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428_lecture19_Options_B_S09

# 428_lecture19_Options_B_S09 - Lecture 19 Option Basics(part...

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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
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)
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
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
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?
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)
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
Gross Payoff of Stock + Put x x Stock price Payoff at expiration \$X = strike price of put This position allows an investor to profit if stock price rises above \$X.

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