Essentials of Investments Eleventh Edition Bodie Kane and
Essentials of Investments Eleventh Edition Bodie, Kane, and Marcus Chapter 15 Options Markets © 2019 Mc. Graw-Hill Education. All rights reserved. Authorized only for instructor use in the classroom. No reproduction or further distribution permitted without the prior written consent of Mc. Graw-Hill Education.
15. 1 Option Contracts Call Option • Right to buy asset at specified exercise price on or before specified expiration date Put Option • Right to sell asset at specified exercise price on or before specified expiration date Strike Price • Price set for calling/putting asset Premium • Purchase price (market value) of option © 2019 Mc. Graw-Hill Education. 15 -2
Figure 15. 1 Microsoft (MSFT): Expiration Microsoft (MSFT): Strike Underlying stock price = $71. 75: Call Underlying stock price = $71. 75: Put June 16, 2017 70 2. 02 0. 24 June 16, 2017 72 0. 67 0. 90 June 16, 2017 74 0. 13 2. 37 July 7, 2017 70 2. 40 0. 58 July 7, 2017 72 1. 15 1. 32 July 7, 2017 74 0. 42 2. 59 © 2019 Mc. Graw-Hill Education. 15 -3
15. 1 Option Contracts In the Money • Exercise would generate positive cash flow Out of the Money • Exercise would generate negative cash flow At the Money • Exercise price equals asset price © 2019 Mc. Graw-Hill Education. 15 -4
15. 1 Option Contracts Options Trading • Most trading occurs on organized exchanges, such as the CBOE • Ease of trading • Liquid secondary market • Standardized by allowable expiration date and exercise price • Limited, uniform set of securities • Results in more competitive market © 2019 Mc. Graw-Hill Education. 15 -5
15. 1 Option Contracts American Option • Can be exercised on or before expiration European Option • Can be exercised only at expiration Option Clearing Corporation • Jointly owned by exchanges • Arranges exercised options through member firms • Requires option writers to post margin • Option purchasers are not required to post margins © 2019 Mc. Graw-Hill Education. 15 -6
15. 1 Option Contracts Other Listed Options • Index options • • Futures options • • Give holders right to buy/sell futures contract using exercise price as futures price Foreign currency options • • Call/put based on stock market index Offers right to buy/sell foreign currency for specified amount of domestic currency Interest rate options • Options on Treasury notes/bonds/bills and other countries’ government bonds © 2019 Mc. Graw-Hill Education. 15 -7
15. 2 Values of Options at Expiration Call Options • Payoff to call holder • • ST − X if ST > X; 0 if ST ≤ X Payoff to call writer • −(ST − X) if ST > X; 0 if ST ≤ X Put Options • Payoff to put holder • • X − ST if ST < X; 0 if ST > X Payoff to put writer • −(X − ST) if ST < X; 0 if ST > X © 2019 Mc. Graw-Hill Education. 15 -8
Figure 15. 2 Payoff, Profit to Call Option at Expiration © 2019 Mc. Graw-Hill Education. 15 -9
Figure 15. 3 Payoff, Profit to Call Writers at Expiration © 2019 Mc. Graw-Hill Education. 15 -10
Figure 15. 4 Payoff, Profit to Put Option at Expiration © 2019 Mc. Graw-Hill Education. 15 -11
15. 2 Values of Options at Expiration Options versus Stock Investment • Strategies • Invest entirely in stock, 100 shares for $90 each • Invest entirely in at-the-money options (X = $90); buy 900 calls, each selling at $10 • Buy 100 call options for $1, 000; invest remaining $8, 000 in 6 -month T-bills at 2% interest © 2019 Mc. Graw-Hill Education. 15 -12
15. 2 Values of Options at Expiration Stock price Portfolio Stock Price: $85 Stock Price: $90 Stock Price: $95 Stock Price: $100 Stock Price: $105 Stock Price: $110 A: 100 shares stock $8, 500 $9, 000 $9, 500 $10, 000 $10, 500 $11, 000 0 0 4, 500 9, 000 13, 500 18, 000 8, 160 8, 660 9, 160 9, 660 10, 160 Stock Price: $105 Stock Price: $110 11. 11% 16. 67% 22. 22% B: 900 call options C: 100 calls + $8, 000 in T-bills Rate of Return Portfolio Stock Price: $85 A: 100 shares stock − 5. 56% B: 900 call options C: 100 calls + $8, 000 in T-bills Stock Price: $90 0. 00% Stock Price: $95 5. 56% − 100. 00 − 50. 00 100. 00 − 9. 33 − 3. 78 1. 78 7. 33 12. 89 © 2019 Mc. Graw-Hill Education. 15 -13
Figure 15. 5 Ro. R to Three Strategies © 2019 Mc. Graw-Hill Education. 15 -14
15. 2 Values of Options at Expiration Option Strategies • Protective put • • Risk management • • Asset combined with put option that guarantees minimum proceeds equal to put’s exercise price Strategies to limit risk of portfolio Covered call • Writing call on asset together with buying asset © 2019 Mc. Graw-Hill Education. 15 -15
15. 2 Values of Options at Expiration Option Strategies • Straddle • • Spread • • Combination of call and put, each with same exercise price and expiration date Combination of two or more call options/put options on same asset with differing exercise prices/times to expiration Collar • Options strategy that brackets value of portfolio between two bounds © 2019 Mc. Graw-Hill Education. 15 -16
Table 15. 1 Payoff to Protective Put Strategy Stock Put Total ST ≤ X ST X – ST X ST > X ST 0 ST © 2019 Mc. Graw-Hill Education. 15 -17
Figure 15. 6 Value of Protective Put Position at Expiration © 2019 Mc. Graw-Hill Education. 15 -18
Figure 15. 7 Protective Put versus Stock Investment © 2019 Mc. Graw-Hill Education. 15 -19
Table 15. 2 Payoff to Covered Call Payoff of stock −Payoff of call Total ST ≤ X ST − 0 ST © 2019 Mc. Graw-Hill Education. ST > X ST −(ST − X) X 15 -20
Figure 15. 8 Value of Covered Call Position at Expiration © 2019 Mc. Graw-Hill Education. 15 -21
Table 15. 3 Payoff to Straddle ST ≤ X Payoff of call +Payoff of put Total 0 +(X − ST) X − ST © 2019 Mc. Graw-Hill Education. ST > X ST − X +0 ST − X 15 -22
Figure 15. 9 Payoff and Profit on Straddle at Expiration © 2019 Mc. Graw-Hill Education. 15 -23
Table 15. 4 Payoff to Bullish Spread Payoff of first call, exercise price = X 1 −Payoff of second call, exercise price = X 2 Total ST ≤ X 1 0 − 0 0 X 1 < ST ≤ X 2 ST − X 1 − 0 ST − X 1 © 2019 Mc. Graw-Hill Education. ST > X 2 ST − X 1 −(ST − X 2) X 2 – X 1 15 -24
Figure 15. 10 Value of Bullish Spread Position at Expiration © 2019 Mc. Graw-Hill Education. 15 -25
Figure 15. 3 Optionlike Securities Callable Bonds • Issued with coupon rate higher than on straight debt • • Investor’s compensation for call option retained by issuer Usually includes call protection period © 2019 Mc. Graw-Hill Education. 15 -26
Figure 15. 11 Values of Callable Bond Compared with Straight Bond © 2019 Mc. Graw-Hill Education. 15 -27
15. 3 Optionlike Securities Convertible Securities • Convey options to holder rather than issuer • Typically give holder right to exchange for common stock, regardless of market price © 2019 Mc. Graw-Hill Education. 15 -28
Figure 15. 12 Value of Convertible Bond as Function of Stock Price © 2019 Mc. Graw-Hill Education. 15 -29
15. 3 Optionlike Securities Warrants • Option issued by firm to purchase shares of firm’s stock Collateralized Loans • Nonrecourse loan • • No recourse beyond right to collateral Three views • Gives implicit call option to borrower • Borrower turns collateral over and retains right to reclaim it by paying off loan • Borrower will repay L dollars and can sell collateral to lenders for L dollars, even if ST is less than L © 2019 Mc. Graw-Hill Education. 15 -30
Figure 15. 13 Collateralized Loan © 2019 Mc. Graw-Hill Education. 15 -31
15. 3 Optionlike Securities Leveraged Equity and Risky Debt • Any time corporation borrows money, maximum possible collateral for loan is total of firm’s assets © 2019 Mc. Graw-Hill Education. 15 -32
15. 4 Exotic Options Asian Options • Options with payoffs that depend on average price of underlying asset during portion of option life Currency-Translated Options • Have either asset or exercise price denominated in foreign currency Digital Options • Have fixed payoffs that depend on price of underlying asset © 2019 Mc. Graw-Hill Education. 15 -33
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