Download - Contemporary Investments: Chapter 15 Chapter 15 FUNDAMENTALS OF OPTIONS What are the basic characteristics of option contracts? What is the value of option.

Contemporary Investments: Chapter 15

Chapter 15 FUNDAMENTALS OF OPTIONS

• What are the basic characteristics of option contracts?

• What is the value of option at expiration?

• What are some common option trading strategies?

• How are options valued?

• What other securities resemble options?


The basic characteristics of option contracts

• Option trading

– The positions and obligations

– The workings of option markets

– Option price quotations


Figure 15.1 – Option Price Quotes from the Wall Street Journal


Options on other securities

• Index options

• Foreign currency options

• Long-term options


Figure 15.2 – Price Quotes for Index Options


Option value at expiration

• Valuing calls and puts at expiration

– Call option value at expiration

– Put option value at expiration


Calculating the profit and loss from an option

• Buying a call option

• Writing a call option

• Buying a put option

• Writing a put option


Figure 15.3 – Profit (Loss) from Buying or Writing a 25 October GE Call Option at Expiration


Figure 15.4 – Profit (Loss) from Buying or Writing a 25 October GE Put Option at Expiration


Common option trading strategies– Some unique risks and opportunities of

options

– Strategies involving just one option contract

– Straddles

– Spreads

• Money spreads

• Why trade spreads?


Figure 15.5 – Holding Period Return from GE Common Stock and a 25 GE Call Option


Combining option and stock options

• Writing covered calls

• Protective puts

• Covered short sales


Figure 15.6 – Holding Period Returns from GE 22.5 and 25 October Call Options


Figure 15.7 – Profit or Loss from Long Straddle (Buying) and Reverse Straddle (Writing)


Figure 15.8 – Profit or Loss from a Bull Spread or Bear Spread


Pricing options

• Determinants of option values

– Price of the underlying stock

– Exercise price

– Time until expiration

– Volatility of the underlying stock

– Level of interest rates

– Dividends


Black-Scholes Option Pricing Model• Black-Scholes pricing model for European

calls.

• Loose interpretation of the Black-Scholes model.

• Determinants of the fundamental value of an option.

• Applying the Black-Scholes formula

• Arbitrage strategy using the Black-Scholes model.


Other securities that resemble options

• Convertible securities

– Valuing a convertible security.

–Why buy convertibles?

• Warrants


Figure 15.9 – Valuing a Convertible Bond