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Derivative Securities (Options): Puts & Calls PowerPoint Presentation
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Derivative Securities (Options): Puts & Calls

Derivative Securities (Options): Puts & Calls

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Derivative Securities (Options): Puts & Calls

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  1. Derivative Securities (Options): Puts & Calls

  2. Lockheed Martin (LMT) Transactions

  3. Lockheed Martin (LMT) Transactions

  4. Lockheed Martin (LMT) Transactions

  5. Lockheed Martin (LMT) Transactions

  6. Rights Warrants Convertibles Puts Calls Types of Options

  7. Common Stock Stock Indexes Debt Instruments Foreign currencies Commodities Financial futures A Growing Market – puts and calls can be traded on:

  8. Why so much interest in options? • “…investors can buy a lot of priceaction with a limited amount of capital, while nearly always enjoying limited exposure to risk.”

  9. Why Options? • A basic question asked by investors is: “Why buy stock options instead of shares in the underlying stock?” • To answer this question, we compare the possible outcomes from these two investment strategies: • Buy the underlying stock • Buy options on the underlying stock

  10. Example: Buying the Underlying Stock versus Buying a Call Option • Suppose IBM is selling for $90 per share and call options with a strike price of $90 are $5 per share. • Investment for 100 shares: • IBM Shares: $9,000 • One listed call option contract: $500 • Suppose further that the option expires in three months. • Finally, let’s say that in three months, the price of IBM shares will either be: $100, $80, or $90.

  11. Example: Buying the Underlying Stock versus Buying a Call Option, Cont. • Let’s calculate the dollar and percentage return given each of the prices for IBM stock:

  12. Characteristics of Options • “Derivative” Securities - obtain their value from the underlying issue • Contract to buy or sell other securities

  13. Characteristics of Options • Noownership interest in the underlying company (dividends; voting rights, etc.) • Provide leverage through a fixed purchase price - exaggerates any gain or loss

  14. Option Exchanges • Chicago Board Options Exchange (CBOE) • Established in 1973 • cboe.org - professional traders • cboe.com - private investors

  15. Option Exchange Features • Central marketplace vs. O-T-C • Secondary market • Option Clearing Corporation (OCC)

  16. The Options Clearing Corporation • The Options Clearing Corporation (OCC) is a private agency that guarantees that the terms of an option contract will be fulfilled if the option is exercised. • The OCC issues and clears all option contracts trading on U.S. exchanges. • Note that the exchanges and the OCC are all subject to regulation by the Securities and Exchange Commission (SEC). Visit the OCC at: www.optionsclearing.com.

  17. Buyer-Seller Relationship(pre-CBOE)

  18. Buyer-Seller Relationship(Post-CBOE)

  19. Option Exchange Features • Standardized Terms: • contract size • expiration dates • exercise (striking) price

  20. Basic Option Terms(listed equity options) • Call Option: • contract to buy stock • 100 shares of stock • exercise price set by exchange • expires on fixed date – 3rd Friday of the expiration month

  21. Basic Option Terms(listed equity options) • Put Option: • contract to sell stock • 100 shares of stock • exercise price set by exchange • expires on fixed date – 3rd Friday of the expiration month

  22. Call - contract to: Buy 100 shares Fixed price Specified term Put - contract to: Sell 100 shares Fixed price Specified term Basic Option Terms

  23. Option Jargon • “Striking Price” - price at which the contract is exercised or carried out • Example: • XYZ-AUG-30; “30” is the striking price, or exercise price of the option

  24. Option Jargon • “Expiration Date” - maturity date; the third Friday of the expiration month • Example: • XYZ-AUG-30; option expires on the third Friday of August

  25. Option Jargon • “Option Writer (Maker)” - seller of an option contract

  26. Option Jargon • “Covered Writer” - already owns shares of the underlying stock; can deliver shares if exercised

  27. Option Jargon • “Naked Writer” - does not own shares of the underlying stock; must buy shares if exercised

  28. Option Jargon[Call Options] • “In the Money” - stock price greater than exercise price

  29. Option Jargon[Call Options] • “Out of the Money” - stock price less than exercise price

  30. Option Jargon[Call Options] • “At the Money” - stock price = exercise price

  31. Option Pricing[Three Prices to Consider] • Underlying stock price per share • Exercise (striking) price of the option contract • Price (Premium) of the option contract

  32. Call Option Pricing • Option premium reflects: • Intrinsic valueof the option, • plus the option’s time value • Premium = IV + TV • Time Value = Premium - IV

  33. Call Option Pricing[ABC-MAY-80] • Intrinsic value (IV): • IV = Stock price - exercise price • IV = $81.75 - $80.00 = $1.75

  34. Call Option Pricing[ABC-MAY-80] • Time value (TV): • TV = premium - intrinsic value • TV = $3.75 - $1.75 = $2.00

  35. Listed Option Quoteson the Web

  36. Put Option Pricing[ABC-JUL-80] • Intrinsic value (IV): • IV = Exercise price - stock price • IV = $80.00 - $79.00 = $1.00

  37. Put Option Pricing[ABC-JUL-80] • Time value (TV): • TV = premium - intrinsic value • TV = $3.00 – 1.00 = $2.00

  38. Option Strategies

  39. Option Strategies

  40. Option Strategies

  41. Option Strategies

  42. Option Strategies

  43. FIGURE 11.2 The Valuation Properties of Put and Call Options

  44. Option Trading Strategies • Buying options for speculation • Hedging with puts and calls • Option writing and spreading

  45. Buying Options for Speculation • Same motivation as buying stock • “Buy low, sell high” • Smaller investment - greater leverage • Limited loss

  46. Hedging with Puts and Calls • Combination of two or more securities • Objectives: • To earn or protect a profit • Limit losses