Lecture9_Option - NBA 6730: Derivative Securities Lecture...

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1 NBA 6730: Derivative Securities Lecture 9: Introduction to Options 09/23/2010 George Gao NBA6730-Derivative Securities I 2 Agenda An option is a contract in which the seller (writer, short) grants the buyer (owner, long) certain contractual rights pertaining the underlying asset or primitive security. We study some basic properties of options in this lecture. Mechanics of options Properties of options Put-call parity
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2 NBA6730-Derivative Securities I 3 (1) Basic Types of Options A call option gives its owner the right (but not the obligation) to buy an asset at a fixed price (the exercise or strike price ) on or before a given date (the maturity or expiration date ) You can buy a contract or sell a contract: buy a call, or sell a call A put option gives its owner the right (but not the obligation) to sell an asset at a fixed price on or before a given date Buy a put, or sell a put The holder will not exercise his/her option unless the payoff is positive NBA6730-Derivative Securities I 4 (1) Basic Types of Options Timing of the contractual right European-style option: the holder of an option can only exercise when the contract expires American-style option: the holder of an option can exercise at any time up to and including the expiration Bermuda-style option: the holder of an option can exercise only on several specifically defined dates over the life of the option All exchange-traded equity options are American. Most index options are European (an exception is the S&P100 index option).
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3 NBA6730-Derivative Securities I 5 (2) Options are Insurance Puts are insurance for asset owners A put option pays off when price goes down Owners of homes, cars, stocks Commodity sellers The deductible is the difference between strike and asset value Calls are insurance for future owners A call option pays off when price goes up Short sellers Commodity buyers Question: are forward contracts insurance? NBA6730-Derivative Securities I 6 (3) Intrinsic Value and Moneyness The intrinsic value of an option is its value if exercised For a call option: maxሾ0, ܵ ݐെܭ For a put option: maxሾ0, ܭ െ ܵ ݐሿ ܭ is the strike price, ܵሺݐሻ is the price of underlying asset at ݐ The moneyness of an option refers to whether the option’s intrinsic value is positive, zero or negative An in-the-money ( ITM ) option has positive intrinsic value An out-of-the-money ( OTM ) option has no intrinsic value and would impose a net cost on the option owner if exercised An at-the-money ( ATM ) option is characterized by a strike price
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4 NBA6730-Derivative Securities I 7 (3) Intrinsic Value and Moneyness Alternatively, we see: ITM: an option is worth something if it is exercised today OTM: an option would cost you something if it is exercised today The payoff of an option at maturity For a call option:
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This note was uploaded on 10/26/2010 for the course JOHNSON 6730 taught by Professor Georgegao during the Fall '10 term at Cornell University (Engineering School).

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Lecture9_Option - NBA 6730: Derivative Securities Lecture...

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