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Unformatted text preview: Option Pricing I by Dr. Fernando Diz Elementary Pricing: Calls Suppose you own a call option on ABC stock with exercise price of E = $40.0 Suppose that at expiration ABC is trading at $35.0 What is the intrinsic value of the option? Elementary Pricing: Calls What transactions take place if you decide to exercise this option (not sell)? Elementary Pricing: Calls 1 . Advice your broker that you are exercising the option. 2. You pay $40.0 per share, and 3. You receive 100 shares of ABC stock. 4. You sell 100 shares of ABC at $35.0 What is your payoff after exercising? Elementary Pricing: Calls What would be the maximum amount an investor would pay for such an option at expiration? The call value will be zero at expiration if the intrinsic value of the option is negative! Elementary Pricing: Calls Suppose now ABC is trading at $45.0 a share at expiration. What is the intrinsic value? What would the CALL option at most be worth? Elementary Pricing: Calls At most $5.0 per share! Why? If I buy the option from you an instant before expiration, I can exercise it immediately. What would my profit be from doing this? Elementary Pricing: Calls 1. I buy the option at $5.0 per share. 2. I exercise it, so that I pay $40.0 per share and get a share of ABC. 3. I sell a share of ABC at $45.0. The profit is zero!!! Elementary Pricing: Calls Total cash flows from the transactions: Transaction Cash Flow Buy one call option @ $5.0 ($5.00) Buy one share of ABC @ $40.0 ($40.00) Sell one share of ABC @ $45.0 $45.00 NET CASH FLOW (profit) $0.00 Elementary Pricing: Calls What does it mean that I cannot make any profits from this strategy?...
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This note was uploaded on 02/09/2010 for the course FIN 459 taught by Professor Yildary during the Spring '07 term at Syracuse.
 Spring '07
 Yildary
 Options

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