Contemporary Investments: Chapter 15 Chapter 15 FUNDAMENTALS OF OPTIONS What are the basic characteristics of option contracts? What is the value of option at expiration? What are some common option trading strategies? How are options valued? What other securities resemble options?

Contemporary Investments: Chapter 15 The basic characteristics of option contracts Option trading –The positions and obligations –The workings of option markets –Option price quotations

Contemporary Investments: Chapter 15 Figure 15.1 – Option Price Quotes from the Wall Street Journal

Contemporary Investments: Chapter 15 Options on other securities Index options Foreign currency options Long-term options

Contemporary Investments: Chapter 15 Figure 15.2 – Price Quotes for Index Options

Contemporary Investments: Chapter 15 Option value at expiration Valuing calls and puts at expiration –Call option value at expiration –Put option value at expiration

Contemporary Investments: Chapter 15 Calculating the profit and loss from an option Buying a call option Writing a call option Buying a put option Writing a put option

Contemporary Investments: Chapter 15 Figure 15.3 – Profit (Loss) from Buying or Writing a 25 October GE Call Option at Expiration

Contemporary Investments: Chapter 15 Figure 15.4 – Profit (Loss) from Buying or Writing a 25 October GE Put Option at Expiration

Contemporary Investments: Chapter 15 Common option trading strategies –Some unique risks and opportunities of options –Strategies involving just one option contract –Straddles –Spreads Money spreads Why trade spreads?

Contemporary Investments: Chapter 15 Figure 15.5 – Holding Period Return from GE Common Stock and a 25 GE Call Option

Contemporary Investments: Chapter 15 Combining option and stock options Writing covered calls Protective puts Covered short sales

Contemporary Investments: Chapter 15 Figure 15.6 – Holding Period Returns from GE 22.5 and 25 October Call Options

Contemporary Investments: Chapter 15 Figure 15.7 – Profit or Loss from Long Straddle (Buying) and Reverse Straddle (Writing)

Contemporary Investments: Chapter 15 Figure 15.8 – Profit or Loss from a Bull Spread or Bear Spread

Contemporary Investments: Chapter 15 Pricing options Determinants of option values –Price of the underlying stock –Exercise price –Time until expiration –Volatility of the underlying stock –Level of interest rates –Dividends

Contemporary Investments: Chapter 15 Black-Scholes Option Pricing Model Black-Scholes pricing model for European calls. Loose interpretation of the Black-Scholes model. Determinants of the fundamental value of an option. Applying the Black-Scholes formula Arbitrage strategy using the Black- Scholes model.

Contemporary Investments: Chapter 15 Other securities that resemble options Convertible securities –Valuing a convertible security. –Why buy convertibles? Warrants

Contemporary Investments: Chapter 15 Figure 15.9 – Valuing a Convertible Bond