Lecture 7 Option Mechanics and Properties

Lecture 7 Option Mechanics and Properties - Lecture 7:...

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Lecture 7: (Ch9&10) Options Properties & Market Mechanics Payoff and Profits Call Stock Price = S Exercise Price = X Payoff to Call Buyer = (S - X) if S >X, 0 if S <X Profit to Call Buyer = Payoff option price Payoff to Call Writer = -(S - X) if S >X, 0 if S <X Profit to Call Writer = Payoff + option price Long c = max(S t – K, 0) Short c = -max(St – k, 0) = min(K – S t , 0) Put Payoffs to Put Buyer = 0 if S X, (X - S) if S < X Profit to Put Buyer = Payoff – Option Price Payoffs to Put Writer = 0 if S > X, -(X - S) if S < X Profits to Put Writer = Payoff + Option Price Long p = max(K – S t , 0) Short p = - max(K – S t , 0) = min(S t – K, 0) Underlying Assets Stock options . Most trading is done on options exchanges. Foreign currency options . Most trading done over-the-counter market. Index options . Both. Futures options . Option expires just before delivery period of futures. Call option acquires long future position. Put option acquires short position.
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Specification of Stock Options Exchange dates. Expiration takes place on first Saturday following third Friday of the month. Stock options are on a Jan, Feb or Mar cycle (see more p.185) Strike prices. European or American. Call or put (option classes) Terminology Option class – calls or puts Option series – consists of all the options of a given class with the same expiration date and strike price. In other words, refers to a particular traded contract. At-the-money (zero cash flow to the buyer if it were exercised immediately), in-the- money, out-of-the-money. Intrinsic value : the maximum of zero and the value it would have if it were exercised immediately. Time value : the value for holding the option Option value = Intrinsic value + Time value Margins Margins are required for the sellers of the options When a naked option is written the margin is the greater of: o A total of 100% of the proceeds of the sale plus 20% of the underlying share price less the amount (if any) by which the option is out of the money o A total of 100% of the proceeds of the sale plus 10% of the underlying share price For other trading strategies there are special rules. Exchange-traded options are adjusted for stock splits. Suppose you own N options with a strike price of K : No adjustments are made to the option terms for cash dividends o When there is a n -for- m stock split, n for o the strike price is reduced to mK / n
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o the no. of options is increased to nN / m Stock dividends are handled in a manner similar to stock splits
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This note was uploaded on 03/30/2011 for the course FIN 3635 taught by Professor Yip during the Three '11 term at University of New South Wales.

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Lecture 7 Option Mechanics and Properties - Lecture 7:...

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