FM12 Ch 09 Tool Kit - 1/10/2007 Chapter 09. Tool Kit for...

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1/10/2007 Chapter 09. Tool Kit for Financial Options and Applications in Corporate Finance FINANCIAL OPTIONS (Section 9.1) FOR A CALL, AT EXPIRATION FOR A PUT, AT EXPIRATION PROBLEM Call Put Call ABC DEF GHI Price of the option Value of stock (P or S) Strike price (X) Gain on the option $15.50 $3.75 $0.00 Price of the option $8.90 $4.65 $1.20 Profit/loss $6.60 ($0.90) ($1.20) An option is a contract which gives its holder the right to buy (or sell) an asset at a predetermined price within a specified period of time. Option contracts, though often quoted in terms of single shares, usually are contracts for a 100 shares. A call option describes a situation in which one investor may sell to someone the right to buy his/her shares of a stock over some interval of time. In this scenario, the writer of the call option (the party that surrenders the right to exercise) is said to hold a short position on the option. Meanwhile, the party that has purchased this right to buy is said to hold a long position on the option. The predetermined price that the stock may be purchased for is called the strike, or exercise, price. When an investor "writes" call options against stock held in his/her portfolio, this is called a "covered call". When the call options are written without the stock to back them up, they are they are called "naked calls". When the strike price is below the current market price, the call option is said to be "in-the-money". Likewise, when the strike price exceeds the current market price, the call option is said to be "out-of-the-money". For instance, if you believed that the price of stock was primed to rise, a call option would allow you to capture a profit off of the rise in price. A put option allows you to buy the right to sell a stock at a specified price within some future period. If you happened to believe that the price of a stock was ready to fall, a put option would allow you the opportunity to turn a profit out of that decline. In the cases of both call and put options, the profit or loss made on an options transaction is determined by the value of the underlying asset, the strike price of the option, and the price of the option. If the value of the underlying asset exceeds that of the strike price, the profit/loss from the call transaction would be equal to the difference between the value of the asset and the strike price less the price of the call. In this case there could be either a net profit or loss depending upon the exercise value and the price of the call. If the value of the underlying asset equals that of the strike price, the profit/loss from the call transaction would be equal to the price of the call, because whether exercised or unexercised the call value would be zero. In this case there is a loss equal to the price of the call.
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This note was uploaded on 06/15/2011 for the course FI515 FI515 taught by Professor Fi515 during the Spring '10 term at Keller Graduate School of Management.

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FM12 Ch 09 Tool Kit - 1/10/2007 Chapter 09. Tool Kit for...

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