Chap+8+Slides+Properties+of+Stock+Options

Chap+8+Slides+Properties+of+Stock+Options - Derivative...

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Unformatted text preview: Derivative Securities FIN 480 (Instructor- Saif Rahman) Chapter 8 Properties of Stock Options Properties of Stock Options Notation Notation c : European call option price p : European put option price S t : Current Stock price C : American Call option price P : American Put option price S T : Stock price at time T FIN 480 (Instructor- Saif Rahman) 1 X : Strike price T : Time when option expires : Volatility of stock price D : Present value of Dividends r : Risk-free rate* corresponding to option maturity (*: continuously compounded) Six Key variables current stock price= S strike price =X time to expiration: T-t volatility of the underlying: 6 horses! Options FIN 480 (Instructor- Saif Rahman) 2 volatility of the underlying: risk free rate: r PV of dividends expected during life of the option: D S X T-t r D Effect of Variables on Option Pricing c p C P Variable S X + + + + European American FIN 480 (Instructor- Saif Rahman) 3 X T r D + ? ? + + + + + + + + + + + Effect of T Effect of T For the American options, the effect is certain because the long term option holder has all the exercise opportunities open to the short term option holder Consider 2 European call options; one matures in 2 months and the other in 3 months. FIN 480 (Instructor- Saif Rahman) 4 short term option holder. For the European options the effect is uncertain because the long term option holder can not exercise before the short term option holder. Say that stock prices plummet after the second month either because the firm pays out a dividend or acquires a smaller company. What does that imply? Effect of : Higher volatility has a positive impact on the options because if the stock price goes in the unfavorable direction the holder need not Effect of r : The results are less clear- cut. This is because full effects of increase in r can be understand only in a general equilibrium context. FIN 480 (Instructor- Saif Rahman) 5 exercise Effect of dividends: When dividends are announced, stock prices plummet on the ex- dividend date and this decreases (increases) the value call (put) options Recap: Dividends Announcement Effect Recap: Dividends Announcement Effect Thur,Jan 15 Mon Feb 16 Wed ,Jan 28 Fri , Jan 30 Stock price FIN 480 (Instructor- Saif Rahman) 6 Declaration date Thur,Jan 15 Payment date Ex-dividend date Wed ,Jan 28 Record date Fri , Jan 30 Stock price should fall on the ex-div date, by the amount of dividend after adjusting for the tax effects . This is because market discounts for the value of dividends . Critical Dates for Dividends Critical Dates for Dividends Declaration date (Jan 15): On this date the Board of directors declares a payment of dividends to all share holders who are on record (as of on record date...
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This note was uploaded on 03/23/2011 for the course BUSINESS bus 173 taught by Professor Rtm during the Spring '11 term at IUP.

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Chap+8+Slides+Properties+of+Stock+Options - Derivative...

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