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MOS 1023 Finance Lecture 3
Intro
-Financial principle of risk
-People tend to be risk averse
-Derivatives help investors manage risk
-Derivatives have been around a long time and new ones are being inventing all the time
Derivatives
-Trading indirect claims on securities
-Cost is lower to buy an option than to buy the actual share
-Operating leverage and financing leverage
-Leverage is getting a higher result (return) for the same or less effort (investment)
Options
-Engage in options based on future expectations
-Buyer of the option has the choice seller is obligated to fulfill contract if buyer exercises right
-Seller = writer
Option Terminology
-European options can only be exercised on the expiration date
-American options can be exercised on any day up to the exercise date (most common)
-Bermudan options have specific dates up until the expiration date when the option can be exercised
(causes price fluctuations)
You local grocery store had turkeys on sale, but unfortunately were hold out. The cashier gave you a rain
check that allows you to purchase a turkey any time in the next month at the sales price. What kind of
option might this be an example of?
A) Bermudan option
B) American option
C) European option
D) Thanksgiving option
How Options Work
-Options work by matching up people with opposite expectations about stock prices
-Someone will get disappointed
-Feeling Bullish think stocks will rise in the future
-Feeling Bearish think stocks will fall in the future
-Offset position having options that will be profitable to offset any losses
-Writer has limited profit only value of premium but unlimited risk
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