Chapter 11: Introduction to Options MarketsI. Option Contract Defined- exchange traded options offer 3 advantages; exercise price and expiration date of contract are standardized, direct link between buyers and sellers severed, transaction costs are lower than for OTC options- liquidity concern of OTC options not a big deal because most dealers use OTC options as part of an asset/liability strategy intended to hold them until expirationII. Differences Between Options and Futures Contracts- only one part is obligated to act (writer) on an option contract- the risk/reward characteristics of the two contracts are different- buyer of contract realizes a dollar-for-dollar gain when price of futures contract changes- options don’t provide symmetric risk/reward relationship; used to protect against asymmetric risk in hedgingIII. Risk and Return Characteristics of Options- should consider the time value of money and the interest that could have been earned when measuring the break even pointIV. Pricing of Options
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