Lecture%2018%20ch%2020%20UGBA%20103%202010

Lecture%2018%20ch%2020%20UGBA%20103%202010 - Chapter 20...

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Chapter 20 Financial Options
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Option Basics • Financial Option • A contract that gives its owner the right (but not the obligation) to purchase or sell an asset at a fixed price as some future date • Call Option • A financial option that gives its owner the right to buy an asset • Put Option • A financial option that gives its owner the right to sell an asset • Option Writer • The seller of an option contract
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Understanding Option Contracts • Exercising an Option • When a holder of an option enforces the agreement and buys or sells a share of stock at the agreed- upon price • Strike Price (Exercise Price) • The price at which an option holder buys or sells a share of stock when the option is exercised • Expiration Date • The last date on which an option holder has the right to exercise the option
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Understanding Option Contracts (cont'd) • American Option • Options that allow their holders to exercise the option on any date up to, and including, the expiration date • European Option • Options that allow their holders to exercise the option only on the expiration date • Note: The names American and European have nothing to do with the location where the options are traded.
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Understanding Option Contracts (cont'd) • The option buyer (holder) • Holds the right to exercise the option and has a long position in the contract • The option seller (writer) • Sells (or writes) the option and has a short position in the contract • Because the long side has the option to exercise, the short side has an obligation to fulfill the contract if it is exercised.
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Interpreting Stock Option Quotations • Stock options are traded on organized exchanges. • By convention, all traded options expire on the Saturday following the third Friday of the month. • Open Interest • The total number of contracts of a particular option that have been written
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Option Terminology At-the-money Describes an option whose exercise price is equal to the current stock price In-the-money Describes an option whose value if immediately exercised would be positive Deep in-the-money describes an option that is in-the-money and for which the strike price and the stock price are very far apart Out-of-the-money Describes an option whose value if immediately exercised would be negative Deep out-of-the-money describes an option that is out-of–the- money and for which the strike price and the stock price are very far apart
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Some uses of options • To hedge • To reduce risk by holding contracts or securities whose payoffs are negatively correlated with some risk exposure • To speculate • When investors use contracts or securities to place a bet on the direction in which they believe the market is likely to move
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9 Important Questions • Can an option ever be free? • An
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Lecture%2018%20ch%2020%20UGBA%20103%202010 - Chapter 20...

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