Transcript Chapter 25 Options and Corporate Securities •Homework: 2, 3,12, & 13

Chapter 25
Options and Corporate
Securities
•Homework: 2, 3,12, & 13
Lecture Organization
 Options: The Basics
 Fundamentals of Option Valuation
 Other Options
 Hedging with Option Contracts
Option Terminology
 Call option
The right to buy an asset at a fixed price during a particular
period of time.
 Put option
The right to sell an asset at a fixed price during a particular
period of time. The opposite of a call.
 Striking price
The fixed price in the option contract at which the holder can
buy or sell the underlying asset. (Also the exercise price or the
strike price.)
Option Terminology
 Expiration date
The last day on which an option may be exercised.
 Exercising the option
The act of buying or selling the underlying asset via the option
contract.
 American option
An option that may be exercised at any time until its expiration
date.
 European option
An option that may only be exercised on the expiration date.
Call Options
Let's say you look in the WSJ on 9/28/2001 and see IBM trading
for $69 per share. You think that IBM is going to go up in price.
How do you make money?
a)
b)
Example: Assume that you own the right to buy IBM for $70/share in
January. Fill in the following table:
Price of IBM Exercise @
Stock in Jan. $70 (Y/N)
55
60
65
70
75
80
85
Gross
Payoff
Put options
You think that IBM is going to go down in price in January. How do you make
money?
Let's say you owned the right to sell one share of IBM stock in January for
$70/share.
January rolls around and the price of IBM has fallen to $60/share. How can you
profit from your option?
Example: Assume that you own the right to sell IBM for
$70/share in January. Fill in the following table:
Price of IBM Exercise @
Stock in Jan. $70 (Y/N)
55
60
65
70
75
80
85
Gross
Payoff
Short Calls
Example: Say you sell 100 November IBM calls with a strike price of $75. The
price of each option is $0.87. Hence you would collect $87 today.
When you sell a call option to someone, you are selling them the right to buy 100
shares of IBM stock from you for $75/share in November.
Short Puts
Example: Say you sell 100 November IBM puts with a strike price of $75. The
price of each option is $7.00. Hence you would collect $700.00 today.
When you sell a put option to someone, you are selling them the right to sell 100
shares of IBM stock to you for $75/share in November.
A Sample Globe and Mail, Report on Business Option Quote (Figure 25.1)
Stock
Series
Close
Bid
Air Canada
Jul-00
$16.00
$19.00 p
$20.00
$21.00
$19.35
3.35
0.60
0.60
0.30
Ask
Total Vol Op Int
Vol
Op Int
Last
3.60
0.85
0.85
0.55
3.95
0.55
0.90
0.50
156
7
20
20
40
Source: The Globe and Mail, Report on Business, July 6, 2000, p. B27. Used with permission
8514
592
150
230
104
Value of a Call Option at Expiration (Figure 25.2)
Call option value
at expiration (C1)
S1  E
S1 > E
Stock price
45 °
at expiration (S1)
Exercise price (E)
As shown, the value of a call at expiration is equal to zero if the stock price is less
than or equal to the exercise price. The value of the call is equal to the stock price
minus the exercise price (S1 - E) if the stock price exceeds the exercise price.
Value of a Call Option Before Expiration (Figure 25.3)
Call price
Upper bound
Lower bound
(C0)
C0  S0
C0  S0 - E
C0  0
45 °
Stock price (S0)
Exercise price (E)
As shown, the upper bound on a call’s value is given by the value of the
stock (C0  S0). The lower bound is either S0 - E or zero, whichever is
larger.
Five Factors That Determine Option Values
Factor
Calls
Current value of the underlying asset
Exercise price on the option
Time to expiration on the option
Risk-free rate
Variance of return on underlying asset
Puts
Warrants and Convertible Bonds
 Warrant
A call option issued by firms that provides the buyer the right
to purchase shares of stocks at a specified price over a
given period of time.
 Convertible bonds
Can be exchanged into a fixed number of stocks anytime up
to and including the maturity date of the bond. Cannot be
separated from the bond.
Other Options
 Call provision on a bond
A call provision provides the issuer the right, but not the
obligation to repurchase the bond at a specified price.
 Put bonds
The owner of a put bond has the right to force the issuer to
repurchase the bond for a fixed price for a fixed period of
time.
 Green Shoe provision
The right of the underwriter to purchase additional shares
from the issuer at the offer price in an IPO.
 Insurance
Insurance obligates the insurer to purchase the underlying
asset at a specified price for a specified period (the term of
the policy).
Risk Profile for a Wheat Grower
Risk Profile for a Wheat Buyer
Option Payoff Profiles
V
P
A. Buying a call
Option Payoff Profiles (continued)
V
P
B. Selling a call
Option Payoff Profiles (continued)
V
P
C. Buying a put
Option Payoff Profiles (concluded)
V
P
D. Selling a put
Sample National Post Future Option Price Quotations (Figure 24.16)
FUTURE OPTION PRICES
Thursday, June 1, 2000
Strike
Calls-Settle
Canola (WPG)
20 metric tons, C$ per metric ton
Strike
July
Aug
Sept
240
18.80
23.40
s
250
9.50
15.40
18.30
260
3.00
9.10
12.10
270
1.00
4.80
7.40
280
0.50
2.20
4.20
290
r
0.90
2.20
300
r
0.30
1.10
310
r
0.10
0.50
320
r
r
0.20
Prev. open int. 9,580
Puts-Settle
July
Aug
Sept
r
1.10
s
1.00
3.00
4.00
3.90
6.60
7.60
11.70
12.20
12.80
21.20
19.60
19.50
31.10
28.20
27.40
41.10
37.50
36.10
51.10
47.20
45.40
61.00
57.10
55.00
Prev. open int. 9,943
The National Post, June 1, 2000. Used with permission.
Example
Consider the following options quote.
Option &
Strike
Calls
Puts
NY Close
Price
Expiration
Vol.
Last
Vol.
Last
74
70
Mar
230
3 1/2
160
1 1/8
74
70
Apr
170
6
127
1 7/8
74
70
Jul
139
8 5/8
43
3 3/8
74
70
Oct
60
9 7/8
11
3 1/8
RWJR
Solution to Example
a. Are the call options in the money? What is the intrinsic value of an
RWJR Corp. call option?
b. Are the put options in the money? What is the intrinsic value of an
RWJR Corp. put option?
c. Two of the options are clearly mispriced. Which ones? At a
minimum, what should the mispriced options sell for? Explain how
you could profit from the mispricing in each case.