Lecture 17-18 - Options Part I 1 Introduction to Options...

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Lily Qiu, Assistant Professor Economics Department, Brown University EC1710, Lecture 17, Spring 2010, page 1 Options, Part I 1. Introduction to Options 1.1 terminologies strike/exercise price expiration/maturity date option premium the purchase price of the option write an option sell an option = hold a short position in the money exercising the option will produce profits for its holder out of the money exercising the option will not be profitable at the money exercise/strike price and asset price are equal American option option holder can exercise the right on or before the expiration date (most traded options in the U.S.) European option option holder can exercise the right only on the expiration date (foreign currency options, CBOE (Chicago Board Options Exchange) stock index options) Bermuda option can exercise on a few specific dates prior ot expiration Intrinsic value of an option the maximum of zero and the value the option would have if it were exercised immediately: max(s-k,0), s is the stock price, k is the strike price Time value of an option it is often better for the holder of an in-the-money American option to wait rather than exercise immediately 1.2 option trading 1)Options are traded both on the exchange and over-the-counter (OTC). Exchange-traded options are standardized o for stock options, one contract provides the right to buy or sell 100 shares of the underlying stock e.g., quoted price $1.2, buying one contract costs $120 o CBOE options typically expire on the third Friday of the month o adjusts for stock splits e.g., if the original exercise price for an un-expired option is $40, after a 2-for-1 split, the exercise price is now $20, and one contract is for 200 shares o adjusts for stock dividends, but not cash dividends o flex options by CBOE offer nonstandard terms (strike price or expiration date) an attempt to compete with the OTC markets OTC options can be tailored to the needs of the traders (maturity date, number of shares committed, etc.), but higher costs 2) The Options Clearing Corporation (OCC) is the clearinghouse for options trading.
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Lily Qiu, Assistant Professor
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