{[ promptMessage ]}

Bookmark it

{[ promptMessage ]}

L12_options - FINANCE431 INVESTMENTS Lecture 12 Option...

Info icon This preview shows pages 1–12. Sign up to view the full content.

View Full Document Right Arrow Icon
FINANCE 431 INVESTMENTS Lecture 12: Option Markets
Image of page 1

Info icon This preview has intentionally blurred sections. Sign up to view the full version.

View Full Document Right Arrow Icon
FIN 431: Investments 2 Options An option is a contract between two parties, let’s call them the writer and the owner . The key feature of an option is that the owner chooses whether the contract is exercised . Example: Department Store gives customer the option to return merchandise for exchange or store credit. Owner of a convertible bond has the option to convert it into stock.
Image of page 2
FIN 431: Investments 3 Options The owner of a Call Option has the option to buy an underlying asset for a specified price. The writer has the obligation to sell if the option is exercised. The owner of a Put option has the option to sell an underlying asset for a specified price. The writer has the obligation to buy if the option is exercised. Like a future, an exchange-traded option: Has two parties, a buyer and a seller Sets a price today for a transaction later Called the Exercise Price or Strike Price Has an expiration date Clearinghouse acts as intermediary
Image of page 3

Info icon This preview has intentionally blurred sections. Sign up to view the full version.

View Full Document Right Arrow Icon
FIN 431: Investments 4 Options Unlike a future, an option Is exercised at the discretion of one party (owner). Requires the buyer (owner) to pay a premium to the writer at the time the contract is initiated. European-style options can be exercised only on the day they expire. American-style options can be exercised any time prior to expiration.
Image of page 4
FIN 431: Investments 5 Options Call Options Example: April 55 Microsoft Call Underlying Asset: 100 Shares Microsoft Expiration Date: Third Friday in April Strike Price: 55 American-Style The owner of this option can buy 100 shares of Microsoft for 55/share anytime prior to expiration. On December 28 Microsoft was trading for about 45.25 The premium for the April 55 call was about 3.25 per share.
Image of page 5

Info icon This preview has intentionally blurred sections. Sign up to view the full version.

View Full Document Right Arrow Icon
FIN 431: Investments 6 Options Call Options You buy 10 April 55 Microsoft calls Initial Investment = ($3.25/share) X (100 shares/contract) X (10 contracts) = $3,250
Image of page 6
FIN 431: Investments 7 Options Call Options On the third Friday of April: If MSFT = 54 You have the right to buy for 55. But you can buy on the market for 54 The options expire Out of the Money Do not exercise. Loss = $3,250 If MSFT = 60 You have the right to buy for 55 The options expire In the Money Exercise: Buy 1,000 shares at 55. You can sell them at 60 Profit = (60-55)*1,000 – 3,250 = $1,750 If MSFT = 56 You have the right to buy for 55 Exercise: Buy 1,000 shares at 55. You can sell them at 56 Exercise: Loss = 1,000-3,250 = -$2,250 If you do not exercise: Loss = -$3,250
Image of page 7

Info icon This preview has intentionally blurred sections. Sign up to view the full version.

View Full Document Right Arrow Icon
FIN 431: Investments 8 Options Call Options Payoff Function The payoff of a call option is equal to: max(0,S-X) S = Price of stock at the time the option expires X = Strike Price MSFT Example : Payoff = max(0,S-55)
Image of page 8
FIN 431: Investments 9 Options Call Options S - X 0 S > X S < X Payoff Table S - 55 0 S > 55 S < 55
Image of page 9

Info icon This preview has intentionally blurred sections. Sign up to view the full version.

View Full Document Right Arrow Icon
FIN 431: Investments 10 Options Call Options S Payoff 55 Payoff Diagram
Image of page 10
FIN 431: Investments 11 Options Call Options C = Initial Premium (call option price) V = Payoff at Exercise or Expiration
Image of page 11

Info icon This preview has intentionally blurred sections. Sign up to view the full version.

View Full Document Right Arrow Icon
Image of page 12
This is the end of the preview. Sign up to access the rest of the document.

{[ snackBarMessage ]}

What students are saying

  • Left Quote Icon

    As a current student on this bumpy collegiate pathway, I stumbled upon Course Hero, where I can find study resources for nearly all my courses, get online help from tutors 24/7, and even share my old projects, papers, and lecture notes with other students.

    Student Picture

    Kiran Temple University Fox School of Business ‘17, Course Hero Intern

  • Left Quote Icon

    I cannot even describe how much Course Hero helped me this summer. It’s truly become something I can always rely on and help me. In the end, I was not only able to survive summer classes, but I was able to thrive thanks to Course Hero.

    Student Picture

    Dana University of Pennsylvania ‘17, Course Hero Intern

  • Left Quote Icon

    The ability to access any university’s resources through Course Hero proved invaluable in my case. I was behind on Tulane coursework and actually used UCLA’s materials to help me move forward and get everything together on time.

    Student Picture

    Jill Tulane University ‘16, Course Hero Intern