fins1612 summaries - week 11 - options.docx
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8/17/2019 FINS1612 Summaries - Week 11 - Options.docx
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FINS1612 – SUMMARIES
Week 11Options
1/6 Nature of Options:
• An option gives the buyer the right, but not the o!i"ation, to buy or sell
a specifed commodity or instrument at a predetermined price (e#er$ise or
strike pri$e) on or beore a specifed date (e#piration %ate).
o Hence an option will on!& e e#er$ise% if it is in the u&er's est
interest
o Thereore there must be the payment o a pre(iu( & the u&er
to the seller (writer)
• These dier rom utures in that they provide as&((etri$ $o)er against
price movements.
• ptions limit the eects o adverse price movements without reducing
profts rom avourable price movements.
• *&pes:
o +a!! options give the option buyer the right to buy the commodity or
instrument at the e!ercise price
o ,ut options: "ive the buyer the right to sell the commodity or
instrument at the e!ercise price
• These can be e!ercised only on the e!piration date (#uropean) or any time
up to the e!piration date (American)
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2/6 Option ,ro-t an% !oss ,a&o. ,ro-!es:
• +a!! option pro-t an% !oss pro-!es:
• The e!ample is where there is a call option or shares in a listed company at
a stri$e%e!ercise price (&) o ' and a premium (*) o '.+
o *he u&er/ho!%er is the !on" $a!! (-igure A)
o *he se!!er/riter is the short $a!! (-igure )
o
/e can see the critical points o the mar$et price o the share (0) atthe time o e!ecution are 1', ' to '2.+ and 3'2.+.
o 4 0 3 & (mar$et price is greater than e!ercise price), the option is 5in
the (one&6
• 7alue o the option to buyer%holder (long call)8
o V = max(S - X, 0) – P
• The value o the option to the writer (short call) is8
o V = P - max(S - X, 0)
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• ,U* option pro-t an% !oss pro-!es:
• The e!ample is where there is a ,U* option or shares in a listed company
at a stri$e%e!ercise price (&) o ' and a premium (*) o '.+
o Fi"ure A is on$e a"ain the u&er/ho!%er 0!on" put
o Fi"ure is a!so the riter/se!!er 0short put
o The critical points here are dierent to the call e!ample, being where
0 at e!piration date are 1'.+, '.+ to ' and 3'
o *he u&er e#er$ises the option is S 3 4 03512
• 7alue o the option to buyer%holder (long call)8
o V = max(X - S, 0) – P
• The value o the option to the writer (short call) is8
o V = P - max(X - S, 0)
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+o)ere% an% nake% options:
9nli$e the case with utures, the ris$ o loss or a buyer o an option
contract is limited to the premium.
However, sellers (writers) o options have potentially un!i(ite% risk and
may be sub:ect to margin re;uirements un!ess the& rite a $o)ere%
option
o The write o an option holds the underlying asset or provides a
fnancial guarantee.
A call option is considered to be written as a covered option i the writer
either8
o wns suT (>hicago board o trade)
and >hicago ?ercantile #!change (>?#) retain open@outcry
trading on the oor involving B, to +, people.
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Cin$s between these internationally allow B@hour trading.
Austra!ian Options Markets 0*&pes *ra%e%
Options on Futures +ontra$ts 0 Traded on 0-# (0ydney utures
e!change))
o uyer o this options contract has the ri"ht to u& 0+a!! or se!!
0put a futures $ontra$t
D@day ban$@accepted bills
0-#%0*4 inde! utures contract
2 and @year >ommonwealth Treasury bonds
vernight options on the above Treasury bonds and share price
inde! utures contracts
Share Options 0 Traded on the A0&)
o 9sually three or more options contracts or each company, each wih
identical e!piration dates but dierent e!ercise prices
o The options clearing house maintains a system o deposits,maintenance margins and a share scrip depository.
• Warrants: Traded on >C4>E &T with settlement through A0& options
clearing house.
o E7uit& arrants attached to debt issues made by companies raising
unds through primary mar$et debt issues (Option to $on)ert %et
to or%inar& shares of the issuin" $o(pan&)
o
Finan$ia! pro%u$t arrants issued or investment and to manageris$ e!posure to price movements in the mar$et.
4ssued by fnancial institutions in American (up to expiration
date) or #uro@type (on expiration date) contracts
Fri$tiona! arrants cover only a part o a listed share so may
re;uire two or more rictional warrants to be e!ercised to buy a
share.
Fu!!& $o)ere% arrants has the underlying shares lodged in a
trust by issuer as a guarantee o issuers capacity to deliver
stoc$ on e!ercising o warrant.
8 *rice o this involves initial specifed instalment and
second instalment based on mar$et value o share.
Open out$r& is a method o communicating on an e!change involving verbal and
hand signal bids and oers to convey trading inormation in the trading pits. This
is ading with the introduction o electronic systems that improve e!ecution speed
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In%e# arrants9 asket arrants9 $appe% arrants9
insta!(ent arrants9 +apita! p!us arrants9 en%o(ent
arrants
;o
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o Hence the greater the spot price volatility, the greater the option
premium 0positi)e re!ationship
> Interest Rates
o O,,OSI*E i(pa$t on put an% $a!! options
-or a $a!! the beneft o present value o deerred payment i
e!ercised is greater than lower present value o proft i
e!ercised. 0,ositi)e re!ationship
-or a put there is an opportunity cost o holding the asset and a
lower present value o the proft i e!ercised. 0ne"ati)e
re!ationship
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@/6 Option Risk Mana"e(ent Strate"ies:
A tra%er $an ha)e the fo!!oin" positions on the future pri$e of the
un%er!&in" se$urit&
u!!ish 0pri$e i!! rise:
0trongly bullish I Gormal call option
?oderately bullish I as stoc$ prices rarely rise by large leaps, setting target
price or bull run and then utiliJing bull spreads to reduce costs (not ris$ as
the option can still e!pire worthless)
o 9sed to proft rom moderate rise in price o underlying security
o *roft is capped but usually costs less to employ or a nominal amount
o e!posure.
u!! $a!! sprea%: >onstructed by buying a call option with low
e!ercise price and selling another with a higher e!ercise price
(same security and e!piration month)
The lower e!ercise price will oten be at the (one& whilst the
higher e!ercise price is out of the (one&
The combination o long calls and short calls yields a proft
graph li$e this8
u!! put sprea%:
>onstructed by selling higher stri$ing (in the money) put
options and buying the same number o lower stri$ing (in the
money) put options on the same underlying security with the
same e!piration date.
The trader hopes that the price o the underlying security goesup ar enough such that the written put options e!pire
worthless.
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*roft is capped but ma!imum loss is much smaller than the
capped proft.
?ildly bullish I ma$e money in the long run i the underlying stoc$ price
does not go down by the option6s e!piration date. 0trategies may provide a
small downside protection as well
o /riting out@o@the@money covered calls is a good e!ample o such astrategy
earish 0pri$e i!! fa!!:
• 0trongly bearish I 0imple put options
• ?oderately bearish I pposite to bullish, stoc$ prices rarely all by large
leaps so set a target price or the e!pected decline and utiliJe bear spreads
to reduce cost.
o nce again, proft is capped but once again usually costs less to
employ
ear $a!! sprea%:
#ntered by buying call options o a certain stri$e price and
selling the same number o call options o lower stri$e price (in
the money) on the same underlying security with the same
e!piration month.
*roft occurs i price goes down to below call option (stri$eprice) value
Coss occurs i price does not go down or, indeed, rises
ear put sprea%:
uying higher stri$ing (in the money) put options and selling
the same number o lower stri$ing (out o the money) put
options on the same underlying security and the same
e!piration month.
*roft ma!imised when price goes below the stri$e price o the
written option (proft is dierence between stri$e prices, minus
the cost o entering into the position I the premium)
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Neutra! / non
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o 4 the options were sold, the holder has a short stra%%!e
0earish on )o!ati!it&
*roftable when there
is not such a
signifcant move
The profit is limited to thepremiums of the put and call,
but it is risky because if the
underlying security's price
goes very high up or very low
down, the potential losses are
virtually unlimited.
The deal breaks even if the intrinsic value of the put or the call equals the sum of the
premiums of the put and call.
The short straddle can also be classified as a credit spread because the sale of the
short straddle results in a credit of the premiums of the put and call.
o Stran"!e: The simultaneous buying and selling o out@o@the@money
put and out@o@the@money call, with the same e!pirations
0imilar to the straddle but with dierent stri$e prices
9nli$e a straddle, the options have dierent stri$e prices. A
strangle can be less e!pensive than a straddle i the stri$e
prices are out@o@the@money
!on" stran"!e', loss is decreased i price remains unchanged
compared with long@straddle. 0u!!ish on )o!ati!it&
http://en.wikipedia.org/wiki/Strike_pricehttp://en.wikipedia.org/wiki/Strike_price
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o Short stran"!e: 0ell call and put options, both out o the money.
A short strangle is similar to the 0hort 0traddle e!cept the stri$e
prices are urther apart, which lowers the premium received but
also increases the chance o a proftable trade.
earish on )o!ati!it&
Note: if u!!ish on )o!ati!it& – $an a!so use short $on%or an% short utter=&
Note: if earish on )o!ati!it& < $an a!so use ratio sprea%s9 !on" $on%or an%
!on" utter=&
http://www.optiontradingtips.com/strategies/short-straddle.htmlhttp://www.optiontradingtips.com/strategies/short-straddle.html
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#"8 Cong asset (bought) and bearish (negative) about uture asset priceK
o Cimit downside ris$ by writing (selling) a call option, i.e Short Call
o
EB: Short asset 0so!% an% u!!ish 0positi)e aout future asset pri$eC
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uy a call in the underlying asset (i.e long@call position)
E": E#pe$tation of in$rease% )o!ati!it& ith no tren%
Hold (buy) a put option
Hold (buy) a call option with common e!ercise price
E": E#pe$t in$rease% )o!ati!it&9 ithout tren%9 ith sta"nation
Hold (buy) call option with out@o@the@money e!ercise price
Hold (buy) put option with out@o@the@money e!ercise price
E": E#pe$t pri$e stai!it&
Ta$e opposite position to long straddle and long strangle8
6/6 Options )s Futures:
The potential gains and losses to buyers and sellers o utures contracts are
dierent rom those o options.
ptions provide one@sided price protection that is not available through
utures
The option buyer limits losses and allows profts to accumulate.
o However, the premium to pay may be ;uite high.