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Options Markets

Options Markets. I. The Development of Options Markets 1. History CBOE was established in 1973 and 18 call options were traded in the same year. In 1977, put options were traded. 2. Organized vs. Over-the-Counter Markets Organized Options Trading Standardized contract

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Options Markets

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  1. Options Markets I. The Development of Options Markets 1. History CBOE was established in 1973 and 18 call options were traded in the same year. In 1977, put options were traded. 2. Organized vs. Over-the-Counter Markets Organized Options Trading Standardized contract Physical trading floor Liquidity Over-the-Counter Trading Foreign currencies, bonds, interest rate swaps Flexibility, Privacy, unregulated

  2. II. Who Trade Options & Why? • Speculator • Hedger • Arbitrageur • III. Social Benefits of Options Markets • Price discovery • The ability of options to provide information on current & future cash prices • Risk management • Hedgers use options to shift unwanted price risk to speculators

  3. IV. The Option Contract • 1. Call Option; Put Option • Exercise (Strike) Price • Call (Put) Premium • Option Buyer (Seller) • In-the-Money; Out-of-the-Money; at-the-Money • Naked Option; Covered Option • Margin Requirement • 2. American Option; European Option • 3. Option Clearing Corporation • 4. Other Listed Options

  4. Index Options: OEX, SPX • Futures Options • Foreign Currency Options • Interest Rate Options • V. The Mechanics of Trading • 1. Option Traders • Market makers – buy @ bid, sell @ ask • Floor brokers • Exchange membership: CBOE – 931 members • Cost $700,000 as of 8/17/2005 • 2. Three ways to execute an option • Allow the options to expire • Exercise right on or before the expiration • Execute an offsetting transaction • 3. Margin Requirement

  5. VI. Profit of Call Options (at Expiration) • 1. Call Option • Long call @ C=$2; X=$55; S0=$50

  6. Profit + 0 Stock Price - 2 $57

  7. 2. Covered Call • Bought stock @ S0=$50, short call @ C=$2 with X=$55

  8. Profit • Covered Call Payoffs + 0 Stock Price $48

  9. VII. Profit of Put Options • 1. Put Option • Long Put: Buy put @ P=$2, S0=$55, X=$50

  10. Profit Put Payoffs $48 + Stock Price 0 • Short Put (mirror image)

  11. 2. Protective Put • Bought stock @S0=$50, long put @P=2 with X=45

  12. Profit • Protective Put Payoffs + Stock Price 0 $52

  13. 3. Straddle • Buy a call @ 7.8 and a put @ 11.8 when S0=160, X=165

  14. Profit + Stock Price 0

  15. IX.Optionlike Securities • Callable bonds • Convertible bonds • Warrants • X. Exotics Options • Asian Options • Barrier Options • Lookback Options

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