19.3.1 European Expiry

A European Expiry may be exercised only at the Expiry Date of the option, that is, at a single pre-defined point in time.

Call Option

• Firstly, the underlying bond has to be priced for the given 'As of Date'.

  Figure 19-1 PCP Formula

  
  

  

  
  

  Description of PCP Formula follows:

  Where:

  it= Interest Rate at time t

  C = F * c = Coupon Payment

  Where F = Face Value of the bond

  c = Coupon Rate

  N = Number of Payments

  M = Maturity Value of the bond

  PCP= Clean Price of the bond

  PDP= Dirty Price of the bond

  LDP = Last Payment Date

  AOD = As of Date

• Calculate the present value of the coupon payments during the life of the option. ( Coupon payments between the As of Date and the Option Expiry Date(OED))

  Figure 19-2 Formula to Calculate the PDP

  
  

  

  
  
• Calculate the Bond Forward Price as of the Option Expiry Date

  Figure 19-3 Formula to Calculate the P Forward-Dirty

  
  

  

  
  
• Calculate the P Forward-Clean as equal to

  Figure 19-4 Formula to Calculate the P Forward-Clean

  
  

  

  
  
• If Strike Price is less than PForward - Clean then the Call Option can be exercised.
• Market Value when the option on the instrument is exercised is as follows:
• Market Value when the option is not exercised: will be the Market Value of the underlying instrument.

Note:

If Strike Price is greater than PForward - Clean then the Put Option can be exercised. The rest of the procedure for calculating Put Option is the same as that for Call Option.