Options and corporate securities

Options and - Lecture V Options and Corporate Securities Read Chapter 23 1 Overview 2 Options The basics 2.1 Definitions 2.2 Option quotations 2.3

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Lecture V: Options and Corporate Securities Read Chapter 23 1. Overview 2. Options: The basics 2.1 Definitions 2.2 Option quotations 2.3 Option payoffs 2.4 Why options are traded 3. Valuing a call option 3.1 The upper and lower bounds on a call’s value 3.2 Valuing a call option to be in the money 3.3 Four factors affecting option values 3.4 Valuing a call option: A more general example 4. Equity as a call option 1. Overview Perhaps you have heard about “warrants” and “rights”. These are both examples of a call option which is the right to buy a share at a prespecified price called the exercise price on or before a given date. A put option is similar except it is the right to sell a share. (A way to remember these is that "call in" means to buy and "put out" means to sell.) There are many examples of options in addition to rights and warrants. Options are used extensively in real estate. Some securities such as convertible bonds can be thought of as containing an option. They allow the holder to convert the bond from debt to equity at a prespecified price. Perhaps the most important type, however, are options which are traded on the Chicago Board Options Exchange (CBOE). In fact the volume of transactions on this exchange is second only to the volume on the New York Stock Exchange. Options that are traded on the CBOE and other exchanges are not issued by the firm. Instead the exchange brings together people that want to buy options with people that want to sell, or "write" or “issue”, options. How can we value these options? There is a model called the Black and Scholes (B- S) Option Pricing Model which allows us to price options. Its assumptions are fairly strong. Given these assumptions its possible to show that the value of a call option is given by the B-S formula. You can see that the value of the call depends on a number of things. In particular it will be shown that the value of the call depends on the exercise price of the option, the variance per period of the stock price and the time to the exercise date in the following
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way. 3 The exercise price of the option (E). It can be shown that, according to the formula, the lower the value of the exercise price the higher the value of the call. 4 The variance per period of the stock ( σ 2 ) . It can be shown that the greater the variance of the stock, the more valuable the call option. 5 The time to the exercise date (t). The greater the time to the exercise date the more valuable the option. Given the assumptions behind the model and given the implications of the formula do you think it will work well? 2. Options: The basics 6 2.1 Definitions As we briefly mentioned there are two types of option, calls and puts: Call option: Right to buy a share from the option writer (also called as seller, issuer) at a fixed price on or before a given date.
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This note was uploaded on 04/11/2010 for the course BUS Business 1 taught by Professor B.mishra during the Spring '10 term at UC Riverside.

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Options and - Lecture V Options and Corporate Securities Read Chapter 23 1 Overview 2 Options The basics 2.1 Definitions 2.2 Option quotations 2.3

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