chapter12 - Chapter 12 1 CHAPTER 12 AN OPTIONS PRIMER In...

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Unformatted text preview: Chapter 12 1 CHAPTER 12 AN OPTIONS PRIMER In this chapter, we provide an introduction to options. This chapter is organized into the following sections: 1. Options and Options Markets 2. Options Pricing 3. The Option Pricing Model 4. Speculating with Options 5. Hedging with Options Chapter 12 2 Options and Options Markets Options Options are specialized financial instruments that give the purchaser the right but not the obligation to do something. That is, the purchaser can do something if he/she wants to, but he/she does not have to do it. Options are a relatively new financial instruments dating back to the 1970s. IBM Example: IBM common stocks trades at $120, an investor has an option to buy a IBM stock for $100 through August in the current year. Chapter 12 3 Options and Options Markets There are two classes of options referred to as put and call options. You may purchase or sell either a call option or a put option. Put and call options each give buyers and sellers different rights and responsibilities as follows: Call Options The buyer of a call option has the right but not the obligation to purchase a pre-specified amount of a pre- specified asset at a pre-specified price during a pre- specified time period. The seller of a call option has the obligation to sell a pre- specified amount of a pre-specified asset at a pre-specified price if asked to do so during a pre-specified time period. Chapter 12 4 Options and Options Markets Put Options The buyer of a put option has the right but not the obligation to sell a pre-specified amount of a pre-specified asset at a pre-specified price during a pre-specified time period. The seller of a put option has the obligation to purchase a pre-specified amount of a pre-specified asset at a pre- specified price if asked to do so during a pre-specified time period. Chapter 12 5 Options and Options Markets Terminology The Premium The buyer of an option pays the seller of the option a premium on the day that the agreement is entered into. The Strike Price or the Exercise Price The pre-specified price is referred to as the strike or the exercise price. Expiration The amount of time specified in the options contract. Exercise The option buyer elects to utilize his/her right. In the case of a call option, the buyer utilizes his/her right to buy the stock. In the case of a put option, the buyer utilizes her/his right to sell the stock. Chapter 12 6 Options and Options Markets Terminology Option Writer The seller of an option. Writing an Option The act of selling an option. European Options European options can be exercised only on the maturity date. American Options American options can be exercised any time prior to maturity....
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This note was uploaded on 02/28/2010 for the course MBA 87 taught by Professor Dpg during the Spring '10 term at Indian Institute Of Management, Kolkata.

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chapter12 - Chapter 12 1 CHAPTER 12 AN OPTIONS PRIMER In...

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