ch15outline - Chapter 15 I. The Option Contract A. A call...

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Chapter 15 I. The Option Contract A. A call option gives is holder the right to purchase an asset for a specified price, called the exercise or strike price , on or before some specified expiration date B. The holder of the call is not required to exercise the option C. The holder will choose to exercise only if the market value of the asset to be purchased exceeds the exercise price D. When the market price foes exceed the exercise price, the option holder may “call away” the asset for the exercise price E. Otherwise, the option may be left unexercised F. If it is not exercised before the expiration date of the contract, a call option simply expires and no longer has value G. Therefore, if the stock price is greater than exercise price on the expiration date, the value of the call option will equal the difference between the stock price and the exercise price; but if the stock price is less than the exercise price at expiration, the call will be worthless H. The net profit on the call is the value of the option minus the price originally paid to purchase it I. The purchase price of the option is called the premium J. It represents the compensation the purchaser of the call must pay for the ability to exercise the option if exercise becomes profitable K. Sellers of call options receive premium income now as payment against the possibility they will be required at some later date to deliver the asset in return for an exercise price lower than the market value of the asset L. But if the call is exercised, the profit to the option writer is the premium income derived when the option was initially sold minus the difference between the value of the stock that must be delivered and the exercise price that is paid for those shares M. A put option gives its holder the right to sell an asset for a specified exercise or strike price on or before some expiration date N. While profits on call options increase when the asset increases in value, profits on put options increase when the asset value falls O. A put will be exercised only if the exercise price is greater than the price of the underlying asset, that is, only if its holder can deliver for the exercise price an asset with market value less than the exercise price P. The owner of the put profits by the difference between the exercise price and the market price Q. An option is described as in the money when its exercise would produce a positive payoff for its holder R. An option is out of the money when exercise would be unprofitable S. Therefore, a call option is in the money when the exercise price is below the asset value T. It is out of the money when the exercise price exceeds the asset value; no one would exercise the right to purchase for the exercise price an asset worth less than that price
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U. Conversely, put options are in the money when the exercise price exceeds the asset’s value, because delivery of the lower valued asset in exchange for the exercise price is profitable for the holder
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ch15outline - Chapter 15 I. The Option Contract A. A call...

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