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Investing 101. Lesson 5 Options. Blind Monkeys Throwing Darts. Malkiel suggested that it does not matter how you choose stocks in efficient markets You can ask some blind monkeys to throw darts on the Wall Street Journal to select stocks. Blind Monkeys Throwing Darts.

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investing 101

Investing 101

Lesson 5

Options

blind monkeys throwing darts
Blind Monkeys Throwing Darts
  • Malkiel suggested that it does not matter how you choose stocks in efficient markets
  • You can ask some blind monkeys to throw darts on the Wall Street Journal to select stocks
blind monkeys throwing darts1
Blind Monkeys Throwing Darts
  • However, rational security analysis is still useful:
    • Monkeys will probably not pick a well-diversified portfolio with a desired level of risk
    • Monkeys do not know the tax considerations of stock choice
    • Monkeys do not take your specific circumstances into account (job, age, location)
a paradox
A Paradox
  • If markets are efficient, then there are no gains from doing research
  • If there are no gains from doing research, then nobody does research
  • If nobody does research, then asset prices are inefficient
  • If markets are inefficient, then it is profitable to do research
congratulations
!!Congratulations!!
  • You have made it to the last day!
  • You have learned about stocks, bonds, mutual funds, economics and portfolio building.
  • Today you are in for a special treat, a peek into a world in which most of the world will never hear about! OPTIONS!
but first
But first….
  • Wait in American Sign Language ---->>
review
Review!
  • What is the SML?
  • What is CAL?
  • What is CAPM?
  • What is Beta?
main teaching points
Main Teaching Points
  • Short selling, Anyone remember what this is???
  • Naked Calls
  • Naked Puts
  • Covered Calls
  • Covered Puts
  • Spreads
derivatives
Derivatives
  • A derivative is a financial instrument whose price depends on the price of another underlying asset
  • Major derivative contracts are:
    • Futures and forward contracts
    • Call and put options
    • Swaps
institutional characteristics of option contracts
Institutional Characteristics of Option Contracts
  • A call option is the right to buy an asset for a certain price at a certain time in the future
  • A put option is the right to sell an asset for a certain price at a certain time in the future
option contracts
Option Contracts
  • An European option can only be exercised on the expiration date
  • An American option can be exercised on any day prior to and including the expiration date
option contracts1
Option Contracts
  • Long position: The option buyer or holder pays a premium and receives the right to buy or sell an asset
  • Short position: The option seller or writer receives a premium and has the obligation to deliver or purchase an asset whenever the option buyer chooses
possible payoffs at expiration
Call Option – Long

max(0, ST – X)

Put Option – Long

max(0, X – ST)

Possible Payoffs at Expiration
possible profits of options long positions
Call Option – Long

max(0, ST – X) – Ct

Put Option – Long

max(0, X – ST) – Pt

Possible Profits of Options: Long Positions
possible profits of options short positions
Call Option – Short

Ct – max(0, ST – X)

Put Option – Short

Pt – max(0, X – ST)

Possible Profits of Options:Short Positions
covered call
Covered Call

Value at

Expiration

  • The profit line:

Payoff

Covered

Call

Profit

S

x

0

covered call1
Covered Call
  • Covered call strategy combines long stock position with short call position
  • What are investors betting on?
  • When does this strategy pay off?
consider yourself informed
Consider yourself informed!

For more info on options and spreads feel free to stick around

option strategies
Option Strategies
  • There are numerous other trading strategies using options
  • The same trading strategies can be implemented with different sets of assets
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