DefinitionsAndPayoffsAtExpirationofCallAndPuts

DefinitionsAndPayoffsAtExpirationofCallAndPuts -...

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Unformatted text preview: Definitions and Payoffs at Expiration of Calls and Puts1 I. The Options Contract An option contract has three elements. The underlying asset, exercise price (also called the strike price) and the expiration date. • Buyer of a call option is the right to buy stock at date t for the exercise price E. • Buyer of a put option is the right to sell stock at date t for the exercise price E. On the other side of each of these contracts is a counterparty. In options parlance “write” is the same as “sell”. • Writer of a call has the obligation to sell the stock at date t for the exercise price E if the counterparty chooses to exercise. • Writer of a put has the obligation to buy the stock at date t for the exercise price E if the counterparty chooses to exercise. II. Payoffs and Profits at Expiration The payoff at expiration is the dollar amount the investor receives at expiration from following the option strategy. The profit at expiration is the payoff, minus the cost of the setting up the strategy. Notation: S Stock price E 1 Exercise price Notes for Finance 100 (sections 301 and 302) prepared by Jessica A. Wachter. Claim: At expiration, Payoff to buying a call Payoff to buying a put = max[0, S − E ] = max[0, E − S ] For these examples, consider E = 100. Suppose that when the strategies were set up, calls and puts with this exercise price each cost $10. 1. Buying a call (long a call) S 70 80 90 100 110 120 130 2. Buying a put (long a put) S 70 80 90 100 110 120 130 Payoff Profit 30 20 10 0 0 0 0 20 10 0 -10 -10 -10 -10 Payoff Profit 0 0 0 0 10 20 30 -10 -10 -10 -10 0 10 20 3. Selling (writing) a call (short a call) S 70 80 90 100 110 120 130 4. Selling (writing) a put (short a put) S 70 80 90 100 110 120 130 Payoff Profit -30 -20 -10 0 0 0 0 -20 -10 0 10 10 10 10 Payoff Profit 0 0 0 0 -10 -20 -30 10 10 10 10 0 -10 -20 ...
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DefinitionsAndPayoffsAtExpirationofCallAndPuts -...

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