Chapter 27 – Options
BA 543 Financial Markets and Institutions
Chapter 27 – Options Markets
What was the embedded cost in the Futures Contract for a hedger?
What would be the preferred set-up for a hedger? Avoid the bad prices Enjoy the good prices
Who would be willing to take the other side of the contract? What economic incentive would you need to
offer? Does this sound like Insurance?
Chapter 27 – Options Markets
The payoff profile desired for producer
Get Fixed Price during Falling Prices, Get Market during Rising Prices
Chapter 27 – Options Markets
An options contract fits the “bill” Two types of options,
Call Option – The right but not the obligation to buy
Put Option – The right but not the obligation to sell
It takes two to make a contract Buyer of the option Seller (Writer) of the option
Chapter 27 – Options Markets
What are the characteristics of an option contract? The agreed to underlying (remember this is a
derivative asset) The agreed to price for transaction in the
future (here it is the strike or exercise price) The time horizon for the option (maturity date) The payment to the seller or writer for
providing the contract option to the buyer
Styles, American or European
Chapter 27 – Options Markets
Just the Basics of the Call Option Buyer’s options: exercise or do nothing Seller’s obligation: perform Pay-off Profile
Just the Basics of the Put Option Buyer’s options: exercise or do nothing Seller’s obligation: perform Pay-off Profile
Just like Insurance (you have an option)
Chapter 27 – Options Markets
U.S. Markets and the Underlying Assets Stock Options
Started Call Options at CBOE in 1973 Put Options not granted until 1977 Markets not very broad until early 80s
Options Clearing Corporation (OCC) Stock Index Options
Started in February 1982 with Value Line Index on the Kansas City Board of Trade (1675 stocks)
First at CBOE was the S&P 100
Chapter 27 – Options Markets
U.S. Markets and the Underlying Assets (continued) LEAPS (Long-term Equity Anticipation
Securities) Stock and Index Options with maturities up to 39
months Spans the market as typical stock and index
options only out 6 months Interest Rate Options
Options on physicals Options on Futures
Chapter 27 – Options Markets
Option Varieties FLEX Exotic Etc.
International Option Exchanges Options on Futures
Mechanics Popularity
Pricing of Options
Chapter 29 – Applications
Applications - Insurance Futures Applications Options Applications
Applications – Speculative Futures Options Strategies
Covered Call Writing Protective Put Straddles Spreads