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L23_Option I

# L23_Option I - Financial Management Fall 2010 Lecture 23...

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Financial Management Fall 2010 Lecture 23: Option Pricing (I) Professor Erica Li Ross School of Business

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Review of last class: option hedging If your value is adversely affected by the rise of certain asset’s price, e.g., the price of your input , you can buy call options on this asset to hedge this risk If your value is adversely affected by the fall of certain asset’s price, e.g., the price of your output , you can buy put options on this asset to hedge this risk Options also allow investors to speculate on the direction that the market is likely to move 1
Roadmap How to price a call option Put-call parity Textbook reading: Chapter 24 except “Stock Option Quotations” in 24.1 “The Upper and Lower Bounds on a Call Option’s Value” in 24.2 24.4, 24.6, 24.7 2

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Stock options The options that Southwest Airlines has in previous examples are option contracts written on commodities The most common option contracts are options on shares of stock, hence the name “stock options” A stock option gives the holder the right to buy (call option) or sell (put option) a share of certain stock on or before a given date for a given price (strike price) We will focus on European options 3
SkyFleet (I) The stock price of aircraft manufacturer SkyFleet has been skyrocketing as the time is getting closer to the first flight- out of its prototype airliner Banker Le Chiffre buys 100M put options on SkyFleet’s stock that have strike price \$100 and expire on the day of the first flight-out Each put option is priced at \$10; the current stock price is \$100 Is Le Chiffre betting on the rise or the fall of SkyFleet’s stock price? 4

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SkyFleet (II) Le Chiffre spends \$1B on the purchase of put options If P=\$80 at expiration, ignore TVM, what is the net payoff?
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L23_Option I - Financial Management Fall 2010 Lecture 23...

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