Options - PowerPoint Presentation

Download presentation
Options
Options

Options - Description


Chapter 19 Jones Potential Benefits of Derivatives Derivative instruments Value is determined by or derived from the value of another instrument vehicle called the underlying asset or security ID: 277651 Download Presentation

Tags

option price stock options price option options stock call put exercise payoff profit 000 500 expiration underlying money asset

Embed / Share - Options


Presentation on theme: "Options"— Presentation transcript


Slide1

Options

(Chapter 19)Slide2

Potential Benefits of Derivatives

Derivative instruments: Value is determined by, or derived from, the value of another instrument vehicle, called the underlying asset or security

Risk

shifting

Especially shifting the risk of asset price changes or interest rate changes to another party willing to bear that risk

Price formation

Speculation opportunities when some investors may feel assets are

mis

-priced

Investment cost reduction

To hedge portfolio risks more efficiently and less costly than would otherwise be possibleSlide3

Option characteristics

Options are created by investors, sold to other investorsOption

to buy is a call option

Call options

gives the holder the right, but not the obligation, to

buy

a given quantity of some asset at some time in the future, at prices agreed upon today.

Option to sell is a put option

Put options

gives the holder the right, but not the obligation, to

sell

a given quantity of some asset at some time in the future, at prices agreed upon today

Option premium – price paid for the option

Exercise price or strike price – the price at which the asset can be bought or sold under the contract

Open interest: number of outstanding optionsSlide4

Option characteristicsExpiration date European: can be exercised only at expiration

American: exercised any time before expirationOption holder: long the option positionOption writer: short the option position Hedged position: option transaction to offset the risk inherent in some other investment (to limit risk)

Speculative position

: option transaction to profit from the inherent riskiness of some underlying asset.

Option contracts are a

zero sum game

before commissions and other transaction costs.Slide5

Call buyer (seller) expects the price of the underlying security to increase (decrease or stay steady)

Put buyer (seller) expects the price of the underlying security to decrease (increase or stay steady)

At option maturity

Option may expire worthless, be exercised, or be sold

How Options WorkSlide6

Options TradingOption exchanges are continuous primary and secondary marketsChicago Board Options Exchange largest

Standardized exercise dates, exercise prices, and quantitiesFacilitates offsetting positions through Options Clearing CorporationOCC is guarantor, handles deliveriesSlide7

Options Contracts: Preliminaries

A call option is:

In

-

the

-

money

The exercise price is less than the spot price of the underlying asset.

At-the-money

The exercise price is equal to the spot price of the underlying asset.

Out-of-the-money

The exercise price is more than the spot price of the underlying asset.Slide8

Options Contracts: Preliminaries

A put option is:

In

-

the

-

money

The exercise price is greater than the spot price of the underlying asset.

At-the-money

The exercise price is equal to the spot price of the underlying asset.

Out-of-the-money

The exercise price is less than the spot price of the underlying asset.Slide9

Options

Example: Suppose you own a call option with an exercise (strike) price of $30.If the stock price is $40 (in-the-money):

Your option has an intrinsic value of $10

You have the right to buy at $30, and you can exercise and then sell for $40.

If the stock price is $20 (out-of-the-money):

Your option has no intrinsic value

You would not exercise your right to buy something for $30 that you can buy for $20!Slide10

Options

Example: Suppose you own a put option with an exercise (strike) price of $30.If the stock price is $20 (in-the-money):

Your option has an intrinsic value of $10

You have the right to sell at $30, so you can buy the stock at $20 and then exercise and sell for $30

If the stock price is $40 (out-of-the-money):

Your option has no intrinsic value

You would not exercise your right to sell something for $30 that you can sell for $40!Slide11

Options

Stock Option QuotationsOne contract is for 100 shares of stock

Quotations give:

Underlying stock and its current price

Strike price

Month of expiration

Premiums per share for puts and calls

Volume of contracts

Premiums are often small

A small investment can be “leveraged” into high profits (or losses)Slide12

Options

Example: Suppose that you buy a January $60 call option on Hansen at a price (premium) of $9.

Cost of your contract = $9 x 100 = $900

If the current stock price is $63.20, the intrinsic value is $3.20 per share.

What is your dollar profit (loss) if, at expiration, Hansen is selling for $50?

Out-of-the-money, so Profit = ($900)

What is your percentage profit with options?

Return = (0-9)/9 = -100%

What if you had invested in the stock?

Return = (50-63.20)/63.20 = (20.89%)Slide13

Options

What is your dollar profit (loss) if, at expiration, Hansen is selling for $85?Profit = 100(85-60) – 900 = $1,600

Is your percentage profit with options?

Return = (85-60-9)/9 = 77.78%

What if you had invested in the stock?

Return = (85-63.20)/63.20 = 34.49%Slide14

Options

Payoff diagramsShow payoffs at expiration for different stock prices

(S)

for a particular option contract with a strike price of

E

For calls:

if the

S<E,

the payoff is zero

If S

>E,

the payoff is

S-E

Payoff = Max [0, S

-E]

For puts:

if the

S>E,

the payoff is zero

If

S<E,

the payoff is

E-S

Payoff = Max [0,

E-S]Slide15

Option Trading Strategies

There are a number of different option strategies:Buying call options

Selling call

options

Covered call

Buying put options

Selling put

options

Protective putSlide16

Buying Call Options

Position taken in the expectation that the price will increase (long position)

Profit for purchasing a Call Option:

Per Share Profit =Max [0,

S-E]

– Call Premium

The following diagram shows different total dollar profits for buying a call option with a strike price of $70 and a premium of $6.13Slide17

Buying Call Options

40

50

60

70

80

90

100

1,000

500

0

1,500

2,000

2,500

3,000

(500)

(1,000)

Exercise Price = $70

Option Price = $6.13

Profit from Strategy

Stock Price at ExpirationSlide18

Selling Call Options

Bet that the price will not increase greatly – collect premium income with no payoff

Can be a far riskier strategy than buying the same options

The payoff for the buyer is the amount owed by the writer (no upper bound on

E-S)

Uncovered calls: writer does not own the stock (riskier position)

Covered calls: writer owns the stock

Moderately bullish investors sell calls against holding stock to generate incomeSlide19

Selling Call Options

40

50

60

70

80

90

100

(1,000)

(1,500)

(2,000)

(500)

0

500

1,000

(2,500)

(3,000)

Exercise Price = $70

Option Price = $6.13

Stock Price at Expiration

Profit from Uncovered Call StrategySlide20

Covered call S< E S>E Payoff of stock S S

Payoff call -0 -(S-E) Premium C C Total payoff C+S C+ESlide21

Covered Call Writing

0

Stock Price

at Expiration

Profit ($)

Purchased share

Written call

CombinedSlide22

Buying Put Options

Position taken in the expectation that the price will decrease (short position)

Profit for purchasing a Put Option:

Per Share Profit = Max [0,

E-S]

– Put Premium

Protective put: Buying a put while owning the stock (if the price declines, option gains offset portfolio losses)Slide23

Buying Put Options

40

50

60

70

80

90

100

1,000

500

0

1,500

2,000

2,500

3,000

(500)

(1,000)

Exercise Price = $70

Option Price = $2.25

Profit from Strategy

Stock Price at ExpirationSlide24

Hedging strategy that provides a minimum return on the portfolio while keeping upside potential

Buy protective put that provides the minimum return

Put exercise price greater or less than the current portfolio value?

Problems in matching risk with contracts

Portfolio InsuranceSlide25

Protective put

S< E S>E

Payoff of stock S S

Payoff put E-S 0

Premium -P -P

Total

payoff

E-P

S-PSlide26

Selling Put Options

Bet that the price will not decline greatly – collect premium income with no payoffThe payoff for the buyer is the amount owed by the writer (payoff loss limited to the strike price since the stock’s value cannot fall below zero)Slide27

Selling Put Options

40

50

60

70

80

90

100

(1,000)

(1,500)

(2,000)

(500)

0

500

1,000

(2,500)

(3,000)

Exercise Price = $70

Option Price = $2.25

Stock Price at Expiration

Profit from StrategySlide28

Exam type question

An investor bought two Google June 425 (exercise price is $425) put contracts for a premium of $20 per share. At the maturity (expiration), the Google stock price is $370. (i) Draw the payoff diagram of the investment position.(ii) Calculate the total profit/loss of the position at the expiration.Slide29

Option pricing

Factors contributing value of an option

price of the underlying stock

time until expiration

volatility of underlying stock price

cash dividend

prevailing interest rate.

Intrinsic value: difference between an in-the-money option

s strike price and current market price

Time value: speculative value.

Call price = Intrinsic value + time

value

Exercise prior to maturity implies the option owner receives intrinsic value only, not time value

Slide30

Factors Affecting PricesSlide31

Black-Scholes Option Pricing Model

Where C: current price of a call option

S: current market price of the underlying stock

X: exercise price

r: risk free rate

t: time until expiration

N(d

1

) and N (d

2

) : cumulative density functions for d

1

and d

2

Slide32

Learning outcomes

:discuss the benefits of using financial derivatives know the basic characteristics of options know the options’ payoffs know how to calculate the profits/losses of a long/short call and put options, covered call and protective put (numerical application) Know the factors affecting option pricing; no numerical problems with Black-ScholesNOT on the exam: Boundaries on option prices p508-509; Put option valuation, riskless hedging, Stock index options p 513-519; Recommended

End-of-chapter

questions:19-1 to 14

Recommended End-of-chapter

problems:19.1, 2, 3

Shom More....
By: phoebe-click
Views: 24
Type: Public

Download Section

Please download the presentation after appearing the download area.


Download Presentation - The PPT/PDF document "Options" is the property of its rightful owner. Permission is granted to download and print the materials on this web site for personal, non-commercial use only, and to display it on your personal computer provided you do not modify the materials and that you retain all copyright notices contained in the materials. By downloading content from our website, you accept the terms of this agreement.

Try DocSlides online tool for compressing your PDF Files Try Now

Related Documents