3531Week4W11 - Week 4 Options Option basics Option payoffs...

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1 Week 4 Options • Option basics • Option payoffs and profits • Option strategies • Option prices, intrinsic values and arbitrage • ESOs • Put-call parity • Stock index options • The Canadian Derivatives Clearing Corporation
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2 Option Basics • A stock option is a derivative security , because the value of the option is ―derived‖ from the value of the underlying common stock. • There are two basic option types. Call options are options to buy the underlying asset. Put options are options to sell an underlying asset. • Listed Option contracts are standardized to facilitate trading and price reporting. – Listed stock options give the option holder the right to buy or sell 100 shares of stock.
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3 Option Basics Option contracts are legal agreements between two parties—the buyer of the option, and the seller of the option. The minimum terms stipulated by stock option contracts are: – The identity of the underlying stock. – The strike price, or exercise price. – The option contract size. – The option expiration date, or option maturity. – The option exercise style ( American or European ). – The delivery, or settlement, procedure. Stock options trade at organized options exchanges, such as the CBOE, as well as (OTC) options markets.
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4 Option Price Quotations • A list of available option contracts and their prices for a particular security is known as an option chain . • Option chains are available online through many sources, including the Montreal exchange ( http://www.m-x.ca ), CBOE ( http://quote.cboe.com ) and Yahoo! ( http://finance.yahoo.com ).
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5 Why Options? • A basic question asked by investors is: ―Why buy stock options instead of shares in the underlying stock?‖ • Compare the possible outcomes from these two investment strategies: – Buying the underlying stock – Buying options on the underlying stock
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6 Buying the Stock vs. . Buying a Call Option • IBM is selling for $90 per share and call options with a strike price of $90 are $5 per share. • Investment for 100 shares: – IBM Shares: $9,000 – One listed call option contract: ($500) • Suppose the option expires in 3 months and in 3 months, the price of IBM shares will either be: $100, $90, or $80.
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7 Buying the Stock vs. . Buying a Call Option • Calculate the dollar and percentage return given each of the prices for IBM stock: Buy 100 IBM Shares ($9000 Investment): Buy One Call Option ($500 Investment): Dollar Profit: Percentage Return: Dollar Profit: Percentage Return: Case I: $100 $1,000 11.11% $500 100% Case II: $90 $0 0% -$500 -100% Case III: $80 -$1,000 -11.11% -$500 -100%
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8 Why Options? Conclusion • Whether one strategy is preferred over another is a matter for each individual investor to decide. – That is, in some instances investing in the underlying
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This note was uploaded on 05/01/2011 for the course ADMS 3531 taught by Professor Profp during the Winter '10 term at York University.

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3531Week4W11 - Week 4 Options Option basics Option payoffs...

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