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# 25 buyingputoptions buyingputoptions 3000 profit from

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Unformatted text preview: options The payoff for the buyer is the amount owed by the writer (no upper bound on V­X) Uncovered calls: writer does not own the stock (riskier position) Covered calls: writer owns the stock Selling Call Options Selling Call Options 1,000 500 Profit from Uncovered Call Strategy Exercise Price = \$70 Option Price 0 = \$6.13 (500) (1,000) (1,500) (2,000) (2,500) (3,000) 40 Stock Price at Expiration 50 60 70 80 90 100 Buying Put Options Buying Put Options Position taken in the expectation that the price will decrease (short position) Profit for purchasing a Put Option: Per Share Profit = Max [0, X­V] – Put Premium Protective put: Buying a put while owning the stock (if the price declines, option gains offset portfolio losses) The following diagram shows different total dollar profits for buying a put option with a strike price of \$70 and a premium of \$2.25 Buying Put Options Buying Put Options 3,000 Profit from Strategy 2,500 2,000 Exercise Price = \$70 1,500 Option Price = \$2.25 1,000 500 0 Stock Price at Expiration (500) (1,000) 40 50 60 70 80 90 100 Selling Put Options Selling Put Options Bet that the price will not decline greatly – collect premium income with no payoff The payoff for the buyer is the amount owed by the writer (payoff loss limited to the strike price since the stock’s value cannot fall below zero) Selling Put Options Selling Put Options 1,000 Profit from Strategy 500 0 Exercise Price = \$70 (500) Option Price (1,000) = \$2.25 (1,500) (2,000) (2,500) (3,000) 40 Stock Price at Expiration 50 60 70 80 90 100 Another Example: Currency Options Another Example: Currency Options For Buyer of £ Call Option For Seller of £ Call Option Strike price = \$1.50 Premium = \$ .02 Strike price = \$1.50 Premium = \$ .02 Net Profit per Unit Net Profit per Unit +\$.04 +\$.04 +\$.02 +\$.02 0 Future Spot Rate 0 \$1.46 - \$.02 - \$.04 \$1.50 \$1.54 Future Spot Rate \$1.46 - \$.02 - \$.04 \$1.50 \$1.54 Another Example: Currency Options Another Example: Currency Options For Buyer of £ Put Option For Seller of £ Put Option Strike price = \$1.50 Premium = \$ .03 Strike price = \$1.50 Premium = \$ .03 Net Profit per Unit Net Profit per Unit +\$.04 +\$.04 Future Spot Rate +\$.02 0 \$1.46 \$1.50 +\$.02 0 \$1.54 \$1.46 - \$.02 - \$.02 - \$.04 - \$.04 \$1.50 \$1.54 Future Spot Rate Valuation of Options Valuation of Options Factors influencing the value of a call option: Stock price (+) Exercise price (­) For a given exercise price, the higher the stock price, the greater the intrinsic value of the option (or at least the closer to being in­the­money) The lower the price at which you can buy, the more value Time to expiration (+) The longer the time to expiration, the more likely the option will be valuable Valuation of Options Valuation of Options Factors influencing the value of a call option: Interest rate (+) Options involve less money to invest, lower opportunity costs Volatility of underlying stock price (+) The greater the volatility of the underlying stock, the more likely that the option position will be valuable Valuation of Options Valuation of Options Factors influencing the value of a put option: The same listed, but different directions for several items. Stock price (­) Exercise price (+) Time to expiration (+) Interest rate (­) Volatility of underlying stock price (+) Black­Scholes Option Pricing Black­Scholes Option Pricing Model Model for determining the value of American call options This work warranted the awarding of the 1997 Nobel Prize in Economics! Black­Scholes Option Pricing Model Black­Scholes Option Pricing Model...
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