FNCE10001 Chapter Notes - Chapter 20: Interest Rate Risk, Strike Price, Call Option
25 May 2018
School
Department
Course
Professor
Financial option contract gives owner the right to purchase or sell an asset at a fixed price at some
future date
Call options = gives owner the right to buy the asset
-
Put options = gives owner the right to sell the asset
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Two kinds of option contracts exist:
Option writer = personal who takes other side of contract to owner
Most common option contract is option on shares of stock
Stock option gives holder the option to buy or sell a share of stock on or before a given date for a
given price
Understanding option contracts:
Exercising the option = holder enforces the agreement and buys/sells
Strike/exercise price = price at which holder buys/sells
American options (most common) allow holders to exercise option on any date up to and
including the expiration date
-
European options allow holders to exercise option only on expiration date
-
Two kinds of options:
Option buyer/holder has a long position in the contract; option seller/writer has a short position in
the contract
Short side has obligation to fulfil contract
Investors exercise options only when they stand to gain something
You get paid for selling an option
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> options always have positive prices
Option premium = market price of option
Upfront payment compensates seller for risk of loss when holder exercises option
Interpreting stock option quotations:
Stock options are traded on organised exchanges
Option interest = total no. of outstanding contracts of that option
At
-
the
-
money = when exercise price of option equals current price of stock
Stock option contracts are written on 100 shares of stock
Option prices are quoted on a per
-
share basis
Call options with strike prices below current stock price
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Put options with strike prices above current stock price
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In
-
the
-
money = payoff from exercising option immediately is positive
Out
-
of
-
the
-
money = payoff from exercising option immediately is negative
Deep in/out of the money = strike price and stock price are very far apart
Options on other financial securities:
Stock index put option can be used to offset losses on an investor's portfolio during market
downturn
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Hedging = using an option to reduce risk
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Options allow investors to speculate, place a bet on direction in which they believe market will
move
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Options on stock indexes
Allow investors to bet on or hedge interest rate risk
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Options on Treasury securities
Options on currencies, commodities
Option Basics
Wednesday, 24 May 2017 5:36 PM
Principles of Finance Page 1
Document Summary
Financial option contract gives owner the right to purchase or sell an asset at a fixed price at some future date. Call options = gives owner the right to buy the asset. Put options = gives owner the right to sell the asset. Option writer = personal who takes other side of contract to owner. Most common option contract is option on shares of stock. Stock option gives holder the option to buy or sell a share of stock on or before a given date for a given price. Exercising the option = holder enforces the agreement and buys/sells. Strike/exercise price = price at which holder buys/sells. American options (most common) allow holders to exercise option on any date up to and including the expiration date. European options allow holders to exercise option only on expiration date. Option buyer/holder has a long position in the contract; option seller/writer has a short position in the contract.
