Buyerwillprofitwhentheunderlyingstockprice

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Unformatted text preview: ime in the future for a certain price. However, forwards are traded OTC, assets are nonstandardised/unique and negotiated individually between buyer and seller. Forwards are not marked to market. Forwards on foreign exchange is most popular. Refer to Lecture on Forex. Options Options An option is a contract which gives the holder the right, but not the obligation, to buy or sell an underlying asset at a specified price for a specified time. American Options – Holder can buy/sell anytime on/before the expiration date of the option European Options – Holder can buy/sell only on the expiration date Options Options Call Option – Gives the buyer the right to buy an underlying security at a specified price (exercise or strike price) – Buyer must pay the writer (seller) an upfront fee (call premium). – Buyer will profit when the underlying stock price is greater than the exercise price (amount must exceed the call premium already paid) when the option expires. Options Options 1. Call Option In the money ­ When the stock price > exercise price (X) at expiry date ­ Buyer will exercise the option, buy at X and selling immediately in the stock market at the current market price (> X) Options Options 2. Call Option Out of the money ­ When the stock price < exercise price (X) at expiry date ­ Buyer will not exercise the option, because you will be buying at X, which is higher than current market price (< X). ­ Option expires unexercised. Options Options Call Option 3. At the money ­ When the stock price = exercise price (X) at expiry date ­ Buyer will not exercise the option because cost of the call premium is incurred. ­ Option expires unexercised. Payoff function Payoff function ­ Buyer of a Call Option Profit ($) Payoff = $1 0 X = $7.50 Call Premium = $1.30 A = $8.80 S = $9.80 Stock Price at Expiration ($) Payoff function Payoff function ­ Buyer of a Call Option In the money ($9.80) When the stock price ($9.80) > X ($7.50) Profit = $9.80 ­ $7.50 ­ $1.30 = $1.00 (Buy at X, sell in market) Breakeven Point ($8.80) When the stock price ($8.80) > X ($7....
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This document was uploaded on 04/02/2014.

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