options lecture 3
DESCRIPTION
Options Lecture 3. Profit ($). 30. 20. 10. Terminal stock price ($). 70. 80. 90. 100. 0. 110. 120. 130. -5. Long Call on IBM. Profit from buying an IBM European call option: option price = $5, strike price = $100, option life = 2 months. Profit ($). 110. 120. 130. 5. 0. - PowerPoint PPT PresentationTRANSCRIPT
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3.1
Options
Lecture 3
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3.2
Long Call on IBM Profit from buying an IBM European call option: option
price = $5, strike price = $100, option life = 2 months
30
20
10
0-5
70 80 90 100
110 120 130
Profit ($)
Terminalstock price ($)
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3.3
Short Call on IBM Profit from writing an IBM European call option: option
price = $5, strike price = $100, option life = 2 months
-30
-20
-10
05
70 80 90 100
110 120 130
Profit ($)
Terminalstock price ($)
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3.4
Long Put on Exxon Profit from buying an Exxon European put option:
option price = $7, strike price = $70, option life = 3 mths
30
20
10
0
-770605040 80 90 100
Profit ($)
Terminalstock price ($)
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3.5
Short Put on Exxon Profit from writing an Exxon European put option:
option price = $7, strike price = $70, option life = 3 mths
-30
-20
-10
70
70
605040
80 90 100
Profit ($)Terminal
stock price ($)
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3.6Payoffs from Options
X = Strike price, ST = Price of asset at maturity
Payoff Payoff
ST STXX
Payoff Payoff
ST STXX
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3.7
Terminology Moneyness :
–At-the-money option–In-the-money option–Out-of-the-money option
• Expiration date• Strike price• European or American• Call or Put (option class)
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3.8
Types of Options• Exchange-traded options
– Stocks– Foreign Currency– Stock Indices– Futures
• Warrants• Convertible bonds• swapoptions • ....
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3.9
Warrants
• Warrants are options that are issued (or written) by a corporation or a financial institution
• The number of warrants outstanding is determined by the size of the original issue & changes only when they are exercised or when they expire
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3.10
Warrants(continued)
• Warrants are traded in the same way as stocks
• When call warrants are issued by a corporation on its own stock, exercise will lead to new treasury stock being issued
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3.11
Executive Stock Options
• Option issued by a company to executives
• When the option is exercised the company issues more stock
• Usually at-the-money when issued
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3.12
Executive Stock Options continued
• They become vested after a period ot time
• They cannot be sold• They often last for as long as 10 or 15
years
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3.13
Convertible Bonds
• Convertible bonds are regular bonds that can be exchanged for equity
at certain times in the future according to a predetermined exchange ratio
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3.14
Convertible Bonds(continued)
• Very often a convertible is callable• The call provision is a way in which
the issuer can force conversion at a time earlier than the holder might otherwise choose
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3.15
Exchangeable Bonds• An exchangeable bond is a sort of
convertible bond that provides the conversion into the shares of a company different from the issuer
• Usually, the underlying stock is the equity of a strategic partnership
• There can be adverse signalling problem which are reduced with “best of” structures
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3.16
Trading Strategies Involving Options
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3.17
Three Alternative Strategies• Take a position in the option & the
underlying• Take a position in 2 or more
options of the same type (A spread)
• Combination: Take a position in a mixture of calls & puts (A combination)
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3.18Positions in an Option & the Underlying
Profit
STX
Profit
ST
X
Profit
ST
X
Profit
STX
(a) (b)
(c)
(d)
cap on long strategy
floor on long strategy
floor on short strategy
cap on short strategy
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3.19
basket of options
• spread type: basket of options of the same type (call or put)– bull spread– bearish spread– butterfly spread
• combination type: basket of options of different types– straddles
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3.20
Bull Spread Using Calls
X1 X2
Profit
ST
initial cash outflow
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3.21
Bull Spread Using Puts
X1 X2
Profit
ST
initial cash outflow
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3.22
Bear Spread Using Calls
X1 X2
Profit
ST
initial cash inflow
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3.23
Bear Spread Using Puts
X1 X2
Profit
ST
initial cash inflow
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3.24
Butterfly Spread Using Calls
X1 X3
Profit
STX2
buy 2 calls and sell 2 calls
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3.25
Butterfly Spread Using Puts
X1 X3
Profit
STX2
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3.26
A Straddle Combination
Profit
STX
bottom straddle
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3.27
A 2nd Straddle Combination
top straddle
X1
Profit
ST
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3.28
A Strangle Combination
X1 X2
Profit
ST
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3.29A Top Vertical Combination
X1 X2
Profit
ST