Topic11 OptionsBasics

Topic11 OptionsBasics - Topic 11: Options Markets FIN 4504...

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Topic 11: Options Markets FIN 4504 Fall 2009
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2 Introduction Options are a type of derivative securities Derivatives: Securities whose prices derive from the prices of other securities. Option terminology: Buy, long Sell, write, short Exercise (Strike) price Premium (price) Maturity (expiration)
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3 Option types 1. Call option Gives the owner the right (not the obligation) to buy the underlying security at a pre-specified price (strike/exercise price) on or before a specified expiration date. Ex: On Wednesday July 30, the October 2003 call option on Microsoft stock with $50 strike price was selling for a premium of $5.00. Important: Each contract is for 100 shares. So, the premium is $500, and if the option is exercised you receive 100 Microsoft stocks, paying $5000 total.
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4 Option types 1. Put option Gives the owner the right (not the obligation) to sell the underlying security at a pre-specified price (strike/exercise price) on or before a specified expiration date.
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5 Important aspects of option contracts 1. Options are side-bets: No impact on the firm 1. Zero-sum game 1. American vs. European European options: Can be exercised only at the maturity American options: Can be exercised early
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6 Important aspects of option contracts 1. Market-exercise price relationship: In-the-money: exercise of the option profitable Out-of-money: exercise of the option not profitable At-the-money: strike price = stock price Market scenarios Call options Put options Market price>strike price In-the-money Out-of-money Market price<strike price Out-of-money In-the-money Market price=strike price At-the-money At-the-money
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Topic11 OptionsBasics - Topic 11: Options Markets FIN 4504...

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