Lec%2010%20-%20Deriviative%20Securities%202

Lec%2010%20-%20Deriviative%20Securities%202 - You need the...

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BANK 3004 Portfolio and Fund Management © HB, 2009 Lecture 10 TOPIC 7 Derivative Securities 2 You need the following resources for this lecture: 1. Financial calculator 2. Normal distribution tables (provided in the Lecture notes folder) Please bring these two items with you. © HB, 2009 Option Values Intrinsic value Example A call option with exercise price = $12, but not expired yet. Share price, S 0 = $10 (today) This call option is out of the money today. Is this option valueless? Intrinsic value is the value of an option if it were expiring immediately. = Payoff if the option was immediately exercised. The price of the share determines the option‟s exact value at expiration. But this option does not expire immediately! What about its value prior to expiration? © HB, 2009 X S if 0, X S if X, - S value Intrinsic In the money Out of or at the money
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BANK 3004 Portfolio and Fund Management © HB, 2009 Time value* The difference between the option price and the intrinsic value. Time value is the part of the value of an option that is due to its remaining time to expiration. » This is a “volatility value” because of the right not to exercise if that action is not beneficial. » Arises because of presence of volatility in the price of the underlying security. * Not to be confused with time value of money Time Value = Actual Price – Intrinsic Value © HB, 2009 Cal Option Value Before Expiration -1.00 0.00 1.00 2.00 3.00 4.00 5.00 6.00 7.00 0.00 2.00 4.00 6.00 8.00 10.00 12.00 14.00 16.00 18.00 20.00 Stock Price, S0 Option Value Use Fig. 16.1 X Value of call option © HB, 2009 What influences call option value? Increase in variable Stock price, S Exercise price, X Volatility of stock price, σ Time to expiration, T Interest rate, r f Dividend payout How do put values respond? Increases Effect on call value Decreases Use Table 16.1
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BANK 3004 Portfolio and Fund Management © HB, 2009 Binomial valuation Binomial model A valuation model based on the assumption that the stock prices can move to only two values over any short time period. »
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Lec%2010%20-%20Deriviative%20Securities%202 - You need the...

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