Scribd
Upload
29 views

Intro To Options

This document defines the basic types of options - American and European call and put options. It describes their key properties including being in, out, or at the money. It also covers option notation, arbitrage opportunities, and how an option's value is determined by the underlying asset price, strike price, time to expiration, and volatility. Basic option transactions and payoffs for calls and puts are illustrated. Common option strategies like protective puts, covered calls, and long straddles are also defined.

Uploaded by

Fatima Mosawi
Copyright
© © All Rights Reserved
Available Formats
Download as PPTX, PDF, TXT or read online on Scribd
29 views

Intro To Options

This document defines the basic types of options - American and European call and put options. It describes their key properties including being in, out, or at the money. It also covers option notation, arbitrage opportunities, and how an option's value is determined by the underlying asset price, strike price, time to expiration, and volatility. Basic option transactions and payoffs for calls and puts are illustrated. Common option strategies like protective puts, covered calls, and long straddles are also defined.

Uploaded by

Fatima Mosawi
Copyright
© © All Rights Reserved
Available Formats
Download as PPTX, PDF, TXT or read online on Scribd
You are on page 1/ 22

Introduction to

Options
B, K & M Chapters 20 & 21
Types of Options
 American Call Option:
 Contract giving its owner the right to purchase a given number
of shares (100) of a specific security at the strike price (X) at
any time prior to maturity (T)
 A call is not an obligation to buy 100 shares at $X per share.
The owner of the call option only exercises if he/she finds it in
his/her interest
 Recall however that for each “long” side of the contract there is
a “short” side. If you sell the option, you will be required to sell
at $X per share when the option is exercised (which will only
occur when the price of the underlying security is greater than
$X)
 “Zero sum game”
Types of Options

 American Put Option:

 Contract giving its owner the right to sell a given


number of shares (100) of a specific security at the
strike price (X) at any time prior to maturity (T)

 Again, if you sell this option, you must buy shares at


$X if the option is exercised
Types of Options
 European Call and Put Options:
 Like American call and put options except that exercise
is only possible at expiration
 The geographical labeling is a misnomer. Most options
traded here and in Europe are American options.
Foreign currency options and some stock index options
traded on the CBOE are important exceptions however.
(The SP500 options contract is a European option while
the SP100 contract is American.)
 Which option will be more valuable?
Notation

 Co: Current price of a call option (per share).


 Po: Current price of a put option.
 X: Strike or exercise price.
 T: Expiration date.
 t: any time between issue date and maturity date.
 So: Current price of the underlying security (stock).
Arbitrage Opportunities
 No Arbitrage Assumption
1. All assets with identical payoff must have the same
price (Law of One Price).
2. There is no asset that has a positive payoff later and a
non-negative payoff now.
Properties of Options
 In the Money: Payoff > 0
 Out-of-the-money: Payoff < 0
 At-the-money: payoff = 0
• X = So: Call is at-the-money (put is at-of-the-money).
• X < So: Call is in-the-money (put is out-of-the-money).
• X > So: Call is out-of-the-money (put is in-the-money).
 Intrinsic Value: The amount that is in the money
 Option Value = Intrinsic Value + Time Value
Properties of Options
Payoffs and Profits:
• Call Option Payoff: Max (St – X, 0)
• Call Option Profit: Max (St – X, 0) – Ct

• Put Option Payoff: Max (X – St, 0)


• Put Option Profit: Max (X – St, 0) – Pt
Properties of Options
Determinants of Options Value:

Variable Call Put


St + -
X - +
T + +
σ + +
Basic Transactions in Calls
 Buyer purchases American call at time 0
 At any time t (0<t<T) the buyer can do:
- Exercise the call by paying 100(X) dollars. He then
receives 100 shares of stock worth 100 (St) dollars in
exchange
- Cancel the position by selling the call for 100 (Ct) dollars
- Hold on to the call
- The maximum loss is limited to the initial investment 100
(C0)
 Writer or seller of an American call option is obligated to
deliver 100 shares of the underlying stock in exchange for 100
(X) dollars
Basic Transactions in Calls
 At any time t (0<t<T) the writer can:
- Close out the position by buying a call for 100 (C t) dollars
- Do nothing
- Maximum loss is unlimited, so margins must be posted to guarantee
payment in the event of an exercise
 Naked position in options refer to short positions in an option that are not
combined with a position in the underlying security
 Here, buying a call is a “bullish” strategy, while buying a put is a “bearish”
strategy
 Although buying a call gives you unlimited upside gain, it is risky (You
stand to lose your initial investment)
 Options can be used by speculators as leveraged stock positions, but they can
also be used creatively to manage risk exposures
Payoff, Profit to Call Option at
Expiration
Payoff, Profit to Call Writers at
Expiration
Payoff, Profit to Put Option at
Expiration
Option Strategies: Protective Put

Asset combined with put option that guarantees minimum


proceeds equal to put’s exercise price

Payoff to Protective Put Strategy:


Option Strategies: Protective Put
Protective Put vs. Stock Investment
Option Strategies: Covered Call

Writing call on asset together with buying asset

Payoff to Covered Call Strategy:


Option Strategies: Covered Call
Option Strategies: Long Straddle
A long straddle is established by buying both a call and a put
on a stock with the same expiration date and strike price. This
is a bet on higher volatility than expected by the market

Payoff to Long Straddle Strategy:


Option Strategies: Long Straddle
Other Option Strategies

 Short Straddle
 Strip
 Strap
 Long Strangle
 Bullish Spread
 Bearish Spread
 Box Spread
 Butterfly Spread

You might also like