Financial Option
1) Math Type Plugin
2) Math Player (free versions available)
3) NVDA Reader (free versions available)
Slides in this presentation contain hyperlinks. JAWS users should be able to get a list of links by using INSERT+F7
1
Chapter Outline
20.1 Option Basics
20.2 Option Payoffs at Expiration
20.3 Put-Call Parity
20.4 Factors Affecting Option Prices
20.5 Exercising Options Early
20.6 Options and Corporate Finance
Copyright © 2020, 2017, 2014 Pearson Education, Inc. All Rights Reserved
2
Learning Objectives (1 of 3)
Define the following terms: call option, put option, exercise price, strike price, exercising the option, expiration date, American option, European option, in-the-money, and out-of-the-money.
Compute the value of a call or a put option at expiration.
List the rights and obligations of the buyer of the option and the seller of the option.
Copyright © 2020, 2017, 2014 Pearson Education, Inc. All Rights Reserved
Learning Objectives (2 of 3)
Use put-call parity to solve for the call premium, the put premium, the stock price, the strike price, or the dividend.
Discuss the following factors that influence call and put option values: stock price, strike price, and volatility.
Describe arbitrage bounds for option prices.
Copyright © 2020, 2017, 2014 Pearson Education, Inc. All Rights Reserved
Learning Objectives (3 of 3)
Explain why it is never optimal to exercise an American call option early on a non-dividend-paying stock, and why it is sometimes optimal to exercise an American put option early.
Explain the use of option modeling to value equity.
Describe how corporate debt can be viewed as a portfolio of riskless debt and a short position in a put option.
Copyright © 2020, 2017, 2014 Pearson Education, Inc. All Rights Reserved
20.1 Option Basics (1 of 2)
Financial Option
A contract that gives its owner the right (but not the obligation) to purchase or sell an asset at a fixed price as some future date
Call Option
A financial option that gives its owner the right to buy an asset
Copyright © 2020, 2017, 2014 Pearson Education, Inc. All Rights Reserved
20.1 Option Basics (2 of 2)
Put Option
A financial option that gives its owner the right to sell an asset
Option Writer
The seller of an option contract
Copyright © 2020, 2017, 2014 Pearson Education, Inc. All Rights Reserved
Understanding Option Contracts (1 of 3)
Exercising an Option
When a holder of an option enforces the agreement and buys or sells a share of stock at the agreed-upon price
Strike Price (Exercise Price)
The price at which an option holder buys or sells a share of stock when the option is exercised
Expiration Date
The last date on which an option holder has the right to exercise the option
Copyright © 2020, 2017, 2014 Pearson Education, Inc. All Rights Reserved
Understanding Option Contracts (2 of 3)
American Option
Options that allow their holders to exercise the option on any date up to, and including, the expiration date
European Option
Options that allow their holders to exercise the option only on the expiration date
Note: The names American and European have nothing to do with the location where the options are traded
Copyright © 2020, 2017, 2014 Pearson Education, Inc. All Rights Reserved
Understanding Option Contracts (3 of 3)
The option buyer (holder)
Holds the right to exercise the option and has a long position in the contract
The option seller (writer)
Sells (or writes) the option and has a short position in the contract
Because the long side has the option to exercise, the short side has an obligation to fulfill the contract if it is exercised.
The buyer pays the writer a premium