They should use the appraisal ratio which adjusts the

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Unformatted text preview: t;X for a put At the money when S = X Out of the money when S<X for a call, and S>X for a put As long as an option has not expired, there is a chance that a stock out of the money can finish in the money, and a stock in the money can finish further in the money, on or before the expiration date because the underlying stock price may change over time. Time value is related to the time to expiration and stock volatility. The longer time to expiration and the higher the stock volatility, the higher the probability that the stock will eventually finish in the money or further in the money. I.e. S*>X for a call and S*<X for a put, where S* stand for the stock price on the expiration date. Due to the time value component, the fact that an American option is in the money does not imply that it is worthwhile to exercise early. Similar, it is not true that prior to the expiration date, options that are out of money are worthless. P AYOFF AND PROFIT/LOSS OF A POSITION A position is used to describe a trading strategy. There are six basic positions for options: 1. 2. 3. 4. 5. 6. Long a stock – buy a share Short a stock – short sell a share Long a call – buy a call option Short a call – sell or write a call option Long a put – buy a put option Short a put – sell or write a put option There are more sophisticated positions that can be achieved by combining these 6 basic positions: Protective Put – to combine a long stock and a long put, so the put can protect the downside risk of the underlying stock Covered Call – to combine a long stock and a short call, where in the event of a call being exercised, the position has a share to deliver. Butterfly Spread – 2 long calls (different exercise prices), 2 short calls with an exercise price in the middle Inverted Butterfly Spread – 2 short class (different exercise prices), 2 long calls with exercise price in the middle L ONG A STOCK Payoff – the value of a position at any point in time. Initial Payoff – value of 1 share at time of purchase = S0. Final Payoff – value of one share at the time of sale = S*. Profit and Loss = S* - S0 11 Cheryl Mew FINS2624 –...
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This document was uploaded on 03/21/2014.

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