Chapter 2: The Structure of Options Markets

1. Chapter 2: The Structure of Options Markets If the financial markets are a war zone, this is the theater of hand-to-hand combat. Richard Thomson Apocalypse Roulette, 1998, p. 49 An Introduction to Derivatives and Risk Management, 6th ed.

2. Important Concepts in Chapter 2 • Definitions and examples of call and put options • Institutional characteristics of options markets • Options available for trading • Placing an options order • The clearinghouse • Accessing option price quotations • Transaction costs • Regulation of options markets • Margins and taxes in option transactions An Introduction to Derivatives and Risk Management, 6th ed.

3. Option terminology • price/premium • call vs. put • exercise price/strike price/striking price • expiration date Everyday examples of options • rain check • discount coupon • airline ticket with cancellation right • right to drop a course An Introduction to Derivatives and Risk Management, 6th ed.

4. The Development of Options Markets • Early origins • Put and Call Brokers and Dealers Association • Chicago Board Options Exchange, 1973 • Resurgence of over-the-counter market An Introduction to Derivatives and Risk Management, 6th ed.

5. Call Options • Current example • Objective of a call buyer • Moneyness concepts • In-the-money • Out-of-the-money • At-the-money An Introduction to Derivatives and Risk Management, 6th ed.

6. Put Options • Current example • Objective of a put buyer • Moneyness concepts • In-the-money • Out-of-the-money • At-the-money An Introduction to Derivatives and Risk Management, 6th ed.

7. The Over-the-Counter Options Market • Worldwide • Credit risk • Customized terms • Private transactions • Unregulated • Options on stocks and stock indices, bonds, interest rates, commodities, swaps & currencies An Introduction to Derivatives and Risk Management, 6th ed.

8. Organized Options Trading The concept of an options exchange • Listing Requirements • Contract Size • Exercise Prices • Expiration Dates • Position and Exercise Limits An Introduction to Derivatives and Risk Management, 6th ed.

9. Options Exchanges and Trading Activity • See Table 2.1, p. 29 for options exchanges An Introduction to Derivatives and Risk Management, 6th ed.

10. Option Traders • The Market Maker • Bid, ask, and bid-ask spread • Scalpers, position traders, spreaders • The Floor Broker • Designated primary market makers • Dual trading • The Order Book Official • Limit orders • Electronic order processing An Introduction to Derivatives and Risk Management, 6th ed.

11. Options Traders (continued) • Other Option Trading Systems • Specialists • Registered options traders • Electronic trading systems • Off-Floor Option Traders • Cost and Profitability of Exchange Membership • See Figure 2.1, p. 32 for CBOE seat prices • Leasing a seat • High risk, stressful work An Introduction to Derivatives and Risk Management, 6th ed.

12. The Mechanics of Trading • Placing an Opening Order • Types of orders • The Role of the Clearinghouse • The Options Clearing Corporation (OCC) • Clearing firms • See Figure2.2, p. 34 • Margin (see Appendix 2.A) • Open interest An Introduction to Derivatives and Risk Management, 6th ed.

13. The Mechanics of Trading (continued) • Placing an Offsetting Order • In the exchange-listed options market • In the over-the-counter options market • Exercising an Option • European vs. American style • Assignment • Cash settlement An Introduction to Derivatives and Risk Management, 6th ed.

14. Option Price Quotations • See web sites of newspapers and options exchanges • Problems • Delayed information • Nonsynchronized prices An Introduction to Derivatives and Risk Management, 6th ed.

15. Types of Options • Stock Options • Index Options • Currency Options • Other Types of Traded Options • interest rate options • currency options • options attached to bonds • exotic options • warrants, callable bonds, convertible bonds • executive options • Real Options An Introduction to Derivatives and Risk Management, 6th ed.

16. Transaction Costs in Option Trading • Floor Trading and Clearing Fees • Commissions • Bid-Ask Spread • Other Transaction Costs An Introduction to Derivatives and Risk Management, 6th ed.

17. The Regulation of Options Markets • Federal regulation • Industry regulation • Over-the-counter market regulation • The issue of which agency has regulatory responsibility has occasionally arisen. Summary An Introduction to Derivatives and Risk Management, 6th ed.

18. Appendix 2.A: Margin Requirements • Definitions • Margin • Initial margin • Maintenance margin • Margin Requirements on Stock Transactions • Margin Requirements on Option Purchases • Margin Requirements on the Uncovered Sale of Options • Margin Requirements on Covered Calls An Introduction to Derivatives and Risk Management, 6th ed.

19. Appendix 2.B: Taxation of Option Transactions • Taxation of Long Call Transactions • Taxation of Short Call Transactions • Taxation of Long Put Transactions • Taxation of Short Put Transactions • Taxation of Non-Equity Options • Wash and Constructive Sales An Introduction to Derivatives and Risk Management, 6th ed.

20. (Return to text slide) An Introduction to Derivatives and Risk Management, 6th ed.

21. (Return to text slide) An Introduction to Derivatives and Risk Management, 6th ed.

22. (Return to text slide) An Introduction to Derivatives and Risk Management, 6th ed.