1. Chapter 20 Understanding Options Principles of Corporate Finance
Seventh Edition
Richard A. Brealey
Stewart C. Myers
Chapter 20
Understanding Options
Slides by
Matthew Will
McGraw Hill/Irwin
Copyright © 2003 by The McGraw-Hill Companies, Inc. All rights reserved

2. Topics Covered Calls, Puts and Shares Financial Alchemy with Options
What Determines Option Value
Option Valuation

3. Option Terminology Call Option
Right to buy an asset at a specified exercise price on or before the exercise date.
Put Option
Right to sell an asset at a specified exercise price on or before the exercise date. 4

4. Option Obligations 5

5. Option Value
The value of an option at expiration is a function of the stock price and the exercise price. 6

6. 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 $55 7

7. Option Value Call option value (graphic) given a $55 exercise price.
$20
Share Price 8

8. Option Value Put option value (graphic) given a $55 exercise price.
50 55
Share Price 9

9. Option Value
Call option payoff (to seller) given a $55 exercise price.
Call option $ payoff 55
Share Price 10

10. Option Value Put option payoff (to seller) given a $55 exercise price.
Share Price 11

11. Option Value Protective Put - Long stock and long put Long Stock
Position Value
Share Price 12

12. Option Value Protective Put - Long stock and long put Position Value
Share Price 13

13. Option Value Protective Put - Long stock and long put Long Stock
Position Value
Long Put
Share Price 14

14. Option Value Protective Put - Long stock and long put Protective Put
Position Value
Share Price 15

15. Option Value Straddle - Long call and long put
- Strategy for profiting from high volatility
Long call
Position Value
Share Price 16

16. Option Value Straddle - Long call and long put
- Strategy for profiting from high volatility
Long put
Position Value
Share Price 17

17. Option Value Straddle - Long call and long put
- Strategy for profiting from high volatility
Straddle
Position Value
Share Price 18

18. Option Value Straddle - Long call and long put
- Strategy for profiting from high volatility
Straddle
Position Value
Share Price 19

19. Option Value
Stock Price
Upper Limit 20

20. (Stock price - exercise price) or 0
Option Value
Stock Price
Upper Limit
Lower Limit
(Stock price - exercise price) or 0
which ever is higher 21

21. Time Decay Chart
Option Price
Stock Price