accounted for separately as derivatives.

The amendments in the new accounting standards update are supposed to resolve the diversity in practice from those two approaches. They clarify the requirements for assessing whether contingent call put options that can accelerate the payment of principal on debt instruments are clearly and closely related to their debt hosts.

According to FASB, an entity performing the assessment under the amendments is required to assess the embedded call put options solely in accordance with the four-step decision sequence. The amendments clarify which steps are required when assessing whether the economic characteristics and risks of call put options are clearly and closely related to the economic characteristics and risks of their debt hosts, which is one of the criteria for bifurcating an embedded derivative.

Consequently, when a call put option is contingently exercisable, an entity does not have to assess whether the event that triggers the ability to exercise a call put option is related to interest rates or credit risks.

The amendments promise to eliminate the diversity in practice in assessing embedded contingent call put options in debt instruments.

For public business entities, the amendments take effect for financial statements issued for fiscal years beginning after Dec. For entities other than public business entities, the amendments are effective for financial statements issued for fiscal years beginning after Dec. Already have an account? Don't have an account?

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