Financial Markets: Lecture 23 Transcript
April 21, 2008
Professor Robert Shiller:
Today I want to talk about options. I should just say what an option is. I'll write
the word. It's a contract that has an owner and the owner of the option contract has rights to find in the
contract either to buy or sell some thing--let's say a share of stock--at a specified price and specified date.
There are two kinds; there's a put and a call. A put option is the right to sell. It's typically a hundred shares, so
we'll say a hundred shares of a company; let's say it's Google. The option would have--if it was a put option
and there was a price, then you would have the right up--let me see, there's the exercise price, also known as
the strike, and there's the exercise date.
I should also emphasize that there are two kinds of options. There are American, so called, and European, so
called. It has nothing to with whether they are in America or Europe because in Europe they trade both
American options and European options and in America they trade both American options and European
options; so, it's very unfortunate terminology. The American--what this means--an American option means
the right to exercise the option on any date until and including the exercise date; with European, it's only on
exercise date. That's what those words mean.
So, usually we're talking about American options. If you have an American option--American put option--on
shares of some stock, then you have the right anytime you feel like it, until the exercise date, to sell that
option at the price specified in the contract, called the exercise price. If it's European, you have to wait until
the exercise date and then you have one day when you can do that. A call option is the right to buy a share of
stock or whatever it is--whatever is specified in the option. In a traditional option, there are two parties;
there's the buy of the option and usually we present them from the perspective of the buyer of the option. The
buyer of the option pays a price to buy the option--not to be confused with the exercise price--and then,
depending on whether it's American or European, has until the exercise date to exercise the option; but, the
buyer doesn't have to do anything. You can just do nothing; you can buy the option and if you do nothing it
becomes worthless because the only way the option ever gives you value after you buy it is if you exercise it,
meaning you say, I will use my right to buy or sell.
The other party is the writer of the option. Because it's a contract, it has to be between two parties. Somebody
is on the other side and you can do either one; you can either buy or write an option. If you--let me make this
clear; if you write a call option, then what you are committing yourself to do as the writer--you sign the
contract from the writer's contract, which goes along with the buyer's contract. Well, it provides rights to the
buyer. If you write a call option, then you--and say it's American--then you are signing a contract --let's say