chapter 15
DESCRIPTION
Chapter 15. Options Markets-The applications. outline. Features of options Call vs., put, Long vs. short In the money, out of the money and at the money Profit and payoff at expiration (examples and calculations) for calls Call buyer Call seller Graph For Puts Put buyer Put seller - PowerPoint PPT PresentationTRANSCRIPT
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outline• Features of options
– Call vs., put, Long vs. short– In the money, out of the money and at the money
• Profit and payoff at expiration (examples and calculations)– for calls
• Call buyer• Call seller• Graph
– For Puts• Put buyer• Put seller• Graph
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Outline
• Option strategy– The risk return trade off– Basic Strategies
• Buy Call: the dangerous one• Sell Call (covered call): Cap your gain• Buy Put (protective put): Do you really need the
protection?• Sell Put: Get paid for a limit order
– Advanced Strategies• Straddle: bet the price would have huge move• Spread: betting on the price pattern• Collar: bracket your profit
– Index options and options on index futures
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Define option
• Option is the right to buy or sell an asset at a specified exercise price on or before a specified expiration date.
• Call Option:• Put Option:• Check:
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American vs. European Options
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
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Option Terminology
• Buy - Long • Sell - Short• Call• Put • Key Elements
– Exercise or Strike Price– Premium or Option Price– Maturity or Expiration
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Market and Exercise Price Relationships
In the Money - exercise of the option would be profitable (without considering the cost/premium of the option)Call: 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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Payoffs and Profits on Options at Expiration - Calls
Notation Stock Price = ST Exercise Price = X Premium=PPayoff: value of option at expiration
ST<X
(Out)
ST=X
(At)
ST>X
(In)
Payoff 0 0 ST-X
Profit -P -P (ST-X)-P
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Payoffs and Profits on Options at Expiration - Calls
Payoff to Call Writer - (ST - X) if ST >X
0 if ST < XProfit to Call Writer
Payoff + Premium
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ProfitProfit
Stock Price Stock Price at expirationat expiration
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Call WriterCall Writer
Call HolderCall Holder
Profit Profiles for CallsProfit Profiles for Calls
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Payoffs and Profits at Expiration - Puts
Payoffs to Put Holder0 if ST > X
(X - ST) if ST < X
Profit to Put Holder Payoff - Premium
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Payoffs and Profits at Expiration - Puts
Payoffs to Put Writer0 if ST > X
-(X - ST) if ST < X
Profits to Put WriterPayoff + Premium
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Profit Profiles for PutsProfit Profiles for Puts
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Profits
Stock Price at expiration
Put Writer
Put Holder
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Equity and Options-risk and return
Investment Strategy Investment
Equity only Buy stock @ 80 100 shares $8,000
Options only Buy calls @ 10 800 options $8,000
Option exercise price: $80, expire in one year
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Equity and Options
Apple PriceApple Price
$75$75 $80$80 $100$100
All StockAll Stock $7,500$7,500 $8,000$8,000 $10,000$10,000
All OptionsAll Options $0$0 $0$0 $16,000$16,000
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Equity and Options
Apple PriceApple Price
$75$75 $80 $80 $100$100
All StockAll Stock -6.25%-6.25% 0% 0% 25% 25%
All OptionsAll Options -100% -100%-100% -100% 100%100%
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Option Strategies-Long Call• Long call: bullish
– Leap Call– Calls that will expire soon– Out of the money call: a gamble– Deep in the money call: a replacement of stock
investing• The downside
– 90% of the time, you lose 100% of your investment (out of the money call)
– You lose money even you are right about the stock– You often pay short term capital gain
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Option Strategies-Long Put
Protective Put (you stock hold is protected by put option)Goal: Buy insurance for your stock, protect it from
falling price. Tax reason: ST tax v. LT taxExecution:
buy Stock and buy Put
Critics: why pay for unnecessary insuranceYou need to continue to roll over
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Option Strategies
Covered Call (potential obligation to deliver the stock is covered by the stock held, compared with naked option writing)Execution:
Long Stock, Short Call
Critics: Why cap the gain when sky is the limit
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Option Strategies-Short Put
• The Process: Sell a put secured by cash
• The payoff: – Keep Premium when price above Ex.– Exercised when price below Ex.
• The idea: a limit order with upfront pay• The view: bullish, flat
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Option Strategies-Short Put
• Buy stock vs. Sell put: a risk return trade off
• Short In-the-Money vs. Out-of-the-Money
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Option Strategies
Straddle (Same Exercise Price)• Bet price will move a lot
– Long Call – Long Put
• Short straddle– Short SPX (S&P 500 index) Puts and Calls,
2 year leap, both out of the money
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Option Strategies• Spread: A combination of two or more call options
(or put options) on the same stock with differing exercise prices or time to maturity– Money spread: buy one and sell another with same maturity,
but different exercising price (betting on price range)• Bullish call spread
– Buy AAPL call ex $400 @$35, with maturity Jan 2015– Sell AAPL call ex $500 @$15, with maturity Jan 2015 – Cost: 35-15=$20– Bet: stock go up above $400, but not high enough to touch $500– Idea: Use premium from selling calls (with higher ex price) to lower the cost
of buying call (with lower ex price)
• Bearish Call spread– Sell NFLX call ex$330 @$25. with maturity Jan 2013 (bet NFLX
won’t go above $330)– Buy NFLX call ex$370 @$17 (protect unlimited loss)
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Spread (continued)– Money spread (continued)
• Bullish Put– Sell AAPL put , ex $300 (bet price won’t go below $300)– Buy AAPL put, ex $250 (protect it stock drops below $250)– Idea: bet stock price won’t fall below $300, but cap the loss
if stock does fall below $250.• Bearish Put spread:
– Buy E-Mini S&P put, ex 1300 @$40– Sell E-mini S&P put, ex 1200 @$15– Bet index might fall below 1300, but above 1200
– Time spread (price timing)• Short AAPL call ex $900 Jan 2014, buy call ex$900 Jan
2015• Bet price will be much higher than $900 by Jan 2015, but
not by Jan 2014.
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Option Strategies• Collar
– Goal: Brackets the value of your portfolio between two bounds. (so you can keep the profit without selling the stock, for tax reasons)
– Execution: buy a protective put (to protect the very possible downside) and sell a covered call (to offset the cost of put)
– Example: • You hold 100 shares of Dell, current price $14• Buy a put : Expiration-Jan 2014, Ex-$13, premium$0.46• Sell a call: Expiration-Jan 2014, Ex-$15, premium$0.36• Cost: 0.46-0.36=$0.1