Chapter 27 Options BA 543 Financial Markets and

Chapter 27 – Options BA 543 Financial Markets and Institutions

Chapter 27 – Options Markets n What was the embedded cost in the Futures Contract for a hedger? n What would be the preferred set-up for a hedger? Avoid the bad prices n Enjoy the good prices n n Who would be willing to take the other side of the contract? What economic incentive would you need to offer? n Does this sound like Insurance? n

Chapter 27 – Options Markets n The payoff profile desired for producer Get Fixed Price during Falling Prices, Get Market during Rising Prices

Chapter 27 – Options Markets n An options contract fits the “bill” n Two types of options, n Call Option – The right but not the obligation to buy n Put Option – The right but not the obligation to sell n It takes two to make a contract n Buyer of the option n Seller (Writer) of the option

Chapter 27 – Options Markets n What are the characteristics of an option contract? The agreed to underlying (remember this is a derivative asset) n The agreed to price for transaction in the future (here it is the strike or exercise price) n The time horizon for the option (maturity date) n The payment to the seller or writer for providing the contract option to the buyer n n Styles, American or European

Chapter 27 – Options Markets n Just the Basics of the Call Option n Buyer’s options: exercise or do nothing n Seller’s obligation: perform n Pay-off Profile n Just the Basics of the Put Option n Buyer’s options: exercise or do nothing n Seller’s obligation: perform n Pay-off Profile n Just like Insurance (you have an option)

Chapter 27 – Options Markets n U. S. Markets and the Underlying Assets n Stock Options n n n Started Call Options at CBOE in 1973 Put Options not granted until 1977 Markets not very broad until early 80 s Options Clearing Corporation (OCC) n Stock Index Options n n n Started in February 1982 with Value Line Index on the Kansas City Board of Trade (1675 stocks) First at CBOE was the S&P 100

Chapter 27 – Options Markets n U. S. Markets and the Underlying Assets (continued) n LEAPS (Long-term Equity Anticipation Securities) n n n Stock and Index Options with maturities up to 39 months Spans the market as typical stock and index options only out 6 months Interest Rate Options n n Options on physicals Options on Futures

Chapter 27 – Options Markets n Option Varieties n FLEX n Exotic n Etc. n International Option Exchanges n Options on Futures n Mechanics n Popularity n Pricing of Options

Chapter 29 – Applications n Applications - Insurance n Futures Applications n Options Applications n Applications – Speculative n Futures n Options Strategies n n Covered Call Writing Protective Put Straddles Spreads