course material-Derivative Securities and Risk Managemen

If the stock price equals the exercise price s s x x

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If the stock price equals the exercise price ( S S 0 = X = X ), the option is at-the-money .
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10 Put Options (1) A put option is an option to sell an asset, such as a stock. The put option buyer and writer negotiated a premium of $1.7 , which the buyer paid to the writer. Expiry (T) Current stock price (S 0 ) Exercise price (X) Premium Sept 16 $25.92 $27.5 $1.7 August 2005 A right to sell the stock at $27.5
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11 Put Options If the stock price is less than the exercise price ( S S 0 < X < X ), the put is said to be in-the-money . If the stock price is more than the exercise price ( S S 0 > X > X ), the put is out- of-the-money . An out-of-the-money put should never be exercised. When the stock price equals the exercised price ( S S 0 = X = X ), the put is at-the-money .
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12 Over-the-Counter Options Market Now a rather large over-the- counter (OTC) options market dominated by institutional investors. There is nearly always some credit risk faced by the buyers of these options.
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13 Advantages of OTC Options 1. The terms and conditions of the options can be tailored to the specific needs of the two parties. 2. OTC is a private market in which neither the general public nor other investors, including competitors, need know that the transactions were completed. 3. OTC trading is essentially unregulated . Its rules are those of commonsense business honesty and courtesy. There are no costly constraints or bureaucratic red tape to cut through.
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14 Disadvantages of OTC Options 1. Credit risk is higher 2. Excludes many customers who are unable to establish their creditworthiness in this market. 3. The size of the transactions in the OTC market are larger than many investors can handle.
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15 Organized Options Trading An exchange is a legal corporate entity organized for the trading of securities, options, or futures. It provides a physical facility and stipulates rules and regulations governing the transactions in the instruments trading thereon. The exchange would specify the contracts’ terms and conditions. Consequently, a secondary market for the contracts was made possible. This made options more accessible and attractive to the general public. Options are marketable as stocks.
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16 Market Maker The market maker is responsible for meeting the public’s demand for options. When someone from the public wishes to buy (sell) an option and no other member of the public is willing to sell (buy) it, the market maker completes the trade. The bid price is the maximum price the market marker will pay for the option. The ask price is the minimum price the market maker will accept for the option. The ask price is set higher than the bid price. The difference between the ask and bid price is called the bid-ask spread .
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