Slide 13 Options

# Slide 13 Options - Option Valuation Outline Options and...

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Option Valuation

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Outline Options and Stock Options Put-Call Parity The Black-Scholes Option Pricing Model More about Black-Scholes Valuation of Equity and Debt in a Leveraged Firm Options and Corporate Decisions: Some Applications
Option Contracts The right, but not the obligation, to buy (sell) an asset for a set price on or before a specified date Call – right to buy the asset Put – right to sell the asset Exercise or strike price –specified price Expiration date – specified date Buyer has the right to exercise the option; the seller is obligated Call – option writer is obligated to sell the asset if the option is exercised Put – option writer is obligated to buy the asset if the option is exercised Options allow a firm to hedge downside risk, but still participate in upside potential Pay a premium for this benefit

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Option Payoffs – Calls The value of the call at expiration is the intrinsic value Max(0, S-E) If S<E, then the payoff is 0 If S>E, then the payoff is S – E Assume that the exercise price is \$30 Call Option Payoff Diagram 0 5 10 15 20 25 0 10 20 30 40 50 60 Stock Price Call Value
Option Payoffs - Puts The value of a put at expiration is the intrinsic value Max(0, E-S) If S<E, then the payoff is E-S If S>E, then the payoff is 0 Assume that the exercise price is \$30 Payoff Diagram for Put Options 0 5 10 15 20 25 30 35 0 10 20 30 40 50 60 Stock Price Option Value

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Payoff Profiles: Calls Buy a call with E = \$40 0 10 20 30 40 50 60 70 0 20 40 60 80 100 Stock Price Payoff Sell a Call E = \$40 -70 -60 -50 -40 -30 -20 -10 0 0 20 40 60 80 100 Stock Price
Payoff Profiles: Puts Buy a put with E = \$40 0 5 10 15 20 25 30 35 40 45 0 20 40 60 80 100 Stock Price Payoff Sell a Put E = \$40 -45 -40 -35 -30 -25 -20 -15 -10 -5 0 0 20 40 60 80 100 Stock Price

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Stock Option Things to notice Prices are higher for options with the same strike price but longer expirations Call options with strikes less than the current price are worth more than the corresponding puts Call options with strikes greater than the current price are worth less than the corresponding puts
What Determines Option Values? Stock price As the stock price increases, the call price increases and the put price decreases Exercise price As the exercise price increases, the call price decreases and the put price increases Time to expiration Generally, as the time to expiration increases, both the call and the put prices increase Risk-free rate As the risk-free rate increases, the call price increases and the put price decreases

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Moneyness : A description of a derivative relating its strike price to the price of its underlying asset.
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## Slide 13 Options - Option Valuation Outline Options and...

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