Financial Option

Financial OptionQuestions 1) Math Type Plugin2) 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+F71Chapter Outline20.1 Option Basics20.2 Option Payoffs at Expiration20.3 Put-Call Parity20.4 Factors Affecting Option Prices20.5 Exercising Options Early20.6 Options and Corporate FinanceCopyright © 2020, 2017, 2014 Pearson Education, Inc. All Rights Reserved 2Learning 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 ReservedLearning 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 ReservedLearning 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 Reserved20.1 Option Basics (1 of 2)Financial OptionA contract that gives its owner the right (but not the obligation) to purchase or sell an asset at a fixed price as some future dateCall OptionA financial option that gives its owner the right to buy an assetCopyright © 2020, 2017, 2014 Pearson Education, Inc. All Rights Reserved20.1 Option Basics (2 of 2)Put OptionA financial option that gives its owner the right to sell an assetOption WriterThe seller of an option contractCopyright © 2020, 2017, 2014 Pearson Education, Inc. All Rights ReservedUnderstanding Option Contracts (1 of 3)Exercising an OptionWhen a holder of an option enforces the agreement and buys or sells a share of stock at the agreed-upon priceStrike Price (Exercise Price)The price at which an option holder buys or sells a share of stock when the option is exercisedExpiration DateThe last date on which an option holder has the right to exercise the optionCopyright © 2020, 2017, 2014 Pearson Education, Inc. All Rights ReservedUnderstanding Option Contracts (2 of 3)American OptionOptions that allow their holders to exercise the option on any date up to, and including, the expiration dateEuropean OptionOptions that allow their holders to exercise the option only on the expiration dateNote: The names American and European have nothing to do with the location where the options are tradedCopyright © 2020, 2017, 2014 Pearson Education, Inc. All Rights ReservedUnderstanding Option Contracts (3 of 3)The option buyer (holder)Holds the right to exercise the option and has a long position in the contractThe option seller (writer)Sells (or writes) the option and has a short position in the contractBecause 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