Lect 17 221 web

Lect 17 221 web - Managerial Finance Lecture 17 Financial...

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1 Managerial Finance Lecture 17 Financial Options Class 16. Summary Risk management allows firms to move cash flows between different states of the world Need to be clear about: what is the risk the firm is worried about? Need to be clear about: the firm is worried about? Why? What is the friction that makes risk management valuable? If hedging is valuable, how should it be implemented ? Forwards are binding agreements between buyers and sellers to buy or sell assets in the future Options give the buyer the right but not the obligation to purchase or sell assets in the future: generally more flexible if the transaction 2 or sell assets in the future: generally, more flexible if the transaction may not occur The choice of risk management tool should focus on the specific risk you seek to avoid Not hedging is an alternative : hedging all risks is rarely desirable
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2 Option Pricing and Early Exercise Decisions Put-call parity: Relationship between European call and put prices: helpful in obtaining put or call values whenever one of them is known Time value of options and early exercise decisions: Should options be exercised early? If so when? Option pricing models: General model : binomial option pricing model • Flexible model Flexible model • Used to value any option Special case : Black-Scholes option pricing • One formula for pricing European style options 3 Portfolio insurance You own $10,000 shares of H.J. Heinz Company The stock price is $50 per share You think HNZ has upside potential Yet, you want protection against a price decline What can you do? 4
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3 Option Combinations: Portfolio Insurance 100 25 50 75 Payoff + Put Stock Call + TBills 5 -25 0 0 25 50 75 100 Stock Price Put-Call Parity for European options There are two alternative ways to insure your portfolio : (Buy Stock) + (Buy Put) = (Buy Call) + (Buy T Bills (Buy Stock) + (Buy Put) = (Buy Call) + (Buy T-Bills) By the law of one price (no-arbitrage), these portfolios must have the same cost (price today): S + P = C + PV ( K ) PV(K) =Present Value of Strike Price 6 If the stock pays dividends , the formula is: S + P = C + PV ( K ) + PV ( Div )
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4 Bid Ask Bid Ask 248 3 253 2 1 000 75 5 79 8 S&P 500 Options (Dec 2012) Calls Puts Strike Price Put-Call Parity European style S&P 500 option quotes Quoted 11/29/11 (CBOE) 248.3 253.2 1,000 75.5 79.8 213.3 218.2 1,050 90 94.3 180.3 185.2 1,100 106.5 111.4 149.9 154.8 1,150 125.6 130.5 121.9 126.8 1,200 147.2 152.1 96.8 101.4 1,250 171.2 176.1 74.7 79.3 1,300 199.2 203.8 55.7 59.5 1,350 229.4 234.3 Index level = 1,195.19 PV(Divs 12/2012 )= 22.7 Interest Rate = 0.15% Interest over 389 days = 0.16% Strike = 1,150: (Buy S&P500) + (Buy Put) + (Sell Call) + (Sell TBills) + (Dividends) 7 - 1195.19 - 130.5 + 149.9 + 1,150/1.0016 + 22.7 = -4.9 In reverse: (Sell S&P500) + (Sell Put) + (Buy Call) + (Buy TBills) - (Dividends) + 1195.19 + 125.60 - 154.80 - 1,150/1.0016 - 22.7 = -4.9 Example: Put-Call Parity Assume: You want to buy a one-year call option and put option on Dell, with a strike price for each of $15 The current price per share of Dell is $14.79 The risk-free rate is 2.5% The price of each call is $2.23 Dell pays no dividends; no dividends will be paid in the next 12 months Using put-call parity, what should be the price of each put ?
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This note was uploaded on 01/08/2012 for the course MS&E 245G taught by Professor Perez-gonzalas during the Fall '11 term at Stanford.

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Lect 17 221 web - Managerial Finance Lecture 17 Financial...

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