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Ch 17. Options and other derivatives: Introduction

2. Call (put) option gives its holder the right to purchase (sell) an asset for a specified price, called the exercise or strike price, on or before some specified expiration date.Key elementsExercise or strike pricePremium or price of optionprice of underlying assetMaturity or expiration. 1. O

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Ch 17. Options and other derivatives: Introduction

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    1. 1 Ch 17. Options and other derivatives: Introduction Overview Values at expiration Option strategies Put-Call parity Option-like securities Exotic options

    2. 2 Call (put) option gives its holder the right to purchase (sell) an asset for a specified price, called the exercise or strike price, on or before some specified expiration date. Key elements Exercise or strike price Premium or price of option price of underlying asset Maturity or expiration 1. Option contract

    3. 3 Call option: April call on Alcan with X=$65, C=$1.90, S=$63.17, ST=$67. value at expiration: ST X=$2 profit: $2 - $1.90 = $0.10 Figure: payoff at maturity Put option: April put on Alcan with X=$65, P=$6.30, S=$63.17, ST=$55. value at expiration: X - ST =$10 profit: $10 - $6.30 = $3.70 No need to own the stock to exercise put Figure: payoff at maturity

    4. 4 In the Money - exercise of the option would be profitable Call: S > X, Put: S < X Out of the Money - exercise of the option would not be profitable Call: S < X, Put: S > X At the Money - exercise price and asset price are equal American - the option can be exercised at any time before expiration or maturity European - the option can only be exercised on the expiration or maturity date

    5. 5 options trading CBOE (Chicago Board Options Exchange) ME (Montreal Exchange) OTC (overthe-counter) market Exchanged-traded options are standardized in maturity dates, interval for exercise price, and contract size. (1 contract is for 100 shares). Exercise prices have an interval of $2.5 or $5 depending on share prices ($35). Maturity of options is generally within one year. There are LEAPS (long-term equity anticipation securities). Quote on Montreal Exchange website

    6. 6 Exercise prices are adjusted by stock split and stock dividend factor: e.g., for a ten-for-one stock split, exercise price will be $6.50 from original exercise price of $65. Cash dividends do not affect option contracts. Call (put) option values are lower (higher) for high-dividend stocks (high-dividend tend to slow the rate of stock price increase).

    7. 7 OCC (Option Clearing Corporation) in US and CDCC (Canadian Derivates Clearing Corporation) guarantee contract performance. All buyers and sellers (writers) of options deal with the clearing corporation. Option writes are required to post margin amounts. Other listed options Stock index options Foreign currency options Futures options Interest rate options

    8. 8 Payoff to call holder (ST - X), if ST >X and 0 if ST < X Profit to call holder: Payoff - Purchase Price 2. Values of options at expiration

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