Chapter 15

Chapter 15 - 15-1Learning ObjectivesGive yourself some...

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Unformatted text preview: 15-1Learning ObjectivesGive yourself some in-the-money academic and professional options by understanding:1. The basics of option contracts and how to obtain price quotes.2. The difference between option payoffs and option profits.3. The workings of some basic option trading strategies.4. The logic behind the put-call parity condition.15-215-2Stock OptionsIn this chapter, we will discuss general features of options, but will focus on options on individual common stocks. We will see the tremendous flexibility that options offer investors in designing investment strategies.15-315-3Option BasicsA 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 optionsare options to buythe underlying asset.Put optionsare options to sellan 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.15-415-4Option Basics, Cont.Option contracts are legal agreements between two partiesthe 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 (Americanor European).The delivery, or settlement, procedure.Stock options trade at organized options exchanges, such as the CBOE, as well as over-the-counter (OTC) options markets.15-515-5Listed Option Quotationswww.wsj.com15-615-6Option Price QuotesA 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 CBOE (http://quote.cboe.com) and Yahoo! Finance (http://finance.yahoo.com).The format for option symbols had been the same for many years. In early 2010, however, the Options Clearing Corporation instituted a new, expanded approach for option symbols. This change was driven by the increasing size of the option market.15-715-7Listed Option Quotesat Yahoo! Finance15-815-8Why Options?A basic question asked by investors is: Why buy stock options instead of shares in the underlying stock?To answer this question, we compare the possible outcomes from these two investment strategies:Buy the underlying stockBuy options on the underlying stock15-915-9Example: Buying the Underlying Stock versus Buying a Call OptionSuppose IBM is selling for $90 per share and call options with a strike price of $90 are $5 per share....
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This note was uploaded on 11/18/2011 for the course FIN 355 taught by Professor Phsiao during the Fall '08 term at S.F. State.

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Chapter 15 - 15-1Learning ObjectivesGive yourself some...

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