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Options+primer - Introduction to Options Barry M Marchman...

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Introduction to Options Barry M. Marchman, Ph.D.
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Why study Options? Speculation You can profit when a stock goes up. You can profit when a stock goes down. You can profit when a stock goes up or down. You can profit when a stock does not move. Insurance (Hedging) You can protect your profits You can insure against various types of loss You can create cash flow from stagnant assets
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Intrade Markets (binary options) Who will be kicked off American Idol? (alt: NYC Snow) Contestant #1 Bid: 23.05 Ask: 32.95 Interpretation: For 32.95 you can bet that contestant #1 loses. If you are right, you get 100. If you guess wrong, you lose your 32.95. If you think this event will NOT happen, you can put 23.05 in your pocket today. If you are right, you keep the money, if you are wrong, you pay 100 later.
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Stock Options Will the price of KO be above $65 or below $65? It costs $330 (premium) to bet that it goes up The premium is the most you will ever lose Gains are “unlimited.” The higher it goes, the more you make. It costs $335 (premium) to bet that it goes down The premium is the most you will ever lose Gains are “unlimited.” The lower it goes, the more you make. This cost was accurate at the time this slide was made, but prices change constantly
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Option - Terminology Contract Features Strike – The over or under bet Underlying – what you are betting on Expiration – 3 rd Friday of the expiration month 100 shares controlled Other Vocabulary Spot – the current price of the underlying Writer – the seller of the option Holder – the buyer of the option 5
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Two Types of Options Contracts Call Option The right to BUY 100 shares Underlying = KO Strike Price = $65 Expiries January 2012 Premium = $3.30 per share Payoff when KO > $65 No additional loss if KO < $65 Put Option The right to SELL 100 shares Underlying = KO Strike Price = $65 Expires January 2012 Premium = $3.35 per share Payoff when KO < $65 No additional loss if KO > $65
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Call and Put Option Payoff (red line) Call Option Payoff X = Spot Price of Underlying Y = Option Contract Profit at Expiration Holder (the buyer) Writer (the seller) Put Option Payoff X = Spot Price of Underlying
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