Post on 28-Dec-2015
transcript
Chapter 20Principles of
Corporate FinanceTenth Edition
Understanding Options
Slides by
Matthew Will
McGraw-Hill/Irwin Copyright © 2011 by the McGraw-Hill Companies, Inc. All rights reserved.
20-2
Topics Covered
Calls, Puts and SharesFinancial Alchemy with OptionsWhat Determines Option Values?
20-3
Option Terminology
Put Option
Right to sell an asset at a specified exercise price on or before the exercise date.
Call Option
Right to buy an asset at a specified exercise price on or before the exercise date.
20-4
Option Obligations
assetbuy toObligationasset sell Right tooptionPut
asset sell toObligationassetbuy Right tooption Call
ShortLong
20-5
OptionsTerminology
Derivatives - Any financial instrument that is derived from another. (e.g.. options, warrants, futures, swaps, etc.)
Option - Gives the holder the right to buy or sell a security at a specified price during a specified period of time.
Call Option - The right to buy a security at a specified price within a specified time.
Put Option - The right to sell a security at a specified price within a specified time.
Option Premium - The price paid for the option, above the price of the underlying security.
Intrinsic Value - Diff between the strike price and the stock price
Time Premium - Value of option above the intrinsic value
20-6
OptionsTerminology
Exercise Price - (Striking Price) The price at which you buy or sell the security.
Expiration Date - The last date on which the option can be exercised.
American Option - Can be exercised at any time prior to and including the expiration date.
European Option - Can be exercised only on the expiration date.
All options “usually” act like European options because you make more money if you sell the option before expiration (vs. exercising it).
3 vs. 70-68=2
20-7
Google Stock
Selected prices for puts and calls September 2008
20-8
Option Value
The value of an option at expiration is a function of the stock price and the exercise price.
Example - Option values given a exercise price of $80
00001020ValuePut
302010000Value Call
110100908070$60PriceStock
20-9
Option Value
Google Call option value (graphic) given a $430 exercise price.
Share Price
Cal
l opt
ion
valu
e
430
$430
20-10
Option Value
Google Put option value (graphic) given a $430 exercise price.
Share Price
Put
opt
ion
valu
e
430
$430
20-11
Option Value
Google Call option payoff (to seller) given a $430 exercise price.
Share Price
Cal
l opt
ion
$ pa
yoff
430
$430
20-12
Option Value
Google Put option payoff (to seller) given a $430 exercise price.
Share Price
Put
opt
ion
$ pa
yoff
430 $430
20-13
Option Value
Call buyer profit – assume strike of $430 and option price of $54.35
Share Price
Pos
itio
n V
alue
Long call
430 484.35
-54.35
Break even
20-14
Option Value
Put seller profit – assume strike of $430 and option price of $48.55
Share Price
Pos
itio
n V
alue
Short put
381.45 430
+48.55
Break even
20-15
Option Value
Masochists Strategy?- Long stock and short call
Share Price
Pos
itio
n V
alue “Silly Strategy”
Short Call
Long Stock
20-16
Option Value
Protective Put - Long stock and long put
Share Price
Pos
itio
n V
alue Protective Put
Long Put
Long Stock
20-17
Option Value
Straddle - Long call and long put
- Strategy for profiting from high volatility
Share Price
Pos
itio
n V
alue
Straddle
Long put Long call
20-18
Financial Alchemy
20-19
Financial Alchemy
20-20
Financial Alchemy
20-21
Financial Alchemy
20-22
Financial Alchemy
20-23
Option Value
Components of the Option Price
1 - Underlying stock price = Ps
2 - Striking or Exercise price = S
3 - Volatility of the stock returns (standard deviation of annual returns) = v
4 - Time to option expiration = t = days/365
5 - Time value of money (discount rate) = r
6 - PV of Dividends = D = (div)e-rt
20-24
Time Decay Chart
Option Price
Stock Price
Option prices decline, ceribus paribus, when the time to expiration declines.
90 days to expiration
60 days to expiration
30 days to expiration
20-25
Option Value
Upper Limit
Stock Price
Lower Limit
(Stock price - exercise price) or 0which ever is higher
20-26
Option Value
The value of an option is bound, on the high end, by the value of the underlying stock. The lower bound is the value of exercising the option. In between, the major determinants are exercise price and stock price.
20-27
Option Value
The greater the distribution of possible outcomes, relative to the final price of the stock, the higher the value of the option. This is due to the greater potential for profit. Thus, Y will have a higher option price, ceribus paribus.
20-28
Option Value
Similar to time decay, the value of an option will be higher when more volatility exists.
20-29
Option Value
20-30
Option Value
20-31
Web Resources
Click to access web sitesClick to access web sites
Internet connection requiredInternet connection required
www.cboe.com
http://finance.yahoo.com
www.optionscentral.com
www.pmpublishing.com