Note5 - FI 478 Investment Strategies and Speculative...

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Unformatted text preview: FI 478 Investment Strategies and Speculative Markets Professor Fan Yu Lecture 5 Introduction to Options This Version: February 15, 2008 c & 2008 Fan Yu. All Rights Reserved. 1 Terminologies & A call option gives its owner the right (but not the obligation) to buy an asset for a pre-speci&ed price (the exercise or strike price ) on or before a speci&c future date. & An option to buy one share of Intel in May, 2006 for $20. & A put option gives its owner the right to sell an asset for a pre-speci&ed price. & An option to sell one share of Intel in May, 2006 for $20. & A European option can only be exercised on the pre-speci&ed date. An American option can be exercise at any time on or before the pre- speci&ed date. & All exchange-traded stock options are American. & All index options are European except the SP100 index option. & Unlike forward or futures, the owner of an option will only exercise when the payo/ of doing so is positive. & A call is said to be in the money if the price of the asset is greater than the strike price. In this case, the payo/ from exercising immediately is positive (absent transactions cost). A call is said to be out of the money if the price of the asset is less than the strike price. A call is said to be at the money when the price of the asset is equal to the strike price. & For puts, the opposite holds. S < K S = K S > K Call Out of the money At the money In the money Put In the money At the money Out of the money & The intrinsic value of an option is the pro&t that would be attained if we exercise it today. When this is negative, the intrinsic value is 0. The di/erence between the option price and the intrinsic value is the time value of an option. 2 & There are 4 basic option positions. & A long position in a call has payo/at maturity given by max (0 ;S ( T ) K ) : & A long position in a put has payo/at maturity given by max (0 ;K S ( T )) : 3 & A short position in a call has payo/at maturity equal to & max (0 ;S ( T ) & K ) = min (0 ;K & S ( T )) : & A short position in a put has payo/at maturity equal to & max (0 ;K & S ( T )) = min (0 ;S ( T ) & K ) : & Options can be used to design securities with customized payo/s. 4 Contract Speci&cation for Stock Options & Exchanges: CBOE, PHLX, AMEX, etc. Also traded OTC. & Contract size: Each contract is for 100 shares and option price is quoted on a per share basis. & Exercise price: Integer multiples of $2.5 for stocks less than $25. Integer multiples of $5 for stocks between $25 and $200. Integer multiples of $10 for stocks above $200. This convention is frequently violated. & Maturity date: All options mature on the Saturday following the third Friday of the month of maturity. The month of maturity follows the January, February or March cycle....
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Note5 - FI 478 Investment Strategies and Speculative...

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