1 chapter 15 options markets. 2 option terminology buy - long sell - short call option: gives its...
TRANSCRIPT
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Chapter 15
Options Markets
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Option Terminology• Buy - Long • Sell - Short• Call Option: gives its holder the right to purchase an
asset for a specified price before or on a specified expiration date.
• Put Option: gives its holder the right to sell an asset at a specified price before or on a specified expiration date.
• Key Elements– Exercise or Strike Price– Premium or Price– Maturity or Expiration
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Market and Exercise Price RelationshipsIn the Money - exercise of the option would be
profitableCall: market price>exercise pricePut: exercise price>market price
Out of the Money - exercise of the option would not be profitableCall: market price<exercise pricePut: exercise price<market price
At the Money - exercise price and asset price are equal
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American vs European OptionsAmerican - the option can be exercised at any
time before expiration or maturityEuropean - the option can only be exercised on
the expiration or maturity date
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Different Types of Options• Stock Options• Index Options• Futures Options• Foreign Currency Options• Interest Rate Options
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Payoffs and Profits on Options at Expiration - Calls
Notation Stock Price = ST Exercise Price = XPayoff to Call Holder
(ST - X) if ST >X
0 if ST < Xor Max {ST – X, 0}
Profit to Call HolderPayoff - Purchase Price
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Payoffs and Profits on Options at Expiration - Calls
Payoff to Call Writer - (ST - X) if ST >X
0 if ST < Xor Min {X – ST, 0}
Profit to Call WriterPayoff + Premium
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Profit
Stock Price
0
Call Writer
Call Holder
Profit Profiles for Calls
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Payoffs and Profits at Expiration - PutsPayoffs to Put Holder
0 if ST > X(X - ST) if ST < Xor Max {X-ST, 0}
Profit to Put Holder Payoff - Premium
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Payoffs and Profits at Expiration - PutsPayoffs to Put Writer
0 if ST > X-(X - ST) if ST < Xor Min {ST - X, 0}
Profits to Put WriterPayoff + Premium
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Profit Profiles for Puts
0
Profits
Stock Price
Put Writer
Put Holder
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Exercise in class1. You purchase one IBM July 120 call contract for a premium of $5. You hold
the option until the expiration date when IBM stock sells for $123 per share. You will realize a ______ on the investment. A) $200 profit B) $200 loss C) $300 profit D) $300 loss
2. You purchase one IBM July 120 put contract for a premium of $5. You hold the option until the expiration date when IBM stock sells for $123 per share. You will realize a ______ on the investment. A) $300 profit B) $200 loss C) $500 loss D) $200 profit
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Exercise in classA call option on Brocklehurst Corp. has an exercise price of $30. The current
stock price of Brocklehurst Corp. is $32. The call option is __________. A) at the money B) in the money C) out of the money D) none of the above
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Equity, Options & Leveraged Equity - Text Example
Investment Strategy Investment
Equity only Buy stock @ 80 100 shares $8,000
Options only Buy 80 calls @ 10 800 options $8,000
Leveraged Buy 80 calls @ 10 100 options $1,000equity Buy T-bills @ 2% $7,000
Yield
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Equity, Options & Leveraged Equity - Payoffs
Microsoft Stock Price
$75 $80 $100
All Stock $7,500 $8,000 $10,000
All Options $0 $0 $16,000
Lev Equity $7,140 $7,140 $9,140
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Equity, Options & Leveraged Equity - Rates of Return
Microsoft Stock Price
$75 $80 $100
All Stock -6.25% 0% 25%
All Options -100% -100% 100%
Lev Equity -10.75% -10.75% 14.25%
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Put-Call Parity Relationship
ST < X ST > X
Payoff for
Call Owned 0 ST - X
Payoff for
Put Written -( X -ST) 0
Total Payoff ST - X ST - X
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Payoff of Long Call & Short Put
Long Call
Short Put
Payoff
Stock Price
Combined =Leveraged Equity
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Arbitrage & Put Call ParitySince the payoff on a combination of a long call
and a short put are equivalent to leveraged equity, the prices must be equal.
C - P = S0 - X / (1 + rf)T
If the prices are not equal arbitrage will be possible
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Put Call Parity - Disequilibrium ExampleStock Price = 110 Call Price = 17 Put Price = 5 Risk Free = 10.25%Maturity = .5 yr X = 105
C - P > S0 - X / (1 + rf)T
17- 5 > 110 - (105/1.05) 12 > 10
Since the leveraged equity is less expensive, acquire the low cost alternative and sell the high cost alternative
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Put-Call Parity Arbitrage
Immediate Cashflow in Six MonthsPosition Cashflow ST<105 ST> 105
Buy Stock -110 ST ST
BorrowX/(1+r)T = 100 +100 -105 -105
Sell Call +17 0 -(ST-105)
Buy Put -5 105-ST 0
Total 2 0 0
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Option StrategiesProtective Put
Long Stock Long Put
Covered Call Long StockShort Call
Straddle (Same Exercise Price)Long Call Long Put
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Exercise in class1 You buy one Chrysler August 50 call contract and one Chrysler August 50
put contract. The call premium is $4.25 and the put premium is $5.00. Your highest potential loss from this position is __________. A) $75 B) $925 C) $5,000 D) unlimited
2 An investor purchases a long call at a price of $2.50. The expiration price is $35.00. If the current stock price is $35.10, what is the break even point for the investor? A) $32.50 B) $35.00 C) $37.50 D) $37.60
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Option StrategiesSpreads - A combination of two or more call options or
put options on the same asset with differing exercise prices or times to expirationVertical or money spread
Same maturityDifferent exercise price
Horizontal or time spreadDifferent maturity dates
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Exercise in class
You buy one Chrysler August 50 call contract and one Chrysler August 50 put contract. The call premium is $4.25 and the put premium is $4.50. Your strategy is useful if you believe that the stock price __________. A) will be lower than $41.25 in August B) will be between $41.25 and $58.75 in August C) will be higher than $58.75 in August D) either a or c