# “ Calls and Puts ” presented by Welcome to. What is an option? Derivative product Contract between two parties Terms of contract Buyers rights Sellers.

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“ Calls and Puts ” presented by Welcome to

What is an option? Derivative product Contract between two parties Terms of contract Buyers rights Sellers obligations Analogy of leasing

Contract Terminology Buyer Seller Expiration month Strike (Exercise) price Option price

Option Values Intrinsic Value –Real immediate, innate value –Amount by which an option is in-the-money –Option with only intrinsic value is at parity Extrinsic Value –Price of option above intrinsic value –Consists of time and volatility

Intrinsic Values vs. Extrinsic Values An option’s price can be broken down into EXTRINSIC value and INTRINSIC value \$8 \$5\$3

Option Values The amount by which an option is in-the-money The innate value of the option Calculation for calls is strike price minus stock price Calculation for puts is strike price minus stock price

Intrinsic Value To determine if there is intrinsic value in an option, determine if there is an immediate benefit in owning (call) the stock or being short the stock (put) at the option’s stock price

Pizzas are selling for \$15. Is there an immediate benefit in owning this coupon? \$10.00 There is \$5 intrinsic value in this coupon

Extrinsic Value The amount of money over and above intrinsic value Mostly composed of time and volatility Value subject to movements of time (theta) and volatility (vega)

Extrinsic Value Any value in the option above intrinsic value is due to time and volatility. Traders are willing to pay for time

Option Value Examples The stock is trading at \$73 May 70 calls trading at \$5.00 – \$3.00 of intrinsic value – \$2.00 of extrinsic value May 80 calls trading at \$1.00 –\$0.00 of intrinsic value –\$1.00 of extrinsic value

Option Value Examples The stock is trading at \$77 May 80 puts trading at \$5.00 – \$3.00 of intrinsic value – \$2.00 of extrinsic value May 70 puts trading at \$1.00 –\$0.00 of intrinsic value –\$1.00 of extrinsic value

Long Instrument −The call gives the buyer the right but not the obligation to purchase a specific security at a specified price by a specified time −The seller of the call is obligated to deliver the stock at the predetermined conditions of the contract Calls

–Buyers of calls have Unlimited potential reward Limited potential loss –Sellers of calls have Limited potential reward Unlimited potential risk Risks and Rewards

Call Example Buy 20 SLB May 40 calls for \$3.00 –Buy = which side of the trade you are on –20 = volume: amount of contracts –SLB = stock symbol –May = expiration month –40 = strike price; expiration price –\$ 3.00 = price per share per contract

Profit and Loss Breakeven –Strike price plus call price Maximum profit –Stock price above breakeven Maximum loss –Total price of call

In-The-Money Calls Any call whose strike price is lower than the stock price Immediate gratification –A call that has immediate value Stock price – strike price is positive number

Out-of-The-Money Calls Any call whose strike price is higher than the stock price Immediate gratification –A call that has no immediate value Stock price – strike price is negative number

At-The-Money Calls Any call whose strike price is equal to or closest to the stock price –ATM calls may be a little ITM or OTM Immediate gratification –ATM calls may provide immediate value Stock price – strike price equals zero or close to zero in either direction

Long Calls at Expiration In-the-money –You exercise your calls and receive long stock at the price of the strike Out-of-the-money –Expire worthless At-the-money –There are no ATM options at expiration

Short Calls at Expiration In-the-money –Your calls will be assigned to you and must sell stock at the price of the strike Out-of-the-money –Expire worthless and you collect your premium At-the-money –There are no ATM options at expiration

Short Instrument −The put gives the buyer the right but not the obligation to sell a specific security at a specified price by a specified time −The seller of the put is obligated to take delivery the stock at the predetermined conditions of the contract Puts

Buyers of puts have Unlimited potential reward Limited potential loss Sellers of puts have Limited potential reward Unlimited potential risk Risks and Rewards

Put Example Buy 20 SLB May 40 puts for \$3.00 –Buy = which side of the trade you are on –20 = volume: amount of contracts –SLB = stock symbol –May = expiration month –40 = strike price; expiration price –\$ 3.00 = price per share per contract

Profit and Loss Breakeven –Strike price minus put price Maximum profit –Stock price below breakeven Maximum loss –Total price of put

In-The-Money Puts Any put whose strike price is higher than the stock price Immediate gratification –A put that has immediate value Stock price – strike price is negative number

Out-of-The-Money Puts Any put whose strike price is lower than the stock price Immediate gratification –A put that has no immediate value Stock price – strike price is positive number

At-The-Money Puts Any put whose strike price is equal to or closest to the stock price –ATM puts may be a little ITM or OTM Immediate gratification –ATM puts may provide immediate value Stock price – strike price equals zero or close to zero in either direction

Long Puts at Expiration In-the-money –You exercise your puts and sell stock at the price of the strike Out-of-the-money –Expire worthless At-the-money –There are no ATM options at expiration

Short Puts at Expiration In-the-money –Your puts will be assigned to you and must purchase stock at the price of the strike Out-of-the-money –Expire worthless and you collect your premium At-the-money –There are no ATM options at expiration

This concludes “Calls and Puts” For more information on options and how to use them properly, check into our classes here at Ion Options, LLC

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