Lecture 9 - Options and Futures

Lecture 9 - Options and Futures - Lecture 9 Options and...

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Lecture 9 - Options and Futures Options: Derivatives: contracts between two parties that have a price and that trade in specific markets Introduction to Options: Option: a securities people purchase representing a claim on a particular stock or group of stocks and gives the holder the right to receive or deliver shares of stock under specified conditions Equity Derivative securities: securities that service their value in whole or in part by having a claim on the underlying common stock Options Basics Option: Claims that give the holder the right, but not the obligation, to buy or sell a stated number of shares or stock within a specified period at a specified price Call Option: An option that gives the holder the right, but not the obligation, to buy a specified number of shares of stock at a stated price within a specified period - purchased if the expected stock price is to rise because the price of the call and the common stock will move together Put Option: an option that gives the holder the right, but not the obligation to sell a specified number of shares of stock at a stated price within a specified period - shares are sold by the owner (buyer) of the put contract to a writer (seller) of the contract, who has been designated to take delivery of the shares and pay the specified price - Investors purchase puts if they expect the stock price to fall Why Option Markets? - 1. Puts and calls expand the opportunity set available to investors, making available to investors, making available risk-return combinations that otherwise would be impossible or that improve the risk-return characteristics of a portfolio - 2. Requires a much smaller investment to claim the underlying common stock + the option buyers maximum loss is known in advance i.e. if the option expires worthless: you only loose the cost of the option - 3. They magnify the percentage gains in relation to buying or short selling the underlying stock. They provide greater leverage potential than fully margined stock transactions - 4. Can participate in market movement with a single trading decision Understanding Options Option Terminology 1. Exercise strike price: the per-share price at which the common stock may be purchased from or sold to a writer (call vs put) 2. Expiration date: the date on which an option expires…the last date it can be exercised 3. Option premium: the price paid by the option buyer to the writer (seller) of the option, whether put or call and is stated on a per-share basis
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Long-term options or LEAPs: options with maturities greater than one year and ranging to two years and beyond How Options Work - The buyer and seller have opposite expectations The call writer expects the price of the stock to remain roughly steady or perhaps move down The call buyer expects the price of the stock to move upward and relatively soon The put writer expects the price of stock to remain roughly steady or perhaps move up The put buyer expects the price of the stock to move down and relatively soon -
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