Options - Finance - Lecture Slides, Slides of Finance

Download Options - Finance - Lecture Slides and more Slides Finance in PDF only on Docsity!

Options

Lecture Agenda

1. Option Basics

2. Call Options

3. Put Options

4. Option Pricing

5. Options Markets

Options Calls Puts Option Pricing Options Markets

Option Basics

Options

What are They?

• Option contracts offer non-linear

payoffs.

• Options give the holder the right (BUT

NOT THE OBLIGATION) to buy (put

option) or sell (call option) an

underlying asset for a specified price

(strike price) over a given period of

time.

Options

Types – Call Options

Call Options

• Call options give the holder the right to

buy the underlying asset at the strike price

prior to the expiry of the option.

• Call option holders have a ‘bullish’ outlook

for the price of the underlying asset (they

will profit if the underlying stock price rises

prior to expiry of the option.)

Options

Types – Where they are Created/Traded

Call Options

Call Options

Definitions

Call Option Defined

• The right, but not the obligation, to buy an underlying asset at a fixed price for a specified time.

Exercise Price or Strike Price

• The price at which an investor can buy the underlying asset.

Exercise

• To implement the rights of options by buying (in the case of call options) or selling (in the case of put options).

Expiration Date

• The last date on which options can be converted or exercised.

Payoff

• The proceeds that would be generated from the option if today was the expiration date.

Call Options

Call Holder’s Option Basics

• The purchaser of a call option has a ‘bullish’ outlook for the

underlying asset.

• Intrinsic value = Underlying asset price – strike price

Out-of-the-Money

• When the underlying asset price is below the strike price the

‘intrinsic value’ of the call option is $0.00.

In-the-Money

• When the underlying asset price rises above the strike price, the

intrinsic value of the call option climbs above $0.00.

(Figure 12 -1 illustrates the Call Holder’s Payoff)

Call Options

Call Holder’s Payoff

12 - 1 FIGURE

$

Option Payoff

0 UnderlyingAsset Price

Long Underlying Intrinsic Value of Option

Out- of-the-money In-the-money

Strike Price = $

If the underyling Asset Price was $60, then the intrinsic value would be $10. ($60 – strike price). This would be an in-the-money call option at the $60 $60 price.

$

$

If the underlying asset price is $40, the option is worthless. If this condition remained until expiry, the option would expire without being exercised. This is an example of an ‘out-of-the- money’ call option.

Call Options

Call Writer’s Option Basics

• The option writer is the person who sells an option
• The writer of a call option has a ‘bearish’ outlook for the

underlying asset and hopes to profit from that.

• The call writer receives the call premium (price) when she sells

the option.

• She hopes the underlying asset price will stay the same or fall, and the call option will remain out-of-the-money, and expire worthless in the hands of the call holder.
• In this way the call writer earns a call premium.

(Figure 12 -2 illustrates the Call Writer’s Payoff)

Call Options

Call Writer’s Payoff

12 – 2 FIGURE

$

Short Option Payoff

0 UnderlyingAsset Price

Call Option Values

Option Premium and Time Value (TV)

• The Option Premium is the actual price of the option prior to expiration.
• At expiration TV=0, so the option premium = IV:
• Equation 12 – 2 can be rearranged to solve for TV:

[12-2] Option^ premium =IV +^ TV

Call Options

Time Value (TV)

• The Time Value (speculative value) of a call option occurs because time remains until the option expires:
  • The longer the time to expiry, the greater the possibility that the

underlying stock price will rise and the call will be worth more:

• Clearly, the longer the time to expiry, the greater the TV.

(See Figure 12 – 3 that illustrates the Call Option Premium)

[12-3] TV =Option Premium+ IV