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Unformatted text preview: 50) Profit = $8.80 $7.50 $1.30 = 0 At the money ($7.50) When the stock price ($7.50) = X ($7.50) Loss = $7.50 $7.50 $1.30 = $1.30 Payoff function
Payoff function Buyer of a Call Option Upside potential – Buyer will benefit from increases in stock prices.
– Appropriate for expected rises in prices of underlying assets. Downside limit – When stock prices fall to equate exercise price, buyer will not exercise right, hence losses are limited to call premium. Writer of a Call Option
Writer of a Call Option The writer of a call option sells the option to the buyer (taking a short position in the option).
Receives an upfront fee (call premium)
Must stand ready to sell the underlying asset to the buyer of the call option at the exercise price. Payoff function
Payoff function Writer of a Call Option
Profit ($) Call Premium =
X = $7.50 Payoff
$1 A = $8.80 S = $9.80 Stock Price at
Expiration ($) Payoff function
Payoff function Writer of a Call Option Upside Limit – Writer will benefit from decreases in stock prices.
– Appropriate for expected decreases in prices of underlying assets.
– But, profit is limited to the call premium, as buyers of calls will not exercise when stock prices fall to less than the exercise price. Unlimited Loss Potential When stock prices rise, buyer will exercise right, forcing the writer to buy at high market price, to sell at lower exercise price to the buyer, hence losses can be unlimited. Options
Options Put Option – Gives the buyer the right to sell an underlying security at a specified price (exercise or strike price) to the writer of the put.
– Buyer must pay the writer (seller) an upfront fee (put premium).
– Buyer will profit when the underlying stock price is lower than the exercise price (amount must exceed the put premium already paid) when the option expires. Options
1. In the money When the stock price < exercise price (X) at expiry date Buyer will exercise the option, buy at market price and selling immediately at X Options
2. Out of the mo...
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This document was uploaded on 04/02/2014.
- Spring '14