428_lecture19_Options_B_S09 - Lecture 19: Option Basics...

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Lecture 19: Option Basics (part II) AEM 428 Manny Dong Materials from Smart et al. Ch. 18
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Class Schedule Option Pricing and Real Option Valuation 4/2, 4/7, 4/9 Earning Management 4/14 Review 4/16 Final Exam 4/21 Stock pitching Exercises 4/23, 4/28 and 4/30
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Class of 4/9 in Park Center Two sections: Section 1: 11:40am-1:00pm Students last name starting with A-L Section 2: 4:30pm-6:00pm Students last name starting with M-Z Park Center Second Floor, Sage Hall, by the elevator
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Options Two Types of Option: Call Put Two Exercise Styles: American Option European Option Parts: Stock Price (S) Option Price (premium) Strike Price/Exercise price (X) Expiration (maturity)
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Net Payoffs S > X S < X Buy A Call with Price C S – X - C - C Sell A Call with Price C -(S – X –C ) =C + X - S C Buy A Put with Price P -P X- S - P Sell a Put with Price P P -(X - S - P) = P+ S - X
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Moneyness of Options Call Put S>X S=X S<X S = current stock price X = strike price
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Car Insurance (Option Related?) You have a car worth of $10,000 and just bought one year full insurance with $500 today. Call or Put? Premium, Exercise price? Expiration? Payoff of buyer and seller? Who has the large risk? Can we draw a payoff diagram?
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Example: Call X = $100, Call price = $5, S = $104 In-the-money or out-the-money? Intrinsic value? Net profit/loss if exercise today? Time value? Intrinsic Value Stock Price 100 105 5 0 104
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Take home Question A European call on ZZZ shares with an exercise price of $100 and maturity of three months is trading at $5. The 3-month interest rate, not annualized, is 0.5%. What is the price (S) of ZZZ that makes the call break-even (net payoff =0)?
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Example: Option Straddle Purchase a put and call at the same strike price Current stock price = 100 Purchase at-the-money call (strike = 100) for $2 Purchase at-the-money put (strike = 100) for $3 What is the total value of your option portfolio for different stock prices?
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Straddle Contingency Graph Plot of net $ gain as a function of stock price Strike price = $100 Option prices: call = $2, put = $3 Net Gain Stock Price 100 106 1 -5 0 105 95 94
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Straddle Performance Lose money when no change in price Price goes up: Call makes money Price goes down: Put makes money Strategy makes money when price moves a lot (depends on option prices)
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Other Option Portfolio Payoffs Now look at portfolios containing options, stocks,  and bonds. Looking at these payoffs will help lead us to an important  option pricing relationship:  put-call parity. Construct portfolios that include options, stocks and bonds. Stock and put options Bond and call options
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Stock + Put: Example Purchasing a put option on stock you already own sets a floor on what you can sell Buy stock at 75, price rises to 100 Lock in gains, buy put at strike = 100 Gains will be at least 100-75 Cost = price of the put option
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This note was uploaded on 09/23/2009 for the course AEM 4280 taught by Professor Ng,d. during the Spring '08 term at Cornell University (Engineering School).

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428_lecture19_Options_B_S09 - Lecture 19: Option Basics...

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